The common feature of all private equity investments is their organizational form and fee structure. Private equity firms are organized as partnerships with general partners running the show and limited partners providing the capital. The limited partners are typically pension funds or other institutional investors. The limited partners agree to commit a certain amount of capital, and the general partners draw down this amount as they invest in enterprises. The drawdown period typically takes several years, so the investors must keep the capital in liquid form in the meantime. Capital is typically committed for 10 years with limited extensions at the discretion of the general partners.

Fees generally take two forms, a management fee levied on the committed capital and an incentive fee (termed carried interest or carry) based on performance. A typical fee structure involves a 2 percent management fee and a 20 percent incentive fee. The 2 percent management fee is levied on the committed capital from the beginning of the fund regardless of how much has been drawn down. So if there is a $100 million fund with capital committed for 10 years, then the total management fee will be $20 million over the 10-year period ($2 million per year).2 The incentive fee kicks in after the limited partners have recovered their committed capital. Note that the management fee is very different from a mutual fund fee. The latter is always calculated ...

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