The definition of private capital

Private capital is the umbrella term for investment, typically through funds, in assets not available on public markets.

Preqin defines private capital as private investments encompassing the following asset classes: private equity, venture capital, private debt, real estate, infrastructure, and natural resources.

Interests in these assets or groups of assets are typically arranged as limited partnerships with investors referred to as LPs. General Partners, or GPs, act as the investment manager, calling and deploying capital from the LPs.

Private equity

Investment in privately owned companies or buyouts of public companies

Venture capital
Investment in young companies with high growth potential

Real estate
Investment in private real estate properties, either commercial or residential

Infrastructure
Investment in private infrastructure assets, such as toll roads, airports, or utility facilities

Private debt
Debt investments that are not financed by banks and are not issued or traded in an open market

Natural resources
Private investment in natural resources such as oil & gas, timberland, farmland, water, and mines

The various asset classes that now comprise private capital originally emerged as an offshoot of private equity. While private equity as an asset class has a relatively long history, the industry only became mainstream in the past three decades, after a boom in leveraged buyouts in the 1980s. As private equity investments became more prevalent, new categories of private investment also emerged, with a growing number of private equity funds targeting opportunities in real estate, infrastructure, and – most notably since the Global Financial Crisis (GFC) in 2008 – debt. Over time these categories of investment have institutionalized to become independent asset classes.

Compared to public markets, private capital fund managers typically take a more active role in the management of the companies and assets in which they invest. They will often contribute to business strategy and can play a part in directly managing assets. The nature, size, and structure of investments in private capital can vary significantly, but generally funds are seeking to create value or support growth of the companies and assets in which they invest. The intention is to secure strong returns on behalf of their investors over a pre-determined lifetime.

Private capital fund structures

There are various routes to market available for investments in private capital. As in public markets, investors can access private capital asset classes through listed funds available from an exchange, but the most common route is through private unlisted funds. Alternatively, they can invest directly in an asset class. See a brief overview of the fund structures below.

Commingled funds
A commingled fund is when capital from multiple investors is pooled to form a fund that is invested in aggregate.

Fund of funds
A fund of funds is a two-tier commingled fund structure, in which capital from multiple investors is pooled together to form a fund that invests in other private capital funds, as opposed to making direct investments.

Separately managed accounts
A separately managed account is when capital from one investor is managed by one fund manager.

Commingled funds

In this section, we are going to explore the most common fund structure: the 'commingled fund.'

In a commingled fund structure, fund managers raise pools of capital from multiple external investors to form a fund. Fund managers use this pooled capital to invest in companies or assets.

Most private capital funds are structured as closed-end investment vehicles, which have a finite lifespan and typically do not allow redemptions or the entry of additional investors after the initial fundraising period. These vehicles are organized as a limited partnership, with two key parties:

The fund manager, or general partner (GP), whose role is to raise capital from investors, and to source, execute, and manage investments in order to realize returns for the investors in a fund.
The investor, or limited partner (LP), which commits capital to the fund, but has no influence over investment decisions. Types of investor typically include institutions such as pension funds, endowment plans, foundations, and insurance companies, as well as high-net-worth individuals.

The terms of the partnership will be documented in a limited partnership agreement, which outlines the details of investments to be made, any specific requirements from the investor (for example restrictions on the scale or geography of investments), the duration of the fund, and the fees to be awarded to the fund manager. The partnership generally has a 10-year life span, during which investors will not be able to redeem their capital. There are five core stages in the life cycle of the fund:

The fund formation phase is the first stage in the fund life cycle. During this time the fund manager develops the fund’s strategy, determines fund terms, and prepares the offering materials, including the limited partner agreement. Fund managers will incur costs associated with setting up the fund, including legal and other organizational expenses. These expenses will usually be offset by profits the fund generates when the fund closes, but if the fund is unsuccessful in reaching a close, the partners are liable to cover costs. This is therefore an anxious time for most managers, especially for emerging managers (those seeking to raise their first fund).

During this time the fund manager will approach potential investors, answering due diligence questionnaires to try and secure capital commitments for the fund. Once the GP has obtained sufficient interest from investors, it will hold an initial closing for the fund, at which point the GP can start making investments. However, for many funds the fundraising period will continue past the initial close, allowing the fund to generate additional capital commitments for subsequent closings until its overall fundraising target has been met. The time taken to raise a fund can vary from a few months (for established managers) to a few years (for emerging managers). According to Preqin data, time spent on the road for private capital funds is an average of 18 months.

In order to generate returns for investors, GPs must find and complete successful transactions. During the deal-sourcing and investing period, capital from the fund commitments will begin to be deployed into investments. GPs will source and evaluate potential investment opportunities, conduct valuation due diligence and close deals, determining an appropriate level of capital commitment for each opportunity. GPs will not request (call) all the capital from LP commitments in one go, but as needed to fund new investments. During this time the fund will still be in deficit, and so investors must be prepared for losses in the first few years prior to the fund generating cash inflows.

Once the fund manager has made investments they will work to manage and grow the companies or assets within their portfolio. At this point the fund will begin to generate returns for its investors. The types of activities undertaken by a fund manager during this time will vary depending on the type of asset and strategy pursued, but the overall goal will be to support the development and growth of the company or asset in order to secure strong returns for investors and to position it for an eventual sale. The time from an initial investment to exit (when the fund sells its position in the asset) can range from months to years.

The final stage in the life cycle of the fund is the exit or harvest phase. During this time the fund manager begins to sell its positions in the companies or assets in which it has invested. The GP will seek to produce a rate of return that will meet or exceed the expectations of its investors. This liquidation will not happen all at once, but over several years following the end of the investment period. Exit strategies vary by asset class, and this might include a sale to a strategic buyer, sale on the secondary market, or in the case of companies a manager might hold an initial public offering (IPO), issuing shares on the public market.

The diagram below is a simplification of the flow of capital between LPs, GPs, funds, and investments.

Generally speaking an investor is required to pay the GP a management fee of 2% of total capital committed to the fund. Once a fund manager has exited the fund’s investments they will also charge a performance fee of 20% of profits generated, and the remaining 80% of profits are returned to the investors.

In this lesson, we introduced you to the definition of ‘private capital.’ Now you know the asset classes included in this sector, all of which emerged as offshoots of private equity after funds began targeting different types of investment opportunities. We also explored the fund structures seen within private capital, and took a deep-dive into the most common structure: the ‘commingled fund.’

Marketing Communication. This material is provided for informational purposes only and should not be construed as investment advice. Views and opinions expressed in this article are as of October 2024 and are subject to change, and there can be no assurance that developments will transpire as may be forecasted in this article. The reference to specific securities, sectors, or markets within this material does not constitute investment advice, or a recommendation or an offer to buy or to sell any security, or an offer of services.

Past performance is not a guarantee of future results. All investing involves risk, including the risk of loss. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.