Fund formation is the period before a fund launches, when a private equity firm goes through the steps necessary to create and initialise the limited partnership structure that will serve as the private equity fund. Once the structure is formed (at the end of the formation stage), the PE firm will become the fund’s General Partner and the investors will become the fund’s Limited Partners.
The formation stage can take anywhere from a few years to a decade, depending on the experience level of the fund and a myriad of other factors. For seasoned private equity firms, this is a rolling process meaning that the plans for forming the next fund are in development relatively early on in the previous fund’s life.
The critical events that occur during the formation stage of a PE fund include the following:
1. Strategy development (GP): The PE firm (future General Partner) develops a clear strategy that will guide the management of the fund. For a new fund, this strategy might have been discussed for years before the launch. For more experienced firms - where this might be their seventh or seventeenth fund in the same strategy - it can be a simple refinement of what has worked previously. That said, firms will often refresh their strategy in response to changing market conditions and opportunities.
2. Offering materials (GP): The PE firm produces all of the materials that are legally required to set up the limited partnership structure and comply with all industry laws and regulations, in addition to those prepared for potential investors. These materials detail all necessary information about the fund and will include the following three documents, presented in decreasing level of detail:
A standard private equity PPM will typically include the following sections:
3. Fundraising (GP & LP): This is where the General Partner announces that the fund is launching and issues an initial capital call to investors to commit capital to the fund. This activity can span anywhere from a matter of months (for seasoned firms with existing relationships and a proven track record) to several years (for new firms that are less established).
Since there are numerous investors in a given fund, it is a stage during which communications go back and forth between the General Partner and prospective Limited Partners, with questions being asked and discussions being held over fund documents.
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