1. Private Equity Business Model?

A private equity fund pools the money from wealthy investors like high net worth individuals,
Institutional investors, Governments/ Sovereign wealth funds and invest that money into any
asset class (Majorly into Start-up companies, real Estate assets, Infrastructure projects etc.) to
make profits out of that investment.

2. Who does the Investment?

Asset Management Company.

3. Profit to the Asset Management Company?

These Asset Management companies/ Asset Managers Collect Management fee for managing
these investors money. In some cases, they also share the profits with investors (Called as
incentive fees).

4. Private Equity Open ended/closed ended.

Generally, PE fund invests in Start-up companies, real Estate assets, Infrastructure projects etc.
they require a lot of time to generate cashflows, so they need investors who can invest for long
term. So, most of these funds are launched closed ended with a definite period (usually 10years)
until which investors can not withdraw the funds.

5. Timeline of PE Funds?

1st year Launch of the fund, this is also called Vintage year of the fund (In this period
they search for Potential Investors and decides in which country fund will be
registered etc. will be investigated)

1-4th year Investment Period (In this period they Find the best investment opportunities
in diff countries, Negotiating the right valuations to make the investments and
completing the legal formalities to make the investment etc.)

2-8th year Operations of the investment and Increase the valuation (Once the
investment period is over, they concentrate on creating the value to the
company/ Investment by taking active part in the business, they guide the
company to implement best business strategies etc)
7-9th year Exit/sale of investment (After creating value to the company fund house/
manager will Sale investment one after the other in different routes by using
different Exit Strategies, like Issue of IPO, sell to other PE, Sell to strategic
buyer/ Company etc).
10th year Once the investments are sole manager will Liquidate the fund and return the
investor money (Investments are sold, and investment is returned).
 PRIVATE EQUITY LAUNCH
6. Private equity Launch?
a. PE raises money from closed group of people, so they prepare a document called PPM (Private
placement Memorandum) and reach out to the potential investors.
b. If investors are ok with the proposal, Investors will commit amount to the fund.
c. Based on the final list of investors/ which country they are form fund house finalises the
structure of the fund (how to register, where to register etc).
d. Once the fund finalises the structure of the fund they will accept the investors in these funds.
It is called close.

Key Terms in PE:

[Link] Name Details

1 Private Placement This is the document used by the fund houses to reach out to
Memorandum (PPM) the prospective investors with fund details. This is like a
prospectus/Advertising Document which contains details like
Investment objective of the fund, risk involved in the fund,
Expected returns and expenses of the fund etc.
2 Limited Partnership (LP) Most of the PE fund register as Limited partnership where in
Investors are treated as Partners. PE may be registered as LLC
(Limited Liability Company also)
3 Limited Partners (LPS) All the Investors in the Equity fund/Hedge fund which is
registered as LP are called as Limited Partners. They will invest
in the fund.
4 General Partner (GP) GP partner is also a partner of the PE fund who manages the
fund.
5 Limited Partnership This is the legal agreement between all the partners, i.e. GP and
Agreement (LPA) LP which contains all the details like Duration of the fund and
how the management fee is calculated, provisions about
incentive fee, when the FS statements will be sent to investors,
Rights and responsibilities of the partners, terms related to
extension of fund etc.

7. Master Fund?
This is the main fund in a private equity fund where most of the investments are part of. The
master fund is responsible for making all portfolio investments.

8. Feeder fund?
Most of the PE/HF will have more than 2 legal entities Master fund, Feeder fund. Generally
offshore funds/ Feeder funds are registered outside the main country to accept international
investors, so that these investors need not pay taxes twice. Feeder fund can be two types onshore
feeder fund (US- Delaware), off shore feeder fund (other tax Heavens).
 Note: These Offshore/On shore feeder funds will invest into master funds which later invests in
targeted investment projects.

9. Blocker?
It is a separate legal entity like a partnership or company registered in in PE/HF mainly to block
the tax liability of the main fund/any other fund.
Ex: If master fund directly invests into India, it may have to pay 35% tax on profits in India, if that
investment is made by a maritus company, it may have to pay low/nil tax in India. Then master
fund will invest in Maritus Company (Blocker), that company will invest in India.

10. Close?
a. If a fund finalises the commitments of the investors and no of investors in a fund, it is
considered as the fund held as close. At this level fund is closed for new investors or list of
investors is finalised.
b. If the fund needs more money they can have 2nd close, final close etc to accept new investors
or to take more commitments from old investors.
c. Generally, fund must close all its close within commitment period (generally 1Year).

11. Vintage Year?

This is the first year of private equity fund in which it is launched.

INVESTOR CASH FLOW

12. Investor cashflows?

a. PE do not collect money from investors at the time of launch of fund, as it takes more
time to find investment opportunities, they only take commitment from investors.
b. Whenever they find the investment opportunities they will call the money through
notice (capital call notice), collects money and invests it.
c. If any investors defaults in paying money within due date (Generally within 15days)
interest will be charged, if default continues GP will find alternative arrangements, like
transferring stake to other investor or asking more money from other investor.
d. similar way when the fund has money by selling the investment, they will distribute that
money to investor.

Key terms:

1. Commitment This is the maximum amount an investor is ready to invest in a

fund throughout its life time.
(Generally, commitment includes management fee, other
expenses if any in that fund)
2. Capital call Whenever a PE fund during the lifetime of the fund needs money
to invest or to pay expense, they will call the money from each
 investor. They will issue a capital call notice to each investor
separately. Capital call will be in proportion to their
commitment.
3. Contribution If an investor remits money to the fund after a capital call notice
is issued, it is the contribution made by the investor to that fund.
Each contribution will reduce the future obligation of that
investor to that fund
4. Unfunded Commitment UFC = Commitment – Contribution+ recallable distribution
Maximum fund available to that fund to invest in that year/later.
5. Distribution It means fund making the payments to the investor whenever the
fund has cash. This can happen when an investment is sold or if
the fund received any interest or dividend.
Distribution can be 3 types:
a. Income distribution: Distribution of income like Interest,
dividend, rent etc
b. Capital Distribution: When an asset is sold, fund will
distribute that money to all the investors i.e. capital
distribution.
c. In kind Distribution: if the fund is distributing a
security/asset to the investor in the fund rather than
cash, it is called In kind distribution.
6. Recallable distribution GP is expecting there will be an investment in the future, in such
cases the distributed money can be recalled to make investment,
in such cases they can mention a distribution as recallable
distribution at the time of distributing the money.
7. J Curve Investor in PE fund will have negative cashflows in initial years of
the fund lifetime. After 5years fund will sell the investment and
distribute that money to investor. So, investor will have positive
cashflows. If we present these cashflows pattern in a graph it will
look like J curve.
8. Management fees It is a fee charged by the Fund house/manager. Management fee
is payable by all the investors to the fund house for managing
their money/Investment.
a. Fee must be paid even if the fund is in losses
b. Different type of funds has different fee arrangements,
Generally MF/HF charges fee on NAV basis and PE fund
charges on commitment basis (Mostly).

This is charged for 2 reasons they are

a. To recover the cost incurred like salaries of research
staff, fund managers, rent and other expenses to manage
the fund.
b. Professional charge for managing the investment,
generating the returns.

Each fund will have different way of calculating management fee,

that will be mentioned in LPA. Most common methods are
 1. Commitment bases
2. Cost of investment
3. Market value of investment
4. NAV bases
5. Switch based method

1. Commitment Based:
A. In this method investor has to pay MF from 1st day till
liquidation/ Last day of the fund even he did not
contributed/invested any money towards
investment.
B. Generally, fund raises MF invoice along with capital
call notice till then MF will we recorded as MF
receivable.
2. Cost of Investment/ Invested capital based:
A. In this method investor will pay only for the amount
invested and for the period it is invested.
B. Cost of investment with leveraged buyout/Borrowed
capital: Fee is calculated on total investment made
including borrowed capital.
3. Market value/ Fair value Method: In this method MF will
be calculated based on the market value of investments.
4. NAV based method: Fee is calculated bases on Net assets
value basis (Assets of the fund – Liabilities of the fund).
5. Switch Based method: In this method fee base will be
changed at some point of time in fund lifetime.

Adjustments to Management Fee: Some of the common

adjustments for calculation of management fee are
1. Tier Based fee: If an investor invests more money in the
fund MF will be charged based on the tier
Ex: Upto 100 cr – 2%, 100 to 500cr – 1.75%, Above 500cr
– 1.5%
2. Step down method: In this case fee rates will go down
over a period. This is applicable for fund where the
efforts of the fund manager will reduce over a period.
3. Side letter Arrangements: This means separate
arrangements is there between the fund and some of the
investor in the fund, this will override the LPA terms.
9. Waterfall 1. Generally, in private equity investment profit will be
provisions/Carried shared between the fund manager/GP and LP (80:20)
Interest/Incentive fee/ 2. Profit sharing is allowed, since this motivates the fund
Profit sharing: manager to put more efforts and generate returns for
the investors/Fund.
3. Though investors are ready to share profits, most of the
times they expect some minimum return/Preferred
return on the investment (8% - Hurdle rate), Any profit
beyond that can be shared with the GP/Fund manager.
 4. Based on the negotiations, expectations of both the
parties, they may agree for step by step distribution of
cashflows, that hierarchy of distribution is called
Waterfall provisions.
Common cash flow distribution in waterfall provisions
are:
a. At first, return all the principal amount to the
investor including management fee.
b. Out of balance amount Pay preferred return to the
investor.
c. After paying preferred return catch up amount will
be paid (i.e. 20% of preferred return) to the GP
d. Remaining amount will be shared between GP and LP
in 20:80
There are two types of waterfall provisions:
1. European water fall method (Most common method
explained above)
2. American waterfall method: In this method GP can take
carried interest on deal by deal basis. i.e. whenever an
investment is sold GP can take carried interest on the
value of investment sold.
Key terms:
Carried Interest: This is the amount paid to the GP as a share in
the profits in the PE fund. (Catch up + 20% share).
Hurdle Rate: This is the minimum rate fund manager/GP should
generate profit/ return before he can take carried interest
amount.
Preferred Return: This is the minimum profit amount payable to
investor on their investment in the fund, calculated using hurdle
rate.
Catch Up: this will give preference to the GP to take a portion of
cash before they can share the profits in 20:80 ratio.
Claw back: This provision in LPA will give the right to investor to
pullback any excess amount paid to GP as carried interest.

13. Investments/Investment Strategy?

Common investment strategies followed by the Private equity fund given below:
a. Venture Capital
b. Buy out/ Leveraged Buy out
c. Real Estate
d. Infrastructure
e. Fund of funds
f. Mezzanine
g. PPE – Private investment in public equity
h. Distressed
a. Venture Capital In this strategy fund will invest into private companies/ Start up
companies. Risk is more in this strategy.
If a company receives funds from these companies it is called
series A. If 2nd time receives then it is called series B.
b. Buy out/ Leveraged Buy 1. In this case (Buy out) fund will buy major stake in an
out existing company (20 – 90%)
2. In leveraged by out fund takes major stake in the existing
company form the borrowed capital.
3. In LBO, investor can get huge return and GP can get
higher carried interest.
c. Real Estate 1. In this strategy, the fund will buy real estate properties
like office park, start hotels, shopping malls etc. The fund
will get rental income plus appreciation in value of asset.
2. To manage these properties, they appoint some
professional/ Consulting companies like asset manager,
property manager.
3. Generally, there will be many adjustments in fund
accounting related to each strategy, in real estate
strategy a common adjustment is rent free adjustment/
Rent straight lining.
4. REIT/Exit Route: In this method PE fund sells the
commercial RE property to the public through REIT (Real
Estate Investment Trust). These REIT can issue
Units/Shares in public. Any investor purchasing
shares/units in trust will get a portion of ownership in
that property. Like companies pay dividends, these REITs
pay dividend out of rental income.
d. Infrastructure In this strategy fund will invest into infrastructure assets like,
High ways, Airports, Sea ports, telecom towers, broad band, gas
line etc.
Like REIT, exit route used here in INVIT (Infrastructure investment
Structure).
e. Fund of funds In this method one PE fund will invest into another PE fund. Main
advantage of this fund is they can find best opportunities across
the world.
f. Mezzanine In this case funds will invest into hybrid securities like convertible
debentures where they can get the safety of the debt instrument
and growth of the Equity instruments.
g. PPE – Private investment in In this case fund will invest into equity shares of listed company.
public equity Generally, fund will buy shares from the public, delist the shares,
improve valuations of the company, comeback to stock exchange
and sell the shares at very high price.
h. Distressed In this case, fund will invest into distressed asset/ distressed
company/ distressed fund. The idea is to buy these troubled
companies or assets at lower valuations and sell at better
valuations.
 14. Valuation of Investments, Level1, Level2, Level3?
All the sources used by the fund to value an investment are grouped into 3 categories, they are:
Level 1 The source used for valuation of investment is active market value of company (Like
Market price in stock exchange)
Level 2 The source used for valuation is the price of similar asset in the active market
Level 3 The source used for valuation is Based on different assumption made by the fund
(forecast of Future earnings capacity of fund, DCF method etc.)

Financial Reporting
15. Accounting Entry flow in Fund Accounting

Date Description Entry Comments

Q1 Entries (Jan to March)
01.01.2021 Fund received No Entry As the amount is
commitments of Rs. committed but not
2000cr received
31.03.2021 Management payable Management fee exp A/c dr Due entry for MF
(Q1 end) 2% To MF payable A/C
-Do- Various expenses of the Audit fee A/c dr Accrued expenses
fund payable Coustodian fee A/c dr booked at Q1 end
Fund admin A/c dr
Proff fee A/c dr
Tax consultant fee A/c dr
To AF payable
To CF payable
To FA payable
To PF payable
To TC fee payable
Q2 Entries (April to May)
01.05.2021 Call the money from Capital contribution recivable A/c Dr
(Q2 Start) investor along with MF To capital A/c

Bank A/c dr
To cap cont received

MF accrued paid now

MF Payable A/c Dr
To Bank A/c
01.05.2021 Investment made Investments A/c dr
To Bank A/c
31.06.2021 All Expense entries will repeat
31.06.2021 FV of investment is 620, Investment A/c dr 20 Investment value
cost is 600 To unrealised gain/loss A/c 20 appreciated
31.06.2021 Cap contribution of 840 Bank A/c dr
received includes To cap con received
expenses
 Investment A/c dr
To Bank A/c
Q3 Entries (July to Sep)
30.09.2021 Fv of investment is Unrealised gain/loss A/c dr 70 Investment valued at
1350, cos is 1400 To Investment A/c 70 FV
30.09.2021 All expense entry will repeat
Q4 Entries (Oct to Dec)
01.10.2021 Assets Sold for 1500cr Investment A/c dr 50 First close unrealsed
To unrealised gain A/c 50 gain/loss by
increasing or
Bank A/c dr 1500 decreasing the
To Investment A/c 1400 investment value
To realised Gain/Loss 100 and then record sale
entry
31.12.2021 Fund expenses paid by Legal expenses A/c dr
GP, now billed to fund To payable to Affiliates
25cr
Payable to Affilates A/c dr
To Bank A/c
-Do- Godrej fund 2 paid proff Proff fee A/c dr
fee on behalf of this To payable to Affliates
fund
-Do- Audit fee Payable is 5Cr, Audit fee payable A/c dr
TDS/WHT deducted is To bank A/c
0.5cr, expense already To TDS Payable
accrued
TDS payable A/c dr
To Bank A/c
31.12.2021 Dividend receivable Dividend Receivable A/c dr
(On Ex To Bank A/c
date)
Bank A/c dr
To Dividend Receivable
If Asset is purchased in Investment A/c dr
FC @ 75/$, now $ is To Unrealised gain/loss on FC
@80 Transaction

16. Private equity FS will be shared by?

PE fund prepares FS on a regular basis (Generally quarterly, As decided by the LPA) for each fund
and send these FS to
a. Each Investor
b. Regulator (As Applicable)
c. For Tax authorities (If needed)
 17. Components/ Sections in FS of Fund Accounting?

1. Statement of Assets and Assets: Investment at fair value, cash and cash equivalents,
Liabilities (SOA) Interest and dividend receivables., capital contribution
receivable.
Liabilities: Management fee payable, capital distribution payable,
accrued expenses and other liabilities, Partners capital.
2. Schedule of investments Total Investments made by the fund house in various companies
(SOI) are shown in proportion of partners capital and shown at cost
and fair value (This fair value is decided based on Level1, 2, 3
valuation).
3. Statement of Operations This is like a profit and loss account of the fund. Major heads
(SOO) under this are
Investment Income: Interest, dividend income, other income
Expenses: Management fee, professional fee, due diligence cost,
broken deal cost, interest expense.
Realized and unrealised gain/loss from investment and foreign
currency.
4. Statement of changes to Any changes in the partners’ capital during the current period will
partners’ capital (SOC) be shown in this.
Partners capital at the beginning of the year + any contributions
made during the year – capital distributions + Allocation of Net
income +/- carried interest.
5. Statement of Cashflows Changes in the cashflows during the period will reported in this
statement. This is like a normal cashflow statement.
6. Notes to Accounts This contains summary of significant policies used by the fund
house, fair value measurement done etc.

Along with these each investor will also get following data

A. Capital Statement of each investor

B. Market outlook report explaining if the investment values are expected to
increase/decrease, market conditions in that country etc to give insights to the investor
about the fund and its investments.

18. General Steps involved in preparation of FS?

a. Fund Amin team – Posting of journal entries (Bank payments, receipts, adjustment
entries like Fee accruals, Investment valuations), preparation of TB and preparation of
monthly/Quarterly FS. This will be sent to the fund house to Review.
b. One the fund house is ok with TB, they will approve the TB.
c. Once TB is approved, Fund admin prepares allocations, Allocation of each income and
expense to each investor, this will help to prepare capital statement of each investor.
Allocations are also sent for review.
d. Once approved, Allocations will be used to prepare capital statement of each investor.
e. Prepare BS and full set of financials, capital statement of partners and sent for review.
f. After approval and audit, they will be sent to investor.
 19. Allocations?
a. Once a TB is prepared and approved, the numbers or Profit/Loss of the fund is finalised.
The fund should allocate profit or loss to each investor to prepare a capital statement,
for this they prepare a file called allocations.
b. Generally, allocations will in proportion to the ownership of each investor, however
there are certain exceptions in the fund, so each partner allocation shall be finalised
before preparing the capital statement, some of the exceptions are discussed below.
Fee free Investor Some partners like GP, employee of the house will not pay
management fee in that fund, so these investors need to
be excluded while calculating the MF and carried interest.
Discounted Investor In some cases, fund will give discount in MF to some
investors like investors who committed more money,
allocations should be done separately for this type of
investor.
Partner transfer If GP agrees to transfer an investor share to another
existing investor or new investor, allocations should be
done differently for this type investors.
Like some of the provisions agreed in LPA, may or may not
applicable to new/existing investor to whom share is
transferred.
Side letter It means an arrangement fund has with some of the
arrangements investor to reduce the fee rate. For such investor fee must
be charged separately for that period where side letter is
effective.
Change in investor If a fund is giving 100% discount in fee to an employee of
Status the company, if the employee leaves the company he
should pay 100% after termination is finalised (In future).

20. Other Key Terms:

1. Broken Deal Cost Before making an investment, fund will conduct research and incur
some expenses like Travelling cost, lawyer fees etc to negotiate a
deal, they may decide not to invest in that deal due to higher
valuations or other reasons, these costs are called as broken deal
cost, accounted as expense in Statement of operations in fund
books
2. Due Diligence cost The process of due diligence is to conduct detailed research on a
company business including finding out any court cases pending on
promoters/company, any risk of failure of business due to
technological changes etc, any cost incurred for this purpose are
called due diligence cost and charged as expense in SOO in fund
books.
3. Financial Highlight In the Asset management industry any fund (PE, HF, MF) has to
disclose certain financial highlights of the fund, so that investors
can understand some important financial information. Some of
them are
 a. Return generated by that fund (IRR)0
b. Expense ratio (Total expense in the fund as a % of
NAV/commitment)
By using these, investors can compare different funds and take a
decision for investment
4. Equalization a. Generally, a PE fund will have more than 1 close which
means they will accept new investor in addition to the old
investor.
b. By that time old investors would have contributed some
amount to the fund, so they expect some return on their
money, since they have contributed in advance.
c. To address these differences equalization process is used.
d. In this process, to bring all the capital contributions equal
to the their commitment/ownership, the fund will collect
extra money from the new investor and pays it to the old
investor along with some interest (Generally 8% or
LIBOR+4%).
5. Rebalancing Rebalancing is done if there is no cash contributions made by the
investor to allocate. Fund will allocate existing expenses (MF
payable) between the old partner and new partner in new
ownership ratio.
6. Open Ended Scheme In open ended funds, Investors can enter/exit the fund anytime.
There is no restriction to the investor in minimum time to be
invested.
7. Closed Ended Scheme In closed ended fund investor can only enter into the fund at the
time of launch of the fund and exit from the fund only at the time
of liquidation of the fund. Transfers can be made to another
investors if the fund allows.
8. Interval fund Scheme These funds are like closed ended fund, where investors money is
locked for most part of the year, however in intervals like 10days in
a year or 10days in each half year, they will keep fund as open in
such interval’s investors can redeem the investments.
9. Investor Types a. Retail Investor – They are like retired employees,
employees or students who have less knowledge on
markets and who invests less money and take less risk
b. High net worth individuals– If an investor has $1mn net
assets, such investors are called HNI.
c. Institutional Investors- These are institutions registered
with regulators like SEBI to invest/deal with financial
products.
d. Sovereign wealth funds- These are funds owned by the
governments
10. Alternative Asset/ There are different types of asset classes which are majorly
Alternative Investment grouped into two:
a. Traditional assets – Equity shares, Debentures/Bonds,
Bank Deposits etc.
 b. Alternative Asset/Investment – Equity funds, Hedge
funds, Real Estate, Gold, Arts, Yachts, Wine, Paintings etc.
11. Asset under Total Assets managed by a company is called Asset under
management (AUM) management.
12. Asset under custodian Generally, as per regulation fund house should keep the assets of
(AUC) the fund in the custody of external entity. Custodian will get fee for
this. AUC means total assets under custody of a custodian.
13. Asset under Assets under administration (AUA) is a measure of the
administration total assets for which a financial institution
provides administrative services and charges a fee for doing so.
14. Net Asset Value (NAV) NAV = Assets of the fund – Liabilities of the fund.
NAV/unit = NAV of the Fund/ No. of units in the fund.
Here Assets= Investment, cash and receivables etc.
Liabilities= Bank loan, Accrued expenses, MF payable