In the landscape of private markets investing, the fund structure as an investment vehicle is a fundamental component that bridges the gap between General Partners (GPs) and investors. It crucially acts as transmission mechanism between sources of risk / return and those eager to access them,  with its own pros and cons that come with it. Let's delve into why the fund structure is pivotal in the private markets investing ecosystem, examining its advantages and potential drawbacks for both GPs and investors.

Why Fund Structures?

For General Partners (GPs)

  1. Capital Access: Different type of funds allow GPs to access various types of investors across different jurisdictions potentially improving the capital raising success. As such, funds can proof to be a versatile and tailorable investment instrument.
  2. Pooling: By pooling resources from multiple investors, funds can amass significant capital. This may enable investments in larger, potentially more lucrative opportunities that might be inaccessible with smaller amounts of capital.
  3. Control: Pooling capital to enable more significant investments may also allow GPs to exercise a higher, more meaningful degree of control over the target company. Such control in the private equity space is paramount to affect real change in the company.
  4. Investor Diversification: Diversifying the capital base through different types of investors can provide stability for the GP. For funds with liquidity features, it reduces the concentration risk that comes along with single or even a handful of large share / unit holders.
  5. Operational Scale & Cost Efficiency: Managing a fund provides GPs the ability to apply their expertise and operational infrastructure across a broad portfolio of investments. This can lead to more efficient management and potentially lower costs per investment.
  6. Track Record: An open ended fund or reoccurring vintages of the same fund allows the GP to establish and maintain an uninterrupted track record. This continuity would be more difficult to achieve through standalone investment deals.

For Investors

  1. Access to Opportunities: Investing in a fund opens doors to private market opportunities that individual investors may find difficult to access on their own due to minimum capital requirements,  lack of direct industry connections or investment knowledge.
  2. Professional Management: Investors benefit from the GPs' expertise in selecting, managing, optimising and exiting investments. This level of direct influence in a portfolio asset’s success is unique to private markets.
  3. Diversification: Through diversification within the fund, investors can mitigate the impact of any single underperforming investment on their overall portfolio. Furthermore, through a portfolio of funds or of Fund-of-Funds (==funds that purchase other funds) an even deeper level of diversification can be achieved.
  4. Security: Investing through a fund may offer additional layers of security depending on the fund type. Regulated funds in recognised jurisdictions operate under stringent requirements on the fund and service providers with ongoing oversight. But even in unregulated environments, investing through funds can be beneficial as the fund entity is separate from the GP and assets are typically custodied and valued by independent service providers.
  5. Tax: To achieve the most optimal (or rather least negative) outcome for its investors from a tax liability perspective, funds generally try to optimise the way portfolio assets are purchased, held and exited downstream. In addition, by investing through certain fund structures investors can avoid having to undertake certain tax filing obligations themselves.

Drawbacks of Fund Structures

Despite these benefits, fund structure also present certain challenges that GPs and investors must navigate.

  • Fees and Expenses: Funds typically include various fees, costs and expenses that are incurred by the fund in the course of its creation and operation. Notably, these include upfront set up costs, ongoing service provider costs and management & incentive fees. These fees reduce investors' net returns and the level thereof can vary significantly between funds.
  • Regulatory Complexity: Funds, especially in jurisdictions like Luxembourg, which is a popular hub for private market funds, must comply with a complex web of regulations. This requires a deep know how in the setup and operating of such funds and may increase the operational burden, set up time and costs for GPs, impacting fund performance and investor returns.
  • Liquidity Constraints: Despite relatively recent regulatory developments that have allowed new fund types to enter the European market with a certain level of liquidity, investments in private markets are generally less liquid than those in public markets. However, investors should be aware that this potential liquidity is generally substantially lower and the risk of prolonged lock-ups (and thus inability to access their capital) is significantly higher than in public markets.
  • Time to Market: Depending on the type and complexity of the fund (especially if it is regulated), the time to launch the fund may be substantial and can regularly take 6-12 months (with 7% of regulated funds launching in >12 months according to the Luxembourg regulator).
  • Blind Pool: While the investor gains an exposure to the GPs investment expertise through their investment, they have no influence on nor live insight into the investment decisions during the life of the fund. Their only, realistically limited, impact is through shareholder / partner meetings.

The Long and Short of It

The fund structure is a critical element in the private markets investing ecosystem, offering a way for GPs and investors to efficiently pool resources, share risks, and capitalise on opportunities that might otherwise be out of reach. Understanding the dynamics of pros and cons of it is essential for both GPs and investors as they navigate private markets, aiming to achieve a balance between the potential rewards and inherent risks of not only investing into it but also in what way to do so.