Private equity is an investment modality aimed primarily at medium-sized businesses that already present strong revenue and a great growth potential.
Understanding private equity concepts is critical for prospective investors who want to maximize the potential of their investment portfolio. Learn more about the meanings of the terms limited partnership (LP) and general partnership (GP) within this context.
In Private Equity, an investment management firm acquires a portion of another company and becomes their partner, actively participating in the administration of the company they purchased in order for it to be valued and its shares to become profitable.
This type of investment is also typically made prior to a growing company’s entrance on the stock market so that its shares can then be traded on a larger scale.
So private equity is an investment strategy aimed at promising companies that have already been making significant gains but are not yet publicly traded so its shares cannot be purchased on the stock exchange.
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When a private equity firm is established, the institutional investors utilize their resources to purchase a stake in the company.
The fund’s investors are then designated as the Limited Partners (LP), and the private equity firm is designated as the General Partner (GP).
Limited Partners (LP)
They are then the institutional external investors who commit a percentage of their capital fundings to the private equity fund during the pre-established duration of the partnership agreement.
Its responsibilities are mostly limited to capital commitment obligations and do not include direct participation in the active management of the companies’ operations.
Each of the funds is liquidated, selling all of its business within a predefined time frame. Once a certain target amount is reached, the investment fund becomes then closed to new investors.
Practical examples of LP types are: wealthy individuals, endowments, pension funds, foundations and institutions.
General Partners (GP)
They consist of the private equity firm itself. Unlike LPs, they usually manage and administer companies in practice.
Some general partners manage the business in full on a daily basis. They have greater legal administrative liability in this regard.
Within the agreement, the GP is also in charge of making the main decisions on the practical management of companies and the portfolio of private equity funds, analyzing investment opportunities and managing the funds so that they meet the objectives of investors.
These companies generate their own revenue through fees charged for their service. LPs are required to pay them an administration fee which generally consists of about 2% of the committed capital in the fund in order to invest with a private equity firm.
So, both types of business partners will have a Limited Partnership Agreement and therefore will build their investment portfolios within it based on the parameters they have established together but taking action in distinctive spheres within the investment assets.
Private equity is regarded as a high-risk investment due to its reliance on the performance of companies following capital injections from investment funds.
However, because it deals directly along with more established businesses that provide significant cash flow from the start, investors in this configuration are able to conduct a more in-depth analysis before investing, which allows for a more accurate assessment of risks.