Fund terms and economics

A limited partnership agreement (LPA) is the governing contract of a private fund organised as a limited partnership, setting out its purpose, term, capital commitments, economics, governance and the rights and obligations of the general partner and the limited partners.

A side letter is a separate agreement between a fund or its general partner and one LP that adds to or varies the limited partnership agreement's terms for that investor, for example on fees, reporting, regulatory accommodations or co-investment rights.

A management fee is the periodic fee a private fund pays its manager for operating the fund, usually a percentage of LP commitments during the investment period and of invested capital or NAV after it.

Two and twenty is shorthand for a manager fee structure of a 2% annual management fee plus 20% of profits as carried interest or a performance fee, the reference point for private equity, venture and hedge fund fees.

Carried interest (carry) is the share of a private fund's profits allocated to the general partner, commonly 20%, after LPs have received back their contributed capital and any preferred return required by the waterfall.

A preferred return (pref) is the annual rate of return, commonly 8%, that LPs must receive on their contributed capital through the distribution waterfall before the general partner shares in profits as carried interest.

A hurdle rate is the minimum rate of return an investment or fund must achieve before a performance-based payment starts; in private funds, the threshold, commonly 8% a year, that LP capital must earn before carried interest is paid.

A GP catch-up is the waterfall tier after the preferred return in which the general partner receives all or most distributions until its cumulative share equals its carry percentage of all profits distributed so far.

A distribution waterfall is the order, set in a fund's limited partnership agreement, in which investment proceeds are divided between LPs and the general partner: typically return of capital, preferred return, GP catch-up, then a carried-interest split.

A European (whole-fund) waterfall is a distribution waterfall that pays carried interest only after LPs have received back all capital contributed to the fund plus the preferred return, measured across the whole fund rather than deal by deal.

An American (deal-by-deal) waterfall is a distribution waterfall that pays carried interest on each investment as it is realised, once LPs have recovered the capital for that deal and, depending on the fund agreement, related costs and realised losses.

A GP clawback is the general partner's obligation to return carried interest it has received in excess of what the fund's cumulative results entitle it to, usually tested at the end of the fund's life and sometimes at interim dates.

The GP commitment is the capital that a fund's general partner and its principals commit to their own fund alongside LPs, putting the managers' own money at risk in the same investments.

A capital commitment is an investor's contractual obligation, made in a fund's subscription agreement and limited partnership agreement, to contribute up to a stated amount of money when the general partner calls it over the life of the fund.

A capital call is the general partner's formal demand, issued under the limited partnership agreement, that limited partners pay a specified portion of their unfunded commitments to the fund by a stated date.

An unfunded commitment is the portion of an investor's capital commitment to a fund that has not yet been called and that the general partner may still draw under the limited partnership agreement.

Distributions are payments of cash, or transfers of securities in kind, from a fund to its partners out of investment proceeds or income, allocated between limited partners and the general partner according to the fund's distribution waterfall.

A fund's vintage year is the year used to group it with comparable funds for benchmarking and portfolio planning, usually the year of its first capital call or of its first legally binding close; conventions differ.

The fund term is the contractual life of a closed-end fund, set in its limited partnership agreement, after which the fund must be wound up unless it is extended under the agreement's extension provisions.

The investment period is the phase of a closed-end fund's life, set in its limited partnership agreement, in which the general partner may call capital for new investments; afterwards calls are limited to follow-ons, committed deals, fees and expenses.

A limited partner advisory committee (LPAC) is a small committee of LP representatives, formed under a fund's partnership agreement, that the general partner consults on conflicts of interest and other matters the agreement reserves for its review or consent.

A key person clause is a limited partnership agreement provision that names individuals the fund depends on and, if they leave or stop devoting the required time, triggers protections such as suspending new investment until LPs decide how to proceed.

A no-fault divorce clause is a fund agreement provision letting a specified supermajority of LPs remove the general partner, end the investment period or dissolve the fund without proving misconduct, usually on terms compensating the GP for lost future economics.

A most favored nation (MFN) clause is a fund term, usually in a side letter, letting an LP elect more favourable terms granted to other LPs, typically only those of LPs with equal or smaller commitments and subject to carve-outs.