Private Equity Fund Structure: GPs, LPs, Carried Interest

Introduction

A private equity fund looks simple from the outside. A firm raises capital from investors, buys companies, runs them for a few years, sells them, and returns the proceeds. The reality is considerably more structured. PE funds are tightly engineered legal vehicles built to align the interests of the people putting up the money (the Limited Partners, or LPs) with the people running the fund (the General Partner, or GP), and the mechanics that make that alignment work, including capital calls, the management fee, the carried-interest waterfall, and the performance metrics, are central to how anyone in or around private equity actually thinks about the asset class.

This guide walks through how PE funds are structured end to end. The GP-LP relationship and what each side actually does, how capital flows in and out across a 10-year fund life, the 2 and 20 fee model and how it has compressed in recent years, the difference between European and American waterfalls, what DPI, RVPI, TVPI, and IRR actually measure, and the structural elements that determine whether a fund manager keeps their job (key-person clauses, GP commitment, LPAC oversight). Whether you are interviewing for a private equity role, evaluating funds as an LP, or just trying to understand how the asset class actually works, the mechanics in this guide are what you need.

Private Equity Fund

A pooled investment vehicle, typically structured as a Delaware limited partnership, in which a General Partner manages capital contributed by Limited Partners to acquire equity ownership in private companies. PE funds usually have a 10-year contractual life, divided into a 5-year investment period (when new deals are made) and a 5-year harvest period (when portfolio companies are exited). Returns to LPs are generated through portfolio-company sales, dividend recapitalizations, and IPOs.

A private equity fund is a limited partnership, which is a specific legal structure with two roles. The General Partner has unlimited liability for the fund's obligations and full management control. The Limited Partners have liability capped at their committed capital and no day-to-day control over investment decisions. In a typical PE fund, the General Partner is an entity affiliated with the PE firm itself (Blackstone, KKR, Apollo, etc.), and the Limited Partners are large institutional investors plus, increasingly, high-net-worth individuals.

The GP runs the fund. That includes sourcing deals, leading diligence, negotiating purchase agreements, working with portfolio-company management during the holding period, executing exits, and reporting performance to LPs throughout. The deal team you see at a PE firm (associates, vice presidents, principals, partners) all work for entities affiliated with the GP. They earn the carry described later in this guide and most of the operating economics of the firm.

The LPs put up the capital. The largest LPs are public pension funds (CalPERS, CalSTRS, Texas Teachers, the Canadian pension boards), sovereign wealth funds (GIC, Mubadala, ADIA), insurance companies, university endowments (Yale, Harvard, Stanford), corporate pension plans, family offices, and increasingly fund-of-funds vehicles aggregating smaller commitments. LPs typically allocate 5 to 15% of their total portfolio to private equity, choosing GPs based on track record, strategy fit, and team continuity. They have very limited input on individual investment decisions and rely on the GP's judgment, which is exactly why fund alignment mechanics matter so much.

When LPs commit to a fund, they sign a subscription agreement for a specific dollar amount (the "commitment"). They do not wire that money on day one. Instead, the GP "calls" the capital in tranches over the investment period, typically the first 5 years of the fund's life, as deals are signed. A typical first capital call might happen 6 to 12 months after final close and fund a portion of an early deal plus management fees and partnership expenses.

Capital calls usually arrive with 10 to 15 business days notice, and LPs are contractually obligated to fund them. The penalty for failing to fund a capital call is severe: the LP's existing fund interest can be diluted heavily, sold to other LPs at a discount, or in extreme cases forfeited entirely. Default is rare among institutional LPs precisely because the consequences are catastrophic, but it does happen, especially during periods of market stress when LPs face a "denominator effect" (their public-market portfolios drop in value, mechanically increasing their PE allocation as a percentage of total assets).

Capital Call

A formal request from a private equity General Partner to its Limited Partners to fund a portion of their committed capital, typically used to finance a new acquisition or pay management fees and expenses. Capital calls usually require the LP to wire funds within 10 to 15 business days. Failure to meet a capital call constitutes default and can result in dilution or forfeiture of the LP's fund interest.

Distributions flow back the other direction. When the fund sells a portfolio company, refinances it through a dividend recapitalization, or otherwise generates cash, the GP distributes the proceeds to LPs. Distributions can be in cash (most common) or in kind (typically stock received in an exit transaction such as an IPO). The order of distribution payments is governed by the waterfall, which is one of the most important structural elements of the fund and is covered in detail later in this guide.

The cycle of commitments, calls, and distributions repeats across multiple funds. A successful PE firm raises Fund I, Fund II, Fund III and so on, with new funds typically opening for fundraising 4 to 5 years after the prior fund's first close. LPs rolling over from one fund to the next are called re-up investors, and a high re-up rate is one of the strongest signals of LP confidence in a GP.

PE funds compensate the GP through two mechanisms. The management fee is an annual cash payment used to cover the GP's operating costs (salaries, office rent, travel, due-diligence expenses). The carried interest (or "carry") is a profit share that pays the GP a portion of fund gains when LPs are made whole and a hurdle is cleared. The combination is historically described as 2 and 20: a 2% annual management fee plus 20% carried interest.

Both numbers have moved. According to CNBC reporting on Bain's 2026 Global Private Equity Report, private equity firms that raised buyout funds in 2025 charged an average management fee of 1.61%, well below the legacy 2% level. The compression is driven by two forces: a tougher fundraising environment that pushed managers to offer fee discounts to win commitments, and the rising prevalence of mega-funds (over $5 billion) where economies of scale let GPs charge less in percentage terms while still earning the same dollar economics. Smaller and middle-market funds still charge closer to 2%; mega-funds increasingly charge 1.25 to 1.5%.

Management fees are usually charged on committed capital during the investment period and invested capital thereafter. The "step-down" reflects the reduced workload of running existing portfolio companies versus actively sourcing new deals. A typical fee schedule looks like:

Carried interest is the more interesting half of GP economics. The standard structure is 20% of fund profits above the LPs' contributed capital, subject to a preferred return (or "hurdle rate") that LPs receive first. The most common preferred return is 8% annualized, sometimes called the "8% pref" in industry jargon. Below the hurdle, all profits go to LPs. Above the hurdle, the GP receives carry on the upside.

Carried Interest

The General Partner's share of fund profits, typically 20% of gains above the LPs' contributed capital and a preferred return. Carry is the primary economic incentive for the PE firm and aligns GP compensation with fund performance. In the United States, carried interest receives long-term capital gains tax treatment (currently 20%) when the underlying assets are held more than three years, a tax treatment that has been the subject of recurring legislative debate.

The waterfall is the contractual order in which fund cash flows are distributed between LPs and the GP. Two main structures dominate the market: the European (whole-of-fund) waterfall and the American (deal-by-deal) waterfall. The choice of structure has material consequences for when the GP earns carry and how much LP protection exists against early-deal underperformance.

European Waterfall (Whole-of-Fund)

In a European waterfall, the GP receives no carry until all LP capital has been returned plus the preferred return on that capital. Only then does the catch-up tier kick in (which gives the GP enough carry to "catch up" to the standard 80/20 split on profits earned to date), followed by the residual 80/20 sharing on additional gains.

A simple worked example: an LP commits $100 million to a fund with a European waterfall, an 8% preferred return, a 100% catch-up, and 20% carry. The fund returns $200 million in gross proceeds. The waterfall flows in order:

1. Return of capital: First $100 million to LP

2. Preferred return: Next $8 million (or whatever 8% compounded works out to over the holding period) to LP

3. Catch-up: Next tranche of profits to GP until GP has received 20% of all profits paid to date (the "catch-up tier")

4. Residual: All further profits split 80% LP, 20% GP

The European waterfall is LP-friendly because it ensures LPs are made whole before the GP earns any carry. ILPA and the largest institutional LPs strongly prefer European waterfalls, and most newer first-time funds are pushed toward European structures during fundraising.

American Waterfall (Deal-by-Deal)

In an American waterfall, the GP earns carry on each individual deal as it exits, without waiting for the full fund to be returned. The hurdle and catch-up still apply, but they are calculated on a deal-specific basis. This means the GP can earn meaningful carry early in a fund's life from successful exits, even if later deals lose money.

To protect LPs against this, American waterfalls include a GP clawback provision. At the end of the fund's life, if the GP has been paid more carry than it would have earned under a European waterfall on the fund as a whole, the GP must return the excess. Clawback enforcement is administratively complex and depends on the GP having the cash on hand (or escrow reserves) to actually pay back what is owed, which is a meaningful risk if the GP has already distributed those amounts to its individual employees.

European waterfalls have become the market norm for new institutional funds. American waterfalls survive primarily in venture capital, where deal-by-deal carry helps attract talented partners early in a firm's life cycle, and in some emerging-markets PE strategies.

LPs evaluate PE fund performance through a small set of standard metrics. Each measures a different dimension of returns, and understanding them in combination is essential for interviewing in private equity, evaluating fund managers, and reading LP reports.

DPI (Distributions to Paid-In, sometimes called "cash on cash") is the most concrete metric: how much of the LP's actual contributed capital has come back as cash. A DPI of 1.0x means the LP has received exactly their contributed capital back in distributions; DPI of 2.5x means they have received 2.5 times what they put in. DPI matters enormously because realized cash beats paper gains, especially in late-cycle environments where unrealized portfolio company values may not survive the next exit.

RVPI (Residual Value to Paid-In) measures the value of the fund's remaining unrealized holdings as a multiple of LP-contributed capital. TVPI is the sum of DPI and RVPI: the total value the fund has produced, both realized and unrealized. The convention is that DPI is harder to fake (it's literal cash received) while RVPI depends on the GP's mark-to-market judgment, so LPs increasingly weight DPI more heavily, especially when GPs are actively raising the next fund.

IRR is the annualized return that accounts for the time value of money. A 2x return achieved in 4 years has a much higher IRR than a 2x return achieved in 8 years, even though the MOIC is identical. PE funds typically target net IRRs of 15 to 20% to LPs after fees and carry, with strong vintages in favorable markets exceeding 25%. MOIC (sometimes called "multiple on invested capital") is the simpler version of TVPI calculated on invested capital rather than paid-in capital. For more on the IRR-MOIC trade-off and how PE deal teams think about return metrics, see the LBO modeling guide and walk me through an LBO answer.

A standard PE fund has a 10-year contractual life, with two extension years available at the GP's discretion. The fund life splits into two distinct phases.

The vintage year of a fund (the year of its first investment, sometimes the year of final close) is one of the most important predictive variables in PE returns. Vintages that deploy into market troughs (2002, 2009, 2020) tend to outperform; vintages that deploy at peak valuations (2007, 2021) tend to underperform. LPs accept that vintage timing is partly luck, which is why they "vintage diversify" by committing to one or more funds every year rather than concentrating in a single vintage.

The fund I, II, III, IV progression is how successful PE firms grow. A first-time fund (Fund I) is typically smaller ($200 million to $1 billion), carries higher LP scrutiny on terms, and depends heavily on the founders' track record from prior employers. Successful Fund I performance lets the firm raise a larger Fund II 4 to 5 years later, and the cycle continues. Megafirms like Blackstone, KKR, and Apollo are now on Fund VII or beyond and raise $20 to $30 billion flagship funds. The largest PE firms have evolved from single-strategy buyout shops into multi-strategy alternative-asset platforms managing infrastructure, credit, real estate, and growth-equity funds in parallel, but the underlying GP-LP fund structure described here applies to each of those product lines.

For more on the broader asset-class ecosystem, see growth equity vs private equity vs venture capital and exit strategies in PE.

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Beyond the GP-LP relationship, the fee model, and the waterfall, PE funds include several structural protections that govern how the relationship actually functions over a 10-year life.

GP Commitment

The GP itself usually commits 1 to 5% of fund size as its own capital, paid alongside LP capital and treated identically in the waterfall mechanics. This is sometimes called "GP skin in the game" and is a key alignment mechanism. The largest LPs increasingly require GP commitments of 5% or more on first-time funds; established mega-funds with longer track records can sometimes negotiate down to 1 to 2%. GP commitment is funded partly out of management-fee economics and partly out of partner capital from senior firm professionals.

Key-Person Provisions

A key-person clause suspends the GP's ability to make new investments if a specific senior partner (or a defined group) leaves the firm or stops devoting time to the fund. The fund effectively goes into a "no new investments" mode until the issue is resolved, typically through replacement of the key person with someone acceptable to a vote of LPs. Key-person clauses are essential because LPs are betting on specific people, not just on a firm name. The high-profile departures from major PE firms in recent years have repeatedly triggered key-person debates with LPs.

LPAC and Side Letters

The Limited Partner Advisory Committee (LPAC) is a standing body of typically 5 to 10 LPs (the largest commitments) that meets quarterly to review conflict-of-interest situations, valuation policies, and major fund decisions that fall outside the GP's standard authority. The LPAC does not approve individual deals but does opine on transactions where the GP has a conflict (e.g., cross-fund transactions, GP-led secondaries). Side letters are bilateral agreements between the GP and individual LPs that grant specific LPs additional rights (most-favored-nation provisions, fee discounts, transparency rights, ESG carve-outs). The largest LPs negotiate extensive side letters; smaller LPs typically take the standard fund terms.

LPA, Subscription Agreement, PPM

The contractual architecture of a PE fund consists of three main documents. The Limited Partnership Agreement (LPA) is the master document governing the fund's economics, governance, and rights of all parties. The subscription agreement is the LP-specific document binding each LP to its commitment. The private placement memorandum (PPM) is the marketing document used during fundraising, summarizing the strategy, team, track record, and proposed fund terms. The Institutional Limited Partners Association (ILPA) Principles and the ILPA Model LPA are widely used reference standards that help benchmark fund terms during negotiation.

Fund-structure mechanics come up constantly in PE associate interviews. The most common candidate mistakes:

Confusing carry hurdle with the IRR target. The 8% preferred return is the hurdle that LPs must receive before the GP earns carry. The fund-level IRR target (typically 15 to 20% net) is the GP's aspiration. Confusing the two suggests the candidate has not internalized how the waterfall actually flows.

Forgetting the catch-up tier. Many candidates explain the waterfall as "8% to LPs, then 80/20." That is incomplete. After the preferred return is paid, the catch-up tier flows to the GP until the GP has earned its full 20% share of profits paid to date. Only then does the residual 80/20 split kick in. Skipping the catch-up tier is one of the most common technical errors.

Confusing committed capital with invested capital. Management fees are charged on committed capital during the investment period, then step down to invested capital. DPI and TVPI use paid-in capital (which equals invested capital plus fees and expenses paid). MOIC uses invested capital. These are subtly different and PE associate interviewers will probe.

Not understanding the difference between European and American waterfalls. This is asked in nearly every PE structure interview. The candidate needs to be able to explain both, articulate why European is more LP-friendly, and explain how clawback works in American structures.

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For a deeper PE interview framework that ties fund mechanics to deal evaluation, see the private equity case study framework and what makes a good LBO candidate.

Private equity fund structure is engineered around a small set of mechanics that align GP and LP incentives over a 10-year life. The points to remember:

Understanding private equity fund structure is foundational for working in or around the asset class. Whether you are an analyst preparing for a PE associate interview, an institutional investor evaluating fund commitments, or simply trying to understand how the largest pools of private capital actually work, the mechanics walked through above are what every PE professional treats as second nature. The 2 and 20 model is the headline, but the catch-up tier, the waterfall structure, the key-person provisions, and the side-letter negotiations are where the real economics and protection actually live.

The good news is that once you understand the underlying logic (how alignment is engineered between GPs running funds and LPs providing capital over 10 to 12 years), the specific terms become easy to absorb. Each piece exists for a reason, and most of the variations across funds reflect responses to specific historical problems: clawback in American waterfalls came after early waterfalls let GPs walk away with too much carry on losing funds; key-person clauses came after high-profile partner departures; ILPA standardization came after years of negotiating the same terms from scratch in every fund. Treat the structure as a body of accumulated lessons, and the rest follows.