A pension fund commits $500 million to PE but never expects more than 70% to be invested at once. A SPAC raises $500 million and loses 60% of it to redemptions before the deal closes. Understanding why both outcomes are normal is the core of this material.
Private equity means buying ownership stakes in companies that do not trade on public exchanges. The defining features: active operational control, multi-year holding periods (typically 7-12 years), illiquidity, and return drivers that go beyond stock price appreciation. PE managers improve operations, expand margins, restructure balance sheets, and time exits. You cannot sell your fund interest on an exchange. That illiquidity is why PE investors demand a premium over public equity returns.
The CAIA curriculum divides PE into three sub-strategies: venture capital, growth equity, and buyouts. This lesson covers the fund structure, institutional mechanics, and exit strategies. VC, growth equity, and buyouts each get their own deep dives in later lessons.
The three PE strategies map onto stages of the business life cycle (Launch, Growth, Maturity, Decline). Earlier in the cycle means higher risk and higher potential reward.
Common mistakes
- Confusing committed capital with invested capital. An LP commits $100 million to a fund. That does not mean $100 million is deployed. Capital is called in tranches over the 3-5 year investment period. At any point, actual invested capital may be 60-70% of committed.
- Thinking subscription lines create real alpha. The IRR boost from subscription lines is purely mechanical, shorter LP holding period, same gain. It does not reflect better investment selection or operational improvements. An LP comparing two GPs must strip out subscription line effects to evaluate true investment skill.
- Reversing the IRR and MOIC effects of subscription lines. Subscription lines increase IRR (shorter holding period) but decrease MOIC (interest costs reduce distributions). Candidates frequently flip these. Remember: time goes down (IRR up), dollars go down (MOIC down).
Bottom line
- PE maps to the business life cycle: VC funds launch-stage start-ups, growth equity the growth stage, buyouts target maturity; the strategies overlap on a continuum.
- GP manages, LP funds: the firm runs two LLCs (a GP earning carry, an Investment Advisor earning management fees), commits 1-5% alongside LPs, and performs five functions: pool, screen, finance, monitor, exit.
- Vintage year groups funds by the year capital deployment began, the only valid basis for comparing fund performance.
- LP-GP relationship runs three phases (entry/establish, build/harvest, decline/exit), a separate timeline from any single fund's 10-year lifecycle.
Exam shortcut
When you see "PE allocation increased without new commitments," the answer is denominator effect. When you see two funds with identical investments but different reported IRRs, check for subscription line timing differences. For subscription lines, remember: "Time shrinks, IRR grows; interest costs rise, MOIC drops." For J-curve questions: standard IRR J-curve dips early and recovers around year 4; subscription lines invert it.
The full lesson (about 5,844 words, 39 min read) adds 2 worked examples, all 8 common mistakes, a self-check, free in the app.
Learning objectives
- intro
- firms and funds
- institutional programs
- subscription lines
- lp gp lifecycle
- publicly traded gps
- exit ipos
- exit spacs
- vc overview
- vc stages
- vc risk returns
- vc return research
- vc valuations
- vc financing
- vc securities
- vc dynamics
- growth equity intro
- growth equity valuation
- growth equity deals
- buyouts overview
- buyout strategies
- buyout characteristics
- lbos
- pipes
- liquid alts
- long term performance
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