Private equity and venture capital — Financing Module 6

Private equity and venture capital have become major sources of capital — globally over $4 trillion AUM. The asset class buys, develops, and exits companies on time horizons of 3-10 years. The fund structure is the same; the strategies are very different.

Fund structure: GP, LP, and carry

Every PE / VC fund has the same structure:

Limited Partners (LPs): the investors. Pension funds, sovereign wealth, family offices, endowments, insurance companies. They commit capital but have no day-to-day control. LPs cap their commitment at a fixed amount — they have 'limited liability'.
General Partner (GP): the fund manager. Makes investment decisions, manages the portfolio, distributes capital. Owns the fund management company. Has 'unlimited liability' (theoretical — in practice the GP entity is itself an LLC).
Fund: the legal vehicle that pools LP commitments. Typically a Cayman LP or Delaware LP for international funds; Mauritius for some Africa-focused funds.

Economics: 2 and 20

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Standard PE/VC compensation:
  Annual management fee:   2% of committed capital (sometimes invested capital)
  Carried interest (carry): 20% of profits above an 8% hurdle

Example: $500m fund, returns 2x net to LPs over 7 years
  Fees over fund life:  $500m × 2% × 7 = $70m
  Profit to LPs (gross): $500m × (2x − 1) = $500m
  Hurdle: $500m × 8% × 7 = $280m... GP gets carry on profits above hurdle
  Profit above hurdle: $220m
  GP carry: $220m × 20% = $44m

  GP total comp: $70m + $44m = $114m on a $500m fund.
  LP net IRR: ~18% after fees.

The 2-and-20 model is famously rich for successful GPs and aligned with LP
returns. Variations: some funds use 1.5-and-15; some use higher hurdles
(10-12%); some catch-up provisions before LPs get any profit.

The compensation model that has made PE/VC general partners extraordinarily wealthy when funds succeed.

VC vs PE buyout — different strategies

Venture capital: backs young, often pre-revenue companies. Takes minority stakes (typically 10-30%). Invests in stages — seed, Series A, B, C — each round at higher valuation. Expects most investments to fail; relies on the 1-in-10 that becomes a 100x. Time horizon: 7-10 years per investment.
PE buyout: acquires established, profitable companies (often via LBO using significant debt). Takes majority or 100% stake. Holds for 3-7 years. Improves the business operationally (cost reduction, growth, professionalisation). Exits via sale to strategic, IPO, or another PE fund. Expects most investments to succeed at moderate returns (2-3x).

The J-curve

PE/VC fund returns follow a J-shape: in early years, investments are made (capital deployed) but no exits yet. Fees are charged. Reported returns are negative for the first 3-5 years of a fund. Then exits start; returns climb. By year 7-10, the fund returns capital plus profits to LPs. A 'good' fund returns 1.5-2.5x net to LPs (15-25% net IRR). A 'great' fund returns 3x+ (30%+ IRR).

The value-creation playbook

PE buyouts create value via four levers: (1) leverage — debt funding lets equity earn higher returns on the same operational improvement; (2) operational improvements — better procurement, lean operations, professionalised management; (3) multiple expansion — selling at higher EBITDA multiple than buying (luck, timing, sector tailwinds, smaller-to-larger M&A); (4) growth — expand market share, geography, product. The best PE firms execute all four; the bad ones rely only on leverage and hope.

African PE/VC landscape

African PE/VC has grown from negligible in 2000 to ~$10bn annual commitments by 2024. Africa-focused funds: Helios, Africa Capital Alliance, AfricInvest, TLcom Capital, Partech Africa, Novastar Ventures. The constraints: smaller deal pipeline at scale, exit liquidity (few IPO routes, M&A markets less developed), currency risk for USD-denominated funds. The opportunities: lower entry valuations, fast-growing markets, less competition than developed markets. Africa-focused funds have generally underperformed developed-market peers on absolute returns but with lower correlation, making them useful portfolio diversifiers for LPs.

Exercise

A Kenyan family business with KES 3bn revenue, KES 500m EBITDA, no debt, is approached by an Africa-focused PE fund offering to buy 60% for KES 3bn. The CEO can stay; the PE fund will take board control and bring 'operational support'. Walk through the considerations.