In order to be well educated with respect to investments, it’s important to be familiar with certain terms that are used in various contexts related to the structure, composition or analysis of prospective investment opportunities. To help you learn the vocabulary, we’ve compiled a list of basic terms that may be important to investors:
Committed Capital – Committed capital is money that is dedicated by limited partners in a private equity fund. It’s usually not invested right away. Instead, the capital is invested over a period of time as investments are located.
Cumulative Distribution – The cumulative distribution of a private equity fund refers to the total amount of cash and stock that has been paid to date to its limited partners. In considering potential private equity fund investments, it’s important for investors to be aware of the historical timing of the fund’s cumulative distribution.
General Partners – General partners oversee the investments in a private equity fund. In return for their work, they are paid management fees and earn a percentage of profits from the fund. Unlike limited partners, general partners have no limit to their liability for the actions of the fund, including legal liability.
Limited Partners – A limited partner is an investor in a private equity fund. Unlike general partners, limited partners aren’t involved in the management of the fund. Limited partners generally have liability limited to the amount of their ownership share.
Preferred Returns – The general partner usually makes his or her money from management fees or carried interest—the latter being the general partner’s share of the fund’s profits . In comparison, management fees are typically about 2 percent of annual commitments. In addition, private equity funds also have provisions in the compensation agreements known as preferred returns. Preferred returns are the minimal annual return—usually about 8 percent— that limited partners receive before general partners start earning carried interest.
Private Equity – Private equity is capital from individuals and institutions that is used to invest and acquire equity ownership in businesses. Partners at private equity firms raise the capital and use the funds to generate returns for shareholders, usually with an investment horizon of four to seven years.