Private Equity Fund Accounting - Commitments & Closings

This is the second in a series of posts on private equity fund accounting.

For the first post, click here.

Before a private equity fund is launched, the private equity firm, or general partner (GP), will solicit commitments to invest from potential investors, or limited partners (LPs). These ‘soft commitments’ are not legally binding and do not represent future subscriptions. They do, however, give the GP some indication of how much capital might be raised.

After the decision is made to launch the fund, the private placement memorandum (PPM) is published. This will outline the target fund size and the minimum fund size.

A ‘hard commitment’ is made by investors when they sign the limited partnership agreement, or subscription agreement. This means the LP is legally bound to invest a specified amount of capital in the fund.

The PPM will specify a deadline by which hard commitments must be made. This deadline is the ‘initial closing date’.

The GP can seek to raise additional capital and the PPM will typically specify that there may be subsequent closings up to a given date.

For example, the DesTek Fund PPM states that the fund is seeking to raise $500 million. The target fund size is $500 million but the PPM states that the minimum fund size is $400 million; if the GP gets hard commitments of $400 million, the fund will launch successfully.

The PPM also states the minimum commitment per LP and usually states the minimum investment to be made by the GP, usually as a % of total commitments.

The initial closing for this fund was 31st December 2013. So investors must have legally committed to investing in the fund by that date. They will not have paid in any cash by that date, but their commitment to do so in the future has been established.

So, as at 31st December, the initial closing date, let’s say 5 LPs have promised to make capital payments to the fund of $80 million each as and when requested to do so by the GP. And the GP has committed to invest $5 million.

Here, then, is the status immediately after the initial closing:

Are there any accounting implications so far? Not really. The LPs receive confirmation of the commitment amounts but, as cash has not yet moved, we have not posted any accounting entries at this point.

What happens next? There will be capital calls (draw-downs) and there will be a subsequent closing. That’s when things get interesting. 

Click here for the next post, Drawdowns (Capital Calls).