Private Funds: Legal Guide to Structure, Documents, and Terms

Concept

A private fund is not a separate legal form but a legal architecture consisting of four elements: fund vehicle (the legal wrapper in which capital is pooled and assets are held), investment manager (the manager who makes investment decisions), investors (LPs or shareholders who sign commitments), and service providers (administrator, custodian, auditor). The relationships between elements are formalized through a set of contracts: LPA or articles, PPM, subscription agreement, side letter, IMA, service agreements.

This article is a legal guide to how a private fund is structured: which legal forms are used for the vehicle, which licenses the manager needs, which documents formalize the contract between parties, how income is distributed in the waterfall, and which typical economic terms are enshrined in the LPA. Many related concepts are covered in separate articles: Capital calls, Side letter, Singapore VCC, Section 13O / 13U, Secondary shares, Fund of funds.

🍓 The legal architecture of a fund revolves around two axes: (1) separation of powers between GP / manager and LP, formalized through the LPA; (2) asset isolation through the choice of vehicle form and jurisdiction. Everything else—economics, taxes, reporting—follows from these decisions.

Legal Architecture

In a classic LP structure, a fund is not a single legal entity but a set:

In corporate vehicles (VCC, Cayman Exempted Company, ICAV), the GP role is performed by the board of directors; LP roles are taken by shareholders. The manager remains a separate licensed entity. This is a structural alternative to the classic LP model, increasingly used for family offices and regulated fund managers.

Jurisdictions for Fund Vehicle

The choice of jurisdiction for the vehicle is determined by the composition of investors, target markets, tax neutrality, and regulatory regime.

The choice is fixed in the LPA and determines the applicable law for all fund documents.

Regulatory Regime for Manager

Manager-level licenses are a separate category from vehicle regulation. Without a license, the manager cannot market the fund to institutional LPs and accept assets.

Fund Documents

The contract between parties is formalized through a set of documents. Each has its own purpose and legal force:

Most-Favoured-Nation (MFN) clause

In side letter. GP's obligation to provide LP with the best terms granted to any other LP of the same or smaller class. Standard for institutional LPs. Implemented through annual disclosure procedure: GP collects all side letters and offers each LP with MFN right to select the best provisions.

Key man provision

In LPA. Condition under which the departure of certain senior partners from the manager gives LPs the right to suspend the investment period or early termination of the fund. Standard mechanism to protect against loss of key team. Triggers: death, incapacity, departure from manager, breach of fiduciary duties.

Fund Models

By legal mechanics of capital collection and return, funds are divided into several models. Each is enshrined in the LPA through its own formulation of subscription, redemption, and distribution.

Capital call mechanics in detail—in separate article Capital calls.

Income Distribution: Waterfall

Distribution waterfall is the legal sequence of distributing exit revenue between LP and GP, prescribed in the LPA. This is the main mechanism for aligning interests: GP receives carry only after return of capital and hurdle to investors.

Standard PE waterfall—four levels:

Two waterfall application regimes:

European waterfall (whole-of-fund)

Waterfall is applied at the level of the entire fund. GP receives carry only after return of ALL called capital and hurdle to all LPs. Safer for LPs, slower for GP. Standard for European PE.

American waterfall (deal-by-deal)

Waterfall is applied to each deal separately. GP receives carry from each successful exit immediately. Faster for GP, riskier for LPs—requires clawback mechanics. Standard for US PE and VC.

Clawback

GP's obligation to return excess carry if, at the end of the fund, LPs did not receive minimum aggregate return. Secured by escrow (part of carry is held by administrator until end of fund) or personal guarantees of GP partners. Especially important in American waterfall.

Hurdle rate (preferred return)

Minimum annual return to LPs before GP receives carry. Can be hard (carry only on above-hurdle profit) or soft (after exceeding hurdle, carry is calculated on all profit through catch-up). Typical values—6–10% per annum.

Capital: Commitment and Drawdown

In a closed-end fund, capital is not contributed immediately. LP signs commitment—a legal obligation to fund the fund at GP's request during the investment period (typically 3–5 years).

More details: Capital calls.

Typical Economic Terms

Standard LPA parameters by strategy:

GP commitment

Obligation of manager partners to invest their own capital in the fund on par with LPs. Standard 1–5% of fund size. Enshrined in LPA as a separate class of interests with LP rights. Reduces conflict of interest.

Management fee offset

Transaction and monitoring fees received by GP from portfolio companies are credited against management fee. Modern market standard—80–100% offset, enshrined in LPA. Without offset—conflict of interest.

Carry distribution

Within GP, carry is distributed according to carry plan with vesting (typically 4–6 years) for senior and junior partners. Separate contractual layer within manager-entity, not part of LPA. Team retention tool.

Tax Transparency

The legal form of the vehicle determines the tax regime:

Pass-through (partnership)

Limited Partnership (Cayman, Delaware, UK, Luxembourg SCSp, HK LPF)—tax transparent. Fund does not pay tax at vehicle level. Each LP reports their share of income in their jurisdiction of residence.

Standard for PE / VC / private credit. Compatible with FATCA, CRS, AIFMD reporting.

Corporate (with preferential regime)

VCC under 13O / 13U, Cayman Exempted Company, Ireland ICAV—corporate, but with tax exemption or near-zero rate. Fund is formally taxed, but actual rate is close to zero.

Applied for family office, regulated investment vehicles, retail-distributed funds.

🍓 Manager is usually taxed separately: management fee—income of manager-entity, carry—separate class of interests in fund. Taxation depends on residence of GP partners: long-term capital gains in USA, capital gains in UK from 2025, 0% in UAE and Singapore with appropriate tax residence.

Types of Funds by Strategy

Legal architecture is the same, but LPA details and regulatory regime depend on strategy:

Q/A

What is the legal difference between closed-end and open-end fund

Closed-end—LPA fixes commitment without right of early exit, drawdown by GP requirement, distributions only after exits, finite life of 7–12 years. Open-end—LPA provides for periodic subscriptions and redemption at NAV under lock-up / gates / side pockets conditions, without fixed term. The difference is not in strategy but in fund vehicle mechanics.

Why is a separate GP needed in LP structure

GP bears unlimited liability for fund obligations. This is a requirement of the Limited Partnership Act in most jurisdictions. To isolate partners from this liability, GP is made a separate corporation (LLC / Ltd) with limited liability. Manager partners are shareholders of GP-entity, not LP structure directly. In corporate vehicles (VCC, Cayman Exempted Company), this trick is not needed—there is limited liability of shareholders by default.

What is the difference between GP and Investment Manager

GP—legal managing partner of vehicle with unlimited liability. Investment Manager—operational entity with team, acting under IMA on behalf of fund vehicle. In practice, both entities are controlled by the same partners, but legally separated: GP enters into contracts, manager performs investment functions. Manager receives management fee, GP receives carry. Separation is needed for regulatory, tax, and liability reasons.

What is a side letter and why is it needed

Individual contract of LP with fund, supplementing standard LPA. Used for large LPs (anchor investors, sovereign wealth funds, pension funds) to whom GP provides special terms: fee discount, MFN clause, expanded information rights, co-investment rights, excused / opt-out provisions, regulatory carve-outs (ERISA, UCITS, Volcker Rule). Signed separately from subscription. More details: Side letter.

What is MFN clause

Most-Favoured-Nation provision in side letter—GP's obligation to provide this LP with the best terms granted to any other LP of the same or smaller class. Protects large LPs from situation where later investors receive better terms. Implemented through annual disclosure procedure: GP collects all side letters and offers each LP with MFN right to select provisions for application. Standard for institutional LPs.

What is the difference between European and American waterfall

European (whole-of-fund)—waterfall is applied at the level of the entire fund; GP receives carry only after return of ALL called capital and hurdle to all LPs. Safer for LPs, standard for European PE. American (deal-by-deal)—waterfall is applied to each deal separately; GP receives carry from each successful exit immediately. Faster for GP, requires clawback mechanics to protect LPs. Standard for US PE and VC.

What is clawback and how does it work

GP's obligation to return excess carry if, at the end of the fund, LPs did not receive minimum aggregate return. Arises in American waterfall: GP could receive carry from early successful deals, and later deals turned out to be unprofitable, and cumulative fund return is below hurdle. Secured by escrow (part of carry is held by administrator until end of fund) or personal guarantees of GP partners. Prescribed in LPA as a separate Section.

What is key man provision

Condition in LPA under which the departure of one or more key senior partners of manager gives LPs the right to suspend investment period, remove GP without cause, or early termination of fund. Standard mechanism to protect against loss of key team on which LPs signed commitment. Triggers usually: death, incapacity, departure from manager on full-time, breach of fiduciary duties. After trigger, LPs vote on consequences (60–75% majority).

What manager licenses are needed to manage a fund

Depends on manager's jurisdiction and LPs. USA—SEC RIA (from AUM > $110M) or ERA for venture funds. EU—AIFM (full-scope or sub-threshold). UK—FCA AIFM. Singapore—VCFM or RFMC. Hong Kong—SFC Type 9. Switzerland—FinIA. UAE—DFSA / ADGM Category 3C. Without license, manager cannot market fund and accept assets. Marketing to LPs in another jurisdiction often requires cross-border passport or local registration.

Which jurisdiction is preferable for a new fund

Depends on LP composition and strategy. Cayman—institutional standard globally, tax neutrality, simple setup. Delaware LP—for US-domiciled funds with US LPs. Luxembourg SCSp or RAIF—for EU-investor pool with AIFMD passport. Singapore VCC—for Asia-focused funds and family office with 13O / 13U tax regimes. HK LPF—for Asia-focused PE / VC with Chinese capital. Ireland ICAV—for regulated UCITS structures and retail funds.

Is a private fund tax transparent

In LP structure (Cayman, Delaware, UK LP)—yes, tax transparent (pass-through). Fund does not pay tax at vehicle level; each LP reports share of income in their jurisdiction of residence. In corporate vehicles (VCC under 13O / 13U, Cayman Exempted Company, Ireland ICAV)—formally corporate, but with tax exemption, actually close to zero. Manager—separate taxpayer with ordinary regime of their jurisdiction. Carry of GP partners is taxed according to rules of their personal residence.

Related Topics

• Capital calls—capital call mechanics in LP fund
• Side letter—individual LP terms and MFN
• SPV—corporate vehicle for one-off deals and projects
• Singapore VCC—corporate form for umbrella fund
• Section 13O and 13U—tax regimes for Singapore funds
• Private fund Singapore—structuring private fund in Singapore
• Secondary shares—transactions on secondary market of LP interests
• Fund of funds—portfolio of other funds
• Satellite strategy—fund's place in international architecture
• Source of funds—KYC package for LP onboarding

FAQ

Why is a separate GP needed in LP structure

GP bears unlimited liability for fund obligations. This is a requirement of the Limited Partnership Act in most jurisdictions. To isolate partners from this liability, GP is made a separate corporation (LLC / Ltd) with limited liability. Manager partners are shareholders of GP-entity, not LP structure directly. In corporate vehicles (VCC, Cayman Exempted Company), this trick is not needed—there is limited liability of shareholders by default.

What is a side letter and why is it needed

Individual contract of LP with fund, supplementing standard LPA. Used for large LPs (anchor investors, sovereign wealth funds, pension funds) to whom GP provides special terms: fee discount, MFN clause, expanded information rights, co-investment rights, excused / opt-out provisions, regulatory carve-outs (ERISA, UCITS, Volcker Rule). Signed separately from subscription. More details: Side letter.

What is MFN clause

Most-Favoured-Nation provision in side letter—GP's obligation to provide this LP with the best terms granted to any other LP of the same or smaller class. Protects large LPs from situation where later investors receive better terms. Implemented through annual disclosure procedure: GP collects all side letters and offers each LP with MFN right to select provisions for application. Standard for institutional LPs.

What is clawback and how does it work

GP's obligation to return excess carry if, at the end of the fund, LPs did not receive minimum aggregate return. Arises in American waterfall: GP could receive carry from early successful deals, and later deals turned out to be unprofitable, and cumulative fund return is below hurdle. Secured by escrow (part of carry is held by administrator until end of fund) or personal guarantees of GP partners. Prescribed in LPA as a separate Section.

What is key man provision

Condition in LPA under which the departure of one or more key senior partners of manager gives LPs the right to suspend investment period, remove GP without cause, or early termination of fund. Standard mechanism to protect against loss of key team on which LPs signed commitment. Triggers usually: death, incapacity, departure from manager on full-time, breach of fiduciary duties. After trigger, LPs vote on consequences (60–75% majority).

What manager licenses are needed to manage a fund

Depends on manager's jurisdiction and LPs. USA—SEC RIA (from AUM > $110M) or ERA for venture funds. EU—AIFM (full-scope or sub-threshold). UK—FCA AIFM. Singapore—VCFM or RFMC. Hong Kong—SFC Type 9. Switzerland—FinIA. UAE—DFSA / ADGM Category 3C. Without license, manager cannot market fund and accept assets. Marketing to LPs in another jurisdiction often requires cross-border passport or local registration.

Which jurisdiction is preferable for a new fund

Depends on LP composition and strategy. Cayman—institutional standard globally, tax neutrality, simple setup. Delaware LP—for US-domiciled funds with US LPs. Luxembourg SCSp or RAIF—for EU-investor pool with AIFMD passport. Singapore VCC—for Asia-focused funds and family office with 13O / 13U tax regimes. HK LPF—for Asia-focused PE / VC with Chinese capital. Ireland ICAV—for regulated UCITS structures and retail funds.