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

Concept

The structure of a private fund is a legal architecture made of four elements — it is not itself a separate organisational legal form. Capital is raised through a combination of: the fund vehicle (holds the capital and assets), the investment manager (makes the investment decisions), the investors (LPs or shareholders who sign commitments) and the service providers (administrator, custodian, auditor). The relationships between the elements are established through a series of contracts: the LPA or articles, the PPM, the subscription agreement, side letters, the IMA and service agreements.

Investment funds here means LP/GP, capital calls and structural forms. Stiftungen, Panamanian foundations and private foundations used to hold and pass on family assets are a different category of object: their function is to hold and transmit a single family's property, not to pool third-party capital under a mandate — see Private foundations.

The same structural mechanics carry across asset classes — private equity and venture capital, private credit, real estate, secondaries — the differences live in the LPA. Many related concepts have their own articles: Capital calls, Side letter, Singapore VCC, Section 13O / 13U, Secondary shares, Fund of funds, Feeder fund, LPA mechanics.

Two decisions govern everything else: the allocation of power between the GP/manager and the LPs, established through the LPA, and asset segregation, achieved through the choice of vehicle form and jurisdiction. Economic terms, tax and reporting all follow these two decisions.

How the model works on one example

A fictional buyout manager forms a Cayman exempted limited partnership as the fund vehicle, a Cayman LLC as its general partner and a Singapore-licensed company as the investment manager. Three investors commit $100M in total by signing subscription agreements; nothing is paid on signing. Over three years the GP issues drawdown notices and calls the full $100M — $94M goes into portfolio companies, $6M pays management fees and expenses — and until the LPA's distribution clause is triggered the LPs' interests entitle them to no cash at all. When the first company is sold, the LPA rather than the GP's discretion fixes the order in which money leaves the fund: contributed capital back to the LPs, then an 8% preferred return on each contribution from the day it was received, then the GP's catch-up and its 20% carried interest. In the worked schedule below the fund distributes $160M over five years; the LPs end with $148M and the GP with $12M — exactly 20% of the $60M profit — whereas the same commitments under a deal-by-deal waterfall would have paid the GP $6M in 2023 that it might later have to return. Every one of those numbers is set by a document, and each document sits with a different party: the vehicle's LPA, the manager's IMA, the investor's subscription agreement.

Three trade-offs that define the model

Control against liability: the LPs give up any say in investment decisions in exchange for liability capped at their commitment, while the GP carries unlimited liability — which is why the GP is itself a limited-liability company. Alignment against timing: the hurdle and the clawback protect LPs, but the more protective the waterfall (whole-of-fund, escrow, interim clawback tests), the later the GP is paid — so the waterfall type and the catch-up percentage are negotiated together. Neutrality against substance: a tax-transparent offshore vehicle passes income straight through to the LPs, but only while the manager can show licensing and economic substance where decisions are actually taken; the wrapper is cheap, the manager is not.

Legal architecture

In the classic LP structure the fund breaks down into several separate legal entities:

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

Fund vehicle jurisdictions

The choice of vehicle jurisdiction depends on investor composition, target markets, tax neutrality and the regulatory regime. The domiciles are compared side by side in fund domicile jurisdictions; the marketing routes — passport, NPPR, reverse solicitation — in cross-border fund distribution.

The Cayman Private Funds Act imposes a standing regime on a closed-ended fund: the application is filed within 21 days of accepting capital commitments and no capital contributions may be accepted until registration (s. 5); thereafter an annual audit filed within six months of year-end (s. 13), valuation at least annually (s. 16), a custodian for custodial assets and cash-flow monitoring (ss. 17–18).

The choice is fixed in the LPA and determines the governing law of all fund documents.

Manager regulatory regimes

Licensing at the manager level is a category separate from vehicle regulation. Without a licence the manager cannot market the fund to institutional LPs or accept assets. Where the perimeter begins — advice, portfolio management, marketing, reverse solicitation — is mapped in fund regulatory perimeter; the manager domiciles are compared in fund manager jurisdictions.

Fund documents

The contracts between the parties are established through a series of documents. Each has its own purpose and legal force:

Most-Favoured-Nation (MFN) clause

Found in side letters. The GP undertakes to give the LP the best terms granted to any other LP of the same or a lower tier. The institutional LP standard. Implemented through an annual disclosure procedure: the GP collects all side letters and gives each LP with MFN rights the opportunity to elect the best provisions.

Key man provision

Found in the LPA. Gives LPs the right to suspend the investment period or terminate the fund early when specified senior partners leave the manager. The standard protection against losing the key team. Triggers: death, incapacity, departure from the manager, breach of fiduciary duty.

Fund models

By the legal mechanics of raising and returning capital, funds fall into several models. Each is established in the LPA through different subscription, redemption and distribution language.

Capital call mechanics are covered in a separate article: Capital calls.

Distributions: the waterfall

The distribution waterfall is the legal order, set out in the LPA, in which exit proceeds are split between the LPs and the GP. It is the principal alignment mechanism: the GP earns carry only after capital and the hurdle have been returned to investors.

The standard PE waterfall has four tiers:

Two regimes for applying the waterfall:

European waterfall (whole-of-fund)

The waterfall is applied at the level of the whole fund. The GP earns carry only after all called capital and the hurdle have been returned to all LPs. Safer for LPs, slower for the GP. The European PE standard.

American waterfall (deal-by-deal)

The waterfall is applied to each deal separately. The GP earns carry immediately on each successful exit. Faster for the GP, riskier for LPs — a clawback mechanism is required. The US PE and VC standard.

Clawback

The GP's obligation to return excess carry if, at the end of the fund, the LPs have not received the minimum aggregate return. Secured through escrow (part of the carry held back until the end of the fund) or personal guarantees from the GP's partners. Particularly important in the American waterfall.

Hurdle rate (preferred return)

The minimum annual LP return before the GP earns carry. Can be hard (carry only on profit above the hurdle) or soft (once the hurdle is exceeded, carry is calculated on all profit through the catch-up). Typical values — 6–10% per annum.

The waterfall in numbers

The same four tiers with concrete numbers — a European waterfall (whole-of-fund), the most common configuration in private capital. LPA terms: commitments $100M, capital fully called and invested, hurdle 8% per annum compounded annually, carry 20%, catch-up 100%. After five years the fund distributes $160M. All figures in this and the following subsections are a fictional teaching example, not market data.

In this shorthand the $30M preferred return is an input, not a result — the 8% rate alone cannot produce it. Compounded on the full $100M over five full years the hurdle would be $46.93M; the lower figure presupposes that capital was called in tranches, and only a dated drawdown schedule makes it computable. The next subsection discloses exactly such a schedule and recomputes the same fund: the rounded $30M corresponds to a computed $30.72M. Until tiers 1–2 clear at the level of the whole fund, the GP receives nothing — that is precisely what whole-of-fund means. The 100% catch-up brings the GP up to the target 80/20 split: beyond return of capital the LPs have received the hurdle, so the GP is due 30 × 20/80 = $7.5M.

The point of the catch-up lies in exactly this reconciliation: fund profit is $60M ($160M − $100M), the GP's carry = $7.5M + $4.5M = $12M — exactly 20% of total profit; the LPs receive $148M in total (capital plus 80% of profit). Under an American (deal-by-deal) waterfall the same GP would start collecting carry from the first successful exits, without waiting for the whole fund's capital to be returned — which is precisely why clawback and escrow matter so much in that model (see Clawback above).

A reproducible calculation: dated contributions and distributions

The shorthand above hides everything an auditor would ask to see. Below, the same fund is recomputed from a fully disclosed schedule — every number remains fictional and is chosen so the arithmetic is transparent: all cash flows fall on exact anniversaries, so the standard LPA convention "compounded annually and calculated daily" coincides with exact annual compounding. Before the tables, it matters which conventions the model assumes — each row below is a term your LPA sets one way or another.

None of these values is "the" market: rates, compounding frequency and the accrual base all vary between LPAs, and each moves the carry — which is why a waterfall result is only meaningful together with its schedule and conventions.

The fund calls $100M in three drawdowns and distributes twice:

Three different quantities of "capital" now exist, and the hurdle runs on only one of them: committed capital is $100M (the legal obligation in the subscription agreements), called capital is $100M (fully drawn by 2022), invested capital is $94M ($6M went to fees and expenses). The preferred return accrues on called capital — each contribution from its own receipt date — not on commitments and not only on the invested portion.

The bookkeeping reduces to one line: the LPs' capital-plus-hurdle balance compounds at 8% a year, contributions add to it, tier 1–2 distributions reduce it. By 1 Jan 2023 the balance is $117.78M ($100M contributed plus $17.78M of accrued hurdle); the $40M distribution is entirely return of capital and leaves $77.78M; two more years of compounding bring the amount owed at 1 Jan 2025 to $90.72M. The final $120M then clears every tier:

The allocations sum to $60.00M + $30.72M + $7.68M + $21.60M = $120.00M — exactly the cash available, nothing created or lost. Across the fund the LPs receive $148.00M and the GP $12.00M — precisely 20% of the $60M profit, the same totals as the shorthand table; only the split between tiers 2–4 shifts (30.72 / 7.68 / 21.60 against the rounded 30 / 7.5 / 22.5).

Sensitivity: one convention at a time

The same schedule, with one convention changed per row and everything else held — the 1 Jan 2025 distribution of $120M in the main columns, and a thinner $100M final distribution (fund profit $40M) in the last column to show when the convention starts to cost the GP money. All figures fictional, computed to $0.01M.

Two things stand out. With a full catch-up and enough profit to complete it, the preferred-return convention changes the split between tiers but not the GP's total: simple or compounded, the GP still ends with 20% of profit, and the hurdle is a timing device rather than a price. It becomes a price only when the catch-up is partial and returns are thin — at a $100M final distribution the 50/50 catch-up costs the GP $3.36M against the 100% version — or when the hurdle is hard, which on this schedule cuts the GP from $12.00M to $5.86M. That is why the hurdle rate, its compounding and the catch-up percentage are negotiated as one package: a lower catch-up is the LPs' compensation for accepting a soft hurdle. The reference points are documents, not law: the ILPA Model LPA term sheet brackets an [80]% GP / [20]% LP catch-up and a [30]% escrow of carry, and nets taxes paid out of the clawback; ILPA Principles 3.0 call the whole-of-fund model best practice, ask for clawback gross of taxes and repaid within two years, and for the GP commitment to be funded in cash rather than by fee waiver — so whether a given fund's clawback is gross or net of tax is a negotiated term.

A low-return scenario: partial call, hurdle unpaid

Same terms, weaker fund: the GP calls $40M / $30M / $20M in 2020–2022 — $90M of the $100M committed, with $10M never drawn — and distributes $20M on 1 Jan 2023 and $80M on 1 Jan 2025, $100M in total.

The LPs recover the $90M called plus $10M of partial hurdle — $100M back on $90M contributed, about 1.11× — yet remain $21.45M short of the full preferred return, so the GP earns neither catch-up nor carry.

Two discipline checks sit in this scenario. First, the hurdle accrued only on the $90M actually called, from actual receipt dates: a model accruing it on $100M of commitments from 2020 would show $123.60M owed at 2025 instead of the correct $101.45M. Second, no tier-3 or tier-4 cash can appear while the tier-2 balance is positive — carry on top of an unpaid hurdle is an arithmetic impossibility, not a negotiating position.

Early carry and clawback: whole-fund vs deal-by-deal on identical flows

Same drawdowns as the base case ($100M called), different exits. Deal A — cost $40M including its allocated fee drawdowns, funded in 2020 — is sold on 1 Jan 2023 for $70M. Deals B and C — $30M each, funded in 2021 and 2022 — are sold on 1 Jan 2025 for $50M in total. Fund-level profit is only $20M.

Under a deal-by-deal (American) waterfall the 2023 exit runs its own waterfall on Deal A alone: return of the deal's $40.00M (a realised deal's tier 1 also returns its allocated fee and expense contributions; no writedowns existed on that date), $10.39M of deal-level hurdle (8% compounded over three years), a $2.60M catch-up, and an 80/20 split of the $17.01M residual — LP $13.61M, GP $3.40M.

The GP books $6.00M of carry — exactly 20% of the deal's $30M profit — while the fund's other $60M of cost is still at risk; under an ILPA-style 30% escrow, $1.80M of that carry would be held back. In 2025 deals B and C owe the LPs $78.61M of capital plus hurdle and return only $50M: everything goes to the LPs, no carry.

The end-of-fund clawback then recomputes carry on a whole-fund basis: the LPs have received $114.00M against a capital-plus-hurdle entitlement of $126.73M, so fund-level carry is zero and the GP owes back the entire $6.00M — in a real LPA capped at carry net of taxes the GP or its partners actually paid, and funded first from escrow, which is why the escrow percentage and guarantee language decide how much cash actually returns; the enforcement mechanics sit in the LPA.

Under a whole-fund waterfall on identical flows nothing needs recovering: the $70M of 2023 is all return of capital; in 2025, $30M completes the capital and $20M pays part of the hurdle ($5.73M stays unpaid); the GP never touches carry.

On the same cash flows the two regimes converge on paper — but only through the clawback. What differs is timing, the LPs' two-year credit exposure to the GP, and the tax leakage on carry that was distributed and must come back. That is the entire case for escrow, interim clawback tests and guarantees in a deal-by-deal LPA.

Capital: commitments and drawdowns

In closed-end funds capital is not contributed all at once. The LP signs a commitment — a legal obligation to fund the fund on the GP's demand during the investment period (typically 3–5 years).

More detail: Capital calls.

Typical economic terms

Standard LPA parameters by strategy — first the three closed-end corporate and credit lines:

Real estate and hedge funds are compared separately: the former adds asset-level SPVs and a mixed waterfall, the latter runs open-end mechanics with no investment period and no catch-up.

Three further terms sit outside this grid and are negotiated in the same conversation.

GP commitment

The obligation of the manager's partners to invest their own capital in the fund alongside the LPs. The standard is 1–5% of fund size. Established in the LPA as a separate class of interests with LP rights. Reduces conflicts of interest; ILPA Principles 3.0 ask for it to be contributed in cash rather than through management-fee waivers or financing facilities.

Management fee offset

Transaction and monitoring fees the GP receives from portfolio companies are offset against the management fee. The market range is 80–100%, established in the LPA; ILPA Principles 3.0 ask for a 100% offset of all fees charged to portfolio companies. No offset — a conflict of interest.

Carry distribution

Within the GP, carry is allocated under a carry plan between senior and junior partners with vesting (typically 4–6 years). A separate contractual mechanism inside the manager entity, not part of the LPA. A team retention tool.

Tax transparency

The vehicle's legal form determines the tax regime; the three layers — fund, manager, investor — are mapped in fund tax architecture:

Pass-through (partnership)

Limited partnerships (Cayman, Delaware, the UK, Luxembourg SCSp, Hong Kong LPF) are tax transparent. The fund pays no tax at vehicle level. Each LP reports its share of income in its jurisdiction of residence.

The standard for PE/VC/private credit. Compatible with FATCA, CRS and AIFMD reporting.

Corporate (preferential regimes)

The VCC under 13O / 13U, the Cayman Exempted Company, the Ireland ICAV — corporate forms, but with a tax exemption or a near-zero rate. The fund is formally a taxpayer, but the effective rate is close to zero.

Used for family offices, regulated investment vehicles, retail-distribution funds.

Substance and regulatory reporting

The fund's legal wrapper brings two ongoing obligations — demonstrating economic substance in the jurisdiction of registration and disclosing investors under automatic-exchange requirements. This determines where decisions are actually made and how much reporting the structure generates.

In most structures economic substance concentrates at the manager level: qualified staff, expenditure and core income-generating activities (CIGA) must sit where the investment decisions are made. That is why a shell Cayman LP wrapper remains workable when management is outsourced to a licensed, staffed manager entity.

Fund reporting rests on several regimes: FATCA and CRS require investor identification and automatic exchange of data; the EU's beneficial ownership registers and DAC6 add UBO and cross-border arrangement disclosure; CARF extends the same logic to crypto-assets from 2026, with the first exchanges in 2027. The cumulative burden of these obligations is one of the practical considerations when choosing an offshore or onshore vehicle jurisdiction.

Fund types by strategy

The legal architecture is the same, but the details of the LPA and the regulatory regime depend on the strategy:

Fund term and lifecycle

A closed-end fund runs for the term pre-set in the LPA: usually about ten years, extendable by one or two years at the GP's discretion or with LP consent. The term drives the entire economic rhythm — capital is locked in the fund for its duration, and by the final date the GP must return it to investors.

The lifecycle breaks into four stages:

1. Fundraising and closing — gathering commitments and signing the LPA.
2. The investment period (the first ~5 years) — the GP calls capital through capital calls and builds the portfolio.
3. Holding and harvesting — managing assets and exiting.
4. Wind-down — returning capital and the final waterfall distribution.

An extension is usually needed when some assets could not be realised in time.

An LP's exit from the fund before the final date runs primarily through a secondary — selling the interest on the secondary market; closed-end structures have no mechanism for early redemption of a commitment. When the term expires but the assets have not yet matured, GPs increasingly propose a continuation fund: the remaining companies move into a new vehicle, and existing LPs choose between cash-out and rollover.

The legal skeleton of a fund has been stable for years — what moves is the tax and licensing layer: Singapore applies the 13O/13U economic conditions from 1 January 2025 (statutory basis — sections 13D, 13O and 13U of the Income Tax Act 1947, with the schemes running until 31 December 2029), the RFMC regime was abolished on 1 August 2024, and the UK brings carried interest into income tax from 6 April 2026.