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It can’t be a coincidence that the same week I launched a series on Private Equity, the biggest PE deal in history was announced, right? Kidding (kind of).

Last week, we got a $55 billion buyout of video game giant EA by a consortium led by the Saudi Public Investment Fund and Silver Lake. This one caught my eye. And not just because I’ve been playing EA video games since before NBA Live 30 years ago…

It’s a monster deal that could kick off another wave of mega-buyouts (the last wave didn’t end too well). And here’s the wild part: assuming a standard 2% management fee, investors are paying roughly $1.1 billion a year just to have their money managed 🤯

Welcome to Part II of our four-week deep dive into The Private Equity CFO. Last week, we explored what any CFO can learn from Private Equity.

This week, we’re stepping to the other side of the table: inside the PE funds themselves. We’ll explore how they’re organized, how they structure deals, why it works, when it works, and why it blows up when it doesn’t.

Quick disclaimer before we dive in: I’ve never worked inside a PE fund, so think of this as a CFO’s view of how the machine runs.

Last week, we said that to understand PE is to understand its math.

So that’s where we’ll spend most of our time today. Next week, we’ll talk about how to make that math come alive outside the spreadsheet.

First, let’s meet the cast of characters:

General Partners (GPs): The folks who run the fund. They raise the capital, hire the team, pick the deals, manage the portfolio, and ultimately make the calls on when to buy, fix, and sell.

Limited Partners (LPs): The investors. pension funds, endowments, sovereign wealth funds, family offices, etc. They provide the money, but they don’t get a say in the day-to-day.

Together, they form a Private Equity fund, a legal partnership, typically ~10 years long, with the GP calling the shots and the LPs supplying the cash. That capital gets deployed into portfolio companies that fit the fund’s investment thesis (more on that later).

Once the capital’s raised, the GPs go to work:

Returns are typically measured in two key ways:

Most funds target a 2–3x MOIC and 15–25% gross (before fees) IRR on their portfolio investments. The ‘gross’ is doing a lot of work here. More on the fee structure in a moment.

But the ultimate measure at a fund level is it’s DPI (Distributed to Paid-In Capital). A DPI of 3 would mean a fund has distributed $3 back to LPs for every $1 of invested. This is important because it focuses on the ultimate realized gains of the fund (ignoring any accounting trickery that can be used to mark investments during the hold period.)

Each fund runs for around a decade: years 0–5 are for deployment, years 5–10 are for harvesting.

And if a GP does a good job in Fund I, they’ll raise Fund II, which is usually bigger. The fundraising machine keeps turning, backed by a track record of exits, DPI and early wins.

PE capital is illiquid by nature, but sophisticated firms often run multiple overlapping funds to smooth cashflows and maintain deal flow.

But if you want to know what drives PE, you’ve got to understand the fee structure and how GPs get paid.

Enter: 2 and 20

2% Management Fee: GPs get paid annually on committed (or sometimes invested) capital. It covers salaries, bonuses, offices, deal sourcing, due diligence costs, travel, dinner at Dorsia, you know, all the overhead. This is what PE funds will tell you ‘keeps the lights on’. Sure… if the lights in question are all the billboards in Times Square. These management fees are also how PE folk get kinda rich.

Note, it’s also not unusual for PE management companies to take a ‘monitoring fee’ from their portfolio companies.

Now, here’s how PE gets super rich…

20% Carried Interest: The kicker. Once the fund returns the original capital plus a preferred return (typically 8%), the GPs take 20% of all profits above that line. There’s often a “catch-up” clause to accelerate the GP’s share once the hurdle’s cleared. This is how PE folk get really stinking rich.

The structure’s been market standard for decades. And while there are variants, they mostly stick close to the 2 & 20 model. It’s also worth noting: carry and management fees typically flow through different entities. The Management Company earns the fees (and spans multiple funds). The General Partner entity is fund-specific and receives the carry.

For juniors in a PE fund, their goal is to climb the ladder to get themselves in the carry pot for the next fund. The circle of life.

Imagine a PE firm raises $1bn of capital and enjoys great success, turning that into $5bn 10 years later. A gross MOIC of 5x and an IRR of 17.5%.

Now let’s show where that money goes. Let’s assume:

Now let’s look at how the $5B gets distributed between the GPs and the LPs. We call this the ‘waterfall of funds’:

Firstly, the $200M management charges get paid. In fact, they already did.

Next up, the LPs get their $1B of capital back.

Next in the stack, the LPs get their 8% return hurdle. 8% of $1B compounded for ten years is $1.159B.

This, in total, is the preference stack amounting to $2.359B. What is left ($2.641B) gets shared in the agreed carried interest share: 80% for LPs and 20% for GPs.

Add that all up, and GPs get $728M of the $5B, and LPs get $4.272B back on their $1B investment. A 4.3x DPI or 15.6% IRR.

And the PE firm has happy investors and some great marketing materials for their next fund.

A couple of technical points:

One of the challenges PE has is that anyone can call themselves Private Equity. And if anyone can… anyone will. And that has led to some commodification of the term. It’s explained well in this post:

But the best firms do generate superior returns. And how do they do it? By being clear about what they are good at, and doing that thing a lot. It’s no different from running any business.

Except in the case of PE, the ‘customers’ are the LPs.

The ‘product’ is the returns they generate.

And the ‘operation’ is the buying, transforming, and selling of companies.

But the best firms have a USP even amongst PE. Their unique approach or focus that makes them different from everyone else.

In PE (and across the investment world), this is pompously referred to as the ‘Fund Thesis.’

Here is a small selection of different fund theses, as an example:

It’s their deep understanding of a narrow niche that gives them the insight to pick the right deals, the talent to transform them, and the partners to exit well.

So now that we understand how a fund works in aggregate, let’s drop down a level into what this means for an individual investment.

Our PE fund has found a deal they like. Here are the numbers for the port co:

Let’s look at two scenarios.

When it goes well

Firstly, what happens if it goes to plan:

When it goes badly

Naturally, these lead to very different outcomes:

The good exit yield a 53.9% gross IRR and the bad exit 3.5%. There’s a lot at stake.

So what do these scenarios mean for the PE fund and the management. Let’s take a look:

Note: The debt has the first call on the proceeds, so we’ll start from the ‘equity outcome.’

The good exit sees everyone get paid. The fund gets its $42m of invested capital back, plus $20M of preferred return, passing their 8% compounding cost of capital onto their portfolio company. This often gets structured using a holding company and preferred equity. And don’t forget 90% of the remaining sweet equity, leaving them with a cool 51% IRR, having turned their $42M into $332M in five years.

And management gets their 10% of sweet equity (i.e. 10% of what is left after the preference stack is paid down), in this case $30M. Of which maybe 10% would be for the CFO, typically 50% to the CEO, and ~40% split amongst the rest of the management team.

But in the bad exit, it’s miserable. Turning $42m into $55M in 8 years makes no one happy. The IRR of 3.5% is not enough to clear the 8% cost of capital hurdle, so all of the value is eaten in the return to the fund. And for management, 8 years of hard work results in nothing.

Of course, it can get worse than a 3.5% IRR. A lot worse. We’ll focus on some of those situations in the final week of this series.

Now, in practice, the PE fund wouldn’t just sit by for 8 years and let this happen. They would certainly replace management (likely more than once). And as they bring new management in, they would need to recapitalize the business and set new thresholds for the sweet equity to make sure the new management is incentivized and is not inheriting the sins of the past.

Secondary deals happen when a PE-backed business is sold to another PE sponsor, usually one whose thesis better fits the business at its current stage. It’s common for the CFO to stay on and roll their equity into the new deal. Done well, this is how CFOs grow their ownership into the upper end of the 1–3% sweet equity range. But beware: the preference stack gets reset. What looks good on paper can unwind in practice if you don’t fully understand the new terms.

Let’s go back to the upside case.

Imagine you are the CFO appointed on day 1 of the deal. Enterprise value of $112m. Your PE operating partners tell you that you have one single brief: get the enterprise value up to $402M within 5 years. And do so on a trajectory that enables an accelerated exit, if needed, while still delivering the fund’s target IRR.

Specifically, that means:

Just like the assumptions in our ‘good exit’ above, you can turn that into a value creation plan (VCP) by quantifying each component of the delta; using simple variance analysis. This helps understand how much of the $290M value creation comes from revenue growth vs margin expansion vs multiple arbitrage.

And then the job of the CFO is to go further and figure out what individual initiatives will deliver that. And who’s job it is to deliver, and by when. Below I’ve expanded this for the revenue growth line as an example:

See how everything is anchored back to value creation.

You can see how this becomes your north star for the next 4 years. It becomes the key assumptions in your long-range plan and the anchor for every dashboard you build. It should permeate through everything in your financial cycle.

Just like we said last week, work back from the exit. And then figure out how to bend the business to make it obey the numbers.

The ability to do this well is the single biggest success driver in PE CFOs that I have seen. Those who understand this and do it well tend to succeed. Those who don’t, leave too much to chance and either get lucky or fail.

The CFO also has a crucial role in managing lender relationships, cashflow, and covenants alongside the VCP. See: ‘3 statement CFO’, which we talked about last week.

We are going to get into different drivers of value creation and deeper into the role that debt plays next week.

If you’re one of the rare operators who can deliver the full Value Creation Plan (VCP), you might think you control your destiny. You've earned the right to finish the job, right?

Not quite.

Macro shifts can blow up even the best-laid exit strategy. The M&A market is highly sensitive to credit conditions. In uncertain times like now, liquidity dries up. And it’s not just about pricing or interest rates. Sometimes the banks just stop lending. Entire debt markets can freeze.

When that happens, fund-level priorities shift, and fast.

Remember: your investors have their own “exit.” Their north star is returning capital to LPs on time and at target IRRs. Your company is just one chess piece on their board. If other exits stall or liquidity evaporates, your chess piece might get moved unexpectedly.

Your exit could be accelerated, even if you’ve only delivered 80 percent of the VCP. Or it could be pushed, sitting in limbo while capital gets recycled elsewhere. You might even face an unexpected recapitalization, just to create liquidity for the fund.

A recap might mean layering on more debt to dividend out proceeds to LPs and the GP, often without a change in control. That can hit your balance sheet, but from the fund’s point of view, it's a liquidity unlock.

If the fund is in Year 9 of a 10-year cycle, everything becomes exit-driven, whether the business is ready or not. GPs in harvest mode behave differently. CFOs who spot that pattern early can get ahead.

The closer you can get to your sponsor, the more you can see this coming.

And don’t forget your GP’s behavior will be driven to an extent by changes in their LP’s priorities too.

Understanding the economics, timelines, and incentives of a PE fund is non-negotiable for any CFO operating in that world. You need to know how to translate strategy into equity value, aligned with the fund’s exit horizon and return targets.

But knowing the rules isn’t enough. Next week, we’ll move from fund level theory to execution. Breaking down the core strategies that actually drive value creation inside a PE-backed business.

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Disclaimer: I am not your accountant, tax advisor, lawyer, CFO, director, or friend. Well, maybe I’m your friend, but I am not any of those other things. Everything I publish represents my opinions only, not advice. Running the finances for a company is serious business, and you should take the proper advice you need.