What Are the Advantages of Setting up a Private Equity Firm as an Llc?

1. What are the advantages of setting up a private equity firm as an LLC?

The structure of private equity usually works in the following manner. A fund is created to pool capital that can be used to purchase or invest in companies and create value for a profit. The fund is based upon two types of partners, limited partners (LPs) and general partners (GP). The two types of partners vary in the amount of control and subsequent liability they each have regarding the company. Limited partners invest their money, but they do not exert control or influence over the management of the invested company. However, general partners invest but are involved in the management and selection of investment companies.  Consequently, the limited partners’ risk is only regarding the loss of their capital invested in the company. However, the general partners’ risk extends beyond their capital and also includes responsibility for the management decisions of the invested company. In order to limit the liability of the general partners most funds create a Limited Liability Company to manage the invested company. Simply put, investors create a fund that creates LLCs to invest and manage other companies. This structure is important because it creates a barrier, commonly referred to as the corporate veil, between the general partners and the liability of the company.  Although this may seem like an unnecessarily complicated strategy to protect the investor, it is crucial for the fund.

Value in the invested company is primarily created from the management, control, and actions performed by the general partners. However, maintaining the ability to control actions in the invested company is what creates liability.  Still, the only way to mitigate risk from failure is to have the ability to manage organizational processes. Private equity investing is high risk and high reward. However, it requires a significant amount of due diligence to ensure circumstances are what they appear to be. If investors did not have control over the decisions of the investment, they would not be able to ensure that incentives align.  The other forms of business structuring, such as sole proprietorship and corporations, don’t allow the investors to meet their needs simultaneously. For example, although a corporation has protection from liability, group ownership, and varying ownership levels; it suffers from double taxation (paying twice on profits). Comparatively, the sole proprietorship lack double taxation but also lacks everything else needed. In conclusion, an LLC structure allows private equity firms to combine capital, limited their liability, and exert control over the investment company without double taxation.