The Money Behind the Money

A private equity fund is not a company. It is a limited partnership — a legal structure with two classes of participant.

Limited Partners (LPs) provide the capital. They are pension funds, sovereign wealth funds, university endowments, insurance companies, and family offices. They commit money — often hundreds of millions — with the expectation of returns that exceed public markets over a 10-year horizon. They have no say in which deals get done. They are, by design, passive.

The General Partner (GP) is the fund manager. Skarn Capital. They find the deals, negotiate the terms, manage the portfolio companies, and execute the exits. They make every decision. In return, they earn fees and a share of the profits.

Skarn Capital Fund III has €1.2 billion in commitments from 14 institutional LPs. The largest is a Dutch pension fund (€180m). The smallest is a German family office (€25m). None of them chose Königshof. They chose Haircut.

LPs do not wire €1.2 billion on the day the fund launches. They commit capital. The money arrives only when Skarn needs it.

When Skarn closes the Königshof acquisition, they issue a capital call — a formal notice to all 14 LPs: "We are acquiring a German manufacturer. Please wire your pro-rata share within 10 business days."

The Dutch pension fund committed €180m (15% of the fund). Their share of the €55m equity cheque: €8.25m. They wire it from a dedicated allocation account. For them, this is one line item in a portfolio of 40+ fund commitments across PE, real estate, infrastructure, and credit.

The blind pool. When the Dutch pension fund committed €180m to Skarn III, the fund had zero investments. No pipeline. No targets. They committed to a team, a strategy, and a track record — not to Königshof specifically. This is why GP selection is the single most important decision an LP makes.

The GP charges an annual management fee — typically 1.5% to 2.0% of committed capital during the investment period (usually years 1–5), then 1.5% to 2.0% of invested capital thereafter.

For Skarn Fund III at 2% on €1.2bn committed: €24 million per year.

This covers the firm's operating costs: salaries for 47 employees across Frankfurt and London, office leases, legal retainers, travel, data subscriptions, and the espresso machine Haircut insists on replacing every 18 months.

Management fees are the GP's revenue regardless of performance. Even if every deal fails, the fees are owed. This is why LPs scrutinise fee structures intensely — and why "fee holidays," "fee offsets," and "step-downs" are negotiated in every Limited Partnership Agreement.

Fee offset: Some LPAs require that monitoring fees, transaction fees, or director fees earned by the GP from portfolio companies reduce the management fee dollar-for-dollar. If Skarn charges Königshof a €1m annual monitoring fee, the management fee to LPs drops by €1m.

Carry is the reason people build careers in private equity.

Carried interest is the GP's share of the fund's profits — typically 20%. But "profits" has a very specific meaning. Carry is not 20% of every euro earned. It is 20% of profits above a minimum return threshold.

Suppose Skarn Fund III invests €1.0bn of the €1.2bn committed and returns €2.5bn to LPs. The profit is €1.5bn. At 20% carry, the GP receives €300 million.

But only after the hurdle.

The hurdle rate (or preferred return) is the minimum annual return LPs must receive before the GP earns any carry. The standard is 8% IRR.

The distribution waterfall flows in four tiers:

Why the catch-up matters: Without it, the GP would only earn 20% of profits above the 8% hurdle, meaning the effective carry rate would be much less than 20% of total profits. The catch-up ensures that once LPs have received their 8%, the GP rapidly receives enough to bring their total share to 20% of all profits generated.

The J-curve describes the typical pattern of fund returns over time:

Funds are measured by three metrics. Each tells a different story:

Gross vs. Net. Gross returns are before fees and carry. Net returns are what LPs actually receive. A fund returning 2.8x gross may deliver 2.1x net after management fees and 20% carry. The difference matters enormously — and is why LPs negotiate fee structures with surgical precision.

Every PE return can be decomposed into its drivers. This is the value creation bridge — the single most important framework for understanding where returns actually come from.

Why it matters: The same 3.0x MOIC can come from completely different sources. A return driven by EBITDA growth is repeatable — it reflects genuine operational improvement. A return driven by multiple expansion is market-dependent — the GP bought at a low point and sold at a high point. A return driven primarily by leverage is mechanical — debt paydown, not value creation.

LPs study the bridge obsessively. A GP whose returns are 70% EBITDA growth will raise the next fund easily. A GP whose returns are 70% multiple expansion will face hard questions.

A PE fund typically has a 10-year life with two optional 1-year extensions. The lifecycle follows a predictable rhythm:

Deployment pressure. A fund in year 4 with 40% of capital still undeployed is under pressure to invest — or risk returning uncommitted capital to LPs and shrinking the fee base. This creates urgency that IB bankers can exploit when timing sell-side processes.

Exit pressure. A fund in year 8 with unrealised portfolio companies needs exits — even at suboptimal multiples — to generate DPI and demonstrate returns before fundraising the next vehicle. Understanding where a sponsor is in their fund lifecycle tells you how flexible they will be on price.

Three mechanisms align GP and LP interests:

1. GP Commitment. Skarn's partners invest 3% of Fund III from their personal wealth — €36m. This is not symbolic. If the fund loses money, the partners lose their own capital alongside LPs.

2. Management Rollover. In the Königshof deal, Wilhelm retains a 5% equity stake (~€10m). This ensures the seller-turned-CEO is incentivised to grow the business post-acquisition — his payout is tied to the same exit that pays Skarn's LPs.

3. Clawback Provisions. If the GP receives carry on early exits but later deals underperform, LPs can claw back excess carry. The GP may be required to return distributions already received. This is the ultimate alignment mechanism — and why European waterfalls are preferred. With whole-fund accounting, clawback risk is structurally lower.