To start a private equity firm, you form a two-tier legal structure (a management company plus one or more limited partnership funds), register with the Securities and Exchange Commission or claim an exemption under the Investment Advisers Act of 1940, draft the fund’s offering and partnership documents, raise capital from accredited or qualified investors under a Regulation D exemption, and file Form D within 15 days of your first sale. Most founders spend six to twelve months on entity formation, compliance setup, and fundraising paperwork before holding an initial close. The sequence matters: each step depends on the one before it, and skipping any of them can disqualify the fund from the exemptions the whole model relies on.
The Two-Tier Legal Structure
Nearly every private equity firm uses the same basic architecture. One entity, the management company, employs the investment team. A separate entity, the fund itself, holds the portfolio investments. Keeping them apart is what gives you liability protection and lets each fund stand on its own.
The fund is organized as a limited partnership. The General Partner controls the fund and bears full legal responsibility for its investment decisions; in practice the GP is a limited liability company owned by the firm’s founders. The GP contributes a small share of total capital. Limited Partners provide the rest as passive investors with no management role, and that passivity is what caps their liability at the amount they committed. The limited partnership also avoids entity-level taxation: profits and losses flow through to each partner’s own return.
The management company is a separate LLC. It employs the firm’s professionals and collects management fees from each fund to cover salaries, rent, and operating costs. It enters into an advisory agreement with the GP of each fund, spelling out exactly what services it provides and at what price. Isolating the management company this way adds a layer of personal-asset protection and keeps one fund’s liabilities from reaching another.
Delaware is the dominant state of formation because of its developed body of partnership law, though you can form in any state whose rules you prefer.
Choosing Your Investor Base
Private equity funds are closed to the general public. The Investment Company Act of 1940 provides two exemptions that keep your fund from being regulated like a mutual fund, and the one you pick dictates who can invest and how many investors you can take.
Section 3(c)(1) Funds
A 3(c)(1) fund can accept no more than 100 beneficial owners. Most of those investors must be accredited under Rule 501 of Regulation D. For individuals, that means a net worth above $1 million excluding the primary residence, or annual income above $200,000 individually (or $300,000 jointly with a spouse) for the prior two years with a reasonable expectation of the same going forward.1U.S. Securities and Exchange Commission. Accredited Investors
Section 3(c)(7) Funds
Larger funds typically organize under Section 3(c)(7), which allows up to 2,000 beneficial owners but requires every investor to be a Qualified Purchaser. An individual qualifies by owning at least $5 million in investments. For entities managing money on a discretionary basis, the threshold is $25 million in investments.2Legal Information Institute. 15 USC 80a-2(a)(51) – Definition of Qualified Purchaser The higher bar means your investor base is mostly institutions and high-net-worth individuals with the resources to absorb the illiquidity and risk that come with a ten-year fund life.
Registering With the SEC
The Investment Advisers Act of 1940 governs how private fund managers register. Under Section 203(m), added by Dodd-Frank, firms that solely advise private funds and manage less than $150 million in private fund assets in the United States can claim an exemption from full SEC registration.3U.S. Securities and Exchange Commission. Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers These firms file as Exempt Reporting Advisers. They avoid the heaviest compliance burdens but still must file reports and disclose information about their funds and conflicts of interest.
Once assets under management reach $150 million, you must register as a full Registered Investment Adviser. That transition requires appointing a Chief Compliance Officer, building out a written compliance program, and submitting to periodic SEC examinations. The timing generally follows your fiscal year cycle, so you have runway to prepare, but the obligation is not optional.
Either way, you file Form ADV through the Investment Adviser Registration Depository. Part 1A collects data about your business practices, ownership, and advisory personnel. Part 2A is a narrative brochure describing your fee structure, investment strategies, and conflicts of interest.4SEC.gov. Form ADV General Instructions You update the filing at least annually and whenever a material change occurs. IARD filing fees range from $40 to $225, scaled to assets under management.5U.S. Securities and Exchange Commission. Electronic Filing for Investment Advisers on IARD – IARD Filing Fees
How You Can Raise the Money
Selling interests in your fund is a securities offering. It must either be registered with the SEC or qualify for an exemption, and private equity funds rely on Regulation D. The path you choose controls how you can find investors and how carefully you must verify their status.
Under Rule 506(b), you cannot use general solicitation or advertising. No public pitches, no mass emails to people you don’t already know, no social media promotion of the fund. You can sell to an unlimited number of accredited investors plus up to 35 non-accredited investors who are financially sophisticated enough to evaluate the offering, though most PE funds avoid non-accredited investors entirely because their inclusion triggers additional disclosure.
Under Rule 506(c), you can advertise openly, but every purchaser must be an accredited investor and you must take reasonable steps to verify that status rather than accept their word for it.6U.S. Securities and Exchange Commission. Exempt Offerings Verification typically means reviewing tax returns or bank statements, or getting written confirmation from a broker-dealer or CPA.
After your first sale, file Form D with the SEC within 15 days.7U.S. Securities and Exchange Commission. What Is Form D? This is a notice filing, not a registration, but missing the deadline can jeopardize your exemption. Most states also require their own notice filings, known as blue sky filings, with fees that vary by jurisdiction. Budget for them in every state where you have investors; first-time founders routinely forget this.
The Bad Actor Rule
Your entire Regulation D exemption disappears if any “covered person” associated with the firm has a disqualifying event on their record. Covered persons include the issuer, its directors and officers, general partners, managing members, and anyone compensated for soliciting investors. Disqualifying events include certain criminal convictions, SEC disciplinary orders, regulatory injunctions, and expulsion from a self-regulatory organization like FINRA. Look-back periods range from five to ten years depending on the event.8U.S. Securities and Exchange Commission. Disqualification of Felons and Other Bad Actors from Rule 506 Offerings and Related Disclosure Requirements Run thorough background checks on every covered person before your first offering.
The Three Documents That Define the Fund
Three core documents define every private equity fund. Getting them wrong does not just create legal risk; it can unwind your offering.
Private Placement Memorandum
The PPM is the disclosure document you give prospective investors before they commit capital. It describes the fund’s investment strategy, the backgrounds of the management team, the fee structure, and every material risk the fund faces. Investors rely on it for due diligence, and it is your primary legal defense against future claims that you failed to disclose something. Specificity matters: vague risk factors provide little protection in litigation.
Limited Partnership Agreement
The LPA is the binding contract between the General Partner and every Limited Partner. It sets the fund’s economics, including the distribution waterfall that controls how profits are divided after investors receive their capital back. The industry-standard arrangement is a two-percent annual management fee on committed capital and a twenty-percent share of profits for the GP, known as carried interest. The LPA typically includes clawback provisions requiring the GP to return excess distributions if overall performance falls short of the agreed return threshold, usually called a preferred return or hurdle rate.
Most LPAs also contain a key person clause protecting investors if the individuals they entrusted with their capital leave the firm. When a key person event occurs, usually the departure or incapacity of a named principal, the fund’s ability to make new investments is suspended. The suspension period in most PE funds runs three to nine months, during which the GP must either find a replacement (often subject to investor advisory committee approval) or convince investors the fund can continue without one.
Subscription Agreement and Side Letters
The subscription agreement is the investor’s formal application to join the partnership. It collects representations about financial status, legal authority, and accredited or qualified purchaser standing, and feeds your anti-money-laundering and know-your-customer records.
Larger or more influential investors frequently negotiate side letters granting specific concessions: reduced fees, co-investment rights, enhanced reporting, or portfolio transparency beyond what the LPA provides. Side letters often include a Most Favored Nation clause giving the investor the right to elect any more favorable terms the fund grants other investors through their own side letters. Managing the interaction between these individual agreements and the LPA is one of the more time-consuming legal tasks during fundraising.
Tax Points That Shape the Structure
Flow-through taxation means neither the fund nor the management company pays entity-level federal income tax; each partner reports their share. A few specific tax issues shape how founders design the structure.
Carried interest receives capital-gains treatment, but only if the underlying investments are held long enough. Under Section 1061 of the Internal Revenue Code, the fund manager’s share of gains qualifies for long-term capital gains rates only if the fund held the relevant assets for at least three years. Gains on assets held between one and three years are taxed at ordinary income rates for the GP, even though they would qualify as long-term under the standard one-year holding period for other taxpayers. The three-year rule was enacted specifically to prevent fund managers from getting favorable tax rates on quick flips.
Tax-exempt investors (pension funds, endowments, foundations, IRAs) still owe tax on unrelated business taxable income. Most passive investment income is excluded from UBTI, but two common fund activities trigger it. If the fund uses leverage to acquire assets, a proportionate share of income from the debt-financed assets counts as UBTI. If portfolio companies are structured as partnerships or LLCs rather than corporations, the active business income flowing through may be taxable to your tax-exempt LPs. Many tax-exempt investors will ask about UBTI before committing, and some will decline if the fund generates it.
Foreign limited partners face U.S. tax on income “effectively connected” with a U.S. trade or business. If a foreign investor participates in a partnership engaged in U.S. business, that investor is treated as conducting U.S. business and must pay tax on their share of connected income at the same graduated rates that apply to U.S. citizens.9Internal Revenue Service. Effectively Connected Income (ECI) Funds expecting significant foreign participation often create parallel structures or use blocker corporations to manage these consequences.
ERISA If You Take Pension Money
If benefit plan investors hold 25 percent or more of any class of the fund’s equity interests, the fund’s assets are treated as plan assets, and the fund manager becomes a fiduciary to every ERISA-governed plan that invested.10eCFR. 29 CFR 2510.3-101 – Definition of Plan Assets – Plan Investments That status imposes strict duties of loyalty and prudence and opens you to personal liability for any breach. Most fund sponsors cap benefit plan participation below 25 percent in the partnership agreement to avoid crossing the threshold.
The Launch Sequence
Once the structure is designed, the exemption path chosen, and the fund documents drafted, execution follows a specific order.
Start by forming the entities with the relevant state authority. File a Certificate of Limited Partnership for the fund and Articles of Organization for the management company LLC. After the state filings are accepted, apply for a federal Employer Identification Number from the IRS for each entity.11Internal Revenue Service. Get an Employer Identification Number The IRS recommends forming the entity at the state level first, since applying for an EIN before the entity legally exists can delay processing.
Next, submit Form ADV through IARD to register as an investment adviser or claim exempt reporting status.4SEC.gov. Form ADV General Instructions This is a prerequisite for legally accepting and managing investor capital. Once accepted, open corporate bank accounts for the management company and a custodial or partnership account for the fund.
With the entities live and regulatory filings submitted, circulate the PPM and subscription agreements to prospective investors. After investors have signed and committed capital, conduct the initial close. The General Partner executes the Limited Partnership Agreements, capital commitments become binding, and the first drawdowns are called to fund operations and acquisitions. File Form D with the SEC within 15 days of the first sale.7U.S. Securities and Exchange Commission. What Is Form D? Submit state blue sky notice filings on whatever schedule each state requires. At that point the fund is operational and can begin deploying capital.
Keeping the Fund in Compliance After Launch
Registration is not the finish line. Several recurring obligations apply once the fund is operating.
Because the fund holds investor assets, you are subject to the SEC’s custody rule. The standard requirement calls for an independent public accountant to conduct a surprise annual examination of client funds. Private funds get an alternative: if the fund undergoes an annual audit and distributes audited financial statements to all limited partners within 120 days of fiscal year end, the custody rule is satisfied without a surprise examination.12eCFR. 17 CFR 275.206(4)-2 – Custody of Funds or Securities of Clients by Investment Advisers Almost every PE fund takes this route. Missing the 120-day deadline is not a minor administrative lapse; it puts you out of compliance with the custody rule entirely.
Form ADV must be updated annually and whenever a material change occurs in operations, ownership, or disciplinary history. Registered Investment Advisers must maintain books and records for specified retention periods, adopt and enforce a written code of ethics, and designate a Chief Compliance Officer who reviews the adequacy of the firm’s policies at least annually. Exempt Reporting Advisers face lighter requirements but remain subject to SEC anti-fraud provisions and examination authority.
The SEC’s Marketing Rule also governs what registered and exempt reporting advisers can say in their materials. If you show the performance of a subset of investments pulled from a broader portfolio, you must show the net performance of that subset too, or present the total portfolio’s gross and net performance with at least equal prominence. The rule also regulates testimonials and endorsements and prohibits compensating anyone with a disqualifying disciplinary event in the prior ten years.13U.S. Securities and Exchange Commission. Marketing Compliance – Frequently Asked Questions