The long-term nature of investments in private equity and real estate can create major long-term problems for funds without sound strategies for managing investor risk and partner liability. Investors need to know how their assets will be handled before entrusting them to a fund manager, and fund managers need to know what they stand to gain or lose from the performance of their funds. Simply put, investment strategy should drive fund structure, not the other way around.
How to Choose a Fund Structure
When forming an investment fund, one of the first structural decisions is whether to organize the fund as a limited partnership (“LP”) or a limited liability company (“LLC”). While both entities provide limited liability protection and pass-through tax treatment, they differ in governance, investor expectations, and operational flexibility.
The traditional private equity, venture capital, real estate, and energy fund model utilizes an LP, with a general partner (typically an LLC, and referred to as the “GP”) responsible for managing the fund and limited partners serving as passive investors whose liability is generally limited to their capital commitments. This structure has become the market standard because it clearly separates management from ownership and aligns with institutional investor expectations.
An LLC-based fund, by contrast, offers greater flexibility in governance and economic arrangements, allowing members to tailor voting rights, distributions, and management authority to the specific needs of the transaction. LLC funds are often well-suited for closely held investment vehicles, joint ventures, family offices, and smaller sponsor-led funds where a customized governance structure is preferred over the traditional GP/LP model. Selecting the appropriate structure requires balancing liability protection, tax considerations, investor preferences, fundraising strategy, and long-term operational objectives.
How to Choose a Type of Fund
Private equity funds generally follow a two-party structure where the GP invests in, administers, and manages investments from limited partners on behalf of the fund, distributes profits when investments are sold, and receives both income from investments and a management fee and/or a carried interest in return. The risk associated with a private equity fund depends on its target investments; venture capital funds targeting startup companies carry a high risk that underlying investments will not turn a profit, and buyout funds focused on established companies carry a lower risk because their underlying investments are generally more stable.
Real estate funds are generally structured as limited partnerships or LLCs, depending on which structure provides the most desirable tax treatment. Open-ended real estate funds let investors withdraw at set periods, while closed-ended funds prohibit withdrawals to guarantee the stability of the fund. Like private equity funds, many real estate funds use significant leverage debt from borrowed money to raise the up-front capital needed to purchase the properties that make up the fund portfolio. Most of the risk in real estate funds is tied to this leverage; the repayment of debt depends on the profitability of the portfolio, which in turn depends on the condition of the real estate market.
Joint ventures are commonly structured as an LLC and are generally used as a method for participating entities to pool assets, skilled workers, or other beneficial tools for their mutual benefit. Most joint ventures are only intended to last for a short period of time, and are best suited to research, production, and other similar ventures.
Conclusion
The ideal structure for your fund will depend on your long-term goals and risk tolerance. Copying the structure of another fund often fails to reflect the small but important differences between individual funds and the entities managing them, so it is imperative to start the fund formation process with a clear idea of how managers will handle costs and what sectors or geographic areas the fund will target, rather than letting the fund structure itself make those decisions. Engaging experienced fund counsel at the outset helps evaluate these considerations, avoids costly restructuring later, and ensures the fund’s governing documents align with both market expectations and your business objectives. If you need help determining the right way to start your fund, RR&A is here to help you solidify your investment strategy and choose a structure that works for you.
Disclaimer: The information and material on this website is general information about our practice and firm. This information does not offer specific legal advice and the use of this information does not create an attorney-client relationship with RR&A or any of its attorneys. The information on this website should not be used for legal advice, and persons should not act upon the information on this website without engaging professional legal counsel.
Tyler is a Law Clerk at R. Reese & Associates in the Houston office. To learn more about Tyler, visit his attorney page.
