Regardless of your company structure, by law, you must keep and maintain financial records in accordance with GAAP. Accurate bookkeeping is an essential step in managing your private equity fund for financial reporting. This not only helps you remain compliant but gives investment groups relevant insights into their equity fund, to help them make calculated investment decisions.
If you are a private equity investment manager, outsourcing accounting services will assist you with complying with partnership accounting standards, and help you stay abreast of the set requirements for private equity funds while ensuring as few run-ins with the IRS as possible.
General accounting vs fund accounting
General accounting standards involve recording all income flowing into a business and all expenses in the general ledger. Fund accounting comprises the general ledger, investment holdings, and capital allocations. Of the accounting standards, a fund is more complex than general accounting standards because a private equity firm purchases assets with investors’ funds.
Whereas large corporations and small businesses that comply with general accounting standards use their own cash to invest in various assets, private equity general partners and fund managers use cash raised from limited partners (LP) and other investors to invest in various assets.
Basic private equity fund accounting
In private equity fund accounting, capital activities cash flows between the fund manager or general partner and LPs. Cash flows include management fees from the LPs to the GP and cash-stock distributions from GP to the LP.
- Capital Call/Distribution
- Commitment: investor fund commitments and unfunded commitment adjustment.
- Allocation: management fees and carried allocation.
- Investor Reallocation
- Interest Transfer
Accounting for private equity fund transactions from all partners must be accurately allocated with complete transparency with regard to each partner’s responsibilities and ownership. Management fees and fund expenses are not allowed in the fund allocation, while LPs pay a percentage based on ownership rights. The distribution of realized investment profits is more complex for outsourced accounting controllers to calculate than ownership calculations.
The investment amount funded by investors can vary with different percentages of ownership in the fund. Percentage calculations of the ownership and capital call for each investor are simple. For example, if an investor contributed $700,000 and a limited partner (LP) provided $300,000 to the fund, the investor would own 70 percent, and the limited partner 30 percent. Investors and LPs invest in different investment vehicles such as endowments, foundations, pension funds, and companies, which require allocation in accounting.
Fund accounting investment and capital activities
Business processes of a private equity fund are divided into two activity categories, capital, and investment, requiring a registered SEC outsourced private-equity advisor. While PE funds are not required to register with the Securities Exchange Commission, an outsourced PE Advisor or CFO is SEC-registered. Advisors and other accounting professionals are subject to requirements for regular disclosure to the public and to disclose conflict of interest with the managed funds.
Examples of investment activities
Investment activities comprise investments
including funds, real properties, companies, land, for example, and cash flows of the fund manager. It means the cash flows from the GP to the funding investment, and cash flow from investments going out to the GP, such as divestment and realization.
- Corporate Activities: security conversion and stock split.
- Allocation: fund operations and entries elimination.
- Interest Income: interest payments and interest accrual.
- Purchase: bond acquisition, investee funding, cash distribution, and direct purchase.
- Valuation and Investment Write-off
Examples of capital activities
In private equity fund accounting, capital activities cash flows between the fund manager or general partner and LPs. Cash flows include management fees from the LPs to the GP and cash-stock distributions from GP to the LP.
- Capital Call/Distribution
- Commitment: investor fund commitments and unfunded commitment adjustment.
- Allocation: management fees and carried allocation.
- Investor Reallocation
- Interest Transfer
Private equity accounting complications
Accounting for private equity has its complications comprising waterfall calculations of distribution, closings, and equity accounting methods.
1. Calculating distribution waterfall
Distribution waterfall calculations are complex in fund accounting because of the different structures and methods of calculating tiers and catch-up. Waterfalls are challenging to calculate and determine the value of an asset based on the return of contributions, preferred return, catch-up, and split between LPs and GP.
2. Closings
Another challenging aspect of private equity fund accounting is closing after its initial close date to conform to a new investor. What makes closings and calculation of appropriate interest complicated, conforming to multiple capital calls and closings of various funds.
3. Equity accounting method
Equity accounting is a method utilized to pull the profits and losses from tiered entities into the upper tier allowing recognition of unrealized gains and losses
To overcome the challenges of private equity fund accounting, custom-designed fund accounting software is essential for the tracking of alternative investments.
Accounting software for equity fund accounting efficiency
Private equity fund accounting software streamlines your fund accounting workflows by combining solutions for:
- General Ledger
- Financial Statement Reporting
- Standardized Workflow
- PE Bookkeeping
- Accounting Standards and Integrated Software
- Tax Planning and Preparation
It is advisable to consult with a CPA about your private equity fund accounting and tax compliance. When searching for an outsourced CPA to manage this for you, it is imperative that they have experience in private equity fund accounting and as this is not the same as general accounting.
At Fusion CPA, we can help you reach your goals for growth. Our private equity fund accounting services combine experience, technology, and expertise to ensure accurate accounting that meets compliance and FASB and IASP standards.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
