The Structure of Private Funds, Their Relation to Private Firms, and the Implications for Accounting, Economics, and Finance Research

Abstract

Private equity and venture capital funds (“private funds”) are an increasingly important component of the economy and hold substantial ownership in other private firms. These funds have unique legal organizational structures, which academic literature has not yet accounted for. This paper has three main goals. First, we lay out the basic legal structure of private funds and describe how these funds interact with the firms they own (“portfolio companies”). Second, we explain the implications of this structure for recent finance research, focusing on how funds’ structure affects secondary market pricing of funds. Third, we discuss how both private fund and private firm structure affects accounting and economics research on private firms. Because a large number of private firms are now owned by private funds, falling under the funds’ unique organizational structure, we urge caution in drawing conclusions regarding private firms when researchers are unable to clearly distinguish between stand-alone private firms and those private firms owned and controlled by private funds (or other parent entities). We also specifically discuss the use of tax return data to study private firms; under the current laws of the U.S., these data are unlikely to allow researchers to isolate stand-alone firms, making these data unreliable for evaluating certain private firm attributes in economics, as well as private firm financial reporting choices in accounting.