Accounting for a Private Equity House and Its Funds: Three Sets of Numbers From One Set of Economics

Private equity looks like one business and reports like three. The manager sells a service. The fund holds assets. The carry vehicle rewards the people who found them. Each sits in a different corner of IFRS, and the answer for one is almost never the answer for the others.

Most reporting failures in the sector are not valuation failures. They are structural ones — a group applying the logic of the fund to the manager, or the logic of the manager to the fund.

Start with the structure, not the standard

A typical platform has four layers: a management company earning fees, a general partner entity holding control rights and usually the carried interest, the fund itself, and beneath it holding companies, blockers and the portfolio businesses. Add parallel funds, feeders, co-investment vehicles and continuation funds and the group has a dozen reporting entities giving genuinely different answers to the same question.

The first job in any engagement is to draw that structure and mark, at every node, three things: who consolidates, what is measured at fair value, and who the financial statements are actually for. Almost everything below follows from that map.

The investment entity exemption is the decisive judgement

IFRS 10 normally requires a parent to consolidate what it controls. For a fund that would produce a consolidated balance sheet of unrelated portfolio companies, which tells an investor nothing about the value of their commitment. The investment entity exemption solves it.

A fund qualifies where it obtains capital from investors to provide investment management services, commits that its purpose is investing solely for capital appreciation or investment income, and measures performance of substantially all its investments on a fair value basis. Multiple investments, multiple unrelated investors and equity-form ownership reinforce the conclusion but are not conditions.

Two traps follow. An entity whose stated purpose includes operational involvement, exit by trade sale to a related operating group, or holding assets indefinitely may fail the solely-for-capital-appreciation test — the exit strategy documented in the offering memorandum matters more than the label on the vehicle. And status can change: a vehicle that becomes or ceases to be an investment entity accounts for the change prospectively, producing a step-change in the balance sheet the market rarely anticipates.

The parent problem, and principal versus agent

The exemption does not travel upwards. A parent of an investment entity that is not itself an investment entity must unwind the fair value accounting and consolidate the underlying portfolio companies. For a manager that controls its own funds, that is the difference between a clean balance sheet and one carrying the debt and revenue of unrelated operating businesses.

Which makes control over the fund decisive. The general partner is a decision maker, and IFRS 10 asks whether it acts as principal or agent. The analysis weighs the scope of its authority, rights held by others — particularly substantive removal rights exercisable without cause by a simple majority of limited partners — its remuneration, and its exposure to variability through commitment, carry and seed capital. Market-standard fees and a modest commitment usually point to agent. A large balance-sheet co-investment, warehoused deals, or kick-out rights that are practically unexercisable can tip the same fund into consolidation.

Fair value: IFRS 13 is stricter than practice assumes

The unit of account is the instrument held — the shares, not the underlying business. For a listed holding, fair value is quoted price times quantity, and a control premium may not be added however commercially real it is. For unlisted holdings the technique is free but the discipline is not: where a transaction price equals fair value at inception, the model must be calibrated to reproduce that price on day one, and the same calibrated inputs tracked thereafter. A portfolio that holds entry cost for four quarters and then re-rates on exit is the classic symptom of calibration never having happened.

• Where the fund holds preferred instruments with liquidation preferences, ratchets or anti-dilution, equity value times percentage is wrong. Option pricing or scenario-weighted models are needed to split value between classes.
• Marketability and minority discounts must be attributes of the asset, not of the holder's size.
• Unlike US GAAP, IFRS offers no practical expedient allowing net asset value to be used as fair value. For a fund of funds, reported NAV is an input to assess and adjust.
• Level 3 disclosure is where auditors concentrate: the opening-to-closing reconciliation, unobservable inputs with ranges, transfers between levels, and a sensitivity analysis. A sensitivity that never moves is a red flag on its own.

Equity or liability: the presentation issue that catches people out

A closed-ended fund with a fixed life carries a contractual obligation to return net assets to investors on wind-up. Under IAS 32 that is a financial liability unless the narrow puttable-instrument exemption applies — and it usually does not, because the exemption requires the class to be the most subordinate and identical in all features. A carried interest class, hurdle-differentiated classes, or a separate general partner interest breaks it.

The consequence is a balance sheet with little or no equity, investor capital presented as net assets attributable to holders, and distributions running through profit or loss as finance costs. The economics are unchanged; the optics are not. Explain it to investors before the first audited set, not after.

The manager's own accounts are a revenue problem

At management company level IFRS 15 governs. Management fees are recognised over time as the service is delivered, net of any transaction and monitoring fees rebated to the fund. Performance fees are variable consideration and are constrained — recognition is deferred until it is highly probable that a significant reversal will not occur, which for a whole-of-fund European waterfall with clawback usually means very late in the fund's life.

Carried interest is the sharper judgement. Where carry is a contractual fee for services it is revenue, subject to the constraint. Where it is held as an actual partnership or equity interest in the fund it is not revenue at all — it is a financial instrument or an equity-method or fair-valued interest, recognised on an entirely different basis. The two routes produce materially different profit profiles from identical economics.

Employee carry plans then raise IFRS 2. Where executives subscribe for carry interests at fair value there is generally no share-based payment charge — but that conclusion rests on a defensible valuation of an option-like instrument at award date, which has to be modelled as one. Awards for nil or nominal consideration in return for service are share-based payments, and the charge is rarely small.

The UAE layer: the Qualifying Investment Fund exemption

Article 10 of Federal Decree-Law No. 47 of 2022 lets an investment fund apply to the Authority to be exempt as a Qualifying Investment Fund. The conditions in the Law are short: the fund or its manager is subject to regulatory oversight by a competent authority in the State or a recognised foreign one; interests are traded on a Recognised Stock Exchange or marketed and made available sufficiently widely; the main purpose is not to avoid Corporate Tax; and Article 10(1)(d) leaves anything further to Cabinet.

The substantive change most likely to catch a private equity platform is the treatment of a concentrated investor. Under Article 3(1), an investor's Taxable Income excludes profit distributions from an exempt Qualifying Investment Fund. Article 3(2) then takes that back where the investor is large enough relative to the fund.

The threshold is not tested on ownership alone. It also catches an investor that, with its Related Parties, can exercise 30% or more of the voting rights, determine the composition of 30% or more of the governing body, receive 30% or more of the profits, or determine or exercise significant influence over the conduct of the fund's business and affairs. A general partner commitment plus an anchor limited partner relationship can reach it without anyone holding 30% of the units.

• Article 3(3) disapplies the rule for the first two Financial Years after establishment, where there is sufficient evidence of an intention not to exceed the thresholds from the third year.
• Article 3(4) disapplies it where the threshold is exceeded for reasons outside the control of the fund or the investor, provided the breach does not exceed ninety days in aggregate in the Financial Year — or on liquidation or termination.
• Article 3(5) is separate: where a fund other than a REIT has an Immovable Property Percentage above 10%, a juridical investor includes 80% of the prorated Immovable Property Income, unless Article 3(6)'s distribution test is met within nine months of the year end.

What is coming

IFRS 18 replaces IAS 1 for annual reporting periods beginning on or after 1 January 2027 and changes the face of the income statement. Entities that invest in assets as a main business activity classify the related income and expenses in the operating category rather than investing, which moves the newly mandated subtotals for funds and managers in opposite directions. Management performance measures disclosed outside the statements — gross and net IRR, distributions to paid-in capital, fee-related earnings — will need to be defined and reconciled within them.

The comparative period is already running. Model the new presentation now rather than in 2027.

The practical point

The complexity here is not arithmetic. It is that a single structural conclusion — investment entity or not, principal or agent, equity or liability, concentrated investor or not — propagates through every statement and cannot be corrected at the margin. Fix the structural judgements first, document them contemporaneously, and the valuation and disclosure work becomes a matter of discipline rather than reconstruction.