Limited Partner (LP)

What is a limited partner in private equity?

A limited partner in private equity is an investor in a buyout, growth or venture fund organized as a limited partnership. ILPA describes limited partners as the investors into private equity funds managed by a general partner, and says that like shareholders in a corporation they have limited liability to the extent of their investment and no management authority.

What is a limited partner?

The term is a legal status before it is an investment role. In a limited partnership there are general partners, who manage and are exposed, and limited partners, who fund and are not. Delaware's Revised Uniform Limited Partnership Act, the statute most private funds are formed under, puts it directly: a limited partner is not liable for the obligations of a limited partnership unless the person is also a general partner or, in addition to exercising the rights and powers of a limited partner, participates in the control of the business. If a limited partner does participate in control, liability runs only to persons who transacted with the partnership reasonably believing, based on that conduct, that the limited partner was a general partner.

That statute then lists a long set of things a limited partner may do without being treated as participating in control, including transacting business with the partnership, serving as an officer or director of a corporate general partner, and acting as an employee or contractor. The practical consequence is that sitting on an advisory committee or consulting on a deal does not, by itself, cost a limited partner its protection.

What are limited partners, and who are limited partner investors?

Limited partners are the capital. ILPA notes that to be a limited partner you must be a legally defined qualified investor, a class that includes public pensions, endowments and insurance companies, and that private equity is long-term capital usually locked up for ten years or more.

In practice the roster is:

• Public and corporate pension plans
• University and foundation endowments
• Insurance company general accounts
• Sovereign wealth funds
• Funds of funds and dedicated emerging manager programs
• Family offices and high-net-worth individuals, usually through a feeder or an aggregator vehicle
• Corporates investing off balance sheet

Who is eligible is set by two statutes working together. A fund relying on section 3(c)(1) of the Investment Company Act may have its outstanding securities, other than short-term paper, beneficially owned by not more than one hundred persons, or 250 persons in the case of a qualifying venture capital fund, defined as a venture capital fund with not more than 10,000,000 dollars in aggregate capital contributions and uncalled committed capital, a figure the Commission indexes for inflation once every five years. A fund relying on section 3(c)(7) must be owned exclusively by persons who were qualified purchasers when they acquired their securities, which for a natural person means owning not less than 5,000,000 dollars in investments and for a person acting for its own account or the accounts of other qualified purchasers means owning and investing on a discretionary basis not less than 25,000,000 dollars in investments. Either exclusion also requires that the fund not be making and not propose to make a public offering of its securities. Those thresholds are why a small fund has a short investor list and a large one has an institutional one.

Limited partner venture capital: what differs

The legal status is identical. Three things about venture change the experience of being a limited partner.

• The distribution profile is later and more skewed. Venture returns concentrate in a few positions, so interim multiples say little until the fund is well past its investment period.
• Marks are estimates, not prices. A venture fund's holdings are illiquid preferred stock valued from the last round and judgment, which means residual value is the largest and least verifiable part of any interim return.
• Fund sizes are smaller and the 3(c)(1) hundred-holder ceiling binds sooner, which is why venture funds use side letters, feeders and aggregator vehicles more often than large buyout funds do.

What a limited partner is actually obligated to do

The commitment is a promise, and the promise is enforceable. Except as provided in the partnership agreement, Delaware law obligates a partner to the limited partnership to perform any promise to contribute cash or property or to perform services, even if the partner is unable to perform because of death, disability or any other reason, and if the contribution is not made the partnership may at its option require cash equal to the unmade portion of the agreed value, in addition to any other rights including specific performance. The same statute treats contributions payable upon a discretionary call by the partnership or a general partner as conditional obligations, enforceable once the call occurs, and permits the partnership agreement to specify penalties or consequences for a partner who fails to contribute.

Translated: a limited partner does not choose when capital leaves. It arrives as a notice with a due date, and defaulting on it is governed by whatever default remedy the agreement contains, which commonly includes forfeiture of a portion of the capital account.

A worked example

Figures are hypothetical. An endowment commits 10,000,000 dollars to a 250,000,000 dollar fund. Its sharing percentage is 10,000,000 divided by 250,000,000, or 4 percent, and that percentage governs every call and every distribution.

The first call draws 15 percent of commitments. The fund calls 250,000,000 times 0.15, or 37,500,000 dollars, and the endowment's share is 4 percent of 37,500,000, or 1,500,000 dollars, which is the same as 10,000,000 times 0.15. It wires within the notice period set in the partnership agreement.

Five years in, cumulative calls reach 80 percent of commitments. The endowment has contributed 10,000,000 times 0.80, or 8,000,000 dollars, and still carries 2,000,000 dollars of unfunded commitment it must keep liquid. The fund then distributes 30,000,000 dollars. The endowment receives 4 percent of 30,000,000, or 1,200,000 dollars, so distributions to paid-in capital is 1,200,000 divided by 8,000,000, or 0.15 times.

Note what the 0.15 does not tell you: nothing about the residual value of the remaining portfolio, which at year five is where essentially all of the outcome still lives.

What is limited partner data?

Two different things travel under that phrase. On the fundraising side it means the dataset a manager uses to target investors: which institutions have committed to which strategies, their pacing, their size bands and their mandates. On the operations side it means the investor master a manager must maintain accurately for every partner: subscription documents, anti-money-laundering and know-your-customer records, tax status and withholding elections, wire instructions, sharing percentage, drawn and unfunded balances, and any side letter terms that alter reporting or fees. The second dataset is the one that causes real damage when it is wrong, because every call notice and every allocation is computed from it.

What is limited partners relationship management?

Limited partners relationship management, usually shortened to investor relations, is the discipline of running that relationship deliberately rather than reactively: a commitment pipeline with owners and next steps, a log of every diligence request and its answer, a single record of what each investor was told and when, and a re-up plan that begins well before the next fund opens. The reason it is a discipline and not administration is that the next fund is raised largely from the current one, so the quality of reporting and responsiveness during fund one is the fundraising work for fund two.

Common mistakes

• Calling every investor a limited partner. An investor coming through a feeder or an aggregator vehicle is a member of that vehicle; the vehicle is the limited partner. That distinction determines who receives notices, who gets a Schedule K-1 from the fund and who counts toward the 3(c)(1) holder limit.
• Treating an unfunded commitment as uncommitted money. It is a legally enforceable obligation payable on someone else's schedule, and the liquidity to meet it has to exist.
• Assuming influence follows size. Rights come from the partnership agreement and any side letter, not from check size, and most limited partners have no management authority at all.
• Reading an interim multiple as a result. Early distributions to paid-in capital of a fraction of a turn is the normal state of a young fund, not a signal.

Adjacent terms

General partner is the counterparty: the entity that manages, makes the calls and earns the carried interest, and the only partner whose liability is not limited in the way the statute describes. Capital call is the mechanism by which a commitment becomes cash, and the document a limited partner's obligations are actually exercised through. Fund life explains the horizon, since a limited partner has bought a ten-year-plus illiquid position with no exit on demand, which is why the secondary market for limited partnership interests exists at all.