TL;DR
A Limited Partner (LP) is an investor who contributes capital to a private equity fund, venture capital fund, or other investment partnership, but does not have an active role in managing the investments.
LPs typically include institutional investors such as:
- Pension funds
- Endowments
- Insurance companies
- Sovereign wealth funds
And high-net-worth individuals.
In return for their investment, LPs receive a share of the profits generated by the fund, usually after the GP has taken their management fees and carried interest.
Role and Responsibilities of Limited Partners
Limited Partners have a passive role in the fund, meaning they do not participate in the management or decision-making processes.
However, they do have certain rights and responsibilities.
1. Providing Capital
The primary role of an LP is to provide the capital that the GP uses to make investments. LPs commit a certain amount of money to the fund, which is typically drawn down over time as the GP identifies and makes investments.
This capital is used to acquire assets, invest in companies, or pursue other opportunities that align with the fund’s investment strategy.
2. Monitoring Performance
While LPs do not manage the fund, they have the right to monitor its performance. GPs are required to provide regular updates to LPs, including financial reports, performance metrics, and information about the fund’s portfolio.
LPs use this information to assess whether the fund is meeting its objectives and to make informed decisions about future investments.
3. Participating in Major Decisions
Although LPs do not manage the fund, they may have the right to vote on certain major decisions, such as changes to the fund’s structure, extensions of the fund’s life, or the removal of the GP in extreme cases.
These rights are typically outlined in the Limited Partnership Agreement (LPA), which governs the relationship between the LPs and the GP.
4. Understanding and Accepting Risk
As investors in private equity and venture capital funds, LPs must understand and accept the risks associated with these investments.
These risks include the potential for loss of capital, the illiquid nature of the investments, and the long-term horizon required to realize returns. LPs should conduct thorough due diligence before committing capital and ensure that the investment aligns with their risk tolerance and financial goals.
How Do Limited Partners Differ from General Partners?
The key differences between Limited Partners and General Partners lie in their roles, responsibilities, and rights within the fund:
- Management Role: The GP is responsible for managing the fund, making investment decisions, and overseeing the day-to-day operations. In contrast, the LP is a passive investor with no direct involvement in the fund’s management.
- Risk and Liability: LPs have limited liability, meaning they are only liable for the amount of capital they have invested in the fund. GPs, on the other hand, may have unlimited liability for the actions and obligations of the fund, depending on the structure of the partnership.
- Compensation: GPs are compensated through management fees and carried interest, which is a percentage of the fund’s profits. LPs receive a share of the profits based on their capital contribution, typically after the GP has taken their fees and carried interest.
- Decision-Making Authority: GPs have full decision-making authority when it comes to the fund’s investments and operations. LPs may have a say in certain major decisions, but their role is largely passive.
Conclusion
Limited Partners (LPs) are the financial backbone of private equity and venture capital funds, providing the capital that drives investment in high-growth opportunities.
Interested in learning more VC related terms? Head over to our VC glossary!