Limited partner (LP)

What is a limited partner?

A limited partner (LP) is an investor who contributes capital to business partnership in exchange for a proportionate share of the profits. Limited partners are not involved in the day-to-day operations or decision-making processes; these responsibilities are handled by the general partners (GPs). LPs have limited liability for any debts the business might incur, and are only liable for the amount of capital they invested.

A limited partnership structure is a business arrangement that involves at least one limited partner and at least one general partner. The LP provides the capital, while the GP operates the business. The relationship between limited partners and the partnership is governed by a limited partnership agreement (LPA), which outlines the rights, responsibilities, and profit-share arrangements of all parties. Limited partners typically receive updates about the partnership’s performance and returns on their investment, but their role remains passive.

While limited partners are not actively involved in daily operations, they still have certain rights and responsibilities for business decisions. Limited partners:

• Must approve any major changes to the business plan or structure of the partnership (usually by majority vote)

• Have the right to review financial statements and request information about the progress of the business

Limited partnerships are attractive to investors because this structure allows them to earn a return on investment while spreading out their personal risk by investing in multiple ventures, which reduces their overall exposure to loss if any one particular investment fails.

Limited partners in private equity and venture capital

In private equity and venture capital, a limited partner is an investor who contributes capital to the fund but does not participate in its day-to-day management. These private funds are typically formed as limited partnerships, with the investment firm serving as the general partner. Firms then use those funds to invest in private companies, and the limited partners receive a share of any eventual profits. In private capital, limited partners are the original source for most of the funding that flows into startups.

The most common types of limited partners in the private equity and venture capital ecosystem are individuals, institutions, and family offices.

• Individual LPs are typically high-net-worth individuals who invest their own personal capital into private funds. Individuals might also choose to be angel investors and invest directly into startups, instead of or in addition to funds.

• Institutional LPs are organizations with large amounts of capital to invest and a mandate to generate consistent returns on a long or even perpetual timeline. Common limited partners in private funds include pension funds, endowments, foundations, and sovereign wealth funds.

• Family offices are private firms that manage the finances of wealthy families. Like individuals, family offices also sometimes make direct investments in startups.

This video gives an overview of how limited partnerships work in venture capital as part of Carta’s free VC 101 curriculum.

Limited partner vs. general partner

A limited partner provides the financial backing for a business venture and does not take an active role in daily management. Limited partners are also known as “silent partners” or “passive investors” because of this hands-off role.

General partners (GP), on the other hand, are directly involved in managing and operating the business. GPs have unlimited personal liability for any debts and losses incurred by the business. In return for managing day-to-day operations and shouldering more risk than limited partners, GPs usually receive a share of the profits produced from the pooled investments of limited partners, in addition to other benefits, like management fees.

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What is a limited partnership agreement?

A limited partnership agreement (LPA) is a contract among the limited partners and general partners involved in a venture that outlines each party’s rights, responsibilities, and obligations. The agreement should specify the percentage of ownership each partner has in the business, how profits will be distributed, and what happens if one partner wants to sell their stake in the business, among other variables.

An LPA can help prevent disagreements between partners and protect each partner’s interests and personal liability in the business.

Before you create an LPA, you may need to file a Certificate of Limited Partnership with your local Secretary of State’s office to officially form the LP entity.

What is a limited liability partnership?

A limited liability partnership (LLP) is another form of business structure in which all partners have limited liability. This differs from a limited partnership, which requires at least one general partner with unlimited liability, and a general partnership, in which all partners assume unlimited liability. LLPs are most common among professional services businesses, such as law firms, accounting firms, or medical practices. Different states have different laws about what sort of business can operate as an LLP.

How are limited partners taxed?

Limited partnerships are taxed as pass-through entities. This means that limited partners receive individual tax treatment on their share of the partnership’s profits or losses, rather than the partnership itself being taxed.