Ownership structures: general and limited partners

How is an alternative fund organized?

Alternative funds are usually set up as partnerships because a partnership can split risk, return and duties between investors and managers however the parties agree. A limited partnership has at least one general partner and a group of limited partners.

Ownership structurespartnerships let risk, return and duties be allocated flexibly

• Limited partnership Memorize the standard private fund
  • General partner (GP) Memorize manages; unlimited liability; earns fees
  • Limited partners (LPs) Memorize passive; liability capped at investment
  • Limited partnership agreement Use it the rulebook for all
  • Side letters Use it custom terms for one or more LPs
• Public–private partnership Use it infrastructure: special purpose entity under a concession agreement
• Master limited partnership Use it units, often listed: more liquid real estate or resource exposure
• Other vehicles trusts, LLCs, REITs, commodity funds, ETFs, joint ventures

Who does what: the GP and the LPs

The general partner (GP) is the fund manager. It buys and sells assets, borrows, sets up reserves, enters contracts and reports to investors, to an agreed standard of care. It has unlimited liability for the fund in principle, usually invests some of its own capital, and earns management and performance fees. One GP may run several funds.

The limited partner (LP) is an outside investor. Each LP owns a fraction of the partnership based on its investment and the partnership terms. LPs are passive: they do not manage the fund (their co-investment rights allow additional direct stakes, but not control of the fund), and their liability stops at the amount they invest. They are typically accredited investors : institutions or wealthy individuals who meet net worth or other tests, because these funds are less regulated than public offerings. The number of LPs is limited.

LPs make a promise rather than a payment. Their committed capital is the total they have agreed to provide. The GP calls it down when it finds deals, often over three to five years of a ten-year fund life. The upfront cash can therefore be a small share of the commitment.

What do the LPA and side letters do?

The limited partnership agreement (LPA) is the rulebook. It covers how profits and losses are distributed, the manager’s investment criteria and limits, and the terms for transfers, withdrawals and dissolution.

Some investors need different terms because of their own legal, regulatory or reporting rules. A side letter is a separate document between the GP and one or more LPs that overrides or adds to the LPA for them. Typical items are:

• extra investment reporting,
• different fee, co-investment or secondary-sale treatment,
• the right to transfer to a related or successor fund,
• an excusal right, the right to skip a capital call.

A most favored nation clause in a side letter gives that LP any better or additional terms the GP later gives others. Without one, a side letter helps only the LPs who signed it.

Compare the bond market: every holder of a public bond gets the same standard indenture. An LPA plus side letters is customized.

Exam tip Ask “for whom?” If the terms apply to every partner, it is the LPA. If they are for one investor (extra reports, a fee discount), it is a side letter.

What other structures appear?

• A public–private partnership (PPP) is an agreement for the public and private sectors to finance, build and run public infrastructure. The private side usually works through a special purpose entity that raises equity and debt for one road or bridge.
• A concession agreement is the contract that grants the private operator the right to operate and charge fees for a fixed term. When it ends, the asset is sold or returned to a public sector body.
• A master limited partnership (MLP) is a partnership whose units are often publicly traded, common in real estate and natural resources. It works like a limited partnership but is usually more liquid.

More liquid ways into alternatives include real estate investment trusts (REITs), commodity funds and exchange-traded funds (ETFs). Direct real estate often uses joint ventures. Trusts and the limited liability company (LLC) are further structures.

Go deeper Why partnerships suit alternatives

A partnership lets the parties choose who bears which risk, who gets which share of return and who has which duties, without the fixed rights of ordinary shares. In many jurisdictions it also passes income through to the partners instead of taxing the fund itself.

Go deeper Other side letter rights

Side letters can also cover rights of first refusal on co-investments, rights to invest in a successor fund, and limits on conflicts of interest.