GP vs LP in private equity: who does what, who is liable, who is paid

Every private equity fund is two parties joined by one contract. One party decides and carries the risk of the unknown. The other pays, waits and gives up control in return for a cap on what it can lose. Get the two roles straight and most fund terms stop looking arbitrary.

This page uses Hong Kong and Cayman partnership law as its Asian reference points. The fundamentals section has the wider map, and how a fund works covers the mechanics around the two roles.

The two roles side by side

What the general partner does

The GP is the firm that raises and manages the fund, as general partner and investment adviser⁷. Most funds are limited partnerships governed by the limited partnership agreement, the LPA⁷. Under the Hong Kong Ordinance the GP must appoint an investment manager to carry out the day-to-day investment functions, and the GP may be that manager itself². It must also appoint an auditor² and make sure the fund has proper custody arrangements for its assets².

Behind those duties sits the money question. A GP calls capital as it needs it: an investor’s commitment is satisfied over time through capital calls⁷. A fund usually lives for ten years, in IOSCO’s 2010 report⁴, and firms tend to start raising a successor at intervals of around five years⁴. The GP is therefore selling the next fund while it is still running the last, which is why the way it treats today’s investors matters to it.

The GP’s own conduct is regulated where it is licensed. In Hong Kong the SFC’s Fund Manager Code of Conduct applies to licensed persons whose business is managing collective investment schemes⁸. It asks the manager to run arrangements that identify, prevent, manage and monitor conflicts of interest⁸ and to disclose material conflicts to fund investors⁸. In the United States the same duty is a fiduciary one: advisers must disclose conflicts in full to get informed consent⁶, and an adviser has a legal obligation to act in the best interests of each fund it manages⁶.

What the limited partner does, and cannot do

The LP’s role is mostly to fund the deals and wait. Nearly all investors in private equity are passive and rely on the manager to invest and to create liquidity⁷. Governance rights for LPs are typically minimal⁷, and LPs typically cannot demand that investments be sold⁷. The LP can sometimes sell its own fund interest to another investor⁷.

In exchange the LP gets the right to share in the income and profit of the fund², does not owe any fiduciary duty to the GP or to other LPs², and is not liable for the fund’s debts beyond its agreed contribution². LPs are institutions as well as individuals: insurance companies, university endowments and pension funds, and high income and net worth individuals⁶.

The LP is not powerless. In more developed markets a fund typically keeps an investor advisory committee made up of a small sample of its investors⁴, and the committee’s task is conflict management rather than investment decisions⁴. ILPA’s principles want such committees to advise the fund on conflicts without making their members fiduciaries⁵. Side letters let a single investor negotiate extra terms, such as enhanced reporting⁴.

Where the two roles meet: liability

The line between the roles is drawn in statute, and it is the line that matters most in practice. A Hong Kong fund must have one GP with unlimited liability for its debts and at least one LP with limited liability¹. A limited partner who takes part in the management of the fund becomes jointly and severally liable with the GP for the debts the fund incurred while the partner so takes part².

The statute then lists what does not count as management, so investors know what they can do safely. The list includes serving on a committee of the fund², reviewing accounts, valuation and assets², and suing for the fund when the GP refuses without good reason². It is not exhaustive². The Hong Kong LPF guide goes through the rest of the Ordinance.

Cayman draws the line differently. The general partners are liable for all debts if the partnership’s assets are inadequate³. A limited partner who takes part in the conduct of the business in dealings with persons who are not partners can be liable if the partnership becomes insolvent³, but only to someone who dealt with the partnership knowing of that participation and who reasonably believed the partner to be a general partner³. Consulting and advising the general partner and consenting or withholding consent to proposed action are safe³. Our reading: Hong Kong looks at what the partner did, and Cayman looks at who relied on it. A prudent LP stays inside both lists.

Who can be a GP or an LP in Hong Kong

The Ordinance is generous about who may fill each seat. A GP may be a natural person aged at least 18² or a private company limited by shares incorporated under the Companies Ordinance², among other kinds of entity². An LP may be a natural person, a corporation, a partnership of any kind, an unincorporated body or any other entity, acting as trustee or in its own right². The Companies Registry confirms that the fund’s GP has unlimited liability¹, so the choice of GP entity is a liability decision. Our reading: a company as GP stands between the manager’s people and that liability.

Whether an individual can invest as an LP in practice depends on the investor tests for private placements, set out on the fund page.

The process of investing as an LP, step by step

Investing as an LP follows a fixed sequence. The investor receives offering documents with the material information about the investment and then enters into agreements as a limited partner of the fund⁶. The agreed amount is a commitment, and the money is not drawn at signing: the manager draws it through the life of the fund as investment opportunities become available⁴. The investor then waits. An investment in a private equity fund is often illiquid, and it may be necessary to hold it for several years before any return is realised⁶.

How the partnership ends: exits and the end of the term

The partnership ends when the investments are sold. Most funds are set up with a ten-year life and scope for up to three 1-year extensions, subject to investor approval⁴. The GP chooses among exit routes: a trade sale to a buyer that fits the company, a sale to the firm’s management team, repayment of preference shares, or a secondary sale to another private equity fund⁴. When a company lists, the firm often keeps a board seat for as long as the fund holds a significant stake⁴.

The LP sees an exit as a distribution, because distributions are made only as investments become cash⁷. An LP that wants out earlier can transfer its interest to another investor, though the fund is not meant to be traded⁷. Each extension needs investor approval, which is one of the few places where the LPs’ consent changes what the GP can do⁴.

How GPs and LPs keep each other honest

Private equity firms often have interests that conflict with the funds they manage and so with the LPs⁶. The contract is where the two sides negotiate the remedy. Four tools recur.

None of this is automatic. These are terms to look for in a fund document, and each is a negotiation. ILPA’s three guiding principles are alignment of interest, governance and transparency⁵.

How each side is paid, and in what order

The GP is paid in two ways: a management fee and carried interest⁴. The LP is paid out of the profit that is left. In ILPA’s preferred whole-of-fund model all contributions plus a preferred return go back to investors before the GP earns carry⁵. The management fee is the exception: it is charged during the fund’s life, not at the end⁴. The fees and carry guide gives the numbers and worked examples.

This page explains roles. It does not recommend a fund or a manager, and it forecasts nothing.