(In this article, I've brought together ideas presented by various parties on Private Equity limited partnerships, with a South African context)
A partnership may be defined as a "legal relationship arising from a contract between two or more persons each contributing to a business or undertaking carried on in common, with the object of making and sharing profits." In South Africa there are ordinary partnerships and extraordinary partnerships.
There are 3 types of extraordinary partnerships in SA: anonymous partnerships, En Commandite and a third type which it is no longer possible to create (and hence is not covered further in this document).
The French word "Commandite" evolved from the latin commendator which means capitalist; who would entrust capital to a trader (commendatorius) for employment in business, with the agreement that whilst he was not a party to the business the trader carried out, he was entitled to profit, and was not liable further than the capital he'd entrusted.
En Commandite
En Commandite partnerships have 2 categories of partners:
- those with limited liability who are known as the "limited partners" or "en commandite partners" or the "fund's investors".
- those with unlimited liability to third parties - known as the fund's "general partner". This is usually the private equity firm.
Extraordinary Partnerships that are "en commandite" are also known as "limited partnerships", as the partner that is en commandite is "only liable to third parties to the same extent that he has contributed to the Partnership, and not more". The limited liability feature is the reason why private equity funds are often structure as en commandite partnerships. Note that its not the partnership as a whole which enjoys limited liability protection, but merely the en commandite partners.
The Partnership Agreement will specify how partners en commandite will share in the profit. Usually the business of the partnership is carried out in the name of one partner only; whilst the other parties merely put forward capital and are not involved in the running of the business.
The identity of the en commandite partners is not disclosed to third parties or the outside world, so as not to create expectations with creditors which will not be realised - if the name were disclosed this may create the impression that the limited partner is a general partner.
En Commandite partnerships are the most commonly used legal structure for private equity funds in South Africa.
Partnership Agreement
The terms of an en commandite partnership are set out in the limited liability partnership agreement between the general partner, the limited partners and the fund manager.
Profit & Fees
The Private Equity manager will usually earn fees based on:
- management fees - usually a percentage of the total commitments
- carried interest - based on the performance of the fund versus a hurdle rate
Limited partners usually have the first return of profits until their capital has been repaid; and then are paid profits up to a predefined hurdle rate (e.g. 10%). Profit above the hurdle rate is split between the general partner and the limited partner. The returns paid to the general partner is known as "carried interest".
Traditionally, limited liability partnerships have a 2% management fee and 20% of the profits above the hurdle rate.
Other Structures for Private Equity
Limited liability partnerships typically have a life of 10 years. However, even a 10 year period is sometimes too short to create optimal returns.
Bewind Trusts
In SA private equity funds are usually structured as either a limited partnership, or a bewind trust. Bewind trusts are mostly only in use by older funds.
Under a bewind trust "the founder or settlor transfers ownership of property to beneficiaries of the trust, but control over the assets or property is given to the trustee(s)." (see SARS: Types of Trust)
"This structure lacks flexibility in terms of ring-fencing the liability of investors, and is not a common vehicle globally". If a structure is pursued which doesn't comply with international norms, the structure may put off potential investors.
SPACs (Special Purpose Acquisition Company)
A SPAC is a permanent investment vehicle which is listed from the start with no operations, and allowed 2 years to acquire sufficient investments. Directors have at least 5% skin in the game. The first investment must be approved by shareholders, and the capital is held in escrow until the first investment has been made, which creates a cash drag on investment returns.
Section 12J Venture Capital Company
Investors can claim amounts incurred on acquiring Venture Capital Companies (VCCs) as a deduction from income (see SARS: Venture Capital Companies). The VCC shares must be held for more than 5 years. To qualify as an approved VCC, the company must:
- be a resident in SA
- "the sole object of the company must be the management of investments in qualifying companies". "The expenditure incurred by the VCC to acquire qualifying shares in anyonequalifying company must not exceed 20% of any amounts received by the VCC in respect of the issue of VCC shares." "A minimum of 80% of the expenditure incurred by the VCC to acquire assets must be for qualifying shares, and each investee company must, immediately after the issuing of the qualifying shares, hold assets with a book value not exceeding:
- R500 million in any junior mining company; or
- R50 million in any other qualifying company"
- "the company's tax affairs must be in order"
- "the company must be licensed in terms of section 7 of the FAIS Act."
SARS provide a list of qualifying VCCs.
Investee companies must be unlisted or a junior mining compay listed on the AltX of the JSE. "During any year of assessment, the sum of the investment income derived by the company must not exceed 20% of its gross income". "The company may not carry out any of the following trades:
- Related to immoveable property, except as a hotel keeper (including B&Bs).
- Financial services such as banking, insurance, money-lending and hire-purchase financing.
- Provision of financial or advisory services, including legal, tax advisory, stock borking, management consulting, auditing or accounting.
- Gambling related activities.
- Manufacturing or buying or selling of liquor, ammunition, arms or tobacco.
- Trade mainly outside RSA."
En Commandite vs Ordinary Partnerships
The above features of an Extraordinary Partnership which is en Commandite, contrasts with ordinary partnerships where all partners are involved in the running of the business and are all liable for the debt of the partnership (as set out in the Partnership agreement).
En Commandite vs Silent Partnership
Silent partnerships are similar to en commandite partnerships; as inter alia in both cases the partners are not disclosed to third parties and they don't take part in the business operations.
The difference is that en commandite partners' liability is limited to their agreed capital contributions; whilst silent partners are liable for their pro rata share of all partnership debts.
Ways En Commandite Partners may lose limited liability
If an en commandite partner takes part in the operations of the partnership, they may be regarded as an ordinary partner and lose their limited liability protection.
If an en commandite partner includes its name in the name of the partnership, it may be viewed as an ordinary partner, and lose its limited liability (the reason for excluding en commandite partners' names is so that creditors wont mistake them for ordinary partners who they can rely on).
If the en commandite partner is represented on the investment committee of the partnership, or takes part in some other way in the investment decisions of the partnership. This poses a problem, as many en commandite partners want to have a say in how their contributions are invested. It is not clear what the degree of the involvement needs to be, before the en commandite partner is loses his limited liability protection.
Pension Funds Act
Regulation 28 of the Pension Funds Act stipulates where Pension Funds may invest. "A fund must not invest or contractually commit to invest in an asset, including a hedge fund or private equity fund, where the fund may suffer a loss in excess of its investment or contractual commitment in the asset...Hedge funds and private equity funds that may expose the fund to a liability must be held in a limited liability structure."
rob@investsouthafrica.co.za
Disclaimer
Due to regulations, my emails and website should be considered as having been set up for entertainment purposes alone. Expect errors and omissions. Investment in shares and other financial instruments should be conducted by professional investment experts only. Any use of the information on my websites, emails and newsletters is at your own risk, and by using it you agree that myself, the owners of our websites, authors and associated parties wont be held liable for any losses suffered as a result of using the information. None of the information should be construed as being advice. Our newsletters, articles, discussions and website are not an offering for any investment. It represents only our and others' opinions. Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsem*nt, or inducement to invest. Illustrations, forecasts or hypothetical data are not guaranteed and are provided for illustrative purposes only. There are risks involved in buying or selling a financial product. Past performance is not indicative of future performance. Any investment values given are not guaranteed. Investment returns can be volatile. When investing there is always the risk of losing all or a substantial amount of your investment, as well as the risk of illiquidity. There may be advertisem*nts on some pages on this website, and we may earn income from these advertisem*nts. We may earn commission on products invested in or annuities purchased. We cannot attest to the accuracy of the material presented here, and opinions expressed may be changed without prior notice. In any event our liability will be limited to R1, and any court cases must take place in Cape Town. You may contact us at rob@investsouthafrica.co.za
Subscribe to our newsletter
Improve your Living Annuity Odds of outperformance
For most retirees I can show a living annuity solution which will probably outperform over the next 10 years. For a free checkup email me at rob@investsouthafrica.co.za
FAQs
What Does Limited Partner (LP) Mean? In the context of private equity, a limited partner (or LP) is a third party investor in a private equity fund. Private equity firms raise private funds in general partnerships where they manage the capital as the general partner.
How do limited partners get paid in private equity? ›
The private equity firm acts as a GP, and the external investors are limited partners (LPs). read more is paid either by way of a management fee, or it can be by way of compensation. A management fee is nothing but a percentage of the total amount of the fund's capital.
What is the difference between GP and LP? ›
A private equity firm is called a general partner (GP) and its investors that commit capital are called limited partners (LPs). Limited partners generally consist of pension funds, institutional accounts and wealthy individuals.
What does Ilpa stand for private equity? ›
Institutional Limited Partners Association - ILPA. 20 Years of ILPA. Annual Reports.
Is private equity a company or LLP? ›
An LLP does not have the concept of equity or shareholding like a company. Hence, angel investors, HNIs, venture capital and private equity funds cannot invest in an LLP as shareholders. Thus, most LLPs would have to rely on funding from promoters and debt funding.
Why do private equity funds use limited partnerships? ›
Limited partnership agreements are popular for various kinds of investment pools. Hedge funds, private equity funds, and venture capital funds usually structure each fund in an LP to allow limited partners to make passive investments in the fund while the general partners make investments and earn carried interest.
How many LPs can a fund have? ›
Recently, the SEC changed regulations regarding the number of investors funds below $10m can have and increased the number to 250 limited partners.
Can you make millions in private equity? ›
Average compensation per employee from management fees alone could easily top $1 million annually, although senior professionals would always earn more than junior staff.
Do LPs get carried interest? ›
Carried interest represents the percentage of profits that will be paid to the fund manager. The typical carried interest rate charged to LPs is 20%. The carried interest paid to the fund manager is directly impacted by the performance of the fund.
What are 3 types of partnerships? ›
There are three relatively common partnership types: general partnership (GP), limited partnership (LP) and limited liability partnership (LLP). A fourth, the limited liability limited partnership (LLLP), is not recognized in all states.
Private equity firms invest the money they collect on behalf of the fund's investors, usually by taking controlling stakes in companies. The private equity firm then works with company executives to make the businesses — called portfolio companies — more valuable so they can sell them later at a profit.
How do I join the ILPA? ›
Membership is open to individuals, and organisations. Members must adhere to ILPA's Guidelines for members. The application is a simple process, first decide if you are applying as an individual or an organisation member, and which category of membership you fit. You can then complete the simple online form.
What is included in limited partnership agreement? ›
The Limited Partnership Agreement identifies what individual or other entity serves as the general partner. It also lists the ownership interests, profit percentage interest and any special rights of the general partner and limited partners.
What are examples of limited partners? ›
However, the limited partners simply invest in the business and have little control over business operations. For example, let's say that Ben, Bob and Brandi are partners in owning and running a bookstore. They own The Book Nook. Per their partnership agreement, Ben and Bob are limited partners.
Which is better Pvt Ltd or LLP? ›
LLPs are also not as recognized in India as a private limited company, since it is a relatively new concept. Private limited company offers its promoters a better image or standing than that of a LLP. Private limited company also enjoys better access to funding from banks and foreign direct investment.
What is the difference between LLP and Pvt Ltd? ›
Shares of Private Limited Company cannot be publicly traded. A Limited Liability Partnership means a business where a minimum of two members are required and there is no limit on the maximum number of members. The liability of the members of an LLP is limited.
Which is better Pvt Ltd or partnership firm? ›
Some advantages of partnership over private limited company include ease of establishment and lower costs. A partnership consists of two or more individuals who own a business together and share all its profits and losses, as well as the right to manage and make decisions on behalf of the business.
Are private equity firms limited partnerships? ›
Private equity funds are closed-end investment vehicles, which means that there is a limited window to raise funds and once this window has expired no further funds can be raised. These funds are generally formed as either a Limited Partnership (“LP”) or Limited Liability Company (“LLC”).
How do private equity firms make money? ›
Private equity firms buy companies and overhaul them to earn a profit when the business is sold again. Capital for the acquisitions comes from outside investors in the private equity funds the firms establish and manage, usually supplemented by debt.
What is the difference between LP and LLC? ›
With an LLC, all of the members obtain limited personal liability. The members may also participate in the management of the business and keep their limitation of liability. In an LP, only limited partners enjoy limited personal liability.
Partners do not receive a salary from the partnership. Rather, the partners are compensated by withdrawing funds from partnership earnings. Partnerships are flow-through tax entities. As such, any profits or losses produced by the partnership pass through to the partners.
How long does private equity hold companies? ›
Private equity investments are traditionally long-term investments with typical holding periods ranging between three and five years. Within this defined time period, the fund manager focuses on increasing the value of the portfolio company in order to sell it at a profit and distribute the proceeds to investors.
Do limited partners get carry? ›
Limited partners are the main investors, but do not manage the fund and share in the profits without an extra fee. Together, these two types of investors make up what's called a limited partnership. Carried interest is only paid to general partners after limited partners receive their original investment and profits.
How much money do you need to start a private equity firm? ›
Historically, the standard minimum investment amount for private equity has been $25 million. Recently, however, some firms have departed from this high threshold to garner a wider investment base. Every firm's minimum requirement is different—some are as low as $25,000.
How many hours do you work in private equity? ›
Private Equity Associate Lifestyle and Hours
At many smaller funds and middle-market funds, you can expect to work 60-70 hours per week, mostly on weekdays, with occasional weekend work when deals heat up.
Is private equity stressful? ›
It's extremely difficult to get into private equity, and once you're in, the job is stressful and requires long hours and sacrifices, especially when deals are in their final stages.
Who gets carry in private equity? ›
The Partners of the firm contribute most of the initial GP investment, so they also claim most of the carried interest pool. Carry is typically based on the percentage of the total pool for each fund, and it vests over several years (often 5 years, back-end-loaded, and sometimes up to 10).
Does an LP need a GP? ›
Limited Partnership (LP)
At least one partner must be a general partner with unlimited liability. At least one partner must be a limited partner. This person's liability is typically limited to the amount of his or her investment.
How does private equity carry interest work? ›
Carried interest is a form of compensation paid to investment executives like private equity, hedge fund and venture capital managers. The managers receive a share of the fund's profits — typically 20% of the total — which is divided among them proportionally.
Why are hedge funds limited partnerships? ›
Most Hedge Funds Are Established As Limited Partnerships
Determines strategy and makes investing decisions and allocations, as well as manages portfolio risk. The investment manager is also invested in the fund and is compensated via a management fee, as well as a performance fee based on the fund's annual performance.
The GP/LP structure may provide symbiotic alignment, whereby the sponsor identifies the opportunity and provides management expertise to execute the business plan while the LPs are able to participate in the fruits of the investment by providing the bulk of the capital needed to consummate the transaction.
What do private equity firms do? ›
Private equity firms invest the money they collect on behalf of the fund's investors, usually by taking controlling stakes in companies. The private equity firm then works with company executives to make the businesses — called portfolio companies — more valuable so they can sell them later at a profit.
What is a limited partner in a fund? ›
Limited partnerships are generally used by hedge funds and investment partnerships as they offer the ability to raise capital without giving up control. Limited partners invest in an LP and have little to no control over the management of the entity, but their liability is limited to their personal investment.
What is the difference between hedge funds and private equity? ›
Hedge funds are alternative investments that use pooled money and a variety of tactics to earn returns for their investors. Private equity funds invest directly in companies, by either purchasing private firms or buying a controlling interest in publicly traded companies.
Are limited partnerships good investments? ›
Limited partnerships can be a great addition to a diversified portfolio. They are complex investments and not suitable for every investor. But many investors can benefit from these investments, if they are prudent in their decisions.
Are hedge funds LLP or LLC? ›
The hedge fund is typically set up as either a limited partnership (LP) or limited liability corporation (LLC). In comparison, a general investment manager can be set up any type of business structure that meets the needs of the investment manager.
How many LPs can a fund have? ›
Recently, the SEC changed regulations regarding the number of investors funds below $10m can have and increased the number to 250 limited partners.
Does an LP need a GP? ›
Limited Partnership (LP)
At least one partner must be a general partner with unlimited liability. At least one partner must be a limited partner. This person's liability is typically limited to the amount of his or her investment.
Does the GP own the LP? ›
GPs generally have full power and authority to act on behalf of the ELP and to bind the ELP without prior consultation with any of the LPs. Any partners that are not general partners are LPs.
How do private equity make money? ›
Private equity firms buy companies and overhaul them to earn a profit when the business is sold again. Capital for the acquisitions comes from outside investors in the private equity funds the firms establish and manage, usually supplemented by debt.
Who can invest? A private equity fund is typically open only to accredited investors and qualified clients. Accredited investors and qualified clients include institutional investors, such as insurance companies, university endowments and pension funds, and high income and net worth individuals.
Why is it called private equity? ›
Private equity firms are, as their name suggests, private — meaning they're owned by their founders, managers, or a limited group of investors — and not public — as in traded on the stock market.
What are the disadvantages of limited partnership? ›
Disadvantages of a Limited Partnership
- Extensive Documentation Required.
- Lack of Legal Distinction for General Partners.
- General Partners' Personal Assets Unprotected.
- General Partners Liable for Each Others' Actions.
- Less Protection from Excessive Taxation.
To form a limited partnership, you have to register in your state, pay a filing fee and create a limited partnership agreement, which defines how much ownership each limited partner has in your company, and other terms of the partnership.
Do limited partners get paid? ›
Partners do not receive a salary from the partnership. Rather, the partners are compensated by withdrawing funds from partnership earnings. Partnerships are flow-through tax entities. As such, any profits or losses produced by the partnership pass through to the partners.
