Limited Partnership
A limited partnership is the legal structure used by most venture capital funds. The structure separates the fund into two parties: general partners (GPs) who manage the fund and make investment decisions, and limited partners (LPs) who provide capital but do not participate in day-to-day management. 1
This structure provides liability protection for LPs, whose financial exposure is limited to their investment amount. It also creates clear incentive alignment, as GPs earn returns only when the fund performs well. 2
How a Limited Partnership Works
In a VC fund structured as a limited partnership:
General Partners (GPs) are the active fund managers responsible for making investment decisions, running the fund's operations, and advising portfolio companies. GPs invest their own capital (typically 1-2% of the fund) and earn management fees plus carried interest. They have unlimited personal liability for the fund's obligations. 3
Limited Partners (LPs) are the investors who provide the capital for the fund. They include pension funds, endowments, family offices, and high-net-worth individuals. LPs do not participate in investment decisions or fund management, and their liability is limited to their committed capital. 3
The Limited Partnership Agreement
The limited partnership agreement (LPA) is the core legal document that formalizes the relationship between GPs and LPs. The LPA specifies:
- GP and LP commitments
- Management fee and carried interest terms
- Distribution waterfall structure
- Hurdle rates and catch-up provisions
- Fund term and extension procedures
- Reporting requirements 2
Tax Treatment
One reason the limited partnership structure is preferred in venture capital is pass-through taxation. The fund itself does not pay corporate income tax. Instead, profits and losses flow through to partners, who report them on their individual tax returns. This avoids the "double taxation" issue that affects corporations. 1
Role in Fund Economics
The limited partnership structure creates aligned incentives through:
GP Entity Commitment: GPs typically invest 1-2% of their own capital alongside LPs. This skin in the game demonstrates confidence and aligns GP interests with fund performance. 2
Clawback Provisions: If a GP receives excess carried interest due to early wins but the fund underperforms overall, clawback provisions require the GP to return overpayments. This ensures LPs are protected from overpaid GP compensation. 1
Distribution Waterfall: Profits are distributed in a specific sequence: first return of capital to LPs, then preferred return to LPs, then catch-up to GPs, and finally split between LPs (typically 80%) and GPs (20% as carried interest).
Key Differences from General Partnership
In a general partnership, all partners have unlimited liability and participate in management. The limited partnership structure provides:
| Aspect | General Partnership | Limited Partnership |
|---|---|---|
| Liability | Unlimited (all partners) | Limited (LPs protected) |
| Management | All partners | GPs only |
| Capital raising | Difficult | Compound structure |
| Investment decisions | Consensus required | GP autonomy |
Alternative Structures
While limited partnerships remain the standard, some funds use alternative structures:
- LLC (Limited Liability Company): Offers flexibility in management and taxation but may have less LP friendly governance.
- Delaware Statutory LP: Many VC funds are formed in Delaware for its well-developed corporate law.
- Parallel LP Structures: Used when a fund has multiple investment strategies or LP groups with different terms. 1
Example Structure
A typical $100 million VC fund structured as a limited partnership:
- LP commitments: $98 million from pension funds, endowments, family offices
- GP commitment: $2 million (2% of fund)
- Management fee: 2% annually ($2M/year)
- Carried interest: 20% of profits above hurdle
- Fund term: 10 years with possible extension
The LP entity is typically a Delaware statutory limited partnership, with the GP entity usually organized as an LLC or corporation to hold the GP's interest. 1