In the private equity investment field, LP (limited partner) refers to the investors in a private equity fund, who contribute capital but have limited liability and limited control over the fund’s investment decisions. The GP (general partner), who manages the fund’s investments, has unlimited liability. This article will provide a comprehensive explanation of the following aspects about LP in investing: the definition and types of LP, LP’s rights and obligations, LP’s considerations for fund selection, and the necessity of investing through LP. With numerous examples and data, this article aims to help readers gain a thorough understanding of the important roles LP plays in private equity investing.
LP refers to the passive investors with limited liability in a private equity fund
In private equity investing, the fund investors are known as limited partners (LPs). They commit capital to a private equity fund, which is managed by the general partner (GP). While GPs have unlimited liability and are responsible for the investment decisions, LPs have limited liability and usually do not participate in the daily management of the fund. The limited partnership structure protects LPs from losing more than their invested capital. Common types of LPs include pension funds, sovereign wealth funds, insurance companies, endowments, family offices, and high net worth individuals. Compared with GPs who actively manage the investments, LPs play a more passive role by contributing funds and enjoying limited liability.
LPs have rights like information access and advisory boards, but obligations like capital commitment
Though passive investors, LPs still have certain rights in a private equity fund. LPs can access information about the fund’s portfolio companies, performance metrics, financial statements, etc. Large LPs often secure a seat on the fund’s Limited Partner Advisory Committee (LPAC). LPACs consult with GPs on material matters like conflicts of interest, replacement of key persons, changes to fund terms, etc. On the obligation side, LPs must honor capital calls from GPs and contribute committed capital during the investment period, which usually lasts 5 years or longer. LPs also pay an annual management fee to the GP based on committed capital, typically around 2%.
LPs assess factors like performance, strategy, team dynamics when selecting PE funds
When investing as an LP, conducting thorough due diligence across qualitative and quantitative factors is critical for identifying promising funds. Key criteria include: past fund performance compared to benchmarks, investment strategy and sector focus, experience and dynamics of the investment team, deal sourcing capabilities, risk management practices, alignment of interest between GP and LPs. Top-tier LPs gain access to the most sought-after funds by leveraging their reputation, large commitment amounts, and value-added capabilities like industry expertise or geographic reach.
Investing in funds as LPs allows diversification and access to top-performing GPs
LPs may question whether they should access private market investments directly as co-investors or through fund structures. Investing solely on a direct basis requires significant resources and capabilities. By investing through funds, LPs can gain exposure to multiple geographies, sectors, and vintages through a single commitment. Top-tier LPs get allocated to oversubscribed, closed-end funds of top-performing GPs, an advantage unattainable for most individual direct investors. For LPs with limited capacities, fund investment provides diversified access to private markets and draws on GPs’ networks and expertise.
In summary, LP refers to the investors with limited liability in private equity funds, who contribute capital but do not manage the investments. LPs conduct rigorous due diligence when selecting funds to invest in. Investing through fund structures allows LPs to gain diversified exposure to private markets and leverage the networks and expertise of top-tier GPs.