Those interested in investments in private equity and private debt would do well to understand the terms “general partner” and “limited partner” — two formal but common partnerships in those types of offerings — and their differences and similarities. To help, here is an overview of those investment titles, as well as ways to invest in private equity.
This is a business owned by at least two parties, including at least one general partner (GP) who runs the company and is liable for any debts. LPs are only liable for the amount of their investment, meaning they are not responsible for business debts beyond their initial investment.
To shield investors from the consequences of a failed venture, limited partnerships are often established by real estate investment funds and hedge funds.
In the U.S., the establishment of limited partnerships are governed by states – with the exception of Louisiana — under the 1916 Uniform Limited Partnership Act. Setting up an LP requires partners to register the entity, usually through the Secretary of State.
Limited partnerships must also craft an internal agreement that outlines how the company will be operated and specifies each partner’s responsibilities, rights, and expectations. The agreement should note how profits and losses will be shared and the manner of profit distribution to partners. Further, the agreement must specify the process to be employed should a partner wish to sell their stake in the partnership.
With this structure, all partners share profits, personal liability for business debts, and managerial responsibilities.
To function legally, general partnerships need not register their business with a state. They also offer structural flexibility, allowing them to more closely control operations. While it is not required, each partnership should have a formal agreement.
A joint venture is an example of a type of GP that is set up to finish a certain project and will be dismantled once the project is done.
General partnerships must include at least two people, and all partners must agree to personal responsibility for any liabilities incurred by the partnership.
The primary similarity is that when it comes to taxes, general as well as limited partnerships are pass-through entities, meaning owners need not file separate business taxes. Rather, partners report business income on their personal returns.
With general partnerships, the division of labor and assets is more equally divided. That is, duties and responsibilities can be divided up in whatever manner, but there will be high involvement among all partners in the running of the business.
In a limited partnership, though, it is a general partner who oversees how the business is run, with a limited partner essentially uninvolved in the day-to-day operations. Limited partners also lack the GP’s decision-making power.
Regarding liability, unless stated otherwise in the agreement, GPs will share equally in the company’s liabilities, losses – and profits. However, with limited partnerships, the GP is still wholly liable, but LPs are liable only up to the amount of their investment.
In terms of setup, a general partnership, as an unincorporated business, need not be registered with the state in which it operates, although a drawn-up partnership agreement is still recommended.
There are a few more steps involved for limited partnership establishment, relative to general partnerships. Even so, setting up an LP is still easier than it is for a corporation or LLC.
The main benefit for limited partners is, beyond the amount of their investment, protection from personal liability.
Other advantages include:
There are drawbacks to LPs, including:
The advantages of GPs include:
To raise capital for their investments, general partners are willing to take more risks than LPs. Thus, GPs have unlimited personal liability.
Because they are not active members of the company involved, limited partners are not required to pay self-employment taxes. The IRS treats them as pass-through entities, requiring file Form 1065 as an information return. Schedule K-1 must be filed by each partner, so that they can report on their tax return their share of business income and losses.
General partnerships are treated similarly regarding taxes; as a pass-through entity, the partnership does not pay taxes. However, each partner does report on their personal tax returns their share of profits or losses.
Limited partnerships are different from limited liability partnerships in that the latter are legal and tax entities. That status permits partners to take advantage of economies of scale by not only working together, but by mitigating their liability for other partners’ actions.
Similar to how private equity (PE) is structured, the LP business structure is frequently employed as a vehicle for investors who pool their capital to invest in real estate or other assets.
No investment is without risk, and as such, private equity’s limited liquidity causes it to have a higher risk profile. However, with higher risk comes the possibility of greater returns. Also with PE, investors generally can wield more say-so in the decision-making processes in the companies in which they invest. Those potential benefits, along with overcrowded public markets, have heightened demand for PE.
The leading alternative investment platform Yieldstreet, on which $4 billion has been invested to date, with net annualized returns of more than 9%, offers curated and highly vetted PE opportunities with early liquidity possibilities and accessible minimums. Such offerings permit investors to take positions in private companies, without the volatility of public markets.
As an alternative asset class, which functions independent of the stock market, PE can also be used to diversify investor holdings. Creating a portfolio of varying investment types can mitigate overall risk exposure and possibly improve returns. In fact, portfolio dive diversification is a crucial component of long-term investing success. Alternative investments can be a good way to help accomplish this.
Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $10,000.
Ultimately, the optimal partnership for one’s business depends on the business’s needs, which structure works best, and the extent of involvement each partner wants, in addition to the cost of partnership formation, and comfort levels, regarding liability. Whichever kind of partnership is chosen, get an agreement in writing so as to avoid future confusion about dividing profits or handling liability concerns.
Remember, too, opportunities in private equity, which can potentially offer high rewards while diversifying one’s portfolio.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.