Question

What happens to the compensation structure of a partner (as it relates to the traditional 2 percent fee and 20 percent carried interest) as the assets under management per partner grow? What happens to the alignment of interests among LPs and GPs?

Answer 1

Limited Partners:

A limited partnership has at least one general partner and at least one limited partner. The general partner has the same role as in a general partnership: controlling the company's day-to-day operations and being personally liable for business debts.

The role of limited partners, however, differs in a few ways:

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• Limited partners do not play an active role in the business. The limited partners (most LPs have more than one limited partner) contribute financially to the business (for example, a limited partner might invest $100,000 in a real estate partnership) but have minimal control over business decisions or operations, and normally cannot bind the partnership to business deals.
• Limited partners are not personally liable. In return for giving up management power, limited partners get the benefit of protection from personal liability. This means that a limited partner can't be forced to pay off business debts or claims with personal assets. A limited partner, however, can lose his or her financial investment in the business.
• Limited partners face slightly different tax rules. For income tax purposes, limited partnerships generally are treated like general partnerships, with all partners individually reporting and paying taxes on their share of the profits each year. Limited partners, as a rule, do not have to pay self-employment taxes; because they are not active in the business, their share of partnership income is not considered "earned income" for purposes of the self-employment tax.

Limited partners need to understand that they can become personally liable if they do not stick to their passive role. If a limited partner starts taking an active role in the business, that partner's liability can become unlimited. If a creditor can prove that a limited partner took acts that led the creditor to believe that he or she was a general partner, that partner can be held fully and personally liable for the creditor's claims.

Some states have carved out exceptions to this "active role in the business" rule. These exceptions usually allow a limited partner to vote on issues that affect the basic structure of the partnership, including the removal of general partners, terminating the partnership, amending the partnership agreement, or selling all or most of the assets of the partnership, without jeopardizing limited partner status

General Partners:

In the business world, the word "partnership" usually refers to general partnerships. A general partnership is a business that has more than one owner and that has not filed papers with the state to create a specific entity such as a corporation or limited liability company (LLC). (To learn more about general partnerships, see Nolo's Partnerships area.)

In a general partnership:

• all partners (called general partners) are personally liable for all business debts, including court judgments
• each individual partner can be sued for the full amount of any business debt (though that partner can in turn sue the other partners for their share of the debt), and
• each partner has "agency authority" for the partnership -- that is, each partner can bind the whole business to a contract or business deal.