An introduction to limited partnership funds: who does what?

This introduction is for people who are considering setting up a UK fund using the traditional structure of an English limited partnership. This is only one of a range of legal structures which can be used, but it is a tried and tested model.

The structure is summarized in the diagram below. This particular one is for a real estate fund, but very similar arrangements can be used for private equity or venture capital funds or investments into other projects.

Typical Limited Partnership Structure

Who does what:

The Fund Manager (or asset manager) is the entity which sources investments, negotiates investments, manages the assets and arranges disposals. This is the ongoing business which engages staff and can provide its services to a number of funds or clients. It is usually structured as a limited company or an LLP. The Fund Manager receives a fee from the Limited Partnership – this can include annual fees based on the assets or net assets of the fund, fees for specific transactions, and fees based on the performance of the fund. ThefFund manager will be an “Alternative Investment Fund” for the purposes of the Alternative Investment Fund Managers Directive, and so the manager will need to be registered with the UK Financial Conduct Authority.

The Limited Partnership is the main vehicle for the fund. Strictly speaking, it is not a separate legal entity, but is a partnership between the “General Partner” and the “Limited Partners”.

The General Partner is usually a newly-formed company which has no assets and carries on no business other than acting as General Partner of that particular limited partnership. This is because a general partner has unlimited liability for the debts of the Limited Partnership. So if a company acted as general partner of more than one limited partnership, there would be a risk of contaminating one partnership with the liabilities of another. The General Partner is often a 100% subsidiary of the Asset Manager.

The Limited Partners are investors in the Limited Partnership. As long as they do not become involved in management, their liability is limited to the amount of capital they invest.

The Operator is required because the Limited Partnership constitutes as ‘collective investment scheme’ for the purposes of UK financial services legislation. The establishment, operation and winding up of a collective investment scheme are regulated activities, and the operator must therefore be authorised by the Financial Conduct Authority (FCA). Its functions include dealing with applications to invest in the fund, making sure that proposed investments by the fund comply with the fund’s constitutional documents, and dealing with distributions to investors. If the Fund Manager has the relevant FCA permissions, then the Asset Manager may act as Operator.

A Depositary (not shown in the diagram) is required unless the fund manager qualifies as “small” for the purposes of the Alternative Investment Fund Managers Directive, which is the case if the manager’s total asset under management do not exceed one of the following limits: €500 million, provided the AIFs are unleveraged and have no redemption rights during the first five years; or €100 million (including assets acquired through the use of leverage). The depositary must be independent and must hold the relevant FCA permissions. Its functions include holding any financial instruments belonging to the fund in custody, verifying the fund’s ownership of all other assets and ensuring that the value of the units of the fund are calculated in accordance with the applicable rules.

A Unit Trust is often used as an additional route for investors to participate in the fund – instead of becoming Limited Partners directly, they can subscribe for participations (known as ‘units’) in a unit trust. In particular, the unit trust allows the fund to accept investments from UK registered pension schemes. The unit trust itself is documented as trust deed between the trustee (which acts as custodian and holds the trust’s assets – initially, the investment in the Limited Partnership) and a trust manager, which manages the day-to-day operations of the trust. The Operator often also acts as trust manager. The unit trust is effectively just a conduit for investing in the Limited Partnership. The trustee becomes a Limited Partner in the Limited Partnership, receives subscriptions from unit holders, and in turn invests them in the Limited Partnership.

A “Carried Interest Partnership” (not shown in the diagram) is a vehicle which allows the key members of the Asset Manager’s staff who are contributing to the fund’s performance to be remunerated in a tax-efficient way. Typically, the Carried Interest Partnership would become another Limited Partner in the Limited Partnership. The Fund’s constitutional documents would provide for amounts received by the Fund to be applied in a particular order, called the “waterfall”. A typical waterfall would say that receipts are applied first in paying the Asset Manager’s annual fees, then in repaying investors’ capital, then paying investors a specified return on capital. Any excess may then be paid as to 80% to investors and 20% to the Carried Interest Partnership. The 20% paid to the Carried Interest Partnership would then be shared between the relevant individuals working for the Asset Manager. This is a simplified description, and in practice a number of detailed provisions need to be agreed.

A Nominee company is often used to hold the legal title to properties, jointly with the General Partner. In other words, the properties will be registered in the joint names of the General Partner and the Nominee, and they will hold the property on behalf of the Limited Partnership. This is required because an English limited partnership is not a separate legal entity, and also so that future purchaser of the properties get good title.

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