Limited partners and general partners have different roles when it comes to investment partnerships. In this video, we'll explore these differences and the roles each plays to help you become a more informed investor.
In the realm of investment partnerships, limited partners or LPs in general, partners or GP's play distinct roles. Limited partners are typically passive investors, providing capital to the partnership. While LPs have the potential to earn returns on their investment. They generally lack decision making authority on the business plan and day to day operations of the investment. General partners usually take on a more active role in managing the entity responsible for making investment decisions and overseeing the partnership's operations, while having the ability to earn potential returns due to the capital they contribute to the project.
GPS are also often eligible for what is called a promotion, which is essentially an added return, as certain performance benchmarks or hurdle rates are achieved by the investment. Let's take a look at an example, and let's assume that LPs contribute 90% of the equity needed for this project, and that GP's contribute 10%. We'll also assume that the investment is producing returns for all investors.
On this first line, 100% of distributions go to all investors, including both LP and GP investors. This is prorated until they have received back an amount equal to their initial investment amount. Taking a look at tier one, 100% of distributions go to all investors, which is prorated and to the first hurdle rate is achieved. Moving to the next year, 70% of distributions go to all investors, while the remaining 30% goes to the GP until the LPs achieve the second hurdle rate.
All of which is prorated due to the GP's 10% equity contribution to the project. A 7,030% split means that the GP participates in their prorated share of the 70%, which comes out to 7%, in addition to another 30% of distributions referred to as the promote. Finally, at tier three, 60% of distributions go to all investors on a pro-rated basis, while the remaining 40% goes to the GP.
Based on this example, if the business plan is executed according to plan, GP investors have the potential to earn a higher return compared to LP investors thanks to the promotion. However, it is important to remember that distributions are never guaranteed.
