Limited Partner: Who Provides the Capital and What They Control

A limited partner is an investor in a private fund. The investor commits an amount, pays it in only when the manager calls, takes no part in running the vehicle, and carries a liability capped at what it committed. Its control is contractual rather than operational: it consents to a short list of defined matters, votes by the value of its commitment, and approves no investment at all.

The whole arrangement rests on a single exchange, and it is worth sitting with before any arithmetic arrives. The investor hands over the decisions and keeps a cap on what it can lose. The manager takes the decisions and carries the exposure that goes with running the vehicle. Everything a limited partner controls was written into a contract before the first rupee moved, and almost nothing can be added to it afterwards. That is the sentence to hold. A reader who arrives expecting to find rights that accumulate with time, or with size, or with unhappiness, is going to be surprised by how short the list turns out to be, and the surprise is the lesson rather than a complaint about it.

What is a limited partner, and what is the word limited doing there?

The shape is familiar from a far smaller setting. Four cousins put money into a shop. Three of them hand over cash and go back to their jobs. The fourth stands behind the counter, buys the stock, hires the boy who sweeps, and decides on a Tuesday whether to take the delivery or send it back. All four have money in the shop. Only one of them is running it. If the shop does badly, the three who handed over cash lose the cash they handed over, and the one behind the counter loses that and answers for everything else the shop signed. The shop is the shape, and a private fund is that shape written down at a scale where the writing down matters more than the handshake.

A limited partnerThe investor in a private fund, which provides capital and does not run the fund. is the one who handed over cash. The word limited is doing exactly one job in that phrase, and it is not the job most readers assume. The word does not mean the investor has a limited say. The investor does have one. The word does not mean the investment is limited in some protective sense. The word means the liability is limited, and limited to a number the investor itself wrote down at the start.

Nilgiri Growth Partners Fund II, invented, is the fund this guide works on throughout. The fund is managed by Nilgiri Alternatives Advisors Private Limited, invented, sponsored by Nilgiri Financial Holdings Private Limited, invented, and settled as a trust whose trustee is Nilgiri Trusteeship Services Private Limited, invented. The fund is registered as a Category II Alternative Investment Fund with the Securities and Exchange Board of India. Twelve investors committed Rs 4,90,00,00,000 between them and the manager committed Rs 10,00,00,000 of its own, being Rs 5,00,00,00,000 in total. The fund bought nine companies. Year 9 Quarter 2 falls 8.50 years after the final close, and every figure in this guide belongs to that one invented fund at that date rather than to private funds in general.

Is a commitment a payment, or only a promise?

Only a promise, and getting this one distinction wrong corrupts everything else a reader meets about private funds. A capital commitmentThe maximum amount an investor has contracted to put in, signed once at the start. is the maximum an investor has contracted to pay when it is asked. A commitment is not a transfer. On the day Nilgiri Growth Partners Fund II held its final close, Rs 5,00,00,00,000 of commitments existed and the fund held almost nothing.

Consider a wedding somebody has been asked to help pay for. An uncle says the caterer will need Rs 6,00,000 across the year and asks for Rs 1,00,000 of it. The answer is yes. The money does not leave the account that evening. The money leaves in four instalments, when the caterer, the tent people, the band and the printer each send their bill, and the last instalment may leave eleven months later. The yes was said once. The paying happens four times, on dates somebody else chose. The obligation started on the evening of that yes, and it is not discharged until the last of the four has gone.

A commitment works the same way. The signature that creates it sits on a contribution agreementThe document an Indian fund's investor signs to bind itself to the commitment.. The contribution agreement is a contract between the investor and the vehicle, and a different document from the one the investor was sent when the fund was being described to it. The document that persuaded the investor binds nobody, and the document that binds it is the one it signed. That sounds obvious written down, and it is the single most common thing a first-time reader of a private fund's papers gets muddled about.

Who decides when the money actually leaves?

The manager does, inside limits the contract set years earlier, and the investor does not. When the fund needs money it issues a call: a notice, signed for the manager by Farida Contractor, invented, telling every investor what to pay and by which date. The amounts are set pro rataIn the same proportion as each party's commitment bears to the total., meaning in the proportion each commitment bears to the whole, so no investor is ever asked for a larger share of a call than of the fund. When the money arrives it has been drawn downCalled and paid in, so the money has moved from the investor to the fund., and the investor's capital account records it.

Nilgiri Growth Partners Fund II called money seventeen times. The first call, in its Year 1 Q1, was for Rs 13,10,00,000 and covered the fund's formation costs and its first year of fee and expenses. The largest single call, in Year 2 Q2, was Rs 60,00,00,000 and bought one company. Across the seventeen the fund drew Rs 4,80,00,00,000 of the Rs 5,00,00,00,000 committed, or 96.0 per cent. Thirteen of the seventeen calls fell inside the fund's five year investment period and accounted for Rs 4,55,50,00,000, being 94.9 per cent of everything ever drawn. The other four, and what they were for, is the whole of the failure block below.

Notice what the investor did not do in any of that. The investor did not choose a date. The investor did not choose an amount. The investor did not choose which company its money went into, and in eleven of the seventeen calls the notice named a purpose that the investor first learned about from the notice. A commitment is a promise to pay on demand, within a contracted ceiling, on somebody else's timetable. The word most people reach for here is illiquid, and the more useful word is unscheduled.

How much of a commitment is still owed at the record date?

Unfunded Commitment

An unfunded commitmentThe part of a commitment that has been promised and not yet called. is the part of a commitment that has been promised and not yet called. An unfunded commitment is not a balance, not a cash pile and not a reserve the investor is holding somewhere on the fund's behalf. An unfunded commitment is an obligation, sitting on the investor, live until the fund's term ends or the manager releases it. Every quarter it appears on the investor's statement as a line, and it is the only line on that statement that describes something the investor still has to do.

Here is where the arithmetic gets dangerous, and it is dangerous because two entirely different numbers are both correctly called an unfunded commitment. One of them belongs to the fund. The other belongs to one investor. In this fund the two differ by a factor of five, and confusing them is not a small slip.

Take the fund level first. Nilgiri Growth Partners Fund II has drawn Rs 4,80,00,00,000 of the Rs 5,00,00,00,000 committed to it. Rs 5,00,00,00,000 less Rs 4,80,00,00,000 is Rs 20,00,00,000, or 4.0 per cent of the total. Rs 20,00,00,000 is the fund's unfunded commitment and it is not any single investor's. Because every call was issued strictly pro rata, that 4.0 per cent is spread across all thirteen commitments in the vehicle in exactly the proportions they were signed in: Rs 19,60,00,000 of it sits on the twelve investors, being 4.0 per cent of their Rs 4,90,00,00,000, and Rs 40,00,000 sits on the manager's own Rs 10,00,00,000. The two shares add back to Rs 20,00,00,000, and if they did not, the pro rata claim would be false.

Investor 1, a domestic life insurance company, committed Rs 1,00,00,00,000. Pro rata drawing means it has paid in the same 96.0 per cent as everybody else, being Rs 96,00,00,000. So its own unfunded commitment is Rs 1,00,00,00,000 less Rs 96,00,00,000, or Rs 4,00,00,000. A figure that can be reached twice is a figure understood, so run the check the other way as well. Investor 1 holds 20.0 per cent of the Rs 5,00,00,00,000 fund, and 20.0 per cent of the fund's Rs 20,00,00,000 is Rs 4,00,00,000. The subtraction and the share agree exactly, and exact agreement is what pro rata means when it is true rather than asserted.

Why does the obligation stay live after the fund has stopped buying?

Because a fund costs money to run whether or not it is buying anything. Nilgiri Growth Partners Fund II's investment period ran five years from its final close and ended at the close of its Year 5. From that day the manager could call capital for only four things, and the fund's own documents number them: a follow-on into a company the fund already had, the management fee, fund expenses, and an obligation already signed for. Notice that two of those four are simply the cost of existing.

What does a limited partner actually control?

A short list, and it is worth reading slowly because the shortness is the point. In Nilgiri Growth Partners Fund II the investors act through an investor advisory committee of seven members, drawn from investors 1, 2, 3, 4, 5, 6 and 8 and chaired by Meera Sathe, invented, for investor 1. The advisory committee holds a consent rightA defined matter the manager may not do without the investors' agreement. on four defined matters: a conflict of interest, the valuation policy, the first extension of the fund's term, and any change to the fund's investment policy. The list runs to four things, all of them written down before the fund began.

Two further matters are decided not by that committee but by a vote across the investors by value. The second extension of the term requires the consent of investors holding more than half of commitments by value. A replacement for a departed key person requires investors holding more than two thirds by value. Neither vote has happened in this fund. No extension has been taken at the record date, and the key-person provision naming Sundari Raghavan and Devendra Karnik, invented, has not been triggered.

Six of the twelve investors also hold a side letter, numbered 1 to 6 in the fund's own records, giving one of them a committee seat, another an excuse right on a sector its mandate excludes, another a transfer right, another a right of first look at co-investment, another a notification if the manager's team composition changes, and the sixth a fee position for the staff vehicle. The fund's fee arithmetic is exact at Rs 9,80,00,000 a year on the Rs 4,90,00,00,000 of investor commitments during the investment period, and not one of the six side letters moves it. What a side letter is, what a most-favoured-nation right does and who ends up paying for a discount are covered separately.

Now the arithmetic that makes a vote by value real rather than democratic. A share is meaningless until the thing it is a share of has been named. Here are the twelve, with both denominators shown.

The four largest add to Rs 3,15,00,00,000, being 63.0 per cent of the Rs 5,00,00,00,000 fund. The six smallest, being investors 7 to 12, add Rs 25,00,00,000 plus Rs 20,00,00,000 plus Rs 15,00,00,000 plus Rs 10,00,00,000 plus Rs 10,00,00,000 plus Rs 5,00,00,000, or Rs 85,00,00,000. The Rs 85,00,00,000 is 17.0 per cent of the fund and 17.3 per cent of investor commitments, and until one of those two has been named nothing has been said. The five smallest between them give 12.0 per cent of the fund. Six of twelve investors, one eighth of the money.

What can a limited partner never control, whatever it holds?

Everything a new reader assumes is on the first list. A limited partner cannot approve an investment, and cannot reject one. The decision belongs to the investment committee, five members, four of them from the manager and one external, and that committee approved all nine of this fund's holdings and every realisation. A limited partner cannot require a sale or block one. A limited partner cannot choose the date its money is called or the amount. Valuing a holding is the independent valuation agent's job, with Rohit Vaz, invented, signing. Whatever board rights exist at a portfolio company belong to the fund and not to the people who funded it. No investor appoints or removes a director there.

A limited partner cannot even leave. Nilgiri Growth Partners Fund II is a closed-endA vehicle that takes money once, has a fixed life, and does not let investors leave at will. vehicle: it took money once, it has a fixed term of ten years from final close, and there is no redemption window at all. Transferring an interest is not something an investor simply does. The documents show that rather than assert it. Investor 4 negotiated a specific transfer right to an entity under the same control in its side letter. A right somebody has to negotiate for is a right the standing document did not already give.

The single most common confusion in this whole subject is between the two committees, so hold them apart deliberately. The investment committee decides what the fund buys and sells. The investor advisory committee consents to four defined matters and cannot approve or reject a single transaction. One of those committees is where the decisions are made and the investors are not on it.

What does limited liability actually limit?

One thing, precisely. The most an investor can be required to put into the vehicle is the amount it committed, and nothing beyond that can be demanded of it on the strength of being an investor. For investor 1 that ceiling is Rs 1,00,00,00,000, of which Rs 96,00,00,000 has gone in and Rs 4,00,00,000 can still be called. There is no thirteenth call for a further Rs 50,00,00,000 because the fund had a bad year, and no share of the fund's other obligations that lands on the investor because the fund cannot meet them itself.

Now the three things it does not do, and each of them catches somebody. First, it does not protect the investor from losing the whole of what it committed. Holding 5 of this fund, Palar Foods Private Limited, invented, cost Rs 35,00,00,000 and was written off in full in Year 6 Q4, returning nothing at all, and the cap did not soften that by a rupee. Second, it does not protect against the timing. The obligation to fund a call is not suspended by inconvenience, and the failure block above is the whole of that point. Third, it does not make the investment safe in any other sense: it caps the size of the exposure and says nothing whatever about the chance of losing it.

Compare the shop again. The three cousins who handed over cash can lose the cash. Limited liability stops the supplier who is owed money by the shop from coming to their houses. Limited liability does not stop the cash they handed over from being gone. Limited liability is a ceiling on the size of the loss and not a floor under the outcome, and readers who hear the word limited and relax have heard the wrong half of it.

Does a bigger commitment buy a bigger voice?

Yes, and fewer than a reader would guess, and the interesting part is which direction the surprise runs in. A reader looks at a list of twelve investors and instinctively hears twelve voices. The arithmetic says something else, and it says it the moment the commitments are ranked and added from the top.

A larger commitment buys something visible and small in this fund: a seat, in investor 1's case, and a most-favoured-nation right, both of them in a side letter. A larger commitment also buys weight, automatically, in any vote taken by value, and weight is where a list of twelve stops behaving like a list of twelve. Investor 1 alone holds 20.0 per cent of the fund. The four largest hold 63.0 per cent of the fund between them. The six smallest investors are half the names on the list and 17.0 per cent of the money, so a vote by value across twelve investors is not a vote across twelve investors in any sense that matters.

What happens if an investor does not fund a call?

Nothing improvised. A reader who has followed everything so far expects a negotiation here, a phone call between grown-ups, some accommodation for a difficult quarter. A clause written years earlier starts to operate instead, and the clause was written by people who had never met the investor that would eventually trip it.

Every one of Nilgiri Growth Partners Fund II's seventeen calls was met in full, so the ladder below is a counterfactual on this fund rather than a description of it. The ladder is the shape of the risk an unfunded commitment actually carries, and worth walking for that reason. A notice goes out with an amount and a date. If the money does not arrive by that date, the investor becomes a defaulting investor, and from that moment the question is not what the manager will do but what the documents already say. There is no standard remedy. A reader's job here is to find three specific clauses before signing anything.

The three clauses are: what counts as a default and from which day, what time there is to put it right, and what the consequences are and who may waive them. Every fund answers all three somewhere in its papers, and the answers differ from vehicle to vehicle, so none of them is usual, typical or expected. The shortfall does not disappear, and that is the part worth carrying away. The shortfall is still owed by somebody, and the other investors are the somebody the documents are most likely to look at next.

What is a limited partner called in an Indian fund?

An investor, a contributor or a unit holder, depending on which document is in hand, and the economics are the ones described above whichever word appears. The whole vocabulary a reader will meet in this subject was designed somewhere else and imported, and the Indian legal shape underneath it is different from the shape the words describe.

An indenture of trust is the form an Indian pooled private vehicle most commonly takes, and Nilgiri Growth Partners Fund II is settled that way. There is no limited partnership here and there is no general partner. In this fund the general partner's role is discharged by the investment manager and the trustee between them, and the contract is a trust deed and a contribution agreement rather than a partnership agreement. The trustee holds the assets and has duties to the beneficiaries. The manager takes the investment decisions and is paid the fee. The sponsor stands behind the manager and holds the manager's own commitment.

The economics were built in that vocabulary before they were built here, and everybody in the room, including the investors, still says limited partner and general partner. So learn both. When somebody says limited partner, read investor, contributor or unit holder. When somebody says general partner, read the manager and the trustee together. When somebody says limited partnership agreement, read the trust deed plus the contribution agreement. The capital account, oddly, keeps its own name and does exactly what its name says.

How does somebody read all this in practice?

More people read a private fund's documents than a reader would guess, and almost none of them are the investor. Somebody on an investment committee has to decide whether to sign a contribution agreement. A monitoring team inside an institution has to forecast what will be called and when. An analyst covering an insurer has to know what that insurer has promised and not yet paid. An auditor has to tie the unfunded line to something. And a student will be doing one of those jobs in three years. Four questions serve all of them, and every one is answerable from a document rather than from a view about anybody.

First, ask which unfunded figure this is. If the answer is Rs 20,00,00,000, that is the fund's. Investor 1's own is Rs 4,00,00,000, and the two differ by a factor of five in exactly the ratio of the investor's share. Second, ask what the remaining unfunded amount is reserved for. In this fund the answer is the fee and the expenses of the six quarters left in its term. Money held back for one more company would be a very different answer.

Third, what a vote by value would actually do. Reading a list of twelve names says nothing; adding the four largest shows that they hold 63.0 per cent of the fund. Fourth, what the consent list contains, counted rather than skimmed. In this fund it is four matters at the advisory committee, plus two decided by a vote across investors. An investor's rights are countable, and a reader who has not counted them has not read the documents.

One more line is worth carrying. The statement does not say the line out loud. Investor 1's capital account at the record date shows a commitment of Rs 1,00,00,00,000, capital contributed of Rs 96,00,00,000, distributions received of Rs 87,60,00,000, all of that being return of capital, and unfunded commitment of Rs 4,00,00,000. An investor that has had Rs 87,60,00,000 back can feel finished. The investor is not finished. The investor still has Rs 4,00,00,000 to pay when asked, and what the residual value on the rest of that statement means is covered separately.