The Limited Partnership: Why Private Funds Use This Structure

A limited partnership splits money from control. Limited partners put in the capital and can never be asked for more than they committed. One general partner decides everything and carries the liability of deciding. Private funds use the shape because it ends on a date and because its terms sit in a contract. The Indian vehicle here is a trust that reaches the same economics.

Start with what a private fund is actually trying to hold. The fund buys stakes in companies nobody can sell on an exchange. The fund cannot get out of any of them on a Tuesday afternoon because it feels like it. Those stakes have to be held for years while something changes inside each business, and then turned back into cash and handed to the people whose money it was. Every structural feature of a private fund follows from three awkward facts about what it holds, and not from anybody's taste in how to organise a business. The money has to be promised rather than paid up front, because it is needed unevenly across years. The vehicle has to stop existing. Otherwise nobody ever gets their money back. And no two of these arrangements are quite the same, so the terms sit in a negotiated contract that a standard rulebook could not carry.

What is a limited partnership, and what exactly is limited about it?

Two neighbours open a tea stall together. One of them puts in Rs 2,00,000 and never comes near the place. The other buys the milk, hires the boy, decides the prices and stands at the counter every morning. In an ordinary partnership, when the gas supplier is unpaid and the landlord is owed three months of rent, the supplier and the landlord can come after both of them, all the way down to whatever each has at home. Being the quiet one is no protection at all. An ordinary partnership is why people who had money but no wish to run anything historically stayed out of partnerships entirely.

A limited partnershipA partnership with two classes of partner, one of them liable only up to what it put in. lets the quiet neighbour in, with two classes of partner instead of one. The limited partners provide capital and stay out of the running of the business. The general partnerThe partner that runs the vehicle and carries the liability that comes with running it. runs it, decides what is bought and sold, signs what needs signing, and stands behind the whole thing. In exchange for staying out, each limited partner gets one specific protection: whatever goes wrong, nobody can reach past what that partner agreed to put in.

Now read the word carefully. Limited misleads almost everybody the first time. Limited means liability, and it means nothing else at all. It does not mean the loss is small. The word does not mean the amount is capped at something comfortable. The word does not mean the partner can walk away early, and it certainly does not mean the money is safe. Take investor 1 of Nilgiri Growth Partners Fund II, an invented vehicle. Investor 1 is a domestic life insurance company that committed Rs 1,00,00,00,000 to the fund. By the record date at the end of the fund's Year 9 Quarter 2 it had paid in 96.0 per cent of that, being Rs 96,00,00,000. Rs 1,00,00,00,000 less Rs 96,00,00,000 leaves Rs 4,00,00,000 of its own commitment unfunded. Every rupee of the Rs 1,00,00,00,000 is at risk in the ordinary sense: if the fund's holdings turned out to be worth nothing, all of it would be gone. The structure promises something narrower and more precise. Nobody can present investor 1 with a bill for Rs 1,00,00,00,001.

Why does one partner have to carry liability that is not limited?

Unlimited liability on one side makes people suspicious of the whole arrangement. A structure designed so that most of the parties are protected turns out to need one party that is not. The exposed party looks like a flaw. The exposed party is the load-bearing beam.

Go back to the tea stall. The quiet neighbour's protection has a condition attached to it that is easy to miss: the protection depends on staying quiet. The moment that neighbour starts hiring, ordering, pricing and signing, they are no longer the silent contributor the arrangement described, and the whole basis of the protection thins out. So the form needs somebody who does the hiring and the ordering and the signing, and that somebody cannot also be the person nobody can reach. The protection the limited partners hold is bought with the decisions they give up, and the general partner's exposure is the price of holding those decisions.

There is a second thing the general partner does, and it is money rather than law. In Nilgiri Growth Partners Fund II the manager committed Rs 10,00,00,000 of its own capital alongside the investors' Rs 4,90,00,00,000. The two add to the Rs 5,00,00,00,000 of total commitments. Rs 10,00,00,000 divided by Rs 5,00,00,00,000 is exactly 2.0 per cent. The manager's commitment is funded in cash and takes the same treatment as any investor interest at every stage of the fund's distributions. The predecessor vehicle, Nilgiri Growth Partners Fund I, invented and now wound up, did the same thing at the same proportion: a Rs 5,00,00,000 manager commitment against Rs 2,50,00,00,000 of total commitments, also exactly 2.0 per cent.

Why is the vehicle built to end on a date?

A company does not need an end date. A shareholder in a listed company who wants the money sells the shares to somebody else, and the company carries on without noticing. The exchange produces a buyer, so the company never has to produce that cash. Remove the exchange and the whole arrangement changes shape. There is no buyer standing ready for a stake in an unlisted business, no screen, no closing price, nobody at all on the other side at four in the afternoon.

So a private fund has to promise the thing the exchange would otherwise have provided. The fund promises to sell what it holds and hand the cash back, and a date is what makes that promise concrete. The end date is not a deadline the manager set itself out of tidiness; it is the only exit the investors have, written down. Everything the manager does happens inside it. There is no version of this where the fund holds a good company for thirty years because it is fond of it.

Nilgiri Growth Partners Fund II runs for ten years from its final close, ending at the end of its Year 10, and its investment period is the first five of those years. Time here is counted from that fund's own final close and never in calendar years, so a moment is written as Year 4 Quarter 2 and in no other way. At the record date used throughout, the end of the fund's Year 9 Quarter 2, exactly 8.50 years have run. Ten years less 8.50 years is 1.50 years, or six quarters. Five of the fund's nine holdings are still unsold with those six quarters to go. Five unsold holdings and six quarters left is not a crisis and not a scandal. A ninth-year fund is doing arithmetic on itself, and the arithmetic is uncomfortable in a way a reader should sit with rather than be protected from.

The fund carries two possible extensions of one year each, and they are not equivalent to each other. The first is at the manager's own election, subject to the prior written consent of the committee of investors that the documents establish. The second needs the consent of investors holding more than half of commitments by value. Neither has been taken at the record date. Both extensions are terms this fund negotiated, not a market standard. A term that actually ends looks like the predecessor fund: Nilgiri Growth Partners Fund I took neither of its extensions and wound up at its own Year 10 Quarter 4.

Why can nobody leave before that date?

The shape is familiar from a recurring deposit set beside a savings account. Money in the savings account is available this afternoon. Money in the recurring deposit is available on a date the depositor and the bank agreed, and pulling it out early is either impossible or expensive. The reason the bank can pay a different rate on the two is not generosity; it is that it knows how long it has the money for, so it can do something with it that takes time.

A private fund is that idea taken to its limit, a closed-end vehicleA fund with a fixed life that takes money once and does not let investors take it back on demand.: money comes in at one or more closings, the door shuts, and the fund never buys an interest back from anybody. There is no redemption at any point in the ten years. The closed door is not an inconvenience attached to the structure; it is the entire thing the structure exists to produce. A manager who might be asked for cash on any Tuesday cannot commit to a company for six years, because the one thing it holds is the one thing it could not sell quickly.

The closed door does its work in this fund's own record. Holding 4, Bhavani Speciality Chemicals Private Limited, was entered at Year 2 Quarter 4, exactly 2.00 years after final close on this fund's clock. At the record date, 8.50 years in, it is still held. The holding has run 6.50 years as one unlisted position, and it is carried at Rs 1,08,00,00,000 against a total cost of Rs 60,00,00,000, being 1.80 times. The 1.80 times is a carrying value, an estimate of a position nobody has bought. The number is not what matters. No fund whose investors could demand their money back would still be holding that position in year seven, and the closed door is the only reason this one can. Andrew Ang, in Asset Management, 2014, sets out the case for treating a locked door as something an investor bears rather than merely tolerates.

So what does an investor who wants out in Year 4 actually do? Not much, from the fund. The vehicle has no mechanism for buying an interest back and no cash sitting idle for the purpose, so it will not. The only route is a transfer of the interest to some other party, on whatever terms the documents allow and with whatever consent they require, and the unfunded part of the commitment travels across with it. Compare a vehicle that works the other way. Nilgiri Absolute Return Fund is open-ended: money there is subscribed rather than committed, no capital call exists in it at all, and investors can ask for their money back. Even that fund puts four contracted stops in front of a redemption, being a lock-up, a dealing window with notice, a limit on how much may leave at once, and the ability to move a holding nobody can value into a separate class. All four are that fund's own contracted terms, and neither shape is better than the other.

What can a contract carry that a company's constitution would struggle with?

Here is the third structural reason, and it is the one people skip. A company's constitutional documents are a rulebook for a body: who the directors are, how shares are issued, what a meeting needs to be valid, what rights attach to each class of share. Constitutional documents are written to govern an entity that will outlive everyone in it, and they treat every holder of the same class of share identically because that is what a class means.

A private fund is not really an entity that needs governing. A private fund is a bargain between a small number of named parties, running for a stated number of years, about money and about people. A constitution governs a body. A contract records a bargain, and a private fund is almost entirely bargain. Look at what Nilgiri Growth Partners Fund II's own papers have to carry, and then ask yourself where each of these would sit in a rulebook for a corporate body.

Every row is the same observation from a different angle. Each of those terms is an agreement between parties, not a rule about a body, and a contract holds an agreement between parties the way a bucket holds water. How the fee's basis changes and what the four tiers pay in what order are covered separately.

Is an Indian private fund a limited partnership?

Everything above is the form as it was designed, and the vocabulary that came with it runs through every conversation about this subject in India. In the actual file of the fund described here, the words are different.

Nilgiri Growth Partners Fund II is settled as a trust. Its constitutive document is an indenture of trustThe deed that settles an Indian fund as a trust and sets out the terms on which it runs., and each investor signs a contribution agreement to come in. There are three separate legal persons in the arrangement and each has one job. Nilgiri Trusteeship Services Private Limited, invented, is the trusteeThe party that holds a trust's assets and owes duties to the people the trust is for.: it holds the assets and owes duties to the beneficiaries. Nilgiri Alternatives Advisors Private Limited, invented, is the investment managerThe firm that makes the investment decisions and is paid for making them.: it decides what is bought and what is sold, and it is the party paid the management fee and, when the arithmetic ever reaches it, the carried interest. Nilgiri Financial Holdings Private Limited, invented, is the sponsorThe firm that establishes the vehicle and stands behind the manager running it.: it stands behind the manager and holds the manager's own commitment of Rs 10,00,00,000 to the fund.

The fund is registered as a Category II Alternative Investment FundThe Indian registration category for a pooled private vehicle, set by the Securities and Exchange Board of India.. There is no partnership in this file and there is no general partner in it, and the economics are the partnership economics anyway. The twelve investors are called limited partners by everybody who deals with them. The manager is called the general partner in half the emails. The commitments, the calls, the capital accounts and the order in which cash comes back are all built exactly as the partnership form built them. The instrument carrying them has changed. The bargain inside it has not.

If the vehicle is a trust, who does the general partner's job?

In the imported form, one party does everything: it decides, it signs, it holds, it answers. In this fund that single role is split across two of the three parties, and the split is not decorative. One role in the imported vocabulary is two parties in the instrument, and the two are not interchangeable with each other.

The trustee holds. Every asset the fund has is held by Nilgiri Trusteeship Services Private Limited, and its duties run to the beneficiaries of the trust rather than to the manager who is paying it attention. The manager decides. Nilgiri Alternatives Advisors Private Limited works out what to buy, negotiates it, monitors it and decides when to sell, and it is the party the fee and the carried interest are written to. The sponsor stands behind. Nilgiri Financial Holdings Private Limited established the vehicle and holds the manager's own Rs 10,00,00,000 commitment, 2.0 per cent of the Rs 5,00,00,00,000 of total commitments. Set those three sentences beside the description of a general partner. The holding and the deciding, which one party did in the other form, have been given to two parties here, and a third stands behind the one that decides.

How liability actually falls between a trustee, a manager and a sponsor in India is set out partly in the instrument the parties signed and partly in the framework the Securities and Exchange Board of India maintains at sebi.gov.in, and it is capable of changing. The parties can be named and what each does understood; the rest is read in the current text. The manager's pay for doing all this, and the sponsor as a firm in its own right, are each covered separately.

Why does the partnership vocabulary survive when the instrument is a trust?

People still say petrol pump when almost nothing about the object is a pump any more, and everybody knows exactly what is meant. Vocabulary is stubborn in the same way here. The stubbornness is better grounded than mere habit. The two descriptions describe two different things and both are accurate.

The partnership words describe the economics. Somebody promises money rather than paying it. Somebody calls it in pieces. There is a class that provides capital and a class that decides. Cash comes back in a fixed order with the deciding party paid last and paid a share. Every one of those sentences is true of Nilgiri Growth Partners Fund II, and the vocabulary that says them cleanly was built by the partnership form and imported wholesale. The trust words describe the instrument: the document signed, the party holding the assets, the duties owed and the category the vehicle is registered in. The vocabulary tracks the economics and the instrument tracks the law, and a reader has to carry both descriptions of one arrangement at the same time.

The double vocabulary looks like sloppiness and is not. A person who insists on saying contributor instead of limited partner in an Indian data room will be understood, and will also spend the rest of the meeting explaining themselves. A person who believes the fund is legally a partnership because everyone said limited partner will look for the wrong document. The search for the wrong document is worked through below. The reader who can hold both is the one who can read the papers.

What goes wrong when a reader searches for the wrong document?

Now the failure worth preventing, and it is not a clever one. The ordinary failure costs people real understanding every week.

How does somebody actually use this when reading a fund's papers?

For an analyst at an institution being offered a commitment, somebody in a manager's operations team, a lender sizing up a fund as a counterparty, or a student who has been handed a set of documents and told to summarise them, the same four questions come in the same order, and they come before any question about the fee or the returns.

The name of the document determines which words a clause will be written in, so the instrument is read before any clause is hunted for. A household reader already knows this discipline from ordinary life: before arguing about a clause in a rent agreement, the first step is establishing that the document in hand is a rent agreement and not a receipt. The four questions are the same idea applied to a structure with more parties in it.

Question 2 is the one people skip and it is the one that repays the most. In the imported vocabulary there is one party to have an opinion about. Here there are three, they are separate legal persons, and knowing which of them is on the other side of any given sentence changes what that sentence means. A duty running from the trustee to the beneficiaries is a different object from a fee running from the fund to the manager, and reading them as though one party held both ends is how people misunderstand the arrangement while sounding fluent about it.

What does this structure not do?

A structure this carefully built invites a reader to expect too much of it. The limit is worth stating. The arrangement decides three things and only three: who decides, who is exposed to what, and in what order money comes back. The structure settles who decides and who is paid in what order, and it settles nothing whatsoever about whether the things the fund bought were worth buying.

Nilgiri Growth Partners Fund II's own record makes that concrete without any argument. Holding 5, Palar Foods Private Limited, invented, was entered at Year 3 Quarter 1 at a cost of Rs 35,00,00,000 and was written off in full at Year 6 Quarter 4 for proceeds of nil, being 0.00 times. Holding 6, Vaigai Edutech Private Limited, invented, cost Rs 30,00,00,000 and is carried at Rs 21,00,00,000 at the record date, being 0.70 times cost, and that figure is an estimate of something nobody has bought rather than a price anybody paid. The trustee held correctly throughout. The manager decided within its authority throughout. Every consent that was required was obtained. The structure was never the thing that decides whether a business does well. The structure worked exactly as written in both cases, and the money still went where it went.

Two further matters sit outside all of this. Every condition, threshold, minimum and effective date attaching to a registration category is set by the Securities and Exchange Board of India at sebi.gov.in, and those conditions change. How income reaching a trustee, a manager, a sponsor or a contributor is taxed in India is a question for the tax authorities.