Who Are Limited Partners in Venture Capital?

As a starting business owner, startup founder, or NFT developer, finding funding is most likely at the top of your priorities list. With that in mind, it’s imperative to understand the types of investors out there and what is the best fit for your needs and preferences. The type of investor you align yourself with will most definitely have a long-term impact on what direction your business will go in and how you will be running your business. Your fundamental principles of how you want to operate have to align with your investor’s investment strategy. Otherwise, you might be in for a bumpy ride.

In this article, we take a look at Limited Partners in venture capital, often referred to as “LPs”. We will cover what Limited Partner’s key roles are in venture capital funds, what are some of their defining characteristics, and how you can find yourself a Limited Partner to invest in your business’s plans.

Who are Limited Partners in venture capital?

Investopedia’s simple definition gives a great concise overview of who a Limited Partner is:

A limited partner is a part-owner of a company whose liability for the firm’s debts cannot exceed the amount that an individual invested in the company. Limited partners are often called silent partners.

Limited Partners in venture capital are the people that give venture funds power — they are the people that provide the capital a fund needs to invest in deals. In addition to providing funds, LPs have to review updates from the fund’s general partner. Very often that’s where Limited Partners’ involvement in the process ends. While some Limited Partners want occasional updates on how things are going with their investment from General Partners who run the funds, LPs have no other obligations than sending their funds on time. As Investopedia’s definition suggests, LPs are silent partners in the sense that they do not deal with the fund’s day-to-day operations and decisions. Sometimes General Partners can call up Limited Partners for advice, especially if the Limited Partner is experienced in the specific field in question, but it’s not exactly standard. With this, limited partners have very limited liability, as they are not liable for the fund’s debts other than the invested amount of money.

Limited Partners can invest their funds in multiple ways. Some opt to put up all of their money at the beginning of the investment partnership. Most however prefer to add funding periodically, however often they have agreed to do so with the general partner. In this instance, the general partner calls on the Limited Partner for additional funding when necessary and the LP is obligated to provide the funds. If a Limited Partner fails to provide the funding, they run the risk of losing some or all of their investment returns or profits. This is more specifically outlined in the fund’s documentation, which is critical for a Limited Partner to thoroughly understand.

Limited Partners in venture capital are very long-term returns oriented, as many may have to wait over seven years before making any returns on their money. This is because that’s how long it may take for a startup to make a big break and gain liquidity, be that through an IPO, a buy-out, etc. However should the fund earn dividends, limited partners will get a piece of the earnings in accordance with their share of funds invested in that project.

A venture capital fund paying its Limited Partners returns is called distribution. While every venture capital fund has its own way of distributing its profits, a quite common split is 80/20, with 80% of profits going to Limited Partners and 20% to the fund and the fund’s General Partner. In addition to the profits earned, the Limited Partners of course first get their originally invested money back.

An easy example would look like this:

One Limited Partner (LP no.1) invests $1M to a fund and another Limited Partner (LP no. 2) invests $2M, making it a total $3M fund. The fund makes a $6M return, meaning a $3M profit.

• The fund’s General Partner charges a standard 20%, making their earnings $600K.
• LP no. 1 would get $1M (their initial investment) + $800K profit.
• LP no. 2 would get $2M (their initial investment) + $1.6M profit.

Who can become a Limited Partner?

Limited partners in venture capital are mostly required to either be accredited investors or qualified purchasers to become an official Limited Partner in a venture capital fund.

An accredited investor must meet one of these requirements:

• Net worth over $1M, excluding the property value of a primary residence.
• Hold a series 7, 62, or 65 license
• Have had an income of over $200K for the last two years with reasonable expectation to make the same amount this year.

A qualified purchaser must have at least $5M of their money in investments.

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The difference between General Partners and Limited Partners in venture capital

As stated, Limited Partners in venture capital are very hands-off and don’t have many obligations other than providing capital to the venture fund for investments and doing so on time.

General Partners however have a lot more going on. They are the ones actually running and managing the fund’s everyday operations. They are responsible for setting up the fund, raising the fund, making investments and managing them, working with businesses invested in, updating Limited Partners, and sending LPs profits when they are earned.

General Partners are much more liable as well, as they are liable for all of the fund’s capital and debts, while Limited Partners are only liable for the money they have invested. General Partners however get paid from more sources: management fees, carried interests, and distributions. Limited Partners only make money through distributions.

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How to find a Limited Partner for your business

Limited Partners in venture capital are not as interested in control as other investors, which makes them a wanted type of investor. You may have decided that you want a Limited Partner to back your business, but where to start?

The first step should be to utilize your network. Ask around, if some of your acquaintances or connections know someone that knows someone that’s looking to invest their money. You might be surprised at how effective this can be.

If you need to expand your search, startup accelerators and incubation hubs are a great place to start. Other events, both online and physical, like conferences, webinars, and summits are ideal for searching for an investor. There are also databases out there that can provide you with information about Limited Partners in venture capital all over the world. Keep in mind to not lock in the first investor you come across. Make sure that your plans and expectations align with their investment strategy and that you are actually compatible.

In addition to needing to find a potential investor, you need to actually sell them on getting behind you and your idea. Limited Partners’ venture capital goals are closely tied to their long-term profit earnings. They want to make sure that you’ll be around for the long run and it’s your job to show them that you are worth betting on. Remember to prepare a pitch and more importantly make sure you can concisely present your idea, what problem it solves and how you are planning to execute it. The investor doesn’t only need to buy into your idea, but also you and your team (if you have one). If the investor doesn’t believe that you are the one capable of executing the idea you’re presenting, it won’t matter how spectacular and original your idea is, they won’t back you.

Conclusion

A venture capital limited partnership is for you if you need to raise capital for your startup from a small group of investors and you don’t want to give up much control of your business. There are many ways to find an investor perfect for you and your idea, but it’s most important that you take the time to really consider whether you and your potential venture capital partners are a good fit, as you’ll be closely connected for the foreseeable future, should you agree to work together.

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Key points:

• Limited Partners in venture capital are the investors that give money to venture funds.
• Limited Partners in venture capital are more long-term and hands-off investors, as they may see the returns of their investment only after many years.
• Unlike General Partners who manage the venture fund and its day-to-day operations, Limited Partners in venture capital have few other obligations besides sending funds on time and usually don’t have a say in the fund’s day-to-day operations.
• Utilizing your network by asking around, going to startup accelerators, conferences and webinars are great ways to find a Limited Partner to back your business plan.

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