TL;DR: The general partner runs the fund and bears unlimited liability. The limited partner writes the check and steps back. The GP earns 2% management fees plus 20% of profits. The LP earns returns after clearing a preferred hurdle. Understanding this split is the foundation of every private equity relationship.
According to LegalClarity, the general partner runs everything and bears unlimited liability for fund debts, while the limited partner provides capital and risks only the amount invested. Two roles. One fund. Neither makes sense without the other.
If you want to raise capital for an acquisition, invest in private equity as an accredited investor, or simply understand how PE firms actually work, you need this structure cold. It shows up in every fund formation, every LP presentation, and every distribution discussion you will ever have in this space.
What a limited partnership is and why it exists
A limited partnership is a legal business structure with at least one general partner and at least one limited partner. Most private equity funds, venture capital funds, and real estate investment funds use this structure. Delaware is the most common jurisdiction for formation.
The structure solves a specific problem: experienced deal professionals need large pools of outside capital to buy companies, but outside investors want liability protection. A limited partnership provides both. The GP controls all investment decisions. The LP provides most of the capital. The LP's personal assets are never at risk beyond what they committed to the fund.
The Limited Partnership Agreement (LPA) governs the entire relationship. The LPA sets profit splits, fees, capital call terms, governance rights, and the conditions under which the GP can be removed. It is the foundational document of any fund, and no two funds negotiate identical ones.
What the general partner actually does
The GP is the decision-maker. Full stop.
The GP sources deals, runs due diligence, negotiates purchase prices, manages portfolio companies after acquisition, and eventually sells those investments to return capital. All major investment decisions live with the GP. LPs have no say in which companies get bought, how they are managed, or when they are sold.
The GP entity is usually structured as a limited liability company. That LLC structure provides some insulation for the individuals running it, but the entity itself is fully liable for all partnership debts. That unlimited liability is the legal trade-off for total control. Creditors can pursue the GP entity's own resources if the fund's obligations exceed its assets.
The GP also owes fiduciary duties to limited partners. The duty of loyalty requires the GP to put investor interests ahead of its own and prohibits self-dealing and undisclosed conflicts. The duty of care requires informed, reasoned decisions. These duties exist by default under partnership law, though LPAs sometimes modify them within legal limits.
Most GPs also invest alongside limited partners. The GP commit, often called "skin in the game," typically runs 1 to 3.5 percent of total fund commitments. This aligns GP incentives with LP returns. A GP who loses LP money also loses its own capital.
What the limited partner actually does
The LP's job is to write the check and step back.
Limited partners include pension funds, university endowments, insurance companies, foundations, family offices, and high-net-worth accredited investors. These investors provide the vast majority of a fund's capital. They have no role in daily management. That passivity is not optional. It is the legal foundation for their liability protection.
An LP's maximum exposure is capped at the capital committed to the fund. If the fund collapses, creditors cannot pursue the LP's personal assets or other investments beyond the committed amount. This cap is why institutional investors, which can lose only what they invested, can commit large sums to PE funds without exposing entire portfolios to single-fund risk.
LPs are not entirely powerless. The LPA typically grants voting rights on fundamental changes: extending the fund's term, amending investment restrictions, or removing the GP for serious breach or underperformance. Most funds also establish a Limited Partner Advisory Committee (LPAC), usually composed of the fund's largest investors, to address conflicts of interest and approve sensitive matters. The LPAC advises but does not manage.
How the GP gets paid: the 2 and 20 model
GP compensation follows a two-part structure the industry calls "2 and 20."
The first part is a management fee. Typically around 2 percent of committed capital per year during the investment period, usually the first three to five years. This fee covers operating costs: salaries, office overhead, due diligence expenses, and legal costs. It gets paid regardless of fund performance. After the investment period ends, many funds step the fee down to a percentage of invested capital only. On a $100 million fund, that 2 percent generates $2 million per year to run the operation before a single deal closes.
The second part is carried interest, the GP's share of fund profits. Carried interest is typically 20 percent of net gains. This is where GP compensation actually scales. But it only kicks in after LPs have received specific minimum returns. Carry that does not get earned does not get kept.
How profits flow: the distribution waterfall
Profits move through a structured sequence called the distribution waterfall. The most LP-friendly version works in four steps.
First, return of capital. LPs receive 100 percent of distributions until they have recovered every dollar of their original investment. No profit sharing until all capital is back.
Second, preferred return. After capital is returned, LPs receive all distributions until they have earned a minimum annualized return on their investment, typically 7 to 9 percent. This is called the hurdle rate. The GP earns nothing until LPs have cleared it.
Third, GP catch-up. Once LPs hit their preferred return, the GP receives a concentrated allocation designed to bring its total profit share up to 20 percent of all profits earned to that point. This catch-up may be 100 percent to the GP or structured as an 80/20 split weighted to the GP.
Fourth, the ongoing split. After the catch-up, remaining profits divide 80 percent to LPs and 20 percent to the GP.
An alternative structure, sometimes called a deal-by-deal waterfall, lets the GP collect carried interest on each profitable exit before LPs have recovered their full capital commitment across the entire fund. LPs generally prefer the whole-fund structure for obvious reasons. Deal-by-deal waterfalls benefit the GP.
How this applies to ETA and lower-middle-market buyers
Most search fund operators and entrepreneurship-through-acquisition (ETA) buyers encounter the GP/LP structure from the GP side. When you raise a search fund, you become the equivalent of a general partner. Your investors are the equivalent of limited partners. You control the acquisition process and the operating company. Your investors provide capital and receive preferred returns before you see any equity upside.
The mechanics are the same whether you are raising $5 million for a search fund or $500 million for a buyout fund. Understand the waterfall before you negotiate equity terms. Understand management fees before you project your personal income during the search period. Understand carried interest before you commit to an investor deck.
For accredited investors looking at PE exposure, the LP role offers liability protection and passive income, but requires trusting GP judgment entirely. The key questions to ask any GP before committing capital: What is the preferred return? What is the waterfall structure? What is the GP commit? What are the key man provisions if the principal leaves?
The structure of a fund answers those questions before the relationship starts. Read the LPA. If the GP does not want you reading the LPA carefully, that tells you something.
For more on how lower-middle-market PE firms structure acquisitions, see how lower-middle-market private equity works.
Tax treatment: pass-through entities and K-1s
Limited partnerships are pass-through entities. The fund itself pays no income tax. Each partner's share of income, gains, losses, and deductions flows through to their individual tax return via a Schedule K-1.
The tax treatment differs significantly by role. For LPs, long-term capital gains from portfolio company exits held more than one year receive preferential tax treatment. For GPs, carried interest has historically received capital gains treatment as well, though this has been a recurring target for legislative change. Management fees are ordinary income.
K-1s from PE funds can be complex. Multiple states, multiple asset classes, and income allocated across different holding periods create tax reporting that requires specialized advisors. Budget for that complexity before you commit capital as an LP.
Frequently Asked Questions
What is the main difference between a general partner and a limited partner?
The general partner manages the fund and makes all investment decisions, bearing unlimited liability for fund debts. The limited partner provides capital and has no management role, with liability capped at the amount committed to the fund.
How does a GP earn carried interest in a private equity fund?
Carried interest is the GP's share of fund profits, typically 20 percent of net gains. The GP earns carry only after limited partners have received their full capital back plus a preferred return, usually 7 to 9 percent annually. A clawback provision requires the GP to return excess carry if later investments underperform.
What is the preferred return in a private equity distribution waterfall?
The preferred return, also called the hurdle rate, is the minimum annualized return LPs must earn before the GP shares in profits. It typically runs 7 to 9 percent. LPs receive all fund distributions until this threshold is met. The GP earns nothing from carry until LPs clear the hurdle.
Can a limited partner lose more than their investment in a private equity fund?
No. A limited partner's liability is capped at the capital committed to the fund. Creditors of the fund cannot pursue an LP's personal assets or other investments beyond the committed amount. This liability shield is the primary reason institutional investors use the limited partnership structure for private market allocations.
