In finance, LP stands for limited partnership, a business structure that pairs one or more managing partners who run the operation with passive investors who put up the money. It’s the standard legal form for private equity firms, venture capital funds, hedge funds, and many real estate investment vehicles, because it cleanly separates the people making decisions from the people funding them.
The letters “LP” can refer to the entity itself (the limited partnership) or, in everyday fund jargon, to one of the investors in that entity (a limited partner). Context usually makes clear which is meant.
The Two Roles Inside a Limited Partnership
Every LP has at least two participants filling two distinct roles: a general partner and one or more limited partners.
The general partner runs the business. That means entering contracts, directing investments, hiring staff, and making strategic calls on behalf of the partnership. In exchange for that authority, the general partner carries unlimited personal liability. If the partnership cannot pay its debts, creditors can pursue the general partner’s personal assets to satisfy them.1Cornell Law Institute. General Partner Because of that exposure, general partners are often themselves LLCs or corporations rather than individuals, so the humans behind the GP keep a layer of protection.
The general partner also owes fiduciary duties to the partnership and its limited partners: no self-dealing, no competing with the partnership, no taking business opportunities that belong to it, and no grossly negligent or reckless conduct.
Limited partners are the money side. They contribute capital and stay out of operations. Their financial risk is capped at what they invested, so if the partnership fails, creditors cannot reach a limited partner’s home, savings, or other personal assets beyond that contribution.
That protection has a condition attached. If a limited partner starts acting like a manager, such as directing employees or signing contracts for the partnership, a court can strip the liability shield and treat that partner like a general partner for liability purposes. The line between investing and managing is the whole ballgame for a limited partner.
How profits, losses, and decisions are divided among the partners is set by the partnership agreement, a private contract signed when the LP is formed. Under federal tax law, each partner’s share of income, gains, losses, deductions, and credits is determined by that agreement.2Office of the Law Revision Counsel. 26 U.S. Code 704 – Partner’s Distributive Share That flexibility is a big reason the LP format keeps its place in sophisticated deals.
How Limited Partnerships Are Taxed
An LP is a pass-through entity for federal income tax. The partnership itself pays no income tax; profits and losses flow through to the individual partners, who report them on their personal returns.3Office of the Law Revision Counsel. 26 U.S. Code 701 – Partners, Not Partnership, Subject to Tax After year-end, each partner receives a Schedule K-1 from the partnership detailing their share of income, deductions, and credits.4Internal Revenue Service. Partnerships This single layer of tax is one of the main reasons investors prefer the LP wrapper over a C corporation, which is taxed at the entity level and again on dividends.
Self-Employment Tax
General partners owe self-employment tax (Social Security and Medicare) on their share of partnership income, regardless of how actively involved they are. Limited partners are generally exempt from self-employment tax on their share. The exception is guaranteed payments a limited partner receives for services actually provided to the partnership, which are subject to self-employment tax.5Office of the Law Revision Counsel. 26 U.S. Code 1402 – Definitions
Passive Losses
A limited partnership interest is automatically treated as a passive activity under federal tax law, meaning the limited partner is presumed not to materially participate in the business. Passive losses can be deducted only against passive income, not against wages or investment income. Excess passive losses carry forward. When a limited partner sells or otherwise disposes of the entire interest, any unused passive losses become fully deductible against all types of income.6Office of the Law Revision Counsel. 26 U.S. Code 469 – Passive Activity Losses and Credits Limited
Basis and Cash Distributions
Cash distributions from an LP are tied to a partner’s basis, a running tally of capital contributed and adjusted upward for allocated income and downward for allocated losses and prior distributions. A cash distribution is not taxable as long as it stays at or below basis. Anything above basis is treated as capital gain.7Office of the Law Revision Counsel. 26 U.S. Code 731 – Extent of Recognition of Gain or Loss on Distribution If you have a $250,000 basis and receive a $300,000 distribution, $50,000 is taxable gain. Partners who lose track of basis can be surprised by a tax bill on what they thought was a return of capital.
Where You’ll Encounter LPs as an Investor
Most people who run across the term “LP” in finance are looking at a private fund. In a typical private equity, venture capital, or hedge fund, the manager sits in the general partner seat and makes every investment decision. Institutional investors, endowments, insurance companies, pension funds, and wealthy individuals subscribe as limited partners.
The “2 and 20” Economics
Investment fund LPs commonly follow a “2 and 20” model. The general partner charges an annual management fee, traditionally around 2 percent of committed capital, to cover salaries, research, and operating costs. On top of that, the GP earns carried interest, typically 20 percent of profits, but only after investors receive a preferred return (often around 8 percent). The remaining 80 percent above that hurdle goes to the limited partners. All of these numbers are negotiated in the partnership agreement and vary from fund to fund.
Capital Calls
Limited partners usually do not wire their entire commitment upfront. The general partner issues capital calls, formal requests for a portion of each LP’s pledged amount, as deals close or expenses come due. A capital call notice typically gives 10 to 14 days to send the funds.
Missing a capital call is costly. The partnership agreement usually allows remedies that include forfeiting part or all of your existing interest, forced sale of your interest, or dilution. Non-defaulting partners may be asked to cover the shortfall. Fund lives commonly run 10 years or more, so a limited partner needs to be confident about funding calls across that entire window before signing on.
LP vs. LLC
The natural comparison is to a limited liability company. Two differences matter most.
Liability. In an LLC, every owner has limited liability. In an LP, only the limited partners do; the general partner is personally on the hook for the partnership’s debts.8U.S. Small Business Administration. Choose a Business Structure
Management. LLC members can all participate in running the company without losing their liability shield. In an LP, limited partners who cross into management can lose theirs. The LP structure fits when investors want to be passive; the LLC fits when every owner wants a voice.
Both are pass-through for federal income tax. But in an LP, only the general partner owes self-employment tax on partnership income, while LLC members typically owe self-employment tax on their share.8U.S. Small Business Administration. Choose a Business Structure For a high-income passive investor, that gap is meaningful.
How a Limited Partnership Is Formed and Ended
Creating an LP requires filing a Certificate of Limited Partnership with the state, usually through the Secretary of State’s office. The certificate generally includes the partnership’s name (state rules often require “Limited Partnership” or “LP” in it), a registered agent to receive legal documents, and a principal business address.
Alongside the certificate, the partners sign a partnership agreement covering profit sharing, management authority, capital contributions, and how partners are admitted or removed. The certificate is public; the partnership agreement stays private among the partners. Many state statutes are modeled on the Uniform Limited Partnership Act, but formation rules, fees, and annual reporting requirements differ by state.
An LP ends when the partnership agreement says it does, often after a set term, upon completion of a project, or by partner vote. Dissolution can also be triggered by the withdrawal or bankruptcy of the sole general partner, unless the limited partners vote to continue.
Once dissolution starts, the partnership enters a winding-up phase. Creditors are paid first, including any partners owed money as creditors. Only after all debts are satisfied do the remaining assets get distributed to the partners according to their interests. If assets fall short of debts, the general partner is personally responsible for the shortfall; limited partners cannot be forced to put in more than their original commitment. To end the LP’s legal existence, the general partner files a certificate of cancellation with the state, often along with tax clearance confirming state tax obligations are settled.