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9.8 Limited partnerships and functionally-equivalent LLCs
Publication date: 27 May 2020
us NFP guide
This section discusses the application of the general accounting requirements described in NP 9.5 to investments in limited partnerships and LLCs that are the functional equivalent of limited partnerships (see NP 9.9) that are not held within a portfolio for which the portfolio-wide fair value option has been elected. The accounting for limited partnership interests held within such portfolios is addressed in NP 9.6.
Throughout this section, any reference to a limited partner includes nonmanaging members of LLCs that are the functional equivalent of limited partnerships, and references to general partners refers to managing members of those LLCs.
A limited partnership is comprised of one or more general partners and one or more limited partners. In these arrangements, voting power and economic interests usually are not aligned, as decision-making authority typically resides with a general partner who may have a small ownership interest relative to the limited partners. The general partner has the authority to transact on the partnership’s behalf, direct the partnership’s operations, and bind the partnership by entering into contracts. The limited partners, on the other hand, invest capital and typically cannot act on behalf of or direct the activities of the partnership.
Evaluations of control or significant influence in these structures cannot be based solely on the level of ownership by the investor, as they are in investments in common stock of a corporation or an LLC that is the functional equivalent of a corporation, discussed in NP 9.7, in which investor voting rights typically are proportionate to their ownership percentages. Because of the fundamentally different nature of the governance model for limited partnerships, a different model is used to assess control.
ASC 958-810 contains guidance specific to NFPs for evaluating limited partnership interests for consolidation or application of the equity method. Under the ASC 958-810 framework, NFPs do not consider the guidance in ASC 810-10 for business entities that have interests in limited partnerships. NFPs exclusively use a voting interest model when evaluating relationships for consolidation. Even when a business entity would apply a voting interest entity model to a limited partnership interest, that model is significantly different from the voting interest entity model applied by NFPs to limited partnership interests. NP 9.8.1 highlights the differences (and similarities) between the NFP and business entity voting interest entity (VOE) models used in accounting for limited partnership interests.
The model used by NFPs to account for interests in limited partnerships differs based on whether the NFP is a general or limited partner.
Figure NP 9-7 summarizes the model used by NFPs to account for interests in limited partnerships.
Figure NP 9-7
Decision tree—accounting for equity interests in limited partnerships
Decision tree—accounting for equity interests in limited partnerships
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Figure NP 9-7A summarizes the model used by NFPs to account for interests in limited partnerships prior to adoption of ASU 2016-01.
Figure NP 9-7A
Decision tree—accounting for equity interests in limited partnerships (prior to adoption of ASU 2016-01)
Decision tree—accounting for equity interests in limited partnerships (prior to adoption of ASU 2016-01)
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9.8.1 Comparing the business entity and NFP voting interest model
Figure NP 9-8 highlights the similarities and differences between the NFP and business entity voting interest entity (VOE) models used in accounting for limited partnership interests.
Figure NP 9-8
Comparison of business entity and NFP voting interest entity (VOE) models used for evaluating investments in limited partnerships
Comparison of business entity and NFP voting interest entity (VOE) models used for evaluating investments in limited partnerships
NFP model (ASC 958-810)
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Business entity model (ASC 810-10)
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9.8.2 Consolidation of interests in limited partnerships
ASC 958-810-25-11 through ASC 958-810-25-29 set forth the NFP-specific consolidation model used to evaluate investments in limited partnerships and similar legal entities. According to ASC 958-810-15-4(b), this model does not apply to interests in limited partnerships that are held within portfolios for which the PWFVO has been elected; the accounting for those interests is subject to the guidance in ASC 321 (or ASC 958-320 prior to adoption of ASU 2016-01) and is addressed in NP 9.6.
An NFP that is a general partner or a limited partner of a for-profit limited partnership or a similar legal entity (such as a limited liability company that has governing provisions that are the functional equivalent of a limited partnership) shall apply the guidance in paragraphs 958-810-25-11 through 25-29 and 958-810-55-16A through 55-16I. However, the guidance in those paragraphs does not apply to the following:
- A general partner or a limited partner that reports its partnership interest at fair value in accordance with [ASC 958-810-15-4](e).
- Entities in industries, such as the construction or extractive industries, in which it is appropriate for a general partner to use the pro rata method of consolidation for its investment in a limited partnership (see paragraph 810-10-45-14).
As described in ASC 958-810-25-12, the analysis begins with a presumption that the general partner controls a limited partnership, regardless of the general partner’s level of ownership. Unless that presumption is overcome, the general partner must consolidate.
The general partners in a limited partnership are presumed to control that limited partnership regardless of the extent of the general partners' ownership interest in the limited partnership.
According to ASC 958-810-25-15, the presumption of control by the general partner is overcome if limited partners hold either substantive kick-out rights or substantive participating rights (see NP 9.8.4). If the presumption is overcome, the general partner’s interest in the limited partnership is accounted for using the equity method.
If the limited partners have substantive kick-out rights or substantive participating rights, the presumption of control by the general partners is overcome and each of the general partners shall account for its investment in the limited partnership using the equity method of accounting.
If an individual limited partner owns a majority of the voting interests that control the substantive kick-out rights, that limited partner might be required to consolidate the partnership, as described in ASC 958-810-25-16.
If one limited partner directly or indirectly owns more than 50 percent of a limited partnership’s kick-out rights through voting interests, then that limited partner shall be deemed to have a controlling financial interest in the limited partnership and shall consolidate the limited partnership. However, if noncontrolling limited partners have substantive participating rights, then the limited partner with a majority of kick-out rights through voting interests does not have a controlling financial interest.
A controlling financial interest that requires consolidation would generally exist if a single limited partner owns a majority of kick-out rights through voting interests. That partner generally would have the ability to unilaterally remove the general partner or cause the partnership to be dissolved. However, if other limited partners hold substantive participating rights (explained in NP 9.8.4.2), the limited partner with a majority of kickout rights would not have a controlling financial interest and should not consolidate the partnership.
If the general partner does not control and no single limited partner has a controlling financial interest, then none of the investors would consolidate the partnership.
Question NP 9-2 illustrates the consolidation analysis for interests in a limited partnership.
Question NP 9-2
Investment LP has three partners, all of which are NFP entities. The partnership agreement provides the general partner with the authority to direct the partnership’s operations and enter into binding contracts on behalf of the partnership. The limited partners have no authority beyond certain limited rights granted in the operating agreement that are neither kick-out nor participating rights. How would the partners evaluate their interests for potential consolidation?
Investment LP has three partners, all of which are NFP entities. The partnership agreement provides the general partner with the authority to direct the partnership’s operations and enter into binding contracts on behalf of the partnership. The limited partners have no authority beyond certain limited rights granted in the operating agreement that are neither kick-out nor participating rights. How would the partners evaluate their interests for potential consolidation?
PwC response
The partners would evaluate their interests for potential consolidation using the guidance in ASC 958-810-15-4(b).
According to the guidance in ASC 958-810-15-4(b), a presumption exists that the general partner controls the partnership and should consolidate it, unless limited partners have substantive kick-out or participating rights that would overcome the presumption of control. In this fact pattern, the limited partners do not have such rights; thus, the general partner would be required to consolidate the partnership.
9.8.3 Noncontrolling interests in limited partnerships
An entity that holds a general partner interest in a limited partnership but concludes that the general partner interest does not represent a controlling financial interest (see NP 9.8.2) must account for that interest using the equity method, pursuant to ASC 958-810-25-15. Alternatively, that interest could be reported at fair value if an election is made under the "Fair value option" subsections of ASC 825-10 (see NP 9.3.)
For noncontrolling limited partner interests, the accounting depends on the nature of the partnership’s activities. If the partnership is involved in real estate, ASC 958-810-15-4(d) (ASC 954-810-15-3(i) for NFP HCOs) requires NFPs to apply guidance specific to the real estate industry described in ASC 970-323, Real estate—investments—equity method and joint ventures, for noncontrolling interests in real estate limited partnerships. If the partnership is not involved in real estate, the accounting is discussed in NP 9.8.3.1.
Excerpt from ASC 958-810-15-4(d)
An NFP with a more than minor noncontrolling interest in a for-profit real estate partnership, limited liability company, or similar legal entity shall report its noncontrolling interests in such entities using the equity method in accordance with the guidance in Subtopic 970-323 unless that interest is reported at fair value in conformity with the guidance described in [ASC 958-810-15-4](e).
According to ASC 970-323-25-6, use of the equity method by noncontrolling limited partners is generally appropriate unless a partner’s interest is so minor that the limited partner has virtually no influence over partnership operating and financial policies. As a result, the threshold for applying the equity method to a partnership investment is significantly lower than is the case for an investment in common stock.
The equity method of accounting for investments in general partnerships is generally appropriate for accounting by limited partners for their investments in limited partnerships. A limited partner's interest may be so minor that the limited partner may have virtually no influence over partnership operating and financial policies. Such a limited partner is, in substance, in the same position with respect to the investment as an investor that owns a minor common stock interest in a corporation, and, accordingly, the limited partner should account for its investment in accordance with Topic 321.
Evaluating whether an interest is “minor” or “more than minor” involves judgment. In making those judgments, NFPs often consider, and apply by analogy, the guidance in ASC 323-30-S99-1 that investments of more than 3 to 5% are “more than minor” interests. AAG-HCO 12.49 provides additional information on distinguishing a minor interest from an interest that is more than minor. In general, we believe that use of the equity method may also be acceptable at lower levels of ownership. As discussed in CG 4.3.1.2, use of the equity method in situations when an investor has a less than 3% investment in a limited partnership or an LLC that maintains separate ownership accounts for each investor (see NP 9.9.2) should be applied consistently by the investor for all such investments.
If the equity method is not used because the interest is deemed to be minor, the limited partner is in the same position with respect to the investment as an investor that owns a minor common stock interest in a corporation. In that situation, the accounting depends on whether the NFP has adopted ASU 2016-01.
- Under ASU 2016-01, the interest is accounted for at fair value on a recurring basis or using the measurement alternative, in accordance with ASC 321 (see NP 9.7.3).
- Prior to adoption of ASU 2016-01, use of the cost method described in NP 9.7.3A would generally be appropriate. AAG-NFP 3.101 illustrates application of this guidance. Alternatively, the NFP could elect to report its interest at fair value using the general fair value option in ASC 825-10.
9.8.3.1 Interests in limited partnerships not engaged in real estate
If the limited partnership’s activities do not involve real estate, NFPs often consider, and apply by analogy, the real estate guidance. Under that approach, the NFP would apply the equity method unless its interest is deemed to be so minor that it has virtually no influence over the partnership’s operating and financial policies. If an NFP does not choose to analogize to the real estate guidance, the interest would be reported in accordance with ASC 321 (i.e., fair value).
For additional information, see AAG-NFP 3.88 through AAG-NFP 3.93, AAG-NFP 4.24 through AAG-NFP 4.27, and AAG-HCO 12.44 through AAG-HCO 12.49.
9.8.3.1A Interests in limited partnerships not engaged in real estate (prior to adoption of ASU 2016-01)
If the limited partnership’s activities do not involve real estate, the accounting differs based on (1) whether the NFP is an HCO and (2) whether a non-healthcare NFP holds the interest in connection with carrying out the NFP’s operations (an operating investment) or to generate investment return (a portfolio investment).
NFPs that hold the interest as an operating investment and NFP HCOs will often consider, and apply by analogy, the real estate guidance described in NP 9.8.3. Under that approach, the NFP would apply the equity method unless its interest is deemed to be so minor that it has virtually no influence over the partnership’s operating and financial policies. If an NFP does not analogize to the real estate guidance, it would apply the cost method described in NP 9.7.3A or alternatively, could elect to report its interest at fair value using the general fair value option in ASC 825-10.
NFPs other than HCOs must apply the guidance in ASC 958-325 when accounting for limited partnership interests held as portfolio investments. According to ASC 958-325, if a non-HCO NFP holds a limited partner interest for purposes of earning income or capital appreciation, it must account for it at either fair value or using the cost method, based on the portfolio-wide accounting policy selected (see discussion at NP 9.6). Thus, an NFP cannot apply the real estate guidance by analogy, and, therefore, has no basis to apply the equity method to these investments.
AAG-NFP 3.91 through AAG-NFP 3.93 illustrate the accounting for an operating investment that is not a real estate limited partnership. In those situations, AAG-NFP recommends that NFPs apply the equity method of accounting by analogy to the real estate guidance.
Example NP 9-1A illustrates the analysis for a limited partnership not involved in real estate that is held by a non-healthcare NFP as a portfolio investment.
EXAMPLE NP 9-1A
Portfolio investment in limited partnership not involved in real estate
Portfolio investment in limited partnership not involved in real estate
Research Institute holds a noncontrolling limited partnership interest in Tech LP, a limited partnership that invests in emerging technology companies in order to achieve above-market returns. Research Institute is an entity within the scope of ASC 958-325, which requires a portfolio-wide accounting policy election for alternative investments entered into for investment return or profit. Research Institute has not elected the portfolio-wide fair value option.
How would Research Institute account for its limited partnership interest in Tech LP?
Analysis
Because Tech LP is not engaged in real estate activities, Research Institute is not required to apply the accounting model in ASC 970-323 for real estate limited partnerships.
Research Institute must apply the guidance in ASC 958-325 in accordance with its accounting policy election and thus, would measure the interest at lower of cost or market (as described in NP 9.2.3A). If desired, Research Institute could instead report its interest at fair value by making an ASC 825-10 election.
After adoption of ASU 2016-01, the specialized guidance in ASC 958-325 for equity interests will be superseded. Research Institute would be permitted to apply the real estate model by analogy and thus, would apply the equity method unless its interest is not deemed to be “minor.” If the real estate model is not applied by analogy, NFP Research Institute would report its interest at fair value in accordance with ASC 321.
9.8.4 Rights granted to limited partners on consolidation analysis
A partnership agreement may provide limited partners with rights to remove the general partner (kick-out rights) or rights to participate in certain significant financial and operating decisions in the ordinary course of business. If those rights are substantive, they can preclude consolidation by a general partner or limited partner whose interest would otherwise require consolidation. In the NFP model, rights granted to limited partners are discussed in ASC 958-810-25-19 through ASC 958-810-25-29.
As noted in NP 9.8.1, evaluation of the rights granted to limited partners is a key consideration under both the NFP and business entity consolidation models, and, in substance, both use “substantive participating rights” and “substantive kick-out rights” with essentially the same meanings. However, in the business entity model, the existence of such rights only overcomes the presumption that the VIE model should apply, while in the NFP model, the existence of such rights overcomes the presumption of control by the general partner. Ultimately, under either framework—NFP or business entity—the existence of substantive kick-out or participating rights directs the focus of the consolidation analysis to whether an individual limited partner has a controlling financial interest and should, therefore, consolidate.
9.8.4.1 Impact of kick-out rights on consolidation
Kick-out rights are rights that give limited partners the ability to either dissolve (liquidate) the partnership without cause, or the ability to remove or replace the general partner without cause and are defined in the ASC Master Glossary.
Kick-out rights (voting interest entity definition): The rights underlying the limited partner’s or partners’ ability to dissolve (liquidate) the limited partnership or otherwise remove the general partners without cause.
Kick-out rights are exercised through voting interests. The voting interest that a limited partner possesses in a kick-out right is generally equal to its economic interest in the partnership. CG 7.3.1 provides a further explanation of the concept of kick-out rights and an example.
The existence of kick-out rights can overcome the presumption of control by the general partner. Said differently, if another party or parties have the substantive right to remove the general partner without cause, and that right is substantive, the general partner does not have control over a limited partnership. CG 7.3.1 discusses the definition of “without cause.” Generally, “without cause” means that no reason need be given to exercise the right. A right to remove the general partner “for cause” (for example, due to gross negligence or illegal acts) would not be considered a kick-out right under the model.
Liquidation rights—that is, rights provided to limited partners to liquidate the partnership without cause—are considered equivalent to kick-out rights because they provide the holder with the ability to effectively remove the entity’s decision maker by dissolving the entity. According to ASC 958-810-25-20, withdrawal rights—that is, rights granted to limited partners to withdraw from the partnership in whole or in part—are not liquidation rights unless the dissolution or liquidation of the entire limited partnership is required upon the withdrawal of a limited partner or partners.
Although a limited partnership’s organizational documents may state that limited partners have the right to remove the general partner, such a statement is not by itself sufficient to make the right “substantive.” According to ASC 958-810-25-19, for a kick-out right to be substantive it must (1) be exercisable based on a simple majority vote of the limited partners and (2) there can be no significant barriers to the limited partners exercising those rights. Both conditions must exist.
Rights are exercisable by simple majority (or lower threshold)
According to ASC 958-810-25-19(a), the first required characteristic of a substantive kick-out right is that the general partner must be able to be removed by a single limited partner or a vote of a simple majority (or lower threshold) of the limited partner interests. When determining the simple majority required, the limited partners’ voting interests should exclude any kick-out rights held through voting interests belonging to the general partner, parties under common control with the general partners, and other parties acting on behalf of the general partners. An NFP investor needs to calculate and ensure that all possible combinations that represent a simple majority of the limited partners’ voting interests allow for the limited partners to kick-out or remove the general partner. ASC 958-810-55-26 through ASC 958-810-55-32 provide four cases illustrating the application of the simple majority threshold in exercising kick-out rights.
No barriers exist to exercise of rights
The second required characteristic of a substantive kick-out right is that the limited partners holding the removal or liquidation rights must have the ability to exercise the rights if they choose to do so. ASC 958-810-25-19(b) provides several examples of barriers to the limited partners ability to exercise their kick-out rights. The list is not all inclusive and includes the following examples.
- Conditions that make it unlikely the rights will be exercisable, for example, conditions that narrowly limit the timing of the exercise
- Financial penalties or operational barriers associated with dissolving (liquidating) the limited partnership or replacing the general partners that would act as a significant disincentive
- The absence of an adequate number of qualified replacement general partners or the lack of adequate compensation to attract a qualified replacement
- The absence of an explicit, reasonable mechanism by which the limited partners can call for and conduct a vote to exercise the rights
- The inability of the limited partners holding the rights to obtain the information necessary to exercise them
If economic or operational barriers to exercising such rights exists, the substance of the rights granted may be called into question. For example, a kick-out right would not be substantive if the limited partners lack an explicit mechanism to exercise that right–for example, if they are unable to obtain the identities of the other limited partners to convene a general meeting, or if they lack the ability to call for a general meeting. Refer to CG 4.4 for additional information regarding evaluating whether kick-out rights (including liquidation rights) are substantive. Although that discussion is written from the perspective of using kick-out rights to determine whether an investee should be evaluated under the variable interest entity model, the considerations when determining whether rights are substantive is essentially the same as in the NFP voting interest entity model.
9.8.4.2 Impact of participating rights on consolidation
Some partnership agreements allow limited partners to participate in decisions that could impact the partnership’s business–for example, a right to block or veto a decision made by a decision-maker. Such “participating rights” allow limited partners to participate in certain financial and operating decisions that occur in the ordinary course of the partnership’s business. Unlike a kick-out right, a participating right does not allow the holder to initiate an action or decision; instead, it allows the limited partner to prevent a decision-maker from executing a decision. Participating rights are defined in the ASC Master Glossary.
Participating rights (voting interest entity definition): Participating rights allow the limited partners or noncontrolling shareholders to block or participate in certain significant financial and operating decisions of the limited partnership or corporation that are made in the ordinary course of business. Participating rights do not require the holders of such rights to have the ability to initiate actions.
Participating rights that are substantive will preclude consolidation by either a general partner or a limited partner that holds a majority of kick-out rights. ASC 958-810-25-27 identifies the following factors to consider when evaluating whether a participating right is substantive:
- The level at which decisions are made, according to the limited partnership agreement
- Related-party relationships between the general partners and the limited partners
- Whether the right involves an operating or capital decision that is not significant to the ordinary course of business
- Whether the probability that an event or transaction that requires the limited partners’ approval will occur is remote
- Whether it would be prudent, feasible, and substantially within the control of the general partner(s) to exercise rights to buy out the limited partners
According to ASC 958-810-25-22, examples of substantive participating rights that would preclude consolidation are (1) selecting, terminating, and setting the compensation of management responsible for implementing the investee’s policies and procedures and (2) establishing operating and capital decisions of the investee (including budgets) in the ordinary course of business.
Rights that allow a limited partner to block or veto a decision that is expected to occur outside the ordinary course of business—for example, the right to approve or veto amendments to the partnership agreement—are not participating rights. Rather, they are considered protective rights—that is, they are designed to protect the value of the interest of the party holding the right. ASC 958-810-25-28 lists examples of protective rights that are often provided to limited partners. Protective rights held by limited partners would not preclude consolidation by either a general partner or a limited partner that owns a majority of kickout rights. Refer to CG 3.4 for more information on distinguishing participating rights from protective rights.
Judgment should be applied based on the specific facts and circumstances in each arrangement in order to determine whether limited partner rights should be considered protective or participating, and if participating, whether the rights are substantive. To assist in this evaluation, ASC 958-810-55-16A through ASC 958-810-55-16I provides examples (not all-inclusive) of possible assessments of individual limited partner rights. The factors and examples in ASC 958-810-25-27 and ASC 958-810-55-16A through 958-810-55-16I are substantially the same as the factors and examples for evaluating noncontrolling shareholder participating rights in corporations in ASC 810-10-25-13 and ASC 810-10-55-1, discussed in CG 7.2.6.2. When considering the discussions in CG 7.2.6.2, “noncontrolling rights” or “rights of noncontrolling shareholder” are analogous to “limited partner rights.”
Question NP 9-3 addresses whether the existence of participating rights could result in consolidation.
Question NP 9-3
If an individual limited partner possesses a majority of substantive participating rights, does that limited partner have a controlling financial interest that requires consolidation?
If an individual limited partner possesses a majority of substantive participating rights, does that limited partner have a controlling financial interest that requires consolidation?
PwC response
No. A participating right provides the holder with the ability to veto decisions, but not the ability to initiate actions. Therefore, unlike a kick-out right, it cannot result in a limited partner having control of the partnership.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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