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10.1.20: Restrictions on the GPGP's Powers
The GPGP is usually granted plenary powers to deal with the partnership assets so that, as an attractive
opportunity looms, the partnership is not faced with an officious lawyer on the other side questioning a
managers power to sign documents. However, certain powers are sensitive, particularly the power to borrow
for purposes of leveraging partnership investments or to organize an SBIC, the latter implying the power and
purpose to leverage due to the nature of SBICS.
[1]
So-called 501(c)(3) entities (e.g. educational institutions
and foundations) may wind up with taxable income if their investments are leveraged, giving rise to
unrelated debt-financed income.
[2]
Hence, a prohibition on borrowing is ordinarily the price of admission
for such nonprofit investors. Similarly, the use of certain trading strategies (e.g., short sales and
commodities futures) are usually frowned on by nonprofit limited partners, since income from such activities
may not qualify as income from investments or be viewed as debt financed, and, thus, not be excluded
[3]

from the definition of unrelated business taxable income.
[4]


[1]
The SBAs participating securities program is designed to avoid debt-financed portfolio investments (the
leverage consisting of stock) and, therefore, unrelated business taxable income. See "SBICs Under the
Participating Securities Program".
[2]
I.R.C. 514. For a general discussion of unrelated debt-financed income, see 2 Phelan, NonProfit
Enterprises: Law and Taxation 11: 19 (1985). See "SBICs". Authorizing the partnership to invest in an
SBIC, or indeed any managed entity (another venture partnership for example), raises the specter of dual
management fees. In such event, the fee at the senior partnership level, including the carried interest, is
usually limited-I% of the assets under double management is typical.
[3]
I.R.C. 512(b).

[4]
See Treas. Reg. 1.512(b)-I(d)(2): [I]f an organization is engaged in the trade or business of writing
options ... the exclusion will not be available. Typically, the agreement will also bar the purchase by the
partnership of securities on margin because the same may give rise to debt-financed income. Elliot Knitwear
Profit Sharing Plan v. Commissioner, 71 T.C. 765 (1979), affd, 614 F.2d 347 (3d Cir. 1980).
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