What is a limited partnership?
A limited partnership is a type of business structure where two or more partners agree to operate a business together. Unlike a general partnership, a limited partnership has at least one general partner and one or more limited partners. The general partner(s) has unlimited liability for the business’s debts and obligations, while the limited partner(s) have limited liability, which means they are only liable for the amount of money they have invested in the business.
Limited partnerships are often used in businesses where one partner wants to invest capital but does not want to take on the responsibility of managing the day-to-day operations of the business. This arrangement can be beneficial for both parties as the limited partner can earn a return on their investment without being involved in the management, while the general partner can access capital without diluting their control over the business.
Pros and cons of a limited partnership
As with any business structure, there are pros and cons to forming a limited partnership. Here are some of the key advantages and disadvantages to consider:
Pros of limited partnership
- Limited liability: Limited partners are only liable for the amount of money they have invested in the business. This means that their personal assets are protected if the business runs into financial trouble.
- Flexibility in management: Limited partners can invest in the business without being involved in the day-to-day management, which can be a good fit for investors who want to be hands-off. Meanwhile, general partners have control over the management and decision-making of the business.
- Access to capital: General partners can raise capital by bringing in limited partners, without giving up control over the business.
- Tax benefits: Limited partnerships are typically taxed as pass-through entities, which means that the business itself is not taxed, but the profits and losses flow through to the partners’ personal tax returns.
Cons limited partnership
- Unlimited liability for general partners: The general partner(s) have unlimited liability for the business’s debts and obligations, which means that their personal assets are at risk if the business runs into financial trouble.
- Legal requirements: Limited partnerships must follow certain legal requirements, such as filing paperwork with the state and maintaining records. Failing to meet these requirements can result in penalties or the loss of limited liability protections.
- Management responsibilities: General partners are responsible for managing the business and making decisions, which can be a lot of work and responsibility.
- Limited partner restrictions: Limited partners may have limited rights and abilities to participate in the management of the business. They may also be restricted in their ability to sell or transfer their ownership interest in the business.
How to form a limited partnership
To form a limited partnership, you’ll need to follow a few key steps:
1. Choose a business name
You’ll need to choose a name for your business that meets your state’s requirements for limited partnerships. Check with your state’s business registration office to find out what the requirements are.
2. File paperwork
You’ll need to file paperwork with your state’s business registration office to register your limited partnership. The paperwork typically includes a certificate of limited partnership that lists the names of the general and limited partners and their contributions to the business.
3. Obtain necessary licenses and permits
Depending on the type of business you’re starting and where it’s located, you may need to obtain certain licenses or permits. Check with your state and local government to find out what’s required.
4. Draft a partnership agreement
It’s important to draft a partnership agreement that outlines the roles and responsibilities of each partner, how profits and losses will be allocated, and other important details. This agreement should be signed by all partners.
5. Obtain an EIN
You’ll need to obtain an employer identification number (EIN) from the IRS. This number is used to identify your business for tax purposes.
Roles and responsibilities of limited partners vs. general partners
In a limited partnership, the roles and responsibilities of the general partner and limited partners can vary. Here’s an overview of what each partner typically does:
- Manages the day-to-day operations of the business
- Makes decisions on behalf of the business
- Has unlimited liability for the business’s debts and obligations
- May invest capital in the business
- Provides capital to the business
- Has limited liability for the business’s debts and obligations
- May not be involved in the day-to-day operations or decision-making of the business
- May have limited rights and abilities to participate in the management of the business
How a limited partnership differs from other business structures
Limited partnerships differ from other business structures, such as sole proprietorships, partnerships, and limited liability companies (LLCs), in several ways:
- Liability: Limited partnerships offer limited liability for limited partners, whereas sole proprietorships and partnerships offer no liability protection. LLCs offer limited liability protection to all members.
- Taxation: Limited partnerships are taxed as pass-through entities, meaning profits and losses are passed through to the partners and reported on their individual tax returns. Sole proprietorships and partnerships are also taxed as pass-through entities, while LLCs can choose to be taxed as either a pass-through entity or a corporation.
- Management: In a limited partnership, general partners manage the business and have unlimited liability, whereas limited partners have limited liability but generally do not participate in management. In a sole proprietorship, the owner manages the business and has unlimited liability. In a partnership, all partners share management responsibilities and have unlimited liability. In an LLC, members can choose to manage the business themselves or hire a manager, and all members have limited liability.
- Ownership: In a limited partnership, there must be at least one general partner and one limited partner. In a sole proprietorship, there is only one owner. In a partnership, there are two or more owners. In an LLC, there can be one or more members.
A Limited partnership can be a viable option for entrepreneurs who want to start a business with a partner while protecting themselves from certain liabilities. However, it’s important to carefully consider the role of each partner and ensure that you comply with all legal requirements.
Additionally, it’s important to have a clear agreement in place that outlines the responsibilities and rights of each partner. With the right planning and execution, a limited partnership can be a successful way to launch and grow a business.
Frequently Asked Questions
A general partner manages the business and has unlimited liability for the business’s debts and obligations, while a limited partner has limited liability but generally does not participate in management.
Advantages of a limited partnership include limited liability for limited partners, flexibility in terms of roles and responsibilities, tax benefits, and easier access to capital. However, there are also some disadvantages, such as general partners having unlimited liability and limited partners having limited control over the business.