Limited Partnership: Understanding Its Pros and Cons and How to Form One

Last updated 04/09/2024 by

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Summary:

Limited partnerships (LPs) are a type of business structure that consists of at least one general partner and one limited partner. While general partners are personally liable for the debts and obligations of the partnership, limited partners have limited liability protection. LPs may be more suitable for businesses with passive investors, while LLCs may be more suitable for businesses with involved members. Forming a limited partnership involves drafting a partnership agreement, filing with the state, obtaining necessary licenses and permits, and opening a business bank account. Profits and losses are passed through to individual partners, and LPs are generally not taxed at the partnership level.

Understanding limited partnerships

A limited partnership is a legal entity that consists of at least one general partner and one limited partner. General partners manage the business and are personally liable for the debts and obligations of the partnership. Limited partners, on the other hand, are passive investors who contribute capital to the business but have limited liability. They do not participate in the management of the business and are not personally liable for the partnership’s debts and obligations beyond the amount of their investment.

The legal structure of a limited partnership is governed by state law, and the partnership must be registered with the state where it operates. Limited partnerships are typically used for investment purposes and are often formed by real estate developers, venture capitalists, and other professionals who want to pool their resources and expertise.

Types of partnerships

Before deciding on a limited partnership, it’s important to understand the different types of partnerships that are available. The most common types of partnerships are:

General Partnership: A partnership in which all partners have unlimited liability for the partnership’s debts and obligations.
Limited Partnership: A partnership that consists of at least one general partner and one limited partner.
Limited Liability Partnership (LLP): A partnership that provides limited liability protection to all partners.
Limited Liability Limited Partnership (LLLP): A limited partnership that provides limited liability protection to all partners.

Each type of partnership has its own advantages and disadvantages, so it’s important to carefully consider which structure is right for your business.

Limited partnership vs. LLC

Another common business structure to consider is a limited liability company (LLC). An LLC is similar to a limited partnership in that it provides limited liability protection to its members. However, there are some key differences between the two structures that may make one more suitable for your business than the other.

One advantage of an LLC is that it is more flexible in terms of management structure. Members of an LLC can participate in the management of the business and are not required to have the same level of formalities as a limited partnership. Another advantage is that an LLC can choose how it is taxed, either as a partnership or as a corporation.

On the other hand, a limited partnership may be a better option if you have passive investors who want to invest in your business but do not want to be involved in management. Limited partnerships also have more flexibility in terms of decision-making, as limited partners do not have the same level of control as general partners.

PRO TIP: Ultimately, the decision between a limited partnership and an LLC will depend on your specific business needs and goals.

Advantages of a limited partnership

There are several advantages to forming a limited partnership:

Limited liability for limited partners: Limited partners are not personally liable for the debts and obligations of the partnership beyond the amount of their investment.
Opportunity for passive investment: Limited partners can invest in the business without being involved in management or decision-making.
Flexibility in management and decision-making: General partners have more control over the management of the business, and limited partners do not have the same level of control or responsibility.

Disadvantages of a limited partnership

While there are advantages to forming a limited partnership, there are also some disadvantages:

Personal liability of general partners: General partners are personally liable for the debts and obligations of the partnership. This means that if the partnership is sued or goes bankrupt, the general partners’ personal assets may be at risk.
Limited control for limited partners: Limited partners have limited control over the management of the business and are not involved in decision-making.
Complexity of formation: Forming a limited partnership can be more complex than other business structures, and may require the assistance of legal and financial professionals.

How to form a limited partnership

If you have decided that a limited partnership is the right business structure for you, here are the steps to follow to form one:

Choose a name for your partnership that is not already in use in your state. You can search your state’s business name database to ensure the name you choose is available.
Draft a partnership agreement that outlines the rights and responsibilities of each partner, the division of profits and losses, and the process for adding or removing partners. This agreement is a crucial document that sets the foundation for the partnership, and should be carefully considered and reviewed by all partners.
File a Certificate of Limited Partnership with your state’s Secretary of State. This document provides legal recognition of your partnership and includes basic information such as the names and addresses of the general and limited partners, the name of the partnership, and the duration of the partnership.
Obtain any necessary business licenses and permits. The requirements for licenses and permits vary by state and industry, so be sure to research what you need for your particular business.
Obtain an Employer Identification Number (EIN) from the Internal Revenue Service (IRS) if you plan to hire employees. An EIN is like a social security number for your business and is necessary for tax purposes.
Open a business bank account. This will help you keep your personal and business finances separate and make it easier to track your partnership’s income and expenses.

It’s important to note that the process of forming a limited partnership may vary by state, so be sure to research the specific requirements in your state. In some states, you may also be required to publish a notice of your partnership formation in a local newspaper.

Forming a limited partnership can be more complex than other business structures, and may require the assistance of legal and financial professionals. However, taking the time to properly form your partnership can help ensure that all partners are clear on their rights and responsibilities, and can help prevent disputes down the road.

Limited partnership FAQs

Here are answers to some frequently asked questions about limited partnerships:

Can a limited partner also be a general partner?

Yes, a limited partner can also be a general partner. However, if a limited partner becomes too involved in the management of the business, they may lose their limited liability protection.

How are profits and losses distributed in a limited partnership?

Profits and losses are typically distributed according to the partnership agreement. General partners may receive a larger share of profits in exchange for their active involvement in management.

What are the tax implications of a limited partnership?

Limited partnerships are generally not taxed at the partnership level. Instead, profits and losses are passed through to the individual partners, who report them on their personal tax returns.

Key takeaways

A limited partnership is a type of partnership that consists of at least one general partner and one limited partner.
Limited partners have limited liability for the debts and obligations of the partnership, while general partners are personally liable.
Limited partnerships may be more suitable for businesses with passive investors, while LLCs may be more suitable for businesses with involved members.
Forming a limited partnership involves drafting a partnership agreement, filing with the state, obtaining necessary licenses and permits, and opening a business bank account.
Limited partnerships are generally not taxed at the partnership level, and profits and losses are passed through to individual partners.

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