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A limited partnership (LP) has two kinds of partners: One who does not get involved in daily management and another who is involved in daily management and bears more personal liability. It’s similar to a general partnership but with some significant differences, especially regarding liability and management control. Here’s how that works and why you might choose this business structure.

Limited Partnership: The Basics

In a limited partnership there are two kinds of partners. Both can be investors in the partnership and share in the profits. But their roles and responsibilities are very different. A general partner oversees the day-to-day operations. The general partner, which can be an entity such as a corporation or a person, can be held liable for debts incurred by the business.

The other kind of partner is a limited partner, who is not liable for any obligations incurred by the business and is limited in their ability to make decisions relating to the business, however. For this reason, limited partners are often referred to as silent partners.

Limited Partnership Advantages

The major benefit of the LP is the limited liability enjoyed by the limited partners. The risk of financial loss faced by these partners is no more than the amount they invested in the partnership. This is different from a general partnership, where all partners may be liable for the business’ obligations.

Another difference is that limited partners cannot be held liable for commitments made by other partners, as is the case with general partnerships.

It is also simple to recruit additional investors by adding more limited partners. This can give the business better growth prospects than a sole proprietorship or general partnership might have.

For tax purposes, LPs are pass-through entities. That is, the business profits pass directly to the partners, according to the amount they have invested, without being taxed first. This avoids the double taxation that impacts shareholders of regular corporations. Partners still report and pay income taxes at their individual rates on the profits they receive from the partnership.

Limited Partnership Disadvantages

Florist working in his storeOne potential disadvantage of a limited partnership is that the limited partners have to avoid taking part in day-to-day management of the company. Otherwise, it’s possible that creditors could successfully argue that they should be held personally liable for the company’s debts.

This need to avoid daily management influence means limited partners must rely on the judgment of the general partner or partners.

Limited Partnership Uses

Limited partnerships are common in the real estate field. The general partner often organizes and manages a project such as constructing a building or development. Limited investors provide the capital in return for a share of the profits.

Limited partnerships are also popular in the film industry, which has time-limited projects similar to real estate development projects. Many professionals prefer LPs to general partnerships because they don’t want to be held liable for commitments made by other partners.

Private equity firms often form LPs to purchase all or part of another company.

How to Form a Limited Partnership

In most states entrepreneurs must pay a fee and file a certificate of limited partnership. Partners can generally handle this without hiring an attorney, although most experts recommend having an attorney review the written partnership agreement. The following are aspects of forming a limited partnership.

Choose a business name. A general partnership’s name can simply be the surnames of the general partners.

File a fictitious business name. If you use a different name than the surnames of the general partners, check with the government of the state you are operating in about registration of that name. Make sure your name is distinct from other names and is actually available. Search your state’s database and the federal database to make sure a business name is available.

Draft and sign a partnership agreement. This agreement should specify what each partner’s contribution is; how profits and losses are allocated; each partner’s duties and authority; protocols for voting on key decisions; how new partners may be vetted and admitted; what happens in a bankruptcy or the death of a partner; and how to resolve disputes among partners.

Obtain licenses, permits, and zoning clearance. Check with state, county and local authorities about what your business needs.

Obtain an Employer Identification Number. Form SS-4 is a form from the Internal Revenue Service that you can use to apply for an Employer Identification Number.

Other Liability-Limiting Structures

Real estate agent outside a newly sold property

The other business entities that offer limited liability to investors include corporations, limited liability companies, limited liability partnerships and limited liability limited partnerships.

  • Corporations are more complicated than limited partnerships and have more burdensome record-keeping and meeting requirements. However, corporations can issue and sell shares as well as issue bonds, which are more flexible ways of raising capital. And because corporations are separate entities, investors cannot be held liable for business debts.
  • Limited liability companies (LLCs) offer all investors limited liability protection. Unlike limited partnerships, all investors can participate in decision-making rather than leaving it under the general partner’s control.
  • Limited liability partnerships (LLPs) have no general partner. All owners of a limited liability partnership have some limited responsibility for the business’ debts.
  • Limited liability limited partnerships are a newer variant that has both general and limited partners. In this entity the general partner also has limited liability.

The Bottom Line

Limited partnerships offer a way to structure a business so that limited partners can’t be held liable for the debts of the business. Tax simplicity and lack of complication and paperwork requirements are other pluses.

Tips on Picking a Business Structure

  • Consider talking to a financial advisor about the most suitable business structure for your company. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool can match you with up to three local financial advisors, and you can choose the one who is best for you. If you’re ready, get started now.
  • LPs are useful in estate planning when a parent is the general partner and offspring are limited partners. Heirs can receive income from a limited partnership’s business activities without requiring a taxable transfer of assets on the general partner’s death.

Photo credit: ©iStock.com/Juanmonino, ©iStock.com/Hirurg, ©iStock.com/fstop123

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
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