What Is A Limited Partnership (LP): Get To Know The Structure

The formation of a Limited Partnership (LP) can be an efficient tool for entrepreneurs who plan to invest without managing or who want to operate without making a substantial investment in a business. This is because an LP can combine complementary resources, including general partners’ expertise and limited partners’ financial investment, to create greater value returns.

An overview of the Limited Partnership entity is provided in this article, including a definition, ups and downsides, how to check if your goals align with what it can offer, and a few things to consider before starting your business.

A Limited Partnership’s definition

A Limited Partnership (LP) is a partnership between at least one general partner and one limited partner.

• A general partner (typically a company) possesses unlimited liability to the business’s debt and obligations. The general partner is responsible for managing the operations of the business.
• A limited partner (also known as a passive or silent partner) has limited liability and restricted control over the company to the extent of his or her investment.

A limited partnership, similar to a limited liability partnership, allows its limited partners to manage the business while only having limited liability for debts and obligations of the company.

Types of partnerships in the US

There are three widely-known types of partnerships in total:

• General partnership

As the name suggests, all partners of this structure are general partners. They assume unlimited liability and partake in every aspect of the business, including operation, shares in profits, debts, etc.

• Liability limited partnership (LLP)

An LLP usually only consists of limited partners with limited liability. A limited liability partnership is particularly suitable for professionals like attorneys, architects, lawyers, and accountants. There are states where LLPs are restricted to professional firms only.

• Limited partnership (LP)

The general partners own unlimited legal liability. Furthermore, they directly operate the business based on their expertise and experience. The silent partners on the other hand generally contribute to the capital through financial investments.

Pros and Cons of an LP

Advantages

• A clear scope of management

It is easier to form a limited partnership since it does not require a board of directors or stock issues. The rights and obligations of the general partner are slightly combined between a board and a manager, focusing on running the enterprise.
Limited partners have little influence over business decisions but at the same time benefit from lower personal liability.

• Potential capital investment

An LP can have numerous additional limited partners, allowing you to attract capital sources by guaranteeing limited legal liability protection for the investors.

Moreover, limited partners do not have to pay self-employment taxes. You can gather investment from family members or friends but maintain major control of the company.

• Pass-through taxation

The business itself does not pay income taxes but only files an annual information return to report the operation income, deductions, gains, losses, etc. Meanwhile, the individual partners will report and pay taxes on their share of company profits.

Investing partners can deduct losses from their investments and reduce their tax liabilities. Hence, the tax filing process is much more simple.

• Easy transition

Limited partners may leave the company or be replaced. In short, they can easily retire and exit the business without causing management problems.

The Limited Partnership does not need to be dissolved in situations where at least one limited partner remains in the company. This is also owing to their limited liability and little power over essential choices.

Disadvantages

• Internal conflict

General partners face maximum personal exposure for business debts and obligations while limited partners have little to no management power. Disagreement and conflict within firms are likely to intensify as each partner stick up to their own interests.

This can lead to costly litigation burdening the firm, which may end up in dissolution if a resolution cannot be reached as well.

• No liability protection for general partners

General partners are the ones to directly map the path of the company and bear the risks originating from unlimited legal liability. They take full responsibility for the LP’s success or mishandling of business dealings. In addition, they are obliged to pay self-employment tax on all their business income from the partnership, whether it’s distributed or not.

• More paperwork to take care of

Limited partnerships require fewer documents and filings than corporations, but the limited partners’ participation makes them more compliant than general partnerships.

General partnerships only require an agreement between the partners to start running.

If you’re forming a limited partnership, your state’s secretary of state will need your Certificate of limited liability partnership and Limited partnership agreement. On this form, a registered agent will be appointed, which is often the general partner.

LLC or LP structure: Which is better for your business?

The LP (Limited Partnership) and LLC (Limited Liability Company) share a central purpose to protect the owner’s personal liability in case of an unfortunate event. Beyond that, the two structures aim at various different purposes and benefits.

Take into consideration the following differences as you decide on the most appropriate business model.

Organizational structure

LLC

• The members own ownership interests
• Forming an LLC is restricted to professionals in several states
• Register by filing Articles of Organization with the state agency

LP

• General and limited partners own ownership interests
• General partners can be an individual or a company (including an LLC)
• Available to certain types of professions
• Required to create a Partnership Agreement

LLCs can choose to be managed by members or outside managers, while LPs must have at least one general partner who runs the company.

In general, LLCs are well-suited for small to medium-sized businesses because they give members some control over the company’s organization and operations.

LPs are commonly used in businesses with multiple partners, with each limited partner sharing partial decision-making power.

Legal protection

LLC

• All members obtain limited legal liability

LP

• General partners own unlimited legal liability
• Limited partners have limited legal liability
• LLC members are not typically personally liable for the debts and obligations of the LLC, whereas LP partners may be held responsible for the negligence or misconduct of other partners.

Taxation flexibility

LLC members can choose how they want to be taxed by filing the appropriate IRS form either as a corporation, partnership, or as a “disregarded entity” (part of the LLC’s owner’s tax return)

In contrast, LPs are automatically taxed as partnerships, so profits and losses are reported on partners’ personal tax returns. Additionally, the partnership is required to file an annual information return.

What to consider before forming an LP

When is forming an LP beneficial for your business?

An LP might be the right option for you if one (or more) of these applies:

• Your business has multiple partners and you need a structure that allows for each partner to have equal rights in the company.
• You need specialized knowledge or skills from a partner, but want to limit their decision-making power.
• You want legal protection for each partner in the event of any negligence or misconduct by one or more partners.

Are the general partners risking more than they should?

The general partner is required to bear all liability for the business and take full responsibility for the company’s well-being, which is a major obstacle existing inside the LP model.

In order to compensate for these disadvantages, GP usually requests adequate compensation and clearly states what it is in the agreement.

As a general partner, you will be putting personal assets, property, and even more at risk for the sake of the business. However, you are likely to earn more control over the LP’s decisions (specified in the limited partnership agreement), which can be beneficial in certain cases.

With the development of your business, you will see an increase in return on investment and efficiency.

What if limited partners want more control over the company?

As with general partners, they will be risking their assets if they insist on getting deeper involved in the operation. It is possible for both sides to become overwhelmed once a disagreement or misunderstanding occurs, resulting in the organization’s failure.

To avoid this outcome, consider converting to or forming a more applicable model:

• An LLC if all owners wish to have limited liability and the right to participate in managing the company
• An S corporation if the scale is projected to be under 100 shareholders and no other corporations, partnerships, or non‐resident aliens as shareholders
• A C corporation if you plan on having multiple shareholders and investors, flexible management and still maintain limited liability protection

Key takeaways

• A limited partnership’s meaning is a business entity that exists when at least one general partner with unlimited liability and at least one limited partner with limited liability do business together.
• LPs are pass-through entities that require easier taxation reporting requirements.
• This structure is a common choice for professional or family businesses, operating under skilled general partners and attracting investments effectively from silent partners.
• Forming a limited partnership only requires registering with your state, paying the filing fee needed, creating a partnership agreement, and having the partners confirm the document.

Regardless of the business model you choose, make sure to consider every detail regarding the shared targets, the nature of the business, and more. Ultimately, make the right decision, whether it’s setting up a new one or converting to another structure.

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