When two or more individuals form a business entity consisting of one or more limited partners, and at least a general partner, the business entity becomes a limited partnership (LP). The general partner of the business takes up the responsibility to run the business, while the limited partners of the business act like investors. This business model is mostly popular in the real estate industry and with small to medium-sized businesses.
In this article, you will learn about what is a limited partnership and how a business with a limited partnership operates. Then, we will inform you how to start a limited partnership business and the steps you shall take to do so. Finally, we will look at some of the major pros and cons of such a type of business. Hence, to learn more about this business type, read on through to the end of the article.
What Is A Limited Partnership?
According to Investopedia,
“A limited partnership (LP)—not to be confused with a limited liability partnership (LLP)—is a partnership made up of two or more partners. The general partner oversees and runs the business while limited partners do not partake in managing the business. However, the general partner of a limited partnership has unlimited liability for the debt, and any limited partners have limited liability up to the amount of their investment.”
It is essential to have both a general partner and a limited partner in a limited partnership business. The general partners of the business have unlimited liability as well as full management control in the business. These individuals make the business decisions that are important for the achievement of the stated business goals.
On the other hand, the limited partners in the business have very minimal control of the business and little to no involvement in the management processes of the business. They only have the liability that is limited to their amount of investment in the limited partnership business. The limited partners are also known as silent partners, as they are only responsible for investing in the business and not running it.
How Does A Limited Partnership Work?
To establish a successful business, it is essential to have both business acumen and money. In a limited partnership business, you can access the business skills of a general partner and also the financial investment capability of a limited partner.
According to the Forbes Advisor,
“The liabilities of the partners depend on the management control they exercise. The general partners have unlimited liability for business debts and obligations, while limited partners have a liability limited only to the amount they invested in the business. The general partners are responsible for their own actions and business decisions as well as those of other general partners.”
In the business, the job of the general partners is to bring their business skills to the table. They manage the business and make both big and small decisions to ensure the success of the business. On the other hand, the limited partners of the business invest in the business but are not fully responsible for managing the business.
Nevertheless, you must not confuse a limited partnership business with a limited liability partnership (LLP). In the latter, all the partners in the business have limited liability. Despite assuming management activities, the business partners still have limited liability for obligations and business debts.
How To Form A Limited Partnership Business?
According to Wall Street Mojo,
“Thanks to the Limited Partnership Act, a business receives significant capital acquisition without diluting ownership or losing control over business activities. The added number does not cause any chaos, as decision-making lies with the general partner. On the other hand, though limited partners cannot directly participate in decision-making, they can still provide mentorship or bring new skills to the business.”
If you want to form a limited partnership business, you and your partner(s) will need to register your venture in an applicable state. The registration typically happens in the Office of the Secretary of the State.
Apart from that, it is also important for the business venture to obtain all the relevant licenses and permits to operate as an LP business. The rules for obtaining these licenses and permits vary based on the locality of the state or the industry. Finally, to check what permits and licenses you need to start the business at the local, state, and federal levels, you must check the official website of the US Small Business Administration.
Compliance Requirement For Limited Partnership in the USA
Only the District of Columbia and Louisiana are the exceptions. However, all the other states of the USA have enacted some type of Uniform Limited Partnership Act. As an LP, it is essential for a business to comply with all the state laws.
If you are starting a small business as a partner to other business entities or individuals without creating a formal registration, your business is seen as a general partnership business. For such businesses, every participating individual has unlimited liabilities to the company and its debts. However, business owners willing to form an LP would be required to formally register their business as an LP. They will also need a certificate of partnership that identifies the general and limited partners.
Your LP must have investor meetings and give the partnerships the right to inspect the financial records and the books of records. You might also be required to publish an annual financial report based on the state in which you are registered.
When Should You Use a Limited Partnership?
It is not too difficult to form an LP because of its simple structure and less requirement for annual business meetings. Business owners have the benefit of getting fresh and new investments without hampering their control over the business in an LP structure.
Now, if you are starting a business, it is essential to understand whether you should go for an LP structure or other business incorporation structures. Here are some scenarios under which an LP structure would be the best –
Family Business:
If your small business is a family business and has multiple investors from the family, with few who run it, a limited partnership would be the right choice. In this case, the business structure is also termed a family-limited partnership. Partners who put the required money into the business are called limited partners in such incorporation methods. But, the few people who run the business are called the general partners. Through such a business structure, it is possible to pass on the management responsibilities to the next generation.
Professional Businesses
If it is a professional business like a law firm or an accountancy firm, the senior partners might want to retire and pass on the management responsibilities to the general partners. LP, as a business structure, helps old business owners retire and pass on their management roles.
Estate Planning
When someone holds real estate as a parent and wants to eventually pass on the property to an heir, they can use the LP structure. These parents can start managing the real estate on behalf of the heir. The income produced from the real estate is also passed on to the heir. The heir can hold complete responsibility for the property and the income once they meet the stated terms and conditions.
Commercial Real Estate Project
Commercial real estate projects can also be incorporated under an LP structure. In such cases, the limited partners are the investors who get the return upon completion of the project. The general partners are the construction managers or the maintenance managers of such projects.
A limited partnership is a great business incorporation method for business owners or entrepreneurs who have a great small business idea but lack financial support. Thanks to LP, they can onboard people who are interested in the business idea and are willing to invest in it.
What Are The Pros And Cons Of A Limited Partnership?
The following are the major pros and cons of a limited partnership business:
Major Pros
Here are the major pros of limited partnership that will benefit your business:
- You will have better access to the skills and expertise of the general partners in the business, as well as the financial resources of the limited partners.
- The limited partner’s liability is limited to the level of investment.
- The management has no interference from investors in decision-making.
- It is easy for limited partners to retire.
- The taxation system is simple.
Major Cons
Here are a few cons of a limited partnership business that you need to be aware of:
- The general partners of the business have unlimited liability.
- Limited partners cannot contribute to business decisions.
- A lot of compliance and paperwork are required.
- The limited partners of the business are liable for expenses that are incurred during their actions.
Wrapping Up
What is a limited partnership? – It is a type of business that forms when two or more business partners start a business together. However, the partners are divided into general partners and limited partners. The limited partners in the business are only liable for the amount that they invest in the business. Whereas the general partners in the business have unlimited liability.
The benefit of starting a limited partnership is that such businesses are pass-through entities, and there are very minimal requirements for reporting. Do you have any more information to add regarding how a limited partnership business operates? Share your thoughts and ideas with us in the comments section below.
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