What is a limited partnership business?

A limited partnership (LP) is a business entity that is easier to create than some other structures and provides flexibility in responsibility and liability for its partners. LPs have two types of partners, general and limited. General partners manage the business and assume its legal and financial liability in the case of lawsuits or business debts. Limited partners invest, have limited liability, and are not involved in business operations.

LPs are typically used for real estate development, private equity funds, and other companies that want to allow investors to contribute capital without having day-to-day obligations or risking personal assets beyond their investment. Limited partnerships are also used to help pass on ownership in a family business and for succession planning.

Read on to learn more about how this type of business partnership is formed, its limitations and its advantages.

Limited partnership characteristics

Responsibilities and liabilities in a limited partnership vary by type of partner. At least one partner in an LP must be a general partner and assume full personal liability. This means if there is a business debt or lawsuit, general partners are on the hook. General partners are also in charge of business management and operations. LPs must also have at least one limited or "silent" partner. A silent partner does not participate in the management or day-to-day operations of a partnership and is only liable up to the amount they invest.

The rules governing limited partners' involvement in the day-to-day operations of a business vary by state. Some state laws allow limited partners to weigh in on management issues such as removal of partners, changes to a partnership agreement, selling of assets or the closing of a partnership. However, a limited partner's hours cannot exceed 500 annually, or else the partner may be considered a general partner.

Limited partnerships are treated as pass-through entities by the Internal Revenue Service (IRS). This means that instead of paying business taxes, profits or losses pass through and are reported on partners' individual income tax returns.

How to form a limited partnership

Limited partnerships are typically quicker and less expensive to start than a corporation. To create a limited partnership, owners need to register and pay fees in the state in which they will operate and comply with any other state-specific requirements detailed by the Secretary of State's office. The document that is usually required to register a limited partnership is called a certificate of limited partnership and it includes the partnership name, the type of business and details on each partner.

In all 50 states, a registered agent is required to be the legal point of contact to receive papers and legal documents for an LP, as is the case to form most corporations or an LLC. If an LP will operate in more than one state, it may be necessary to file for what are called "foreign qualifications" in those other states. Requirements and filing fees vary from state to state.

Partnership agreement

A partnership agreement is important because it outlines the rules for how a business operates and could prevent disputes between partners.

Elements of a limited partnership agreement include:

• The agreed-upon name of the business.
• The ownership percentage of each partner.
• A specific list of what each partner will contribute to the business.
• How profits, losses and withdrawals will be divided and distributed.
• Which partners have authority to make decisions and sign contracts.
• Processes for resolution to navigate disagreements.
• Rules for what happens to assets if a partner withdraws or dies.

To be successful, the process of creating an agreement should be thoroughly discussed and transparent between all partners involved. As you start your business, consult with an experienced business attorney before drafting or signing any agreement.

Pros and cons of limited partnerships

As with any business structure, there are pros and cons to limited partnerships.

Pros

• Easy to establish. Once the partnership agreement is drafted and all the partners have agreed to the terms, paperwork only needs to be filed locally and not at the federal level.
• Straightforward to dissolve. Likewise, if partners are on good terms, dissolving a partnership is fairly easy and will follow the terms in a partnership agreement. State laws vary on partnership dissolution requirements.
• Uncomplicated tax rules. Because taxes pass through to partners, no separate business tax filing is required.
• Supports raising of capital. The structure of a limited partnership could be good for raising capital because some partners can invest and avoid management responsibilities or liabilities.
• Good for succession planning. The flexibility of partners to step back from management but still be financially involved makes limited partnerships helpful in family business and succession planning.

Cons

• Partners are liable. Because a limited partnership does not create a separate legal entity, general partners are personally responsible for lawsuits and business debts. Limited partners avoid this liability as long as they do not get too involved in day-to-day management.
• Limited say for silent partners. Some limited partners may find it difficult to avoid getting involved in business operations if they have a financial stake.
• Compliance requirements. Limited partnerships typically need to file an annual report and maintain certain financial records.
• Shared decision-making. Depending on what is outlined in the partnership agreement, many partners in a limited partnership may have a say in business decisions. If partners disagree on the direction of the company, it could jeopardize growth opportunities.

Limited partnerships: Compare and contrast

Limited partnerships and other types of business structures have some similarities and differences, including nuances when it comes to liability protections for participants.

LP vs. limited liability partnership (LLP): These two types of business structures are similar, but while LPs have general partners and limited partners, LLPs have no general partners. The liability for business debts and lawsuits of all partners in an LLP is limited. In some states, it may be possible to form a limited liability limited partnership (LLLP) to provide liability protection for a general partner. Like in an LP, a general partner or partners run the business but, unlike in an LP, the LLLP spreads liability across all partners to limit general partners' liability. Since LLLPs are only available in some states, this type of partnership may not make sense if the partnership plans to operate in multiple states.

LP vs. limited liability company (LLC): In general, all members of an LLC have the right to manage the business, while limited partners of an LP cannot be active participants. General partners of an LP have unlimited personal liability. Members of an LLC generally have personal liability protection because the LLC is a separate legal entity from its owners.

LP vs. general partnership: General partners have full control of a business and unlimited liability, while limited partners have less liability and don't participate in day-to-day operations. A general partnership is the most basic form of partnership (typically formed when partners form their business by signing a partnership agreement) and is automatically dismantled if a partner dies or enters into bankruptcy. Limited partnerships, which require filing with the state to register, are more complicated to establish.

LP vs. corporation: Partnerships are generally less time-consuming and less expensive to establish than corporations. Corporations typically have additional layers of management and legal documentation to file, including incorporation documents, corporate bylaws, shareholder agreements and stock certificates, as well as additional tax filing requirements. Because of their ability to issue stock and transfer ownership to third parties, investors sometimes prefer this business structure. A corporation is a separate legal entity, which typically provides protection for personal assets from creditors if there is a lawsuit or business debt.

Limited partnerships offer flexibility in liability and operational responsibilities for businesses that want to raise capital or evolve ownership. This business structure could provide a strong foundation if your plans and partner preferences align with what an LP provides. Another way to start strong is by establishing a business checking account. A business checking account can contribute to business credibility, keep business and personal finances separate, and streamline financial management. Look for an account that offers mobile banking, overdraft protection, and invoicing and accounting tools.

Ready to take the first step?

When forming any type of business, a business checking account is an essential first step to deposit, move and borrow money for your business. With a Citizens business checking account, you'll have all of the features you need to manage your business' finances.

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