A limited partnership (LP) is comprised of one or more general partners and one or more limited partners in order to form a separate, legal entity. Very much like a General Partnership, save for the separate, limited status of the limited partners. The driving concern is usually protection from liability and the ability to distribute funds among many shareholders (in the form of dividends) that would otherwise not be possible under a standard corporation. The general partners are responsible for the daily operations of the company, and are personally liable for its obligations and debts. To absorb the liability, a corporation or a limited liability company is most often used in the general partner position of a Limited Partnership. The limited partners invest capital in the company and share in the profits, but take no part in the daily operation of the business. Their liability, should the company be sued, is limited in proportion to the amount of capital that they invest.
Businesses that organize as limited partnerships often do so when the focus is on a single or limited duration project. An example of a business activity where limited partnerships are frequently used is in real estate development or in the film industry. In the Real Estate scenario, general and limited partners come together to work on a short term project, a construction job. The limited partners invest money and the general partners manage the venture. A limited partnership is often used to encourage the investment of capital by offering investors limited liability. A properly drawn up limited partnership agreement is the foundation to an effectively structured limited partnership. This agreement is usually a privately signed document that is not normally publicly recorded.
For example, B. Smith has his eye on a tract of land in a growing area. He has a plan on how to profitably build ten homes on the property but he does not have the money to complete the job. His friend, Jeff, has money to invest but does not know how to develop land. Bill and Jeff can form a limited partnership that will allow Jeff to limit his liability. So, Jeff contributes his capital to the LP in exchange for an interested in the limited partnership. Bill acts as general partner and manages the construction. Preferably, to take liability protection a step further, Bill could incorporate or form a limited liability company to be the general partner. This scenario would allow for the maximum of liability and asset protection for Bill and Jeff in their venture.
Advantages of a Limited Partnership
Tax benefits, protection of assets, and liability protection for the limited partners are just a few of the advantages found within the framework of a Limited Partnership. When a limited partner is sued, the assets inside of the limited partnership are protected from seizure.
Additionally, it is easier to attract investors for a business proposition as limited partners. A limited partnership is considered to be a separate legal entity, and as such can sue, be sued, and own property. Forming a limited partnership also helps with credibility, anonymity, lawsuit protection, and allows you to deduct employee benefits.
Some of these advantages are:
- Provides legal framework to the beginning of the business
- Profits are reported on the partners’ personal tax returns (pass through taxation)
- Asset protection; when a limited partner is sued, the assets inside of the LP are protected from seizure.
- Limited Partners are protected from liability in a business lawsuit
- Limited Partnerships are a separate legal entity that can own property, sue, and be sued
Disadvantages of Limited Partnership
In a Limited Partnership, the general partner bears the burden of running the business and is directly liable for the obligations and debts of the company. As a separate legal entity, there is a certain amount of paperwork required to form the Limited Partnership. There are also corporate formalities, such as annual meetings, that are required of a limited partnership . Limited Partnerships must also plan for their duration. Unless planned for in the limited partnership agreement, the partnership dissolves in the event of the death, bankruptcy, or departure of a member. Depending on the situation, the Limited Partnership could foster conflict between general partners, and result in one partner entering into a legally binding agreement without the consent of the other partners. Thus, it is vitally important to have a properly drafted partnership agreement.
Some of these disadvantages outlined are:
- More legal documentation required than a General Partnership
- The General Partner is directly liable for debts and obligations of the company
- The formalities of a limited partnership must be observed to keep the business in good standing and to properly safeguard the limited liability
- Divided authority among partners
In conclusion, a Limited Partnership can be a valuable business organization of planned for and documented properly.