You’ve decided to embark on a new business venture and are starting to sift through all the steps you’ll need to take to get your business off the ground. One of those crucial decisions is what type of business you should create. If you’re starting a business and thinking about having silent partners, then a limited partnership might be what you’re looking for.
Limited partnerships are an excellent choice for entrepreneurs who are seeking out investors but wish to maintain control of their company. They allow you to find partners who want to invest in your idea without having to contribute to the day-to-day operations.
In this guide, we’ll cover everything you need to know about limited partnerships. We’ll go over what they are, how they’re different from other partnerships, and some pros and cons you should consider.
What Is a Limited Partnership?
A limited partnership is a business entity in which there are general partners and partners with limited liability. The partners with limited liability — or silent partners — have a certain level of liability protection but have no control of any business operations.
Limited partnerships are controlled by one or more general partners. These members will make all business decisions, manage the company, and steer the business in the right direction. These partners are vulnerable to unlimited liability and aren’t protected if the business gets into financial or legal trouble.
Partners who have limited liability are simply providing capital to the company. They have no say as to how the business operates and lack any legal power whatsoever. In exchange, these silent partners are protected from all debts and legal obligations. The only thing at stake is the amount of money they invested in the company, which is outlined in the limited partnership agreement.
So how are limited partnerships different from other partnerships like general partnerships and limited liability partnerships?
Limited Partnership vs. Other Partnerships
The main difference between limited partnerships and other partnerships is the level of liability that’s distributed among partners. Some entities don’t have any limited liability at all while others offer liability protection to all partners.
General Partnership
General partnerships are the simplest partnership to form. Once two people go into business together, it automatically becomes a partnership. The difference between a general partnership and a limited partnership is that all partners are responsible for the debts and legal obligations of the business. General partners don’t have limited liability protection, leaving their personal assets vulnerable if things don’t go as planned.
Members of a general partnership also play an active role in the company with shared responsibilities and duties laid out in the partnership agreement. In a limited partnership, limited partners can invest and then not contribute to the daily duties of the business. This isn’t the case for a general partnership where all individual partners must pull their own weight.
Limited Liability Partnership
In a limited liability partnership (LLP), all partners have limited liability protection. There aren’t any general partners who are exposed to liabilities from business operations. When it comes to a limited partnership, there are two types of partners. There are general partners who are exposed to liability, and there are limited partners who enjoy limited liability protection.
Advantages of a Limited Partnership
Limited partnerships bring benefits to both types of partners of the business. They’re easy to form, offer pass-through taxation, and give investors a lucrative opportunity to invest without having to do much work.
Limited Partners Are Protected
Limited partners are completely shielded from any debts, legal obligations, and personal liability stemming from the business. This means that limited owners are in the clear if the company goes bankrupt, is sued in court, or is the subject of legal action. The only risk a limited partner has is losing their initial investment in the company.
Pass-Through Taxation
Like a general partnership, LLC, and sole proprietorship, an LP enjoys pass-through taxation. All profits and losses that the business incurs will be passed along to your individual tax return. Instead of being taxed at the corporate level and at the personal level, you’ll only be taxed on your personal income tax return. This opens doors to tax write-offs and increased savings when tax season rolls around.
Reap the Rewards Without the Work
If you’re a limited partner, you get to reap all the rewards without putting in any work. As a limited partner, you have no say in how the business functions. However, if the business is successful, you can sit back and watch the profits roll in without even lifting a finger. It’s almost like a source of passive income. It doesn’t get much easier than that.
Easier to Form Than a Corporation
Limited partnerships require much easier to form than corporations. You won’t need to lumber through piles of paperwork to launch an LP. With corporations, you can get bogged down with legal documentation and business formation processes.
Enticing to Investors
If we were to say you could invest in something with virtually no risk, would that sound enticing? That’s what an LP offers limited partners. They can invest in the business without having to worry about losing more money than they’re putting in. They can only lose how much money or property they put in. No need to fret about the possibility of the business defaulting on loans, getting sued, or going bankrupt. All of their personal assets are completely protected.
Disadvantages of a Limited Partnership
Limited partnerships do pose some threats. For a general partner, they don’t offer liability protection. And for a limited partner, they don’t have a say in how the business is operated.
General Partners Are Unprotected
While limited partners have complete protection, general partners have unlimited liability. All debts and legal obligations can be passed directly to general partners. Your personal assets are at stake if the company goes bankrupt or is subject to legal action. That means if the company gets into trouble, you could be stuck with the bill.
Limited Partners Have No Say
Although limited partners have the luxury of reaping financial rewards without having to do any work, they don’t have any say in how the business runs. Limited partners have virtually no power and aren’t able to make any business decisions. You’re pretty much out of luck if you’re a limited partner and wish to influence business decisions or operations.
When Do Limited Partnerships Make Sense?
Limited partnerships make sense for small business owners seeking investors. They’re also a great choice for businesses that have partners that don’t wish to contribute to the day-to-day operations of the organization
This business entity is attractive for entrepreneurs who want investors on board but also want to retain full control of the company. You can seek out investors with the stipulation that you make all decisions and can operate the business independently. If you’re not looking for investors, then a limited partnership is likely not the right fit for you.
It’s also not a very good fit for entrepreneurs who want to go into business together and have equal say as to how the business will run. Limited partners will have no say and will be sitting on the sidelines as the general partners make all the decisions. If all partners want to have some form of control over the business, then a limited partnership won’t serve you well.
Limited partnerships also skew towards certain types of businesses.
Popular Limited Partnership Businesses
There are a few types of businesses that tend to form limited partnerships. Among them are family businesses, real estate projects, and professional businesses.
Family Businesses
Families who run businesses together will use the limited partnership business structure. This allows for a few family members to operate the business while others simply sit back and invest in the business. In many cases, general partners who have operated the business for years will take a step back and pass the business down to other family members. At that point, they become limited partners to share in profits without management responsibilities.
Real Estate Projects
Real estate projects — primarily commercial real estate projects — are another popular option for forming a limited partnership. Investors will supply capital for projects like shopping complexes or apartment buildings and have general partners manage all development and construction. When it’s all said and done, they’ll collect on any profits resulting from the project.
Professional Businesses
Professional businesses, like architect companies, law firms, or doctor offices will choose to form limited partnerships. Like family businesses, once a general partner wishes to retire or leave the company, they can become a limited partner. The other general partners will then take control of operations while the limited partner collects on their investment.
Weighing Your Options
Although limited partnerships aren’t the most popular type of business entity, they’re a fitting choice for some business owners, especially those operating a family business, real estate venture, of professional business.
They allow you to seek out investors while retaining full control of your business. The one downside you should consider is that as a general partner, you won’t have any personal liability protection. If that worries you, then you may want to consider an LLC as your business entity of choice.
