Limited Partnership (LP): Definition & How to Form One?
A limited partnership (LP) is a type of business partnership with two classes of partner. One is general partners, who manage the business and are liable for its debts. The other is limited partners, who are only liable for the amount they originally invested. LPs are formed by filing a certificate of limited partnership in the state where you’re located.
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KEY TAKEAWAYS
- Limited partnerships (LPs) are formed when two or more partners decide to go into business.
- The limited partners in the partnership are only liable up to the initial amount they invested. General partners have unlimited liability.
- An LP is a type of pass-through entity, meaning there aren’t many reporting requirements.
- Forming an LP and the steps to take can vary depending on which state you are located in.
What Is a Limited Partnership?
A limited partnership (LP) is a business structure in which two or more people contribute capital to a business, but only one partner–the limited partner–is liable for the debts and obligations of the business. The other partners, who are limited partners, are only liable for the amount of money they originally invest in the business.
LPs are often used by investors who want to limit their liability, but still have a say in how the business is run. For example, a wealthy investor might contribute $1 million to an LP, but only be liable for $100,000 if the business fails. LPs can also be used to start a business with multiple owners.
In this case, the general partner would usually be the one with more experience in running a business. The limited partners would provide capital, but wouldn’t be as involved in the day-to-day operations.
If you’re thinking about starting a business with one or more partners, a limited partnership could be a good option for you. Just be sure to consult with a lawyer or accountant to make sure it’s the right choice for your business.
How Do Limited Partnerships Work?
LPs are formed by filing a certificate of limited partnership with the appropriate state agency, which typically requires the names and addresses of the general and limited partners, the name of the partnership, and the duration of the partnership.
Each state has its own laws governing the formation and operation of LPs. They are often used for real estate investment partnerships, where one or more partners invest money while another partner manages the property.
The limited partners are only liable for debts up to the amount they invest, while the general partners are liable for all debts incurred by the partnership.
How Do You Form a Limited Partnership?
A limited partnership is a business arrangement in which two or more individuals contribute capital to a common enterprise, with each partner having a limited liability for the debts and obligations of the business. The limited partnership structure is often used by venture capitalists and other investors who want to minimize their risk while still being able to participate in the management and profits of the business.
There are a few things to keep in mind when forming a limited partnership:
- Choose your partners wisely – You will be working closely with your partners, so it is important to choose individuals that you can trust and who have complementary skills.
- Draft a partnership agreement – This document should outline the roles and responsibilities of each partner, as well as the ownership structure and profit-sharing arrangement.
- Register your partnership – Most states require limited partnerships to register with the Secretary of State or other designated agency.
- Comply with tax requirements – Limited partnerships are subject to special tax rules, so it is important to consult with a tax advisor to ensure that you are in compliance with all applicable laws.
When Are Limited Partnerships Useful?
It can depend, but there are often two primary reasons why an LP would get created. The first is for commercial real estate projects, and the second is for family limited partnerships.
- Commercial real estate projects – LPs are helpful when creating commercial real estate developments. The general partner often plans and oversees project upkeep and construction. The limited partner is an investor who contributes capital for a project in exchange for a return on the income stream once it is finished.
- Family limited partnerships – A family business may also use LPs. Family members can pool their funds and choose a general partner after doing so. When the general partner owns real estate and the limited partners are heirs, family limited partnerships can also be formed. These LPs can be created if the parties do not want the real estate to be sold upon the death of the general partner and the LP has an income stream.
What Are the Advantages of a Limited Partnership?
The advantages of an LP depend on the type of business and the partners involved. For example, an LP can offer tax benefits if the LPs are not actively involved in the business.
Additionally, LPs can offer flexibility in terms of management and control. The GPs have full control over the business, but the LPs can negotiate for certain rights, such as the right to approve major decisions.
Another advantage of an LP is that it can attract a wider range of investors. LPs are often more willing to invest in a business than other types of investors, such as venture capitalists, because they have less risk. As well, they can provide valuable expertise and networks that can help a business succeed.
What Are the Disadvantages of a Limited Partnership?
There are a few key disadvantages of organizing a business as a limited partnership. First, limited partners have very limited control over the business and are largely at the mercy of the general partner.
Second, limited partners can be held liable for debts and obligations of the partnership, even if they had no direct involvement in incurring them. Finally, it can be difficult to dissolve a limited partnership if the partners are not in agreement.
For these reasons, many businesses opt to organize as LLCs or corporations, which offer greater flexibility and protection for the owners. Limited partnerships can still be a useful tool in certain circumstances, but it is important to understand the potential risks before moving forward.
Summary
A limited partnership (LP) is a specific type of partnership and business structure that consists of two or more partners. General partners oversee the day-to-day operations and generally run the business. Limited partners don’t take part in managing the business in any form.
However, the key thing to understand is that general partners receive unlimited liability for potentially business debt. Limited partners, on the other hand, have limited liability but only up to the initial amount of their investment.
The specific rules and regulations for LPs can vary from state to state.
FAQs About Limited Partnership
In an LP, only limited partners have limited personal liability. With an LLC, every member owns a level of limited personal liability.
Yes, a limited partner is a part-owner of a company. However, they are not involved in operating the business.
Limited partners are required to pay self-employment tax on any guaranteed payments, but they aren’t required to pay self-employment tax on distributed shares.
They can get paid periodically throughout the year from the business. The business will always keep a capital account for each individual partner.
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