Selecting the right business structure is a critical decision for any entrepreneur, as your choice impacts ownership, liability, and how you operate. Limited partnerships are a popular option because they offer a blend of general partnerships with the added flexibility of limited investors.
Here’s everything you need to know about this unique structure.
[Read more: What Is a General Partnership?]
What is a limited partnership?
A limited partnership is an agreement between two or more people running a business together with varying levels of liability and ownership. Essentially, the more liability you have in a limited partnership, the more say you have in how the business operates.
In a limited partnership, there are both general and limited partners.
- General partners are liable for all debts and obligations of a business. General partners handle everything required to manage the business, including making day-to-day decisions, while bringing the necessary skills to achieve the business’s goals.
- Limited partners are only accountable for the amount they’ve invested in a company. They act as silent partners and are not responsible for running the business—only for investing in it.
Limited partnerships offer pass-through taxation, in which profits and losses are reported on partners' individual tax returns, avoiding corporate-level taxes. While general partners pay self-employment taxes, limited partners generally do not, except on income from services provided beyond their investment.
Keep in mind that limited partnerships are distinct from limited liability partnerships. In limited liability partnerships, all partners have limited liability—meaning they can assume management activities, but have limited liability for business debts and obligations. As with every business type, a limited partnership comes with both advantages and disadvantages.
Pros of limited partnerships
Depending on the type of business you’re looking to operate, you might consider a limited partnership. Some pros of this arrangement are:
- Growth is scalable. With a solid business idea and plan, and a team of general partners playing a more active role than limited partners, limited partnerships are relatively easy to scale up in size.
- Limited partnership shares are considered securities. In other words, shares of a limited partnership can be sold to help raise capital — without going public.
- Limited partners have limited liability for losses. As a limited partner, you are only accountable for the amount of money you’ve chosen to invest in the business. So, if your company gets sued, you won’t be responsible for paying hefty funds like general partners. You get to decide how involved you are in the business, both physically and financially.
- Partners can be quickly replaced. If a limited partner decides to leave the business suddenly, management can easily and quickly find a replacement for them. This not only prevents turnover issues but also makes limited partnerships more attractive to venture capitalists.
- Two heads are better than one. Having constant input and support is invaluable in business. While you can certainly run a company on your own, it’s always helpful to have another perspective.
Cons of limited partnerships
Before deciding whether a limited partnership is right for you, you’ll want to consider their cons. Some major concerns include:
- General partners are personally responsible for business debts and risks. As a general partner, all the debts and risks fall onto you. If someone slips up, or your company is sued, you’re the one accountable for the consequences.
- Profits are treated as personal income. That being said, you’ll have to file tax returns based on your profits.
- Fundraising is difficult. Limited partnerships automatically come with liabilities, meaning not many people will want to invest and assume a share of debt. This makes funding especially challenging.
There’s no one-size-fits-all approach to structuring your business. You’ll need to evaluate your business’s goals and the desired level of owner involvement to see if a limited partnership is right for you.
Is a limited partnership right for you?
Generally, a limited partnership is ideal for business owners who anticipate going into business alone but could use a bit of financial support. For instance, if you originally intended to start a sole proprietorship or general partnership, you likely feel comfortable assuming most of the liabilities in your business. Deciding on a limited partnership will allow you that same freedom and independence, with more access to less complex funding from investors.
Additionally, family businesses and commercial real estate projects are two business types that can benefit from a limited partnership. In a family business, management responsibilities can be structured to pass on to the next generation, and in a commercial real estate project, general partners provide oversight of the construction and maintenance of the project.
Sometimes, forming a limited partnership can be the wrong choice for your business. If there are multiple owners who all want to maintain control of business decisions, or if you don’t need to raise any capital due to a preexisting loan or funding source, this structure might not be the right choice for you.
There’s no one-size-fits-all approach to structuring your business. You’ll need to evaluate your business’s goals and the desired level of owner involvement to see if a limited partnership is right for you.
[Read more: The Most Common Business Entities for Startups]
How to form a limited partnership
To officially form a limited partnership, you will need to take certain steps to ensure your business is properly registered with federal and state authorities.
Register your business
The first step in registering your business is confirming its name and ensuring its availability by searching your state’s business database. Next, you’ll need to designate a registered agent who serves as a clear point of contact for your business; your registered agent will be responsible for receiving and processing document deliveries from the state.
Prepare a detailed partnership agreement
A partnership agreement is a legally binding internal document defining how the business will be operated, outlining the rights, responsibilities, and expectations of each partner. It should dictate how decision-making works in the business, both for day-to-day and major decisions. The partnership agreement should also spell out how profits and losses will be shared among the partners, as well as the formal process by which partners can sell their stake in the company.
After drafting a partnership agreement, the next step is to acquire a federal tax ID number (or EIN) from the Internal Revenue Service. An EIN identifies your business for tax purposes and is necessary for operating business bank accounts and hiring employees.
Acquire any necessary licenses, permits, and insurance
The specific licenses, permits, and insurance you must secure will vary from state to state. For example, some states require limited partnerships to obtain a general business license. Certain industries, such as agriculture, mining, and firearms, might require both federal and state licenses. You might also be legally required to acquire workers’ compensation insurance or other industry-specific policies in addition to general liability policies.
Be sure to check with every government agency including federal, state, county, and municipal offices — to ensure compliance with all permitting requirements.
[Read more: How to Write a Business Partnership Agreement]
Best practices for managing risk in a limited partnership
In addition to carefully reviewing the partnership agreement and other legal documents and filings associated with your business, here are some tips for managing risks in a limited partnership.
- Conduct thorough due diligence. Be sure to carefully evaluate the financial health, operational stability, and legal compliance of potential partners and investors. By taking time to research and analyze these areas, you can better understand associated risks and make more informed decisions.
- Diversify your portfolio. Investing in a diverse range of assets can spread risk across multiple investments, which reduces exposure.
- Monitor your investments. Keeping track of investments helps investors target potential risks early on. Regularly tracking performance metrics, returns, and cash flow allows you to see the bigger picture and swiftly take appropriate steps when needed.
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