Limited Partnerships: What You Should Know
Like other common types of ownership structures, limited partnerships have various nuances in terms of how they work and can affect your operations. Due to this, you should have a strong understanding of limited partnerships before you start a business.
In this post, we’ll explain what limited partnerships are and how they work. We’ll also review the pros and cons of structuring your small business as a limited partnership.
What is a Limited Partnership?
A limited partnership exists between one general partner — who has unlimited liability — and one or more limited partners who have limited liability. Since the general partner has unlimited liability, they are personally liable for all the partnership’s business debts. Conversely, limited partners aren’t personally liable for company debts in this ownership structure.
How Limited Partnerships Work:
Due to the unlimited liability of a general partner, if a limited partnership owes money, the debtor could pursue the general partner’s personal assets. This can include real estate, such as their home. However, that debtor wouldn’t be entitled to pursue any of the limited partner’s personal assets. This is beneficial for the limited partner(s) because their downside risk is limited to their total investment in the business.
That said, in this type of partnership, the limited partners have very little control over daily business decisions and operations. It’s up to the general partner to make all day-to-day business decisions.
In terms of tax treatments, profits from a limited partnership will pass through to personal tax returns for both limited and general partners. However, general partners will be required to pay self-employment taxes on their income from the partnership.
The Pros of Structuring Your Business as a Limited Partnership:
1. Relatively Easy to Raise Money
One of the top advantages of limited partnerships is that you can raise money from a relatively small number of investors. Moreover, starting a limited partnership is easy to do compared to other ways of raising money. Although the process varies by state, you’ll generally need to pay a fee. In addition, you’ll need to file a certificate of limited partnership and create a limited partnership agreement.
Ultimately, the simplicity of setting up this type of partnership makes it a good option. This is especially true if you’d like to raise money from a small, close group of investors.
2. Limited Liability for Investors
The only money a limited partner puts at risk is the money they invest in the business. This is a major advantage if you’re looking for a partner to help provide funding. Plus, there’s no limit to the number of partners you can have, which makes it easier to allocate enough capital.
3. Business Decision-Making for the General Partner
As mentioned earlier, the general partner makes all the business decisions. For you, as a business owner, this means that you can be sure to remain in control of your business. Of course, your partnership agreement may set some limits on your rights. Regardless, limited partnerships generally help ensure that you remain in control of your business.
The Cons of Structuring Your Business as a Limited Partnership:
1. Unlimited Liability for General Partner
Unlimited liability is risky for your business is risky because if your business fails, your creditors can seize your business and personal assets. Other business structures, like corporations and limited liability companies, can help prevent creditors from going after anything except your business assets.
2. Limited Partners Can Become Liable
It’s a serious mistake to assume that limited partners are always protected from liability. This is because if a limited partner becomes too involved in the business, they may be legally considered a general partner. If this happens, and your creditors can prove it, that person will be personally liable for the debts like a general partner would be.
3. Lack of Limited Partner Involvement
As mentioned, for a limited partner to avoid liability, they can’t be too involved in the business. If you’re looking for partners to help you run your business, this is a disadvantage. Rather than working with limited partners, you’ll need to hire employees or freelancers if you need extra help.
Conclusion: Consider Forming a Limited Partnership
As a business structure, the limited partnership’s biggest perk is the ease with which you can raise money. In comparison, its greatest downfall is the general partner’s unlimited liability.
If you have a close group of silent partners and you don’t mind putting your assets at risk, a limited partnership might be worth it. However, if not, other ownership structures will likely serve your business better.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.