A limited partnership (LP) is a form of business ownership that has two types of partners: general partners and limited partners. There may be one or more general partners, and one or more limited partners. A general partner is involved in operating the business. A limited partner invests money or assets in the business and shares in the profits, but does not have a role in operating the business. A limited partner might be thought of as a “silent partner.”
A general partner is personally liable for the debts, obligations, and acts of the business. This means that the general partner’s personal assets (home, car, bank accounts, etc.) may be subject to being lost to satisfy business debts and court judgments. In this respect, being a general partner is the same as being a sole proprietor or a partner in a regular partnership.
A limited partner is NOT personally liable for the debts, obligations, or acts of the business. A limited partner may lose whatever he or she has invested in the business, but creditors of the business may not go after a limited partner’s personal assets. Limited partners must be careful not to become active in running the business or to do anything that makes a third party think he or she is a general partner. A limited partner may loose the limitation of liability if he or she becomes active in operating the business. In some states, a limited partner may keep the limitation of liability while participating in certain decisions, such as voting on changes in the Limited Partnership Agreement, removing general partners, selling all or most partnership assets, or terminating the partnership.
A limited partnership is NOT the same as a limited liability partnership (LLP) or registered limited liability partnership (RLLP), which is a different type of business entity allowed in many states. In an LLP, there is only one type of partner, and they all have limited liability. LLPs are generally used by various professionals, such as attorneys and accountants, who are not permitted to form LLCs or corporations in many states.
Is a Limited Partnership Right for Your Business?
A limited partnership can provide benefits to small business owners who might otherwise operate as a sole proprietor or general partnership. It can provide an infusion of cash or other assets into your business from one or more investors, without turning over any control of your business to your investors. For many small business owners, it’s the best option available.
Limited partnerships are typically used by those who need investors to help fund their business, but want less complexity, expense, and paperwork than would be involved in creating and operating a corporation or LLC. If you are comfortable with the personal liability risk associated with operating as a sole proprietor or regular partnership, forming a limited partnership is one way of raising funds to start or expand your business. Your other choices are to borrow money from a bank or other lender, or form a corporation and sell stock.
How to Form a Limited Partnership
The basic documents used to form a limited partnership are a Limited Partnership Agreement and a Certificate of Limited Partnership (sometimes called a Registration Statement). A typical Limited Partnership Agreement will include such things as the names of the general and limited partners, the name of the partnership, the contributions of the limited partners, and provisions for making business decisions, resolving disputes, admitting new partners, settling with partners who wish to leave, and how the partnership may be terminated. It can be a rather lengthy document.
A Certificate of Limited Partnership is a document that must be filed with the state government (most typically with the Secretary of State), providing certain basic information about the limited partnership. Many states have an official form that must be used to register your limited partnership. There is a fee for filing, which varies by state.
If there is more than one general partner, there may also be a separate partnership agreement just between the general partners, which defines their relationship with each other.
All states have laws governing limited partnerships. Most states have adopted a version of the Uniform Limited Partnership Act (ULPA), but a few have created their own limited partnership laws. All of these laws are similar in their basic requirements, including things like what must be in a limited partnership agreement, reserving a partnership name, the duties of partners, the requirement for registration with the state, and annual reporting requirements.
Running a Limited Partnership
The day-to-day operation of a limited partnership, as well as the long-term planning, is conducted by the general partner (or general partners). If you are the only general partner, you alone control the operation of the business. If there are other general partners, you will need to work with them to operate the business. On the other hand, the limited partners are in the position of silent investors, and do not have any say in the operation of the business.
The IRS requires limited partnerships to have an Employer Identification Number (EIN), and file a U.S. Return of Partnership Income (IRS Form 1065) to provide certain information. The limited partnership does not pay federal income tax, as the earnings are passed through to the partners, who report their share of the earnings on their individual tax returns. General partners report their earnings as active income, and pay income tax and self-employment tax. Limited partners report their earnings as passive income, and pay income tax but NOT self-employment tax. For more information, obtain a copy of IRS Publication 541.
WARNING: Violating securities laws can result in criminal prosecution. In addition to state limited partnership laws, you will also need to consider state and federal securities laws. The interests of limited partners (not the general partners) are considered securities, much like shares of stock in a corporation. If you are offering limited partnership interests to no more than 10 investors (up to 35 in some states), all of whom are known to you, and all of whom live in your state, you will generally not be subject to state or federal securities laws.
Federal securities laws generally come into play when securities are being offered across state lines, or offered to the general public (called a public offering). The federal laws exempt offerings confined to one state and only offered to specific people personally known to the general partners (called a private offering). State securities laws vary, so even if you are only making a private offering to fewer than the maximum number of investors allowed in your state, there still may be some minimal filing requirements. You will need to consider securities laws of each state in which an investor lives.
Things can get complicated if you are selling limited partnership interests to: (1) anyone in another state (even a close relative), (2) more than ten investors, or (3) investors from the general public (a public offering), rather than people you know (a private offering). If any of these factors apply to your limited partnership, you should consult a lawyer to be sure you comply with all applicable securities laws.
It’s easy to form a limited partnership online. Fill out a simple questionnaire and LegalZoom will create and file your Certificate of Limited Partnership with the state. When we receive your certificate back from the state, we send it to you along with instructions on next steps.