What is a Limited Partnership (LP)? Definition, Pros & Cons

Limited partnerships (LPs) are a popular type of business structure, and for good reason.

If you are an entrepreneur or business owner and have ever wondered why or how you could potentially benefit from an LP, this article is for you.

In this article, we’ll provide:

• An introduction to the concept of LPs.
• A comparison to similar structures such as general partnerships and limited liability corporations.
• A step-by-step guide to starting an LP.
• An analysis of how a limited partnership could potentially benefit your business.

Key Takeaways

• In a limited partnership structure, general partners control the day-to-day operations of the business, while limited partners offer financial support for a portion of the profits.
• Pros of LPs include limited liability for limited partners, attraction to investors, flexibility in cost sharing, and tax advantages
• Cons include unlimited liability for general partners, limited control for limited partners, added complexity, and the potential for conflict
• LPs are similar to general partnerships and limited liability corporations but with some key differences.

What is a Limited Partnership (LP)?

A limited partnership or LP is a type of business structure in which a partnership between two or more parties (whether they’re individuals or institutions) is typified by two distinct partner profiles: general and limited partners. 

General partners typically contribute to the day-to-day operations of the organization, such as management and decision-making. 

These partners are personally liable for the partnership’s debts and obligations. 

If the amount demanded by a business debt or legal claim wasn’t sufficiently covered by the organization’s assets, the assets of general partners can be used to satisfy any outstanding debt.

Limited partners do not contribute to the day-to-day administration of the organization; instead, they contribute capital much like an investor. 

Limited partners have limited liability, meaning their obligations to the partnership are strictly limited to the capital they invest. 

In the case of a debt or legal claim being leveraged against the organization they are partners in, the assets of a limited partner up for seizure are restricted to what they have supplied to the organization.

Limited Partnership Examples

Limited partnerships are often found in medium to large-size businesses where both active management and passive investment are necessary. 

Investors may become partners in order to pool resources while limiting their personal liability. 

Limited partnerships can be most often observed in the fields of real estate, venture capital, and private equity.

Pros and Cons

Pros

• Limited liability for limited partners: personal assets are protected from the organization’s debts and legal obligations, and liability is restricted to the amount of capital invested.
• Attraction to investors: If a business is in a position where it requires significant financial resources, the offer of a limited partnership opportunity is one investors who have no wish to be involved in the management of the business often find attractive.
• Flexibility in cost-sharing: Profits and losses can be distributed to limited partners depending on their contribution – there is a lot of room for negotiation.
• Tax advantages: LPs are considered pass-through entities for tax purposes, which means the business itself doesn’t pay income tax. The profits and losses faced by each individual partner are reported on their individual tax returns. Partners can use this to their advantage.

Cons

• Unlimited liability for general partners: In this regard, the limited partner’s gain is the general partner’s loss; any and all of their personal assets can be used to settle debts and/or legal obligations.
• Limited control for limited partners: Limited partnerships have minimal say in the management of the business as a result of their passive role.
• Added complexity: Compliance and regulatory requirements are often exacerbated in this business structure compared to others depending on the state the business operates in.
• Potential for conflict: Cost sharing, while more flexible, can also be considerably more complex, leaving more room for disagreement. Furthermore, Limited partnerships can prove tricky to dissolve or terminate in such cases.

General Partnership vs. Limited Partnership

While the two structures are similar, there are a few key differences. These will be articulated in the table below:

Criteria	General Partnership	Limited Partnership
Liability	General partnerships are partnerships in which all members have unlimited personal liability in the case of business debts and legal claims	In limited partnerships, general partners have unlimited personal liability, but limited partners’ liability is restricted to their contributions to the business, protecting personal assets
Management	All members have an equal say in the running of the business	General partners manage the day-to-day operations of the business – limited partners have minimal say
Flexibility	Simpler to form and manage, with relatively few regulatory requirements	Can be more complex to form and be subject to more fed-specific regulation
Profit/loss sharing	Based on terms outlined in the partnership – can be equal among all members	More flexibility depending on the relative contributions of the limited partners and their requirements

If financial support and flexibility are things you consider important for your business, a limited partnership structure could work for you. 

However, the question of whether you should opt for a general or limited partnership is one only you can make as you know your business’s immediate and future needs better than anyone. 

Both the pros and cons of both structures should be assessed before a decision is made.

LLC vs. LP

Again, the two structures bear many resemblances, but differ in a couple of important ways.

Criteria	Limited Liability Corporation	Limited Partnership
Liability	All members (owners) have limited liability – personal assets are inaccessible by creditors and legal claims may be leveraged against the business	In limited partnerships, general partners have unlimited personal liability, but limited partners’ liability is restricted to their contributions to the business, protecting personal assets
Management	Members can choose to run the business themselves or elect a manager to do so for them	General partners manage the day-to-day operations of the business – limited partners have minimal say
Flexibility	Simpler to form, manage, and dissolve with fewer ongoing requirements	Can be more complex to form and be subject to more fed-specific regulation
Taxation	Both structures are taxed as pass-through entities	Both structures are taxed as pass-through entities

As highlighted in the previous comparison, the differences between these two structures may favor any business more or less based on its specific immediate and future needs.

The pros and cons should be assessed before a decision is made.

How to Form a Limited Partnership

Learn the steps you need to take in order to form a limited partnership:

1. Choose a business name that ends in “Limited” or “Ltd.” – The name must be unique and comply with any state-specific requirements. Most states contain a database of currently in-use names on their Secretary of State website.
2. File a certificate of limited partnership with your state – The documentation required to do this will usually be accessible through your state’s Secretary of State or a similar agency. Information required will include the business’s name and address, the names and addresses of general partners, and the terms of limited partners among other things.
3. Draft a partnership agreement – This document outlines the responsibilities of each partner, the management structure, and other key aspects of the business.
4. Choose a registered agent – A registered agent is a person or entity responsible for receiving official correspondence on behalf of the business. They must have a physical address within the state of the business’ organization. This is often a general partner, although can also be a service or a third party.
5. Obtain proper licenses and permits for your state – These often vary from state to state. Contact your local government offices to determine which ones will apply to your business, and how to obtain these.

Business formation services such as LegalZoom offer a quickstart option to get your business up and running in a fraction of the time, with a fraction of the hassle.

Is a limited partnership a good idea?

Limited partnerships offer a prime opportunity for both businesses to receive financial support and investors to invest with the guarantee of liability. 

However, there’s more to it than that. This article has discussed the pros and cons of limited partnerships, how they compare to general partnerships and limited liability corporations, and the process of limited partnership formation. 

At the end of the day, the decision of whether or not using a limited partnership business structure is a good idea for your business is yours and yours alone to make. 

I hope that this article has helped you on your journey to making that decision.

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