A partnership is either a formal or informal business type that allows two or more entrepreneurs to work together towards a common business goal.
But not all partnerships are created equal, as there are actually several different types of partnerships that all function a bit differently.
One such type is the limited partnership, or the LP. In this guide, we’ll cover the basics of what this partnership type is, how it works, and how it’s different from other partnership structures. Should you form an LP for your company, or is another business type a better choice?
Select a state below to set up a Limited Partnership. We'll walk through the important details and how to take care of the paperwork.
What Is a Limited Partnership?
A limited partnership is one of several popular American business entity types, and unlike some other informal partnership types, an LP is a formal business structure that registers with its Secretary of State. By registering this way, the partnership gains some liability protection for its owners.
The limited partnership is unique because it has two classes of partners: limited partners and general partners. Limited partners are often referred to as passive investors, as they contribute capital to the business, but they do not make active decisions in the day-to-day operations.
Managing the daily affairs falls to the general partner(s) instead. These partners may also invest some capital when starting out, but their main agenda is helping the business succeed by taking an active role in the managerial aspects. The general partner’s role is much more involved in making decisions for the company, like entering into contracts, hiring and firing employees, and more.
The other key difference between these two partner types is their personal liability: whether or not they have to pay up from their personal assets when the business defaults on a contract. Limited partners have limited personal liability, which means that they can typically be held liable only for the total amount of their initial investment.
General partners, however, can personally take the hit when things go wrong in the business. Their personal liability stems from the fact that they make the decisions. While limited partners won’t be harmed by the business decisions unless they overstep their role and start making decisions for the company, general partners have both more responsibilities and more risks than their limited partners do.
How Does a Limited Partnership Work?
Unlike a general partnership, which is an informal business entity that doesn’t even require the filing of formation documents, the limited partnership does have a formal startup process that includes preparing and filing a certificate of limited partnership.
This document outlines the roles of your partners, as well as some other important aspects of your business, like the identity of your registered agent.
As part of this formation process, the partners enter into a partnership agreement. This document is somewhat similar to the LLC’s operating agreement, and it establishes the details of the relationship between the company’s partners.
For example, a good partnership agreement should include a statement of how the profits are split between the partners. If the limited partners get a cut to compensate them for their investments, the partnership agreement establishes that procedure.
The partnership agreement should also dictate how decision-making works in the business. The general partner makes the day-to-day decisions, but for major decisions that affect the structure of the business, the limited partners may need to be involved as well. The partnership agreement should establish if and when these decisions should pass to all partners.
How Is a Limited Partnership Different from Other Partnership Types?
As we’ve mentioned, the limited partnership is not the only type of partnership ― there are also general partnerships, limited liability partnerships, limited liability limited partnerships, and joint ventures. While this article isn’t dedicated to these types, understanding the differences between them will help you better understand a limited partnership.
General partnerships are the most basic partnership type, and they share much in common with the sole proprietorship. These partnerships don’t have to register with the state ― they form automatically when the partners begin conducting business together. The drawback to this type of partnership is that there is no personal asset protection.
Limited liability partnerships (LLP) are quite similar to professional LLCs, or PLLCs. LLPs as a business structure are only available to entrepreneurs in certain certified professional fields, including (but not limited to) lawyers, accountants, architects, dentists, chiropractors, and more. With a limited liability partnership, the partners receive personal asset protection, but this does not extend to issues of malpractice.
Another form of partnership is the limited liability limited partnership (LLLP), which is a much more recent development in the American business landscape. This business structure is a form of limited partnership, and therefore has the same general partner/limited partner format. The difference is that the LLLP’s general partners enjoy the same level of personal liability protection as the limited partners do. The LLLP is only available in 29 states, so if you want to form one, you should make sure you’re doing so in a state that recognizes this business type.
Finally, you’ll sometimes see a joint venture referred to as a partnership. The joint venture is an agreement between two distinct business entities to collaborate on a project. For the most part, the joint venture only exists temporarily until work on that project is complete. The joint venture is not a business structure in itself, but it is not uncommon to see its partners form an LLC, corporation, or formal partnership to provide a framework for the project.
A limited partnership isn’t uncommon in any industry, but it’s especially popular for real estate businesses, law firms, accounting businesses, and financial investment firms.
This is because the LP’s structure allows for highly experienced entrepreneurs to team up with investors in the form of limited partners to create a flexible business structure that provides mutually beneficial roles and responsibilities for all parties.
Overall, the limited partnership model isn’t for everyone, but if your business can benefit from the uneven partnership structure, you should give the LP a look.