What Is a Limited Partnership?

If one partner wants to run the business and the others only want to invest, a limited partnership might be the right choice for you. Learn how a limited partnership works, how it differs from other partnerships, and how to create one.

By , Attorney (University of North Carolina School of Law)

Suppose you have a brilliant business idea that you want to put into action. But you're short on capital (money) to finance your project. Fortunately, you've pitched your idea to some investors, and they want to finance your business.

You and your investors decide to form a limited partnership (LP). As a general partner, you'll be in charge of the day-to-day business strategy and execution. As limited partners, your investors will be in charge of financial contributions.

What Is a Limited Partnership and How Does It Work?

An LP is a business entity that consists of at least one general partner and one or more limited partners. Typically, the general partner is an experienced businessperson who provides both financial resources and daily management skills to the partnership. A limited partner is an individual or business that offers only capital or financial resources to the business.

This business structure offers owners a unique opportunity. Some owners can be tasked with running the day-to-day operations and carrying out business obligations and objectives; other owners can take a back seat and fund those operations. This type of partnership can work well with a group where one person (the general partner) is personally invested in the business's success and the other people (the limited partners) see the partnership as an investment.

Partners' Personal Liabilities for Business Debts

Partners in an LP don't just differ in what they contribute to the business. They also differ in their level of liability for the partnership's debts:

  • General partners have unlimited personal liability for business debts. So, creditors can force general partners to pay for the LP's business debts out of their own pockets. For example, if the partnership owes a landlord $10,000 in rent, the landlord can recover the $10,000 debt from the general partner.
  • Limited partners have limited liability for business debts. In contrast to their general partners, limited partners are only liable for business debts to the extent of their financial investment. In other words, they only stand to lose the money they put into the business. For instance, if a limited partner invested $20,000 into the partnership and the business has $50,000 in debt, then the limited partner might lose their $20,000 investment. But they wouldn't have to pay any additional money to cover the rest of the business's debt.

But a limited partner can lose their limited legal liability if they become involved in directing or operating the business. If a limited partner becomes more than an investor and contributes to the daily activities of the business, they can become a general partner and be personally liable for the LP's debts.

A general partner is subject to unlimited personal liability because of their authority over daily business decision-making. If there's more than one general partner in an LP, general partners are jointly and severally liable for the partnership's debts and liabilities and debts—that is, each general partner is entirely responsible for the company's debts.

For instance, suppose Lois and Lana are general partners in an LP. The LP has $100,000 in debts. Lois and Lana use the limited partners' investments to pay off some of the debt, leaving $70,000 to be paid. The LP's creditors decide to sue Lana, and the court orders her to pay $70,000 since she's a general partner.

Usually, partners have a partnership agreement that lays out how much of the business's debts each partner is responsible for. For example, the agreement might say that the general partners are equally responsible for the business's debts. If one partner is ordered to pay the business's full debt, but under their partnership agreement they're only responsible for half of that debt, they can recover the other half from their business partner.

Partners' Fiduciary Duties to the Partnership

In an LP, general partners have certain fiduciary duties to the partnership because they're responsible for the management and operation of the company. Limited partners don't typically owe these duties to the LP.

General partners have the following fiduciary duties:

  • duty of good faith and fair dealing (to be honest and fair)
  • duty of loyalty (to put the partnership's interests above their own)
  • duty of care (to act reasonably in their business management), and
  • duty of disclosure (to keep the other partners informed about the partnership).

For more information, read our article on fiduciary duties in partnerships.

Partners' Shares of the Partnership's Profits

General and limited partners in an LP don't share profits and losses equally. Traditionally, each partner's profits and losses are determined by the value or percentage of any capital contributions made to the business.

However, the partners could decide to deviate from this traditional approach through their partnership agreement. It's common for LPs to allocate a greater percentage of the business's profits to limited partners until they're paid back what they initially invested. Once limited partners get back their initial investment, partnerships often distribute the profits more evenly.

For example, suppose Fred is a general partner and Daphne and Velma are limited partners in an LP. Daphne and Velma each initially contribute $15,000 to the partnership. The partners decide to distribute a higher percentage of the profits to Daphne and Velma until they recover their initial contributions. So, at the start of the business, the partners decide on the following profit distribution:

  • 40% to Daphne
  • 40% to Velma, and
  • 20% to Fred.

A year into the partnership, Daphne and Velma have each received $15,000 in profit distributions—the same amount they each initially invested. Their partnership agreement states that once Daphne and Velma are paid back their investments, the profits will be distributed in the following way:

  • 30% to Daphne
  • 30% to Velma, and
  • 40% to Fred.

Though general partners don't generally contribute as much as limited partners financially, they pull their weight through their labor and personal liability risk. Therefore, it's not unreasonable for general partners to see the value they bring to the business returned to them in profits.

Limited Partnerships vs. Other Types of Partnerships

There are three main types of partnerships:

Each type of partnership differs in how owners share in the business's responsibilities, profits, and liabilities.

LPs vs. GPs. LPs have general and limited partners whereas GPs only have general partners. General partners in a GP, like those in an LP, are personally liable for the business's debts and are responsible for the company's day-to-day operations.

LPs. vs. LLPs. An LP has general and limited partners whereas an LLP only has limited partners. The partners in an LLP manage and operate the business and have limited liability for business debts. In contrast, partners in an LP either manage the business's daily activities or have limited liability. For more information, read our article on LPs vs. LLPs.

Should You Form a Limited Partnership?

An LP's structure offers owners many benefits. But both general and limited partners face some drawbacks under this type of business. You should consider these factors when deciding whether an LP is right for you and your business.

Advantages of Forming a Limited Partnership

An LP offers several benefits:

  • Choice and flexibility. An LP can be a great choice for owners who want different things out of a business. Some people are looking to run a business and to personally make the choices to see their company succeed. Other people don't want to dedicate the time to start a new business but want to diversify or expand their investments. An LP offers both. And if a limited partner wants to become more involved in the business, they have the opportunity and flexibility to become a general partner.
  • Financial appeal. Because limited partners have limited liability and aren't expected to contribute any significant time to the business, an LP can be a great sell to investors. If you want to start a business but don't have the money to do so, you can propose forming an LP. You, as the general partner, will take on all the liability risk and take care of business operations while the limited partners can sit back and collect their share of the profits.
  • Limited partners have limited liability. Limited liability is always preferred to unlimited liability. Limited partners have the benefit of not risking their own money to satisfy business debts.
  • Easy to form and maintain. LPs are relatively easy to create. States generally only require one formation filing and the fee to file is usually low. The duties of each partner are generally straightforward and static—general partners make the business decisions and limited partners provide the funds. You can usually capture all the necessary details of your LP in your partnership agreement, including how profits are distributed and how the LP is dissolved.

Disadvantages of Forming a Limited Partnership

An LP isn't without its downsides:

  • General partners have unlimited liability. Creditors can come after general partners personally to pay business debts. This risk is a downside when compared to other business structures like corporations and limited liability companies (LLCs) that offer all owners limited liability.
  • No flexibility for taxes. Partnerships aren't flexible in how they're taxed like LLCs are. When you form an LLC, you can either be taxed as a pass-through entity or you can elect to be taxed as a corporation. Some companies find that they save money by electing to be taxed as a corporation because corporations are usually taxed at a lower rate. But partnerships can't elect to be taxed as a corporation and owners must report their earnings on their personal returns. (For information, read our article on how LLCs are taxed.)
  • Limited partners can't make decisions for the business. While a limited partner has the flexibility to become a general partner and make business decisions, becoming a general partner would cause them to lose their limited liability status. If they want to protect their personal assets, limited partners will have to resist the urge to make any management decisions. Staying uninvolved can be difficult when you're putting money into a business that you have no control over.

How Do You Form a Limited Partnership?

Forming an LP is very similar to forming a GP. The main difference is that you'll need to submit formation filings to the state to form an LP. Whereas with a GP, you form it just by going into business with someone else—no paperwork is needed. To learn the steps necessary to form a partnership, read our article on how to form a partnership.

You should take the following steps to form an LP:

  1. Choose a business name. Your business name should be different from any other business name on file with the state. States typically require your company name to end in "Limited Partnership," "L.P.," "LP," or "Ltd." (For help picking a name, read our FAQ on choosing a business name.)
  2. Register your business with the state and pay the required fee. You can usually file your form—usually called a "certificate of limited partnership"—online with your state's secretary of state's office or corporations division. You'll likely need to designate a registered agent to receive official papers for your business.
  3. Draft a partnership agreement. Just like corporations have their bylaws and LLCs have their operating agreements, you need a document to govern your partnership. Your partnership agreement should lay out each partner's responsibilities and obligations, how profits are distributed, when partners can enter and leave the company, and how the business should be dissolved.
  4. Obtain an employer identification number (EIN). Even if you don't have employees, you'll need to obtain an EIN from the IRS for tax reporting purposes.
  5. Apply for business licenses, permits, and registrations. You might need to apply for a business or professional license, register with your local tax agency, and comply with zoning ordinances. If you have employees, you might need to follow additional employer requirements. (For more information, see our article on legal requirements for starting a small business.)
  6. Open a business bank account. You should keep your business finances separate from your personal finances. Opening a business account will also help you keep track of your company's income and expenses for tax purposes. Some banks require you to have an EIN to open a business account.
  7. Obtain liability insurance. Because general partners are personally liable for the business's debts, you should invest in a business liability insurance policy.

(For a checklist, see our article on how to start a business.)

How Do You Dissolve a Limited Partnership?

To end your LP, you'll need to vote to dissolve the partnership and file the appropriate forms with your state. You'll also need to wind up your business by:

For more information, see our article on how to dissolve an LP.

For Further Guidance on Limited Partnerships

Limited partnerships can be a good option for a group where one person is interested in managing the business while the others are only interested in collecting passive income. If you have experience with running a small business, you might be able to create and manage your LP on your own.

But because the roles in an LP are so varied, it might be helpful to talk to a business lawyer about your and your partners' responsibilities and liabilities. An attorney can help you decide whether an LP is the best choice for you. They can also help you negotiate and draft a partnership agreement, apply for the appropriate business licenses and permits, and assess your personal liability for your partnership's debts.

Find the business structure that fits your business. Take our business formation quiz for help deciding the best structure for your business.
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