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Limited Partnership

Limited Partnership: Advantages & Disadvantages

 
two hands holding two puzzle pieces to see if they fit together
 
 

What is a Limited Partnership?

A limited partnership requires two or more people or businesses coming together to conduct business to make a profit. Unlike a general partnership or a limited liability partnership, a limited partnership requires at least one “limited partner” in the partnership. A limited partner is a partner who is not actively participating in the control of the partnership as the limited partner is more of a passive one who contributes money or assets and then sits back and receives the profits. In general, a limited partner is not personally liable to the partnership, meaning that the limited partner’s personal assets (e.g. car or house) will not be used to pay off any debts the partnership incurs. Instead, in exchange for giving up control of how the partnership operates, a limited partner will only be liable to the partnership for the amount of money that limited partner contributed.

For example, if a limited partner contributed $1,000 to the partnership and later that partnership ends up taking out a business loan of $5,000 that it now cannot pay off, the bank can only go after that limited partner for the $1,000 that partner contributed, but not more even though the bank is still owed $4,000. Instead, the bank will have to go after other limited partners and the “general partner” to recover the remaining $4,000. However, this does not mean that you or any other partner is not personally liable for your own conduct. If you are the one who took out that bank loan on behalf of the partnership and now cannot pay it off, then your personal assets will be used to pay off the bank loan if the partnership does not have enough funds.

There must also be at least one “general partner” – a partner who is actively engaged in the management and control of the partnership and who is personally liable to the partnership. It seems at first that you would want to be a limited partner when creating the limited partnership, but by being a limited partner, you will be giving up your say in how the partnership will be managed and how it will conduct business. In this type of partnership, there is more of a give and take relationship between the partners.

Do I Need A Written Partnership Agreement For A Limited Partnership?

To form your business as a limited partnership, you will need to have a partnership agreement either orally or in writing. Although California law does not require that the partnership agreement be in writing, I highly recommend that you put any agreement in writing because disagreements will come up and will cause tensions among you and your partners. Without something in writing to refer to, those tensions can turn into grudges and destroy any friendly or business relationship you or your partner may have had with the other partners as you or your partners may feel that they are being taken advantage of and being treated unfairly.

To avoid such disagreements, put any agreement in writing. If you can afford to, hire a business lawyer to draft the partnership agreement to ensure that each partner is treated fairly and the agreement is tailored to the limited partnership’s business needs. Keep in mind that without any type of partnership agreement, your business will automatically become a general partnership instead of a limited partnership. Refer here for more information on a general partnership.

Advantages of a Limited Partnership

  • Limited liability for limited partners – Limited partners are not personally liable to the actions of every other partner or to any debts the partnership takes on

    • This means that the limited partners’ personal assets are protected as the limited partners’ liability to the partnership is only the amount the partner contributed to the partnership

  • Easy to form – File a certificate of limited partnership and create a partnership agreement

  • Inexpensive – The only necessary costs are filing the certificate and creating the partnership agreement

  • No double taxation (flow through taxation) – The partnership itself is not taxed and instead, each partner is taxed individually with the profits/losses being reported on each partner’s own income tax

    • This is different from a corporation where the corporation will have to pay a business tax for simply operating as a corporation and additionally, each shareholder will have to pay taxes on their own income tax forms

  • Increased financial resources – Can pool funds with a partner(s), which can double or triple the amount of funds your business has to operate from

Disadvantages of a Limited Partnership

  • General partner is personally liable to everything the other partners do – The general partner is personally liable for all the actions every partner does, which includes any debts that a partner incurs.

    • This means that, as a general partner, you can be personally liable for a business loan your partner took out without your knowledge, so a bank can come after you to pay off the loan if your partner is not able to. Although unfair, you will be liable for paying off the loan and if you are unable to do so, the bank can come after your personal assets too.

  • Franchise Tax Board taxUnlike a general partnership, a limited partnership will have to pay the California Franchise Tax Board a tax just for the privilege of doing business in California

    • Keep in mind that this tax is imposed on the partnership as a business entity and each partner will still have to pay additional taxes on their own personal income tax forms

  • Limited partner has no say in operation – The limited partner gives up control of the day-to-day activities of the partnership in exchange for limiting the liability the limited partner is exposed to

Costs of Starting a Limited Partnership

  • Business License/Permits – check out http://www.calgold.ca.gov/ to know exactly what licenses and permits you need to obtain to conduct business in your particular city and county

  • Certificate of limited partnership

  • Partnership Agreement

  • Franchise Tax of at least $800/year

  • Obtaining an Employer Identification Number (EIN)

  • Fictitious Business Name, if applicable

  • Intellectual property protection, such as registering your partnership’s name as a trademark or registering any copyrights or patents your partnership may have

 

*The above article is for general informational purposes only and should not be taken as legal advice. Please contact a business lawyer to find out how any information here applies to your particular circumstances.