Definition of limited partnership (LP)


What is a limited partnership (LP)?

A limited partnership (LP) – not to be confused with a limited liability company (LLP) – is a company made up of two or more partners. The general partner oversees and manages the business while the limited partners do not participate in the management of the business. However, the general partner of a limited partnership has unlimited liability for the debt, and all limited partners have limited liability up to the amount of their investment.

Key points to remember

  • A limited partnership (LP) exists when two or more partners go into business together, but limited partners are only liable up to the amount of their investment.
  • A limited partnership is defined as having limited partners and a general partner, who has unlimited liability.
  • LPs are flow-through entities that offer little or no reporting requirements.
  • There are three types of partnerships: limited partnership, general partnership and limited liability partnership.
  • Most states in the United States regulate the formation of limited partnerships, requiring registration with the Secretary of State.

Understanding limited partnerships (LP)

A limited partnership must have both general partners and limited partners. General partners have unlimited liability and have full control over the management of the business. Limited partners have little or no management involvement, but also have liability limited to the amount of their investment in the limited partnership.

Partnership agreements should be created to define the specific rights and responsibilities of general partners and limited partners.

Types of partnerships

Typically, a partnership is a business in which two or more people own it. There are three forms of partnerships: the limited partnership, the general partnership and the limited liability partnership. The three shapes differ in various aspects, but also share similar characteristics.

In all forms of partnership, each partner must contribute resources such as property, money, skills or labor to share the profits and losses of the business. At least one partner participates in decisions concerning the day-to-day affairs of the company.

All partnerships should have an agreement that specifies how to make business decisions. These decisions include how to divide profits or losses, resolve disputes and change the ownership structure, and close the business, if necessary.

Limited partnership (LP)

A limited partnership is generally a type of investment company, often used as an investment vehicle to invest in assets such as real estate. LPs differ from other partnerships in that the partners may have limited liability, which means that they are not liable for trade debts that exceed their initial investment.

The General Partners are responsible for the day-to-day management of the Partnership and are responsible for the financial obligations of the Partnership, including debts and litigation. Other contributors, called limited partners (or limited partners), contribute capital but cannot make management decisions and are not responsible for any debt beyond their initial investment.

Sponsors can become personally liable if they take a more active role in the LP.

General partnership (GP)

A general partnership is a partnership where all partners share the profits, management responsibilities and liability for debts equally. If the partners plan to share the profits or losses unevenly, they should document this in a legal partnership agreement to avoid future litigation.

A joint venture is often a type of general partnership that remains valid until the completion of a project or until a certain period of time has elapsed. All partners have the same right to control the business and to share the profits or losses. They also have a fiduciary responsibility to act in the best interests of other members as well as the company.

Limited Liability Company (LLP)

A limited liability company (LLP) is a type of partnership where all the partners have limited liability. All partners can also participate in management activities. This is different from a limited partnership, where at least one general partner must have unlimited liability and limited partners cannot be part of management.

LLPs are often used to structure professional service firms, such as law firms and accounting firms. However, LLP Partners are not responsible for the misconduct or negligence of other partners.

Special considerations

Almost all states in the United States regulate the formation of limited partnerships under the Uniform Limited Partnership Act, which was originally introduced in 1916 and has since been amended several times. The most recent revision dates from 2013. The majority of the United States (49 states and the District of Columbia) have adopted these provisions, Louisiana being the only exception.

To form a limited partnership, partners must register the business in the relevant state, usually through the office of the local secretary of state. It is important to obtain all relevant business permits and licenses, which vary by locality, state or industry. The United States Small Business Administration (SBA) lists all local, state, and federal permits and licenses required to start a business.

Note that in music, LP stands for long duration, which is another word for an album. An LP is longer than a single or Extended Play (EP) album. It was originally used to describe longer vinyl albums. However, it is now also used to describe CDs and digital music albums.

Advantages and Disadvantages of a Limited Partnership (LP)

The main advantage of an LP, at least for limited partners, is that their personal liability is limited. They are only responsible for the amount invested in the LP. These entities can be used by general practitioners when looking to raise capital for investment. Many hedge funds and real estate investment partnerships are incorporated as LPs.

Limited partners also do not have to pay self-employment tax. LPs are flow-through entities, which means that the entity files a Form 1065, and then the partners receive Schedule K-1 which they use to include their share of the income or loss on their own tax returns.

In contrast, LPs require the general partner to have unlimited liability. They are 100% responsible for management control but are also held responsible for any debt or mismanagement of business relationships. In addition, Limited Partners are only permitted to participate in a limited way in the Transactions. If their role is deemed non-passive, they lose the protection of personal responsibility.

  • Liability protection of limited partners

  • Intermediate entity for taxation (i.e. taxed only once unlike C-corp)

  • Ease of creation and reporting (e.g. no annual meeting required)

  • Less formal structure

  • No self-employment tax for limited partners

The inconvenients
  • GPs have unlimited personal liability (although they also have management control of the LP)

  • Limited partners in management participation

  • Ownership may be more difficult to transfer than other entities, such as an LLC

  • Not as flexible to change management roles

Limited Partnerships (LP) FAQs

What is a limited partnership (LP) in business?

Companies that form a limited partnership usually do so to own or operate a specific set of assets, such as a real estate investment company or a limited partnership for the management of pipelines. One party (the general partner) has control over the assets and management responsibilities, but is also personally responsible. The other party (the limited partners) are usually investors whose personal liability is limited to their investment.

What is the difference between an LLC and a limited partnership?

LLCs and LPs provide flexibility in structuring responsibilities, profit sharing, and taxes. A limited partnership allows certain investors (limited partners) to invest without having a management role or any personal responsibility, while the general partners bear all the responsibility. With an LLC, owners can protect themselves from personal liability, but all generally have management roles. An LP must have at least one sponsor.

SARLs also benefit from greater flexibility in tax reporting. Often times, the general partner of an LP will be structured as an LLC to help provide protection against personal liability, as LLC managers are not generally held personally responsible for corporate responsibilities.

What is the difference between an LP and an LLP?

An LP and LLP have a similar structure. However, limited partnerships have general partners and limited partners while LLPs do not have general partners. All partners in an LLP have limited liability.

What is the taxation of limited partnerships?

Limited partnerships are taxed as flow-through entities, which means that each partner receives a Schedule K-1 that they include in their personal income tax return.

What are the advantages of a limited partnership?

Limited partnerships are ideal entities for raising capital for a particular investment or set of assets. They allow limited partners to invest while keeping their liability limited.

The bottom line

Limited partnerships are typically used by hedge funds and investment partnerships because they provide the ability to raise capital without giving up control. Limited partners invest in a limited partnership and have little or no control over the management of the entity, but their liability is limited to their personal investment. During this time, the general partners manage and manage the limited partnership, but their liability is unlimited.

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