Limited Partnerships (LPs)

Photo by Tim Evanson is licensed under CC 2.0.

A limited partnership is a type of artificial entity consisting of general partners and limited partners. General partners run the business, while limited partners hold equity stakes in the business but do not have a say in its day-to-day operations.

Because LLCs and corporations are usually better business structures for traditional businesses, limited partnerships are most often seen as investment vehicles, particularly with real estate, or in the context of estate planning.

Formation of Limited Partnerships

Forming a limited partnership requires registration with the Secretary of State. The name, registered agent, and a list of general partners must be submitted to the Secretary of State in order to receive the certification of formation.

The requirement of this proactive step differs from general partnerships. Since a general partnership is formed whenever two or more persons go into business together as co-owners, they may be formed without making any filing—and in fact may be formed accidently.

Limited partnerships, however, are very different. A limited partnership must consist of at least one general partner and one limited partner. A partnership without any limited partners is simply a general partnership, and a partnership with only limited partners cannot function.

Role of the General Partners

Absent an agreement to the contrary, general partners have the right to make all business decisions without the consent or input of the limited partners. Even with an agreement to the contrary, the ability of limited partners to exercise influence over the business decisions of the LP is limited.

As I discussed in a previous post, the partners in a general partnership have joint and several liability, meaning that they are personally liable for the debts and liabilities of the partnership, including those incurred by other general partners.

The same level of liability applies to the general partners of a limited partnership. For this reason, the general partner in limited partnerships is often not an individual, but an artificial entity that provides limited liability protection. It is not unusual, for example, for an LLC to serve as the general partner of a limited partnership.

Role of the Limited Partners

Unlike general partners, limited partners have traditionally had very limited management rights and do not have the apparent authority to act on behalf of the partnership. Also unlike general partners, limited partners have limited liability protection and limited rights to withdraw from the partnership.

Traditionally, the distinction between general and limited partners has been strictly enforced. In the past, limited partners that acted like general partners by exercising a greater control over business matters could lose their personal liability protection and be held liable as general partners if another party relied on the limited partner’s authority to act on behalf of the business.

Modern statutes, however, have modified this, generally rejecting the notion that limited partners can be held liable as general partners just for participating in management.

Conclusion

The limited partnership serves a valuable purpose for small businesses, particularly businesses operating as investments, in that it allows for the raising of capital from investors without providing investors a say in the management of the business.

This is particularly valuable in the context of real estate investments. It is not uncommon for real estate investors to raise capital by selling limited partnership shares in a proposed apartment complex, for example, that they intend to run. They are therefore able to raise enough funds to develop or purchase a property without having to risk the investors taking over the business or exerting an undue amount of influence.

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See Also:

The Corporation

The Limited Liability Company (LLC) Part 1