Basic Business Structures Part 3: The Limited Partnership

Here in Part 3, I will discuss the limited partnership.

 

Limited partnerships are rather different from general partnerships, covered in Part 2, because limited partnerships have two different classes of partners — general partners and limited partners — as a result, there are a number of important differences between general partnerships and limited partnerships.

In most jurisdictions, limited partnerships are required to file registration statements with the state’s Secretary of State office — if two or more people enter as co-owners into a business for profit there is a presumption that they intended to form a general partnership, not a limited partnership, therefor the partners must declare their intent to form a limited partnership in a registration statement. However, like a general partnership, a limited partnership is not required to execute a partnership agreement; in the absence of a written agreement the state’s limited partnership act and the course of dealing between/among the partners serve as the agreement.

Limited partnerships have two classes of partners: general partners and limited partners — there must be at least one partner in each category. While both categories of partners are usually equity owners in the business, managerial powers are mostly reserved to the general partners. Like a corporation, where the board of directors are the managers of the business and the stockholders are passive investors, in a limited partnership the general partners are the managers of the business while the limited partners are usually simply passive investors.

Like in general partnerships, general partners of limited partnerships are responsible for the management of the partnership and normally have agency power to bind the partnership in the ordinary course of business; however, unlike the tendency for unanimity among partners in general partnerships, in limited partnerships management decisions are generally made by only a majority of general partners. Conversely, limited partners are generally restricted to voting on admission of new general partners, and to ratify major partnership transactions, and have no agency authority to bind the partnership. The management structure and rights of general and limited partners can be varied by a written partnership agreement.

General partners are normally jointly and severally personally liable for the liabilities of the partnership, while limited partners’ liability is limited to the capital they have invested in the partnership — hence the term “limited partner”. Limited partners’ limited liability can be compromised if they take a part in the management of the partnership beyond the powers granted in the partnership agreement. Several jurisdictions grant a full limited liability shield to limited partnerships in a form of business organization known as the Limited Liability Limited Partnership (LLLP). However, the LLLP is not as universally recognized as other forms of business organization; Massachusetts is among the states that does not recognize the LLLP and treats LLLPs organized in other states as simply limited partnerships.

Taxation of limited partnerships is identical to general partnerships, with all profits, losses, credits, and the tax liability flowing through to the partners. Like general partnerships, limited partnerships can specially allocated partnership profits, losses, and tax credits among partners so it is possible to allocate to one class of partners.

Limited partnerships can be good for entrepreneurs as it has clearly defined classes of managers and passive investors; however, in Massachusetts and many other states, limited partnerships are ineligible for limited liability shields, which can reduce the attractiveness of the limited partnership as a form of business organization to entrepreneurs.

 

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