A legal partnership between two or more partners, comprising at least one limited partner and one general partner
A limited partnership (LP) is a type of business structure recognized in many countries around the world. Fundamentally, it is simply a legal partnership between two or more partners.
There must be at least one limited partner and one general partner (GP) to form a limited partnership. The general partner oversees and manages the limited partnership, and the limited partners are not active in managing the business.
Limited partnerships are typically set up as investment vehicles for a certain purpose like investing in a real estate project or a venture capital fund. In such cases, the general partner manages the investment and the partnership itself may have a limited life (funds may need to liquidate, or exit, their investments at some point over the defined life of the fund).
While general partners have unlimited personal liability if something goes wrong under their management, limited partners are only liable up to the amount of their investment, hence the name limited partners.
For example, if there is a legal judgment against the limited partnership, the general partners have unlimited liability to “cure” the judgment, but the limited partners would only lose the amount of their investment. Simply put, general partners’ personal assets may be used to satisfy obligations if the LP can’t meet the limited partnership’s obligations.
Regardless of form, limited partners must contribute either money or assets to the partnership in order to share in the partnership’s profits (or losses), usually on a pro-rata basis.
A limited partnership has distinctive characteristics relative to other business forms, mostly related to the roles and liabilities of its partners. The following are some key characteristics of a limited partnership:
If the partnership’s assets are insufficient to cover its liabilities, general partners’ personal assets may be used to satisfy obligations. General partners will usually charge management fees as compensation for managing the limited partnership.
When a limited partnership is structured as an investment fund, it may have a finite lifespan, and the investments would need to be liquidated according to the partnership agreement. A limited partnership might also be dissolved in certain situations (this would be specified in the partnership agreement).
Limited partnerships are typically structured as pass-through entities. This means that the partnership itself is not subject to income tax, but its partners are. The partnership’s profits and losses are passed through to the individual partners, and the partners report their proportion of the profits and losses of the partnership on their own personal tax returns.
Forming a limited partnership is usually easier than forming a corporation. Corporations typically require significantly more initial documentation, as well as ongoing documentation, depending on where the corporation is formed.
Limited partnerships, on the other hand, usually require less documentation upon formation. The main partnership document is the partnership agreement, which outlines the contributions, responsibilities, and profit allocation among the partners.
Selling an interest in a partnership is more difficult than other business forms and may require the consent of the other partners.
Despite the disadvantages, limited partnerships are used in a variety of industries, including the following:
A limited partnership is similar in some respects to a corporation. In a limited partnership, the LPs own the partnership while the general partner manages it. In a corporation, shareholders are the owners and shareholders elect a Board of Directors, which in turn hires and oversees the managers of the corporation (like a CEO or CFO).
Additionally, both a limited partnership and a corporation result in limited liability for limited partners as well as for corporate shareholders.
However, there are many differences between limited partnerships and corporations. First, partnerships are known as pass-through entities and are not usually subject to tax at the partnership level. Therefore, limited partners will recognize their share of the partnership’s taxable income on their personal tax returns. Bottom line: there is only one level of taxation in a partnership (the individual partner level).
This is in contrast to a corporation, which pays income taxes on its taxable income. The corporation’s shareholders will pay tax if the corporation distributes dividends or if the shareholder sells shares at a gain. In other words, shareholders of corporations are effectively taxed twice: once at the corporate level, and then again at the shareholder level if shares are sold at a gain or dividends are received.
Additionally, most publicly traded companies are organized as corporations since corporations can have an unlimited number of shareholders, and calculating taxes is relatively easier when compared to a partnership. Also, it’s easier to transfer ownership of a corporation relative to partnership interests in a limited partnership. A corporate shareholder can easily sell shares but selling a partnership interest might require the consent of the other partners.
It is typically more difficult to create a corporation, which will require articles of incorporation and corporate bylaws. Additionally, there will be additional costs related to board meetings, shareholder meetings, and record maintenance. In contrast, a limited partnership just needs to obtain a certificate of limited partnership in the appropriate jurisdiction and have a partnership agreement. In other words, corporations are highly regulated and require a more formal creation process relative to limited partnerships.
Finally, corporations usually have an indefinite life. However, partnerships may have a finite life, as discussed previously. Nevertheless, this can be addressed in the partnership agreement.
A limited partnership and a limited liability company are similar in many ways but differ in some key areas. Below are some key differences between the two structures.
Limited partnerships and limited liability partnerships are quite similar but differ in how liabilities are treated as well as how they are typically used.
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