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ACROBAT | 6-MINUTE READ

Limited partnership: What is it and how to draft an agreement?

Here’s what you need to know about limited partnership agreements.

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What is a limited partnership?
How does a limited partnership work?
How to draft a limited partnership agreement.
Pros and cons of limited partnership.
Frequently asked questions

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Gain insight into the specifics of a limited partnership and LP agreements. The business structure you select plays a crucial role in shaping various aspects of your company, including daily operations, tax obligations, and the level of personal liability you assume. Each structure offers different advantages and legal protections, so it’s essential to choose one that aligns with your business goals while providing the right balance of risk management and benefits.

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Factors such as ownership flexibility, ease of fundraising, and regulatory requirements should also be considered, as they can impact your long-term success and growth potential. Taking the time to evaluate your options carefully can help ensure a strong legal and financial foundation for your business.

What is a limited partnership?

A limited partnership (LP) is a business structure that consists of at least one general partner and one or more limited partners. It is a flexible entity that combines elements of both general partnerships and corporations, allowing for a division of management responsibilities and liability among its members.

In an LP, the roles and responsibilities of partners are clearly defined:

General partner(s). General partners are responsible for managing the business, making decisions, and handling day-to-day operations. They also assume unlimited liability, meaning their personal assets could be at risk if the business faces legal or financial troubles.

Limited partner(s). Limited partners, sometimes referred to as silent partners, primarily invest in the business but do not participate in management decisions. Their liability is limited to the amount they have invested in the partnership, which helps protect their personal assets.

This structure makes LPs particularly appealing for investors who want to contribute capital to a business without taking on the responsibilities and risks of active management. Limited partnerships are often used in industries such as real estate, private equity, and professional services, where passive investors provide funding while general partners oversee operations.

A limited partnership agreement establishes the type of partnership as described above. It’s also important to note the differences between a limited partnership agreement versus a general partnership agreement.

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How does a limited partnership work?

A limited partnership must include at least one general partner and at least one limited partner to be legally recognized.

General partners oversee business operations and hold full responsibility for the company's financial commitments, meaning they bear unlimited personal liability. In contrast, limited partners contribute capital but typically do not engage in management decisions. Their financial risk is restricted to the amount they invest, shielding their personal assets from business liabilities.

Establishing a limited partnership (LP) involves several key steps, typically governed by state laws:

1 Filing a Certificate of Limited Partnership. To formally create an LP, the general partners must file the necessary paperwork with the appropriate state agency, usually the Secretary of State’s office. This document outlines the names of the partners, the business name, and other essential details.

2 Drafting a partnership agreement. While not always legally required, a partnership agreement is highly recommended. It defines the roles and responsibilities of general and limited partners, profit distribution, decision-making processes, and provisions for adding or removing partners.

3 Compliance with regulatory requirements. Depending on the industry and location, LPs may need business licenses, permits, or adherence to securities regulations if seeking outside investors.

Limited partnerships are particularly useful for businesses where passive investment is common and operational control is best left to designated managers. Some typical use cases include:

Real estate investment. Many real estate development projects use LPs, where general partners handle property acquisition, management, and development, while limited partners contribute capital without day-to-day involvement.

Private equity and venture capital. LPs are a preferred structure in these industries, as they allow investors to provide funding while fund managers make investment decisions.

Film production. The entertainment industry often relies on LPs to finance movies and television productions, with investors backing the project while producers handle the creative and business aspects.

Professional firms. Some law firms, medical practices, or financial service companies use LPs to bring in investors while allowing experienced professionals to manage operations.

The flexibility and liability protection offered by LPs make them a popular choice in these industries, balancing investor security with business efficiency.

How to draft a limited partnership agreement.

Understanding how to write a contract or draft a solid agreement is essential for protecting the interests of all parties involved, and this is especially true when creating an LP agreement. A limited partnership agreement helps protect your business into the future by outlining each partner’s roles and responsibilities, as well as how they share in the business profits. You should use this type of agreement if you want to form a limited partnership or formalize an existing limited partnership.

When creating an LP agreement, the following elements should be clearly defined:

Partnership name and purpose
- Specify the official name of the limited partnership.
- Outline the primary business activities and objectives.

Roles and responsibilities of partners
- Define the authority and obligations of general partners, including management duties.
- Clarify the role of limited partners, ensuring they understand their passive involvement.

Capital contributions
- Detail how much each partner is investing in the partnership.
- Explain how additional capital may be raised, if needed.

Profit and loss distribution
- Establish how profits and losses will be divided among partners.
- Specify whether distributions will be made regularly or based on certain conditions.

Liability and indemnification
- Outline the extent of liability for general and limited partners.
- Include indemnification clauses to protect partners from personal financial risk.

Decision-making and voting rights.
- Define how major business decisions will be made.
- State whether limited partners have any voting rights in specific situations.

Transfer of partnership interests
- Set rules for adding or removing partners.
- Detail procedures for transferring ownership stakes.

Dissolution and exit strategy
- Describe the conditions under which the partnership may be dissolved.
- Outline steps for winding down the business and distributing remaining assets.

Once drafted, the LP agreement should be reviewed by a legal professional to ensure compliance with state laws and regulatory requirements. All partners should carefully read and sign the document, acknowledging their rights and responsibilities. Keeping a well-structured agreement in place can help prevent future conflicts and establish a strong foundation for the partnership’s success.

However, make sure to obtain legal advice before developing your limited partnership agreement to ensure it is airtight, comprehensive, and meets your own business needs.

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The pros and cons of a limited partnership.

Limited partnership agreements offer a blend of benefits for passive investors, but they require careful consideration due to potential limitations. Here’s a brief look at the pros and cons:

Pros:

LP agreements allow investors to support a business without actively participating in its management.

Limited partners can benefit from the knowledge and experience of general partners.

Pass-through taxation can result in lower tax liabilities.

Personal assets are protected from business-related risks.

Cons:

Limited partners have little say in business decisions.

Potential profit limitations may exist.

Limited partners share exposure to general partners’ actions.

LP agreements can involve legal complexities and additional costs.

Frequently asked questions.

Why choose a limited partnership?

A limited partnership can be an attractive choice for businesses seeking a mix of active management and passive investment. General partners have the flexibility to manage the business, while limited partners can invest without taking on personal liability beyond their investment. LPs are often preferred in industries like real estate, venture capital, and entertainment, where passive investors want to contribute capital while limiting their exposure to risk.

What is the difference between an LP and an LLP?

A Limited Partnership (LP) consists of at least one general partner who manages the business and assumes full liability, and one or more limited partners who invest in the business but have limited liability. In contrast, a Limited Liability Partnership (LLP) typically includes partners who all have limited liability and are usually involved in the management of the business. An LLP offers greater protection for all partners against personal liability for the actions of other partners.

What is limited partnership taxation?

Limited partnerships are generally not taxed as separate entities. Instead, the income, deductions, and credits "pass through" to the individual partners, who report them on their personal tax returns. General partners are taxed on their share of the profits, while limited partners are typically only taxed on the income they receive from the partnership. This structure helps avoid double taxation, which is common in corporations.

Can limited partners participate in management?

No, limited partners typically cannot participate in the day-to-day management of the business without risking their limited liability protection. If a limited partner becomes involved in management, they may lose their limited liability status and become subject to the same risks as general partners.

Can a limited partnership have more than one general partner?

Yes, an LP can have multiple general partners, each of whom shares management control and unlimited liability for the business’s obligations. However, it's important to specify the roles and responsibilities of each general partner in the partnership agreement to avoid confusion and potential conflicts.

Can a limited partnership be converted into another business structure?

Yes, a limited partnership can be converted into another business entity, such as a corporation or limited liability company (LLC), through a legal process. This typically requires approval from the partners and compliance with state regulations. It's important to consult a legal professional to understand the implications and procedures involved.