What is a limited partnership? Definition, pros and cons

A limited partnership is a business entity featuring several business partners — general and limited — who help to either invest in or run the company. Different from a limited liability partnership (LLP), this type of business entity may be best suited for those who desire to pool their funds together to create a company, but who are not all interested in running the day-to-day affairs.

To determine whether a limited partnership is the right choice for you and your business ventures, it’s important to understand the advantages and disadvantages of such a decision. Plus, if and when other legal entities are better suited for your business needs. 

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What is a limited partnership?

A partnership is a type of business that consists of two more people or partners where each will contribute assets or some other form of value to the company. Each partner also shares in the gains and losses derived from the company. Where a limited partnership differs from a standard partnership, is that it has features that are a cross between partnerships and corporations.

One of the main features of a limited partnership is the two different types of partners — general and limited. A general partner is the one who is responsible for the daily operations of the business and is fully legally responsible for all aspects of the business. This includes the business’ debts, financial and legal obligations, as well any business dealings. The general partner is seen as an agent of the company and is a fiduciary, acting in the best interest of the business.

A limited partner, on the other hand, has the right to share the profits and losses of the business but takes a less active role. Their liability only extends to the amount contributed or invested in the business. For example, if a limited partner invests $500,000 into the business and the business gets sued, the partner is only liable for up to $500,000. 

This type of partner doesn’t manage the day-to-day affairs but, in some cases, has the right to vote on important matters, such as allowing new partners to join the company. Think of these types of partners as “silent” partners.

Other characteristics of a limited partnership include:

• If a general partner leaves and other partners don’t submit any documentation opposing the decision, the limited partnership may need to be dissolved. 
• A limited partner in a limited partnership is typically not dissolved automatically if a limited partner leaves or withdraws from the business. 
• Many states require that you form a limited partnership in accordance with the state statute. 
• Your business may need to act in accordance with the Uniform Limited Partnership Act, depending on the state. 
• One person cannot be both the general and limited partner.
• The limited partnership itself doesn’t pay any federal taxes. Your state may have its own regulations when it comes to state taxes.

While partnerships don’t pay federal taxes, the IRS does require that you file an annual report that reports the business’ income, gains, losses and deductions. A limited partnership is a pass-through entity, meaning partners share in its profits and losses. Therefore, each one will need to report their share of income or loss on their personal tax returns. 

Limited partnerships will issue Form 1096 (Schedule K-1) to each partner to indicate their income or losses incurred to help them file their annual income tax return, though general partners may also be responsible for paying self-employment taxes. 

Limited partnership advantages and disadvantages

Limited partnership advantages

• Liability protection: Limited partners are generally more protected as they’re only responsible for up to the amount they’ve invested into the business. 
• Taxes: As a pass-through entity, a limited partnership is only taxed once (the partners pay taxes).
• Reporting: Limited partnerships generally don’t have as much required documentation compared to other entities like corporations. 
• Access to skills: This type of business entity offers access to financial resources from limited partners and business expertise from general partners. 
• More control: General partners can make decisions without having to receive input or votes from limited partners, with some exceptions. 

Limited partnership disadvantages

• Less flexible than other business entities: You may not be able to transfer a limited partnership as easily as other business types. 
• More responsibility: General partners need to take on all the liability of the business, and can put their personal assets at stake if business assets aren’t enough to handle a lawsuit.
• Inability to make input: Even if they wanted to, limited partners aren’t able to make decisions related to the management of the business.
• May lose liability protections: Any limited partners that take a more active role in the business may be declared to have unlimited liability in the business. 

How to start a limited partnership

With the exception of some states, all others in the U.S. govern the formation of a limited partnership through the Uniform Limited Partnership Act. 

To form a limited partnership, you will first need to decide on who your partners are, the business name and a registered agent who will receive official documentation on the business’s behalf. To officially form your business, you will need to apply for a Certificate of Limited Partnership through your secretary of state. 

Information you may need to provide includes:

• Name of the business.
• All partners’ names and their roles.
• Name of the agent of the business.
• Nature of the limited partnership.
• Additional information about roles and responsibilities, such as instances when a general partner may leave, how partners will share in profits and losses and when a partnership can be dissolved. 

Depending on the nature of your business, you may need to apply for additional business licenses and permits before you can operate in the state. In some cases, you may also need to register with your state’s Department of Revenue. 

Limited partnership vs. other types of partnerships

LIMITED PARTNERSHIP	GENERAL PARTNERSHIP	LIMITED LIABILITY PARTNERSHIP
General members responsible for managing business. All members have an equitable share in losses and profits of business. General members assume all liabilities, whereas limited members assume limited liability.	All members responsible for management of business. Shares losses and profits of business. All members limited in their liabilities.	All members responsible for managing business. All members assume all liabilities of the business. Members can shield personal assets from lawsuits.

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Limited partnership vs. general partnership

A general partnership, like a limited partnership, requires its partners to share in the profits and losses of the business. However, all members of a general partnership are also responsible for all of the business’ day-to-day affairs and all liabilities. All partners need to act as fiduciaries, or individuals that act in the best interest of the business. 

In most cases, partners in general partnerships have equal voting rights and control over the business unless stated otherwise in official documentation. Limited partnerships don’t share responsibilities equally depending on the type of partner you are. 

Limited partnership vs. limited liability partnership

Whereas a limited partnership only gives limited partners limited liability, in a limited liability partnership, this is the case for all partners. Another difference is that all partners can also take an active role in management decisions. 

Each partner is generally not liable for any of the actions partners engage in in the business. Partners in limited liability partnerships can have equal shares in the business or a percentage, depending on the business documentation. 

Limited partnership vs. LLC

A limited liability company, or LLC, is a type of business entity that also allows pass-through taxation. That’s because the LLC is a separate legal entity from its owners. Individuals or partners can own the LLC, and partners can include individuals or businesses. 

If there is more than one member, the LLC is typically classified as a partnership unless the business files a form to be considered a corporation. LLC members can generally shield their personal assets from business debts or lawsuits. Unless agreed upon otherwise, all members usually have equal say in the business and share all profits and losses.

When should you choose a limited partnership?

Limited partnerships are best for business owners who still want to retain control of the operations while allowing investments or an infusion of cash coming in from other partners. Or, it could be that someone has the skills and expertise to pursue a business idea but doesn’t have the funding necessary to get it off the ground. In this instance, having limited partners can help with the funding aspect, and the general partner is free to grow the business.

For example, you are a real estate developer with a track record for creating profitable commercial real estate projects. However, you want to strike out on your own and don’t have the means to come up with your own funds or can’t get enough commercial loans. 

In this instance, you can bring on a limited partner to help fund the projects, with the perk that this person will receive a portion of the profits generated. Or, it could be the other way around, where you have the funds but lack the skills or desire to run the real estate venture. 

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