A Limited Partnership (LP) is a form of business partnership that is similar to a general partnership except that while a general partnership must have at least two general partners (GPs), a limited partnership must have at least one GP and at least one limited partner. Limited partnerships are distinct from limited liability partnerships, in which all partners have limited liability.
Please note that when limited partnership is being established, or when the composition of the firm is changing, limited partnerships are generally required to file documents with the relevant state registration office. Limited partners must disclose their status when dealing with other parties, so that such parties are on notice that the individual negotiating with them carries limited liability.
It is customary that the documentation and electronic materials issued to the public by the firm will carry a clear statement identifying the legal nature of the firm and listing the partners separately as general and limited. Unlike the GPs, the limited partners do not have inherent agency authority to bind the firm unless they are subsequently held out as agents (and so create an agency by estoppel); or acts of ratification by the firm create ostensible authority.
The pros of a Limited Partnership often outweigh any perceived cons but irrespective of how attractive and easy to set up a business legal entity or structure is, there are always pros and cons of owning such business status hence the need to weigh your options before choosing one. In this article, we will be looking at the pros and cons of owning a Limited Partnership.
Pros of Starting a Business as a Limited Partnership
Table of Content
- 1. The Owner Faces Only Limited Liability
- 2. Shares of Limited Partnership Are Considered as Securities
- 3. Limited Partnership Is Simple and Flexible
- 4. Business Expenditures Can Be Debited Directly from Personal Income
- 5. Easy Means of Exiting the Business
- 6. Limited Partners are Immune from High Levels of Liability
- 7. You Can Scale-up the Growth of the Business
- a. Limited Partner is Limited in Key Decision Making
- b. Profits are Treated as Personal Income
- c. In a Limited Partnership, General Partners are Personally Liable for Business Debts
- d. Difficulty in Raising Money for Expansion
- e. Require a Certain Level of State Registration
- f. Limited Partners Have No Voting Power
1. The Owner Faces Only Limited Liability
You can’t talk about the pros of starting a Limited Partnership without talking of the fact that the owner of the business faces limited liability. What this means is that, if the business goes bankrupt or is sued, the limited partner is only liable up to his investment in the business and the business’s assets.
The owner will not be personally liable, and unless the limited partner has done something as an individual to make him or her liable, he or she can’t be sued as an individual.
Another obvious pro of limited partnership is that the shares are considered as securities. In essence, it means the shares of a limited partnership can be sold to any third party in other to raise capital that has an equity percentage.
This takes away the requirement for a company to go public in order to sell shares while still benefiting from the cash infusion of an equity payment. Limited partners can also directly sell their shares to others as long as they have made a first offer to the general partners.
3. Limited Partnership Is Simple and Flexible
When you put Limited Partnership side by side with other business legal structures, you will notice that limited partnership is rather inexpensive and applications are fairly basic. They are also flexible enough that they can create management structures that are centralized like a corporation’s would be or not centralized at all where managing partners each have an equal stake in what needs to happen. This allows partners to share resources, limit their personal liabilities, and maximize their profits.
4. Business Expenditures Can Be Debited Directly from Personal Income
When it comes to Limited Partnership any business expenditure that is incurred can be directly debited from the personal income of the partner (owner of the business). There are several costs associated with running a business and in Limited Partnerships, those costs are broken up into shares based on the partnership structure or may be able to be taken in full if one member takes responsibility for the costs for everything.
5. Easy Means of Exiting the Business
When compared to other investment opportunities, limited partners can quickly exit a business if the need arises. So also, limited partners can easily be replaced with other partners at any given time as long as the general partners have given their permission for this to happen or have refused to purchase the limited partnership stake. This means exit issues that venture capitalists see in other businesses don’t exist in this structure of business.
6. Limited Partners are Immune from High Levels of Liability
Another advantage of owning a limited partnership business is that as long as a limited partner stays passive in their involvement with a business opportunity, they are protected by the limited liability clauses that are in the law today. This status is subjected to change if the limited partner makes any effort to materially participate in any way. If that doesn’t happen, then creditors can only pursue a limited partner for the amount of their investment only.
As expected, a good percentage of limited partnerships aren’t going to become as profitable as a publicly traded company, but that does not in any way mean the partnership can’t scale up to size to provide huge profits to every partner involved. Having a fantastic idea is no doubt very important when you are talking about business scalability.
In addition to that, you are expected to have each general partner fulfill their responsibilities, and also have limited partners remain passive at all costs. As a matter of fact, no matter how bad the business situation is, the business structure can be changed so that if a company needs to continue growing, it will be able to do so.
The Cons of Owning a Limited Partnership
Here are some of the cons of having a Limited Partnership business;
a. Limited Partner is Limited in Key Decision Making
A major drawback with limited partnership business is that the limited partners doesn’t have much say in regular business matters or large decisions. As a matter of fact, if the limited partner participates too much in the day-to-day running of the business, he or she could lose that limited partner status and become a general partner.
b. Profits are Treated as Personal Income
Another drawback with Limited Partnership is that every managing partner in a limited partnership is taxed on their personal income returns at the end of the tax year. This means that the taxes are considered to be pass-through, but that means needing to pay the self-employment tax in addition to regular income taxes.
Business taxes aren’t imposed to the business itself and the limited partner only pays taxes on any profits that are distributed to them as they would with any other investment income.
c. In a Limited Partnership, General Partners are Personally Liable for Business Debts
Another major con is that in a Limited Partnership, General Partners are personally liable for business debts. This is actually considered a double disadvantage. Managing members of a limited partnership are personally responsible for any debts that their business creates.
This means their personal assets can be ordered to be used to pay for outstanding business debts, just as a sole proprietorship. The second issue here is that partners are also personally responsible for the debts created by one another.
d. Difficulty in Raising Money for Expansion
When it comes to business expansion or leveraging on opportunities to grow businesses, business owners usually attract investors for the purpose of raising money. In this regard, it is very difficult with a Limited Partnership.
Usually, investors coming into a limited partnership automatically assume a share of the debt if they become a general partner and that’s not something most investors are going to do if they want to have any control over how the business is operated. The only hope here is to sell more equity to another passive investor.
e. Require a Certain Level of State Registration
Unlike a general partnership, limited partnerships still typically require a certain level of state registration. This is because this structure requires one general partner and one limited partner in order to exist. This means the one limited partner is more of a passive investor while the general partner gets to take advantage of all the benefits of being in the structure. For the limited partner, it’s a lot like owning stocks or bonds.
f. Limited Partners Have No Voting Power
When it comes to Limited Partnership, limited partners do not have voting powers. As a matter of fact, the only thing that limited partners typically receive for their investment into a partnership is a dividend payment that is based on the profits received.
This means they don’t have to pay self-employment taxes on money that is received, but they may have to pay a capital gains tax on any earnings. This is the price to be paid for not having their personal assets be placed at risk assuming they stay out of the day-to-day operations of the business.