What is a limited part­ner­ship?

If two (or more) people want to set up their own business and open a company together, the first thing they need to agree on is what legal form to choose. Since a limited part­ner­ship is usually easier to set up than a cor­po­ra­tion, the part­ner­ship is usually the preferred choice, since it doesn’t require a minimum capital con­tri­bu­tion or any fixed capital holdings.

However, as they say, there is no such thing as the perfect legal structure. Each one has its own ad­van­tages and dis­ad­van­tages. So what makes the limited part­ner­ship stand out, and what do you need to know about it? What are its ad­van­tages and dis­ad­van­tages? Here, we will outline the answers for you.

The limited partner con­tributes a certain amount of money, known as a limited partner con­tri­bu­tion, from their own funds when the company is founded. The amount of this con­tri­bu­tion is not regulated by law and can be de­ter­mined in­di­vid­u­al­ly, in con­sul­ta­tion with the other partners. In the event of in­sol­ven­cy, the limited partner is only liable to the extent of the con­tri­bu­tion they made, so their private assets remain untouched. This means that the limited partner is legally limited in their liability. The pre­req­ui­site for this, however, is that the con­tri­bu­tion (which can consist of both money and material assets) has already been made in full by this time.

This is the dif­fer­ence between how a limited part­ner­ship functions, versus a general part­ner­ship in which the partners are per­son­al­ly liable to the creditors for the company’s li­a­bil­i­ties as joint debtors. For more in­for­ma­tion on legal de­f­i­n­i­tions of limited part­ner­ships, please visit the Cornell website.

Aside from a limited partner, a limited part­ner­ship must also have a general partner within the company. They are, however, fully liable to creditors i.e. with the entire assets of the company and, in an emergency, their private assets. Both a natural person and a legal entity can enter a limited part­ner­ship as a general partner – for example, a limited liability company (LLC) so that the original limited part­ner­ship becomes an LLC & Co.

Sub­se­quent­ly, general partners bear a much higher risk when setting up a limited part­ner­ship, but in return they have the right to manage the company on their own – in other words, they represent the company in­ter­nal­ly and ex­ter­nal­ly. A limited partner is typically excluded from managing the company, but can be granted a power of attorney or procu­ra­tion. These must be recorded as a deviation in the articles of as­so­ci­a­tion.

However, in 2001 the Revised Uniform Limited Part­ner­ship Act in Section 303 stated that the limited partner may exercise control over entity oblig­a­tions and increase their personal liability. This places them on a par with general partners. However, not all states have adopted this federal leg­is­la­tion, so it is important to check with the state gov­ern­ment where you are running your business to ensure that your company is legally wa­ter­tight.

A limited part­ner­ship offers share­hold­ers numerous ad­van­tages and is par­tic­u­lar­ly suitable for a family business. However, anyone wishing to become a general partner in a limited part­ner­ship should be aware of their re­spon­si­bil­i­ties and consider the decision carefully. The following example il­lus­trates the con­se­quences of an ill-con­sid­ered decision:

Jenny Smith has always dreamed of being her own boss. After careful con­sid­er­a­tion, she decides to go into business for herself by selling in­no­v­a­tive office furniture. Tables that can be folded out and adjusted in height, office chairs with in­te­grat­ed massage functions, and lamps that adjust their light intensity according to natural light present – these are her planned best­sellers.

Her sister Annie and brother Alex are en­thu­si­as­tic about the business idea and want to be part of it, con­tribut­ing a con­sid­er­able amount of money. Since Alex’s former classmate founded a limited part­ner­ship several years ago, Alex knows about the ad­van­tages of this legal structure and is able to convince Jenny to start a limited part­ner­ship. For Jenny Smith, it was clear from the outset that she wanted to run the company, so, as a general partner, she con­tributed around $30,000 to the “Smart Office” company. Her siblings Annie and Alex each have a role as limited partners, con­tribut­ing $10,000, which they register as a liability sum.

Business has been good for about a year, and all the share­hold­ers are satisfied with their profits and re­spon­si­bil­i­ties. However, in their third financial year, numerous com­peti­tors appear in the market, offering sig­nif­i­cant­ly lower prices and con­sis­tent quality. “Smart Office” becomes insolvent and must pay debts to the value of $100,000. However, in addition to the existing limited part­ner­ship capital ($30,000 from Jenny Smith and $10,000 from each of her siblings) is not enough.

Annie and Alex each lose $10,000, thus ful­fill­ing their oblig­a­tion as limited partners of the limited part­ner­ship – their private assets remain untouched. However, Jenny Smith is a general partner and must pay the remaining $50,000 herself. It doesn’t matter whether or not she has suf­fi­cient financial means. Her car, house, apartment (i.e. her property) must also be used for repayment.

It would be useless to dissolve the limited part­ner­ship in this instance, since after the dis­so­lu­tion Jenny Smith still has to settle the debts using her personal assets. Anyone who wants to start a limited part­ner­ship with a general partner role should be aware of this risk and re­spon­si­bil­i­ty. Jenny Smith could have reduced her liability risk if she had started a limited liability cor­po­ra­tion as a general partner. You can read more about this in our article on founding a limited part­ner­ship: liability, costs, and more.

Click here for important legal dis­claimers.