When two or more people join together to operate a business, they often choose a limited partnership as their legal structure. While it is fairly simple process to start a limited partnership, provisions regarding liability can sometimes pose major challenges to shareholders. Whoever enters into a limited partnership doesn’t just take over a part of the management duties, they also become...
The limited partnership is a very flexible legal form when it comes to financing, liability, and profit distribution, leaving a lot of room to maneuver for the partners. For example, in principle there are often regulations that define the distribution of profits and losses at the end of the financial year. General and limited partners can also make their own individual agreements in the articles of association, whereby they specifically state their share of any turnover surpluses and/or losses. What is the point of a specific agreement on profit distribution in a limited partnership? And which guidelines apply if no agreements have been made in the articles of association regarding profit distribution?
Profit distribution in a limited partnership made simple
Many states in the USA have legislation in place to regulate the sharing of profits and losses in a limited partnership. Many of these state laws are based off the Uniform Limited Partnership Act (ULPA), which includes its 1976 revision called the Revised Uniform Limited Partnership Act (RULPA), a federal law that aims to regulate limited partnerships. However, states are not obliged to adopt this legislation, and instead, many choose to draft their own laws pertaining to limited partnerships. This is particularly relevant when it comes to profit distribution within a limited partnership. Limited partnerships are encouraged to draw up their own agreements on profit distribution in a partnership agreement when the company is formed. If they fail to do so, and a dispute is brought before a judge, the judge will simply refer to their state partnership legislation and that will dictate the outcome of your disagreement. For example, in New York, the NY Pship L § 121-503 (2016) states that in the absence of a partnership agreement, profits and losses will be allocated on the basis of each partner’s value, which is based on the value of each partner’s contribution. However, it is up to you to make sure you are familiar with your state’s partnership legislation so that you can avoid legal pitfalls.
This drives home how important it is to prepare a partnership agreement so that you are legally protected from your business partners. Always consult with a legal professional to ensure that any contracts you enter or disregard will not land you in legal trouble down the road.
Why is it important to outline limited partnership profit distribution in a partnership agreement?
If you want to circumvent your state regulations concerning profit distribution, drawing up a partnership agreement is necessary. This kind of contract is particularly advantageous if there are major differences between the individual shareholders with regards to financial participation and involvement in the business process.
Liability also plays a crucial role here: a contractually agreed upon profit distribution method can also take the risks that partners hold into consideration. On the one hand, it comes down to financial participation, since the higher the limited partner’s capital contribution, the higher their liability sum is as a rule. On the other hand, the individually negotiated distribution of profits can grant the completely liable general partners a higher share of the profits.
Your limited partnership agreement does not require any formalities in principle – you therefore have complete freedom to define individual profit and loss sharing. If in doubt, however, you should definitely seek legal advice in order to ensure that annual profit distribution is being regulated to the satisfaction of all shareholders involved.