Are you thinking about investing in a friend’s business? Want to raise funds from investors without the hassle of founding a corporation? Then it would be best if you thought about forming a limited partnership.
In this guide, we’ll explain what a limited partnership is, whether it’s the correct business entity type for your company, and how to set one up.
what exactly is a limited partnership?
A limited partnership is an unincorporated business with both general and limited partners.
General partners manage and are liable for debts, while limited partners offer capital without day-to-day involvement and enjoy limited liability protection.
A limited partnership is an unincorporated business with at least one general partner and one limited partner (sometimes known as a silent partner).
General partners share in the partnership’s revenues and losses, are involved in day-to-day management, and are personally liable for the partnership’s debts.
Limited partners, on the other hand, typically do not participate in the day-to-day operation of a business and instead just provide money. They also have what is known as limited liability.
what is limited liability?
Limited liability protects partners from being personally responsible for others’ mistakes in a partnership. If a general partnership goes bankrupt, creditors can seize assets. Limited partnerships safeguard investors by limiting liability to their initial investment.
One of the most significant hazards of engaging in a business partnership is that sometimes things may not work out, and you may be liable for someone else’s mistakes.
If you form a general partnership with someone and it goes bankrupt, creditors can seize your assets, even though the debt is not your fault.
letting limited partners invest in a business while limiting their liability to the amount of their initial investment helps to avoid this issue.
For example, suppose you invest $10,000 to become a limited partner in your friend David’s new pizzeria. If the pizzeria ever goes bankrupt, creditors can only pursue the initial $10,000 investment. The rest of your valuables are safe.
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how can I establish a limited partnership?
In order to establish a Limited Partnership, you need to follow these steps
step 1:
choose a state to register in.
Have you ever wondered why so many businesses choose to incorporate in Delaware? It is primarily due to the state’s flexible business formation legislation and generally business-friendly climate.
Read up on your state’s partnership requirements, compare tax rates across state lines, check the overall trend in your business, read up on the pros of filing in Delaware, and, most importantly, consult with a lawyer to identify the best fit for you.
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step 2:
choose a name that isn’t already in use
Select an exclusive name for your limited partnership by checking state registries and conducting a Google search to avoid duplicates and prohibited words, especially if operating across state lines.
You must choose a name for your limited partnership that is not already in use by another business in the state in which you are filing. Check the state’s company registry to see if the name you’re contemplating is already in use (here’s Delaware’s registry, and here’s California’s).
Run a Google search as well, especially if you plan to conduct any business out of state. Make sure it doesn’t contain any words that your state forbids (for instance, the word “insurance” is illegal in a number of places).
step 3:
create a partnership contract.
A partnership agreement, sometimes called an operating agreement, is similar to a corporation’s bylaws.
A partnership agreement should, at the very least, state the following:
- The partnership’s name
- How will your partnership’s revenues be distributed?
- How will its losses be distributed?
- What happens if someone wishes to sell their partnership stake?
A well-written partnership agreement should also include the following provisions:
- The type of your company
- The duration of the partnership (if it has an expiration date).
- The kind of partners it will have (more on this below)
- The capital, time, and resources that each partner is expected to provide
- Guidelines for what happens when the partnership must be dissolved
- How should differences be resolved?
The helpful partnership agreement generator from LawDepot should give you an idea of what goes into a regular partnership agreement.
As tempting as it may be to draft one yourself, never sign a partnership agreement without first having it reviewed by a lawyer.
A lawyer can assist you in crafting an agreement that meets the specific demands of your business, anticipates any future problems, and saves you a lot of grief if one of the partners decides to sue each other.
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step 4:
register with the secretary of state in your state.
In most situations, your partnership agreement must be filed with the Secretary of State. The location of where you file will differ by state, so check your state government’s website for details on where to file and any fees you may be required to pay.
what distinguishes limited partnerships from other types of partnerships?
Limited partnerships are distinct from the other three commercial forms that can be formed with many partners: corporations, general partnerships, and limited liability partnerships.
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corporations
A corporation is another type of corporate entity that can be formed with numerous persons, and no one is personally liable for the company’s debts.
partnerships in general
A general partnership is one in which each partner is a general partner, has equal management rights, and is equally accountable for the partnership’s debts.
A general partnership can be formed with a simple verbal agreement. General partnerships are the least expensive, fastest, and easiest entity type to form.
partnerships with limited liability
Limited liability partnerships (LLPs) must have at least one limited liability partner who functions similarly to a limited partner but also engages in the day-to-day management of the business.
what motivates people to form limited partnerships?
1.They Make it Easy to Raise Funds.
As a limited partner, you can invest money in a firm without risking any of your assets. This can appeal to friends and family members who want to invest in your company but don’t want to risk more than their initial investment.
2.Self-Employment Tax is not Something you Have to Pay.
General partners have to pay self-employment tax, but limited partners don’t have to because they get payments that are like dividends in exchange for their investment in the business.
helpful resource: business entities understanding tax implications
what are the disadvantages of establishing a limited partnership?
There are many reasons why you might want to think about forming a general partnership or a corporation rather than a limited partnership:
1.Limited partnerships are more complex to set up than general partnerships.
The laws for founding limited partnerships differ significantly by state and must be clarified. In some states, you need a partnership agreement, a state ID number, a Certificate of Limited Partnership, and workers’ compensation insurance to start a limited partnership. Some states do not require any of these requirements.
Look up your state and industry on the U.S. Small Business Administration website here to find out what licenses and permissions you need to form a limited partnership.
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2.If You’re a General Partner, You’re Still on the Hook.
In a limited partnership, a general partner doesn’t have limited liability. If you have problems with your creditors, they can still seize your LP’s assets.
3.You can Lose your Limited Partner Status.
If a limited partner begins to play an active role in a limited partnership, which might happen if they ever disagree with how the general partner is operating the business, they risk losing their limited status and being held liable for the business’s liabilities in the same way that a general partner is.
