When applied to specific business scenarios, limited partnerships have a number of benefits and drawbacks that all prospective parties should consider. While the largest advantage of a limited partnership for limited partners is limited personal liability for the debts of the business, one main disadvantage for limited partners is that they may lose their investments in the business if it does not succeed. Before making a final decision about their exact role in a business partnership, prospective partners should carefully weigh the following limited partnership advantages and disadvantages:
| Advantages of Limited Partnership | Disadvantages of Limited Partnership |
|---|---|
| Limited partners are only responsible for (up to) the amount of money that was invested into the business. | Limited partners must follow specific and strict rules in regards to their involvement in the business, otherwise risk losing their limited liability and investments. |
| Limited partners have protected investments, meaning that they cannot lose more money than they contributed to the project. | Limited partnership are typically only used in short-term projects and special situations, meaning that they do not function the best for a true, full-time business in all scenarios. |
| Limited partners can still earn as much money off of a business as a general partner because all partners share both expenses and profits. | Limited partners do not directly participate in everyday operations and therefore cannot be held fully liable, unless they begin to take an active role in general responsibilities. |
| General partners can use their expertise in a subject or field to run a business while limited partners solely contribute funds to make the business possible. | Limited partnerships require more strict filing formalities since more people are generally involved, though not all co-owners are responsible for everyday operations. |
| Limited partnerships are usually only taxed once because they are legally considered a pass-through entity. Limited partners do not need to file a self-employment tax. | Ownership can be more difficult to transfer between partners, should something happen to a general partner. |
| Limited partnerships support a less formal business structure. | Limited partnerships are not as flexible as general partnerships in terms of changing or assigning different management roles. |
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Limited partnerships can be found in many business settings, as long as more than two participating parties are involved. One of the most popular limited partnership examples can be applied to a family business venture. For example, Maria, Carla, and Sergio are partners in owning Maria's Italian Kitchen. Carla and Sergio were solely responsible for contributing $50,000 to start the business while Maria continued running the everyday operations. Maria would be considered a general partner, while Carla and Sergio are limited partners in the business.
Suppose a large Italian restaurant chain opened next door and Maria's Italian Kitchen lost business. In that case, Maria would still owe the $200,000 in rent, but neither Carla nor Sergio would be held liable for paying more than $50,000 that they invested to collectors. Maria could be held personally liable for the full $200,000 as a general manager, but if her limited partners contribute their liable amount, then she would only be liable to pay the difference ($100,000). If Maria's Italian Kitchen becomes a profitable business, Carla and Sergio would also be entitled to a share of the profits. For instance, if the three owners agreed to share their profits equally and the restaurant made $300,000 in a year, each partner would receive $100,000 in profit. However, if it did not do well financially, Carla and Sergio risk losing their investments.
At any time, Carla or Sergio could begin to take a more active role in the partnership and eventually be considered general partners by a building manager or other legal party. For example, suppose Carla became responsible for writing rent payment checks and calling the building manager when a piece of kitchen equipment breaks. In that case, a building manager may be able to legally hold Carla liable for late payments or other actions just as a general partner would be treated, regardless of his contributed amount. Consequently, this means that Carla may have to pay more than she originally contributed.
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Limited partnerships are a viable and often beneficial way for all participating partners to become involved in a business in some capacity while still earning a profit. A limited partnership is usually formed by a general partner who wishes to retain full control of the business while simultaneously bringing in an investor who only takes a share of the income. In essence, a general partner is an expert who will run the complex operations of the business, while limited partners are simply investors who help the business get started. Limited partners are not stockholders in the business, and therefore they do not receive dividends on their investments.
The most common uses for a limited partnership include hedge funds and investment partnerships, where a general partner has the ability to earn additional profit through investments (and investors) without losing control of their business. Limited partners most often join a limited partnership to gain a profit rather than become a fully liable general partner.
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A business partnership is a for-profit business that has been created and is run by two or more owners. The owners are either general partners, who handle everyday operations such as handling real estate transactions, or limited partners who solely invest their own money into the business and have little involvement in running the venture. There are a few types of business partnerships, including general partnerships, limited liability partnerships, and limited partnerships. In a general partnership, all owners are equally responsible for running the business and can be held liable for any mistakes or omissions made by another partner. Limited liability partnerships are run similarly (where all partners share ownership and responsibility for debts), but each partner cannot be held liable for the negligent actions of another partner.
Limited partnerships are made up of two or more partners, where at least one is a general partner, and one is a limited partner (sole investor). Limited partners cannot be held liable for more than the amount of money they contributed to the business, versus general managers who are liable to pay the full amount of debts that a business may incur. Limited partners also cannot lose more money than they contributed to the project. For instance, if a limited partner contributed $500,000 to a business and the business now owed $800,000 in debts, then the limited partner would not be liable to pay more than $500,000 (while a general partner would be liable for the full $800,000 debt). If a limited partner becomes more involved in everyday operations, such as making a transaction on behalf of a general partner, then they can be considered a general partner as well and consequently be liable to pay the full $800,000 debt just as a general partner would be required.
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Video Transcript
Limited Partnership
Partnership is the most common type of business structure for businesses with more than one owner. A business partnership is a for-profit business established and run by two or more individuals. There can be any number of partners involved in the business, as long as there are at least two. The partners serve as co-owners of the business.
Most business partnerships are general partnerships. A general partnership is a partnership where all partners have responsibility for the business and unlimited liability for business debts. General partners share the benefits and the obligations of the business. This means that a general partner can be held personally liable for the partnership's debts.
However, there are other types of partnerships where at least one owner isn't burdened with full personal liability for the business' debts. One of these is known as limited partnership. A limited partnership is a business partnership where at least one owner is a general partner and at least one owner is a limited partner. The general partners make everyday business decisions and are personally liable for business debts. However, the limited partners simply invest in the business and have little control over business operations.
For example, let's say that Ben, Bob and Brandi are partners in owning and running a bookstore. They own The Book Nook. Per their partnership agreement, Ben and Bob are limited partners. They are investors in the store. They each gave $50,000 to establish the store. Brandi is a book expert, so she runs the store. Brandi is a general partner. Note that all the partners will be considered general partners unless there's a written agreement between the partners stating otherwise.
Advantages of Limited Partnerships
Limited partnerships, like The Book Nook, hold several advantages, especially for limited partners, like Ben and Bob. The main advantage for limited partners is that their personal liability for business debts is limited. A limited partner can only be held personally responsible up to the amount he or she invested. Limited partners enjoy a protected investment, knowing they cannot lose more money than they've contributed.
For example, let's say a book superstore opens right next door to The Book Nook. As a result, The Book Nook loses customers to the new store. Brandi is several months behind in paying the store's rent and hasn't paid the bills for the last two shipments of books. In total, The Book Nook owes its creditors $200,000, and the creditors have filed lawsuits in an effort to collect.
The creditors can seek payment from any or all partners, though the creditors cannot collect more than they are owed. Remember that Ben and Bob are limited partners. As such, neither can be held personally responsible for an amount more than he invested. This means that Ben can be held personally liable for no more than $50,000, and Bob can be held personally liable for no more than $50,000.
On the other hand, Brandi is a general partner. Her personal liability for business debts is unlimited. Brandi can be held personally liable for the entire $200,000, or if the creditors already collected from Ben and Bob, she'll be held personally liable for the remaining $100,000.
Another advantage for limited partners is that they can still make as much money off the business as general partners. All partners share everyday business expenses but also share the business profits. For example, let's say that Ben, Bob and Brandi agree to share their business profits equally. If The Book Nook makes $300,000 net profit, then each partner will be awarded $100,000.
Disadvantages of Limited Partnerships
Now let's take a look at some of the disadvantages of limited partnerships. The main disadvantage is that limited partners risk losing their investments. If the store simply doesn't make money or if the store has debt obligations, Ben and Bob might lose their $50,000 contributions.
Another disadvantage is that limited partners must follow strict rules regarding their involvement in the business or risk losing their limited liability. Remember that limited partners don't actively participate in business operations. However, if a limited partner starts taking an active role in everyday business and a creditor reasonably believes that partner to be a general partner, then that partner can be held personally responsible for the amount owed that creditor.
For example, let's say that Ben rented the space for The Book Nook. Ben signed the lease and always writes the checks for the rent. Whenever there's an issue, Ben's the one who contacts the building manager.
When The Book Nook slips behind on rent payments, the building manager sues The Book Nook and Ben, believing Ben to be a general partner. Ben won't be allowed to escape personal liability by claiming to be a limited partner. Ben can be held personally responsible for the delinquent rent payments even if those payments exceed his investment.
Lesson Summary
Let's review. While the most common type of business partnership is a general partnership, there are other types of partnership that limit a partner's personal liability. One of these is called limited partnership. It's a business partnership where at least one owner is a general partner and at least one owner is a limited partner.
The general partners make everyday business decisions and are personally liable for business debts. However, the limited partners simply invest in the business and have little control over business operations.
Learning Outcomes
After this lesson, you should have the ability to:
- Describe what a limited partnership is
- Differentiate between the roles and responsibilities of the general partner and that of the limited partner
- Describe the advantages and disadvantages of a limited partnership
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