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Choosing your legal structure is one of the first things you’ll do as a new small-business owner. Among the different types of business structures, a limited partnership is an option that gives you a way to raise money from a close group of investors, but is usually a good choice in only a few circumstances.
Overview of limited partnerships
The definition of a limited partnership is a business with more than one owner, including at least one general partner and at least one limited partner. The general partner is in charge, making business decisions and taking personal responsibility for the business’s debts and lawsuits. Limited partners are simply investors in the business; they don’t have control of day-to-day operations, and they’re only liable for as much as they invest in the company. If limited partners do take on an active role in running the business, they can lose their limited liability and can be held fully responsible for the business’s debts and lawsuits, much like the general partner.
Note: Don’t confuse limited partnerships with limited liability partnerships (LLPs); they’re two different business structures.
Unlike general partnerships and LLPs, limited partnerships aren’t typically used to structure actively run businesses. Instead, they’re often used in family estate planning and as investment vehicles, particularly in the commercial real estate and film industries. When used for raising investments, the limited partners function much like stockholders investing in a public company, only standing to lose the money they invest. They’re considered passive investors because they contribute money to the partnership but don’t have control over decisions.
Limited partnerships, by definition, are also more complicated to set up than general partnerships, which form automatically when two partners go into business together. To form a limited partnership, you have to register in your state, pay a filing fee and create a limited partnership agreement, which defines how much ownership each limited partner has in your company, and other terms of the partnership.
You can consider forming a limited partnership if you’re starting a business on your own and have friends or family members interested in investing money but not in helping you run the business. You should consider a different structure, such as an LLP, limited liability company (LLC), or corporation, if you’re not looking to raise investments, or you want to run your business with a partner who has equal control of the company.
Advantages of limited partnerships
They’re a good way to raise investments. A limited partnership is one way to raise startup or expansion capital for your business. As the general partner, you can gather investments from family members and friends but still maintain full control of the company.
Disadvantages of limited partnerships
General partners have complete liability. As with sole proprietorships and general partnerships, as a general partner you assume full responsibility for the business’s debts and lawsuits. For example, if your business gets sued, your personal assets, including your home and car, are at stake.
They’re not conducive to actually running a businesses. Limited partnerships are structured well for raising investments, especially in the real estate industry. However, they’re not well suited for running an active business, as the limited partners aren’t allowed to participate in running or managing the business. In most cases, if you’re looking to open a business, it will make more sense to form an LLP, an LLC or a corporation.
Limited partnership interests are considered securities. Since limited partners are passive investors in the partnership, their shares are considered securities and are subject to securities regulation by the federal and state government.
Should you form a limited partnership?
Consider forming a limited partnership if you want to raise capital for your business from a small group of investors, especially family, friends or people in your community. You’ll be able to maintain full control of the business while gathering capital from passive investors who have limited liability.
For most businesses, a limited partnership isn’t the best option because the general partners have a large amount of personal liability and limited partners can’t participate in running the company. Instead, consider forming an LLP, an LLC or a corporation.
Don’t form a limited partnership if:
There are multiple owners who all want to have control of business decisions. A limited partnership needs at least one limited partner who is OK with investing in the company but not managing the business.
You don’t need to raise capital. Limited partnerships are most useful when it comes to raising investments. If you have a business loan or can operate without an outside source of funding, there’s no need to form a limited partnership.
How to form a limited partnership
If you decide to form a limited partnership, talk with an attorney and accountant before you spend money and time setting it up. Even if you’ve done your research, these professionals can provide advice that’s specific to your business, and either affirm that you’re making the right decision or suggest a different business structure that could be more beneficial for you.
Registering a limited partnership differs by state, but typically you’ll do the following:
Decide what state to register in. The requirements for forming a limited partnership vary by state, and some states offer more advantages than others. Find information about specific state filing requirements on the Register With State Agencies page of the U.S. Small Business Administration website. You can also consult an attorney to get more information about what state is best for your business based on state business laws and tax codes.
Register with the state you choose. To form a limited partnership, you must file with your state agency, usually the secretary of state’s office, and pay a filing fee, which varies by state. For example, in Delaware, one of the most common states in which to incorporate a business, it costs $200 to file for a certificate of limited partnership. Your application will ask for the name of your business, and many states require the name to include the terms “limited partnership” or “LP.”
Create a limited partnership agreement. A limited partnership agreement is a legal document that outlines your role as the general partner and the roles of the limited partners. The agreement should describe how profits and losses will be divided among partners, how partners can leave the partnership and how the partnership can be dissolved. You can consult an attorney to help you create this agreement, or you can write one yourself using an online template.
Get the proper licenses and permits for your business. If you’re using a limited partnership as a business structure, you’ll need certain licenses and permits to legally operate, depending on your state, locality and industry. Use the SBA Business Licenses and Permits search tool to find links to the relevant paperwork you’ll need.
File income taxes as a limited partnership
As with general partnerships, your limited partnership doesn’t file income taxes at the business level. Taxes “pass through” the business to you and the other general and limited partners. Your limited partnership still has to file an annual information return (Form 1065) to report its income, deductions, gains and losses to the IRS.
Your partnership also must file a Schedule K-1 for each of the general and limited partners to document how much of the business’s income and losses each partner is responsible for. You and the other partners must include your portions of the partnership’s gains and losses on your individual tax returns.
Top states for limited partnerships
The costs and requirements of registering a limited partnership differ by state. Home state incorporation is when you form a limited partnership in the state your business operates in. However, you might benefit by setting up your limited partnership in a state other than the one you operate in. If you do this, you must file for foreign qualification to legally operate in your state.
Delaware and Nevada are generally considered the most advantageous states in which to incorporate due to their business-friendly laws and tax codes. However, it can be helpful to consult an accountant or attorney to help you decide the state that’s best for your business.
If you decide a limited partnership is the right structure for your business, the next step is to register your business with your state and begin drafting your limited partnership agreement.
If you’re still hesitant about how to structure your business, read about your other options, including sole proprietorship, general partnership, LLP, LLC and corporation. It’s also a good idea to talk to an attorney, accountant or a financial advisor to double-check that the structure you choose is the best option for your business.
Learn how to start your business
NerdWallet has rounded up some of our best information on starting a business, including structuring and naming your company, creating a solid plan and much more. We’ll help you do your homework and get started on the right foot.