For many new businesses, a partnership is a great starting point. A partnership allows entrepreneurs to join forces to make their business succeed and give each other moral support.
But choosing a partnership begs the question: what type of partnership? In some states, there are as many as five different types of partnerships. Two common options offered across the board are limited partnerships and general partnerships.
What is the difference between a limited partnership (LP) and a general partnership? This guide has you covered. We’ll discuss the three basic differences between these partnerships so you can choose the one that’s right for you.
Differences Between the Limited Partnership and General Partnership
1) Management Roles of Each Partner
Each partner in a partnership has certain roles and responsibilities to fulfill. After all, that’s what makes a partnership work. But those roles aren’t the same in every partnership. In fact, management roles are actually one of the primary distinctions between a limited partnership and a general partnership.
In a general partnership, every partner has the same rights to manage the business. This includes signing contracts, getting loans, hiring staff, and more. Of course, each partner may have areas of expertise, but when it comes to management, each partner has the same rights and responsibilities.
In a limited partnership, the management structure differs. There are actually two types of partners in this business type: limited partners and general partners. Only the general partners have the right to “manage” the business, while the limited partners act more like investors. They provide capital to get the partnership started, but they don’t make management decisions.
2) Personal Liability Protection
A big factor in picking a business type is whether or not the business has limited liability protection. If a business has personal asset protection ― or in other words, if it limits the owners’ liability ― then the personal assets of an owner cannot be taken to pay for a settlement when the business defaults on a debt, or in the case of a lawsuit.
General partnerships do not have this liability protection. If something goes wrong and the business needs to pay a legal settlement or debt, it’s possible that the partnership’s business funds won’t be enough to cover it. If that happens, the personal assets of each partner can be seized as payment.
For instance, let’s say that one partner signs a contract and it ends badly. If the partner that entered into the deal goes bankrupt, then the other partner will have to pay for the damages, even if they didn’t know about the contract to begin with.
A limited partnership, however, does things a little differently. That’s because limited partners don’t make decisions in the management of the business.
In return for this hands-off approach, the limited partners have minimal liability in the business ― in fact, they’re only liable for the amount they invested in the business. General partners, however, do make decisions in the business, so they take on the liability for those decisions.
3) Formalities and Requirements to Form the Partnership
The process to form any partnership is relatively straightforward, but there are some significant differences between setting up a general partnership and a limited partnership, and the same applies for what rules and regulations the business has to follow after forming.
A general partnership is extremely informal, as there are very few requirements to set one up. In fact, there is no formation process for a general partnership ― you don’t even need to file any documents with your state government.
All that’s typically required is obtaining any licenses required for your specific industry, which not all general partnerships even need. That’s why many partnerships can simply start working without completing any paperwork with the state.
Limited partnerships have a few more hoops to jump through, starting with a formal formation process. To form an LP, you will need to file a certificate of limited partnership, which outlines some key attributes of your business, like the identities of the limited and general partner(s), and the name and address of your registered agent (which can be a person or service).
What Types of Businesses Form These Partnerships?
The limited partnership is rather popular in a number of industries, as the uneven split between limited partners and general partners can be advantageous for a variety of businesses. Still, we can make some generalities about who typically uses an LP.
The most popular form of limited partnership actually has its own name: the real estate limited partnership, or RELP. Why do real estate businesses prefer this structure? Primarily, this is due to the fact that the limited partnership allows for well-established property managers or development firms to take on the role of the general partner, while investors make financial contributions to the business as limited partners.
Some other situations where you might see an LP are law firms, accounting businesses, and financial management/investment firms, for much the same reason as you’ll see LPs formed for real estate purposes.
Additionally, family-owned businesses are quite common for this business type, as you’ll sometimes come across the term “family limited partnership” or FLP. This is thanks to the limited partnership’s ability to alleviate gift and estate tax burdens. If you form an FLP with relatives, you’re able to pass your assets down to the next generation by taking advantage of the LP’s gift tax exemptions.
As for general partnerships, there aren’t too many good reasons to use this business structure, unless you operate a business with extremely minimal liability risk, or if your business isn’t a very serious endeavor.
For example, if two teenagers want to start a lawn mowing business in their neighborhood, that would be an instance where a general partnership might make some sense.
It’s tempting to think that all partnerships function similarly, but as we’ve seen, limited partnerships and general partnerships have a few nuances that make them unique.
We hope this guide has helped you better understand which partnership type is right for you.