There are a lot of decisions you’ll make when starting a business. One of the first is deciding on the structure of the business. There are general partnerships, limited liability corporations, sole proprietorships, corporations, limited partnerships, and more. Whichever structure you choose will have long lasting legal and tax consequences, so it’s really important to get it right.
Partnerships, in general, are the simplest business structures when two or more people are involved in a business. Limited partnerships have at least one general partner with unlimited liability. All other partners have limited liability. The partners with limited liability usually also have limited control over the company.
A general partnership is not a limited partnership
Most business partnerships are general partnerships. In a general partnership, all partners contribute to the daily management of the business, and each partner has the authority to make business decisions and sign legally binding contracts for the company.
Usually, all of the contributions, liabilities, and responsibilities of the partners are equally divided unless otherwise stated in the partnership agreement.
What is a limited partnership
While similar to a general partnership (GP), a limited partnership (LP) has some distinct differences.
A limited partnership contains at least one general partner and at least one limited partner. Sometimes called “silent partners,” limited partners provide capital, but unlike in a general partnership, they can’t participate in business-related decisions. They also lack management control and the right to property that’s provided to general partners. As such, their liability is limited to the extent of their investment in the business.
Partnership businesses don’t pay federal income tax. Instead, all losses, credits, deductions, and income is passed through to the partners who then report and pay taxes on the companies assets as part of their personal income taxes.
In the same way, limited partners also avoid “double taxation.” LPs are not taxed at the business or corporate level and taxes are instead “passed through” and reported on the partners’ personal tax returns. The tax benefits and liability protection of LPs make them an enticing option for potential investors.
Pros and cons of a limited partnership
As with most business structures, there are pros and cons of a limited partnership. The advantages of a limited partnership include:
- A limited partner is only liable for the amount of money or property the partner contributed to the partnership.
- In a limited partnership, profits and losses flow through the business to the partners. All partners are taxed on their personal income tax returns.
- Limited partners get to share in the profits and losses of a business, but they don’t have to take part in the daily operations of the business.
- Creating a limited partnership often requires a lot less paperwork than forming a corporation.
- A limited partnership can include two or more people, so one can leave or be replaced without dissolving the partnership.
- The general partner(s) personal assets are unprotected in a limited partnership
- The general partner in a limited partnership bears maximum risk if the business is sued or goes bankrupt
- In a limited partnership, the general partner(s) carries the burden of all debts and obligations
- Limited partners have very little say in the decision-making process
If you’ve decided to start a limited partnership. There are some steps you need to take. Let’s take a look at how to get started.
Picking a name for your limited partnership
As limited partners in a limited partnership have little say in most business decisions, picking a name for the partnership falls squarely on the shoulders of the general partner(s). Although the process can take time, choosing the right name for your business can make your company the talk of the town. You’ll want to consider a name that’s marketable and identifies your brand, plus what you do or what products you sell. But, there are also things to consider to protect your name and your business identity.
When picking a name for a limited partnership, many businesses will either use the names of the partners (e.g., Brown, Jones, and Davis), or a business name (e.g., Gatello Coffee Brewers). But, generally, you can name your company whatever you like.
Keep in mind that some professions, like law, may require the partnership to include the names of the partners, and partnership names cannot be the same as that of an existing corporation, LLC, or other limited partnership in your state.
Be sure to search the availability of the business name before choosing one for your partnership. You can do this through your local Secretary of State’s database. Be sure to also check the U.S. Patent and Trademark Office so that the name you choose doesn’t violate any registered trademarks. And, it’s always a good idea to do a domain search if you plan to have an online presence.
Some states allow you to reserve a business name before adopting it for use. But, the length of time that you can reserve the name for varies from state to state, so check with your Secretary of State’s office for deadlines. Some states may also require you to include “Limited Partnership” or a related abbreviation in your business name.
For instance, in Colorado, most businesses are required to include a designator (an abbreviation or term that’s part of your entity or business name). For a limited partnership, this may include L.P., LP, lp, limited partnership, or limited.
In most states, if you pick a name for your business that does not include the names of the partners, you will need to register the name with a local or state agency. The common term for this is fictitious or assumed name. However, registering a fictitious name doesn’t always protect your business name.
How can you protect your business name?
Once you’ve settled on a name, you need to protect it. There are four ways to register your business name. Each way serves a different purpose, but some may be legally required depending on your location and business structure.
- Doing Business As (DBA): This doesn’t give legal protection but might be legally required in your state. Keep in mind that registering a DBA, however, shouldn’t be confused with incorporation, and it doesn’t always provide trademark protection.
- An entity name: This offers protection at the state level.Each state has different rules about what your entity name can be, and some states require that your entity name reflect the kind of business you’re in.
- A domain name: This protects your business’s website address and allows you to find a business name with a matching or similar domain name.If you plan to have a website, choose a domain name (URL) and get it registered. Once you do, no one else can use your domain for as long as you own it.
- Registering a trademark: This protects you at the federal level. A trademark protects names, words, logos, and symbols that distinguish products and services at the national level. They also prevent other companies in the same or similar industries from using your trademarked name. It’s worth applying for a trademark as your business name is one of your most valuable business assets.
Drafting your limited partnership agreement
Drafting a partnership agreement is a basic necessity for all partnerships. The same holds true for a limited partnership. There may come a time when partners disagree or when a partner should be removed. That may seem inconceivable when forming your partnership, but you never know what may happen in the future.
A limited partnership agreement lays out the terms of your limited partnership, from buy-out options to ownership interests, and everything in between. The best time to draft your agreement is when you’re ready to lay out the business terms of your limited partnership, or when you’ve already formed a limited partnership, but you want to formalize the terms you’ve agreed on.
Your limited partnership agreement should include details like your business name and address, the purpose of forming your partnership, profit sharing, and loss and asset distribution. You’ll want to define how business decisions will be made (by majority vote or unanimous vote), and include the ownership percentage and capital contributions of each partner.
Your partnership agreement should also cover the management roles for all partners and how to dissolve the partnership — if that time ever comes.
Designating a registered agent
Some states require every business entity to have and maintain a registered agent for their business. A registered agent is a third-party who accepts all legal documentation, such as court subpoenas, correspondence from the Secretary of State, service of process notices, tax forms, and notices of lawsuits.
A limited partnership is considered a “statutory entity.” A statutory entity is governed by state laws, which provide some level of asset protection for the owners. All states require statutory entities to file with the state to disclose information about the business, and to appoint and maintain a registered agent within the state.
The registered agent must be a resident of the state where you registered your LP. He or she must also have a physical address where documents can be delivered.
File a Certificate of Limited Partnership
When forming a limited partnership, completing and filing a Certificate of Limited Partnership is mandatory in most states. Depending on the state where you file, the certificate is a more generalized form when compared to a partnership agreement, and only requires basic information about your business, like the business address, registered agent name and address, names and addresses of partners, etc.
This certificate is filed with the state, and forms can be found online at your local Secretary of State website.
How do you register for an Employer Identification Number (EIN)?
Sometimes known as a “Federal Tax Identification Number,” an Employer Identification Number (EIN) is a nine-digit number used by the IRS to identify a business for tax purposes. All corporations, limited liability companies, and partnerships must obtain an EIN in order to open business banking accounts, hire employees, or make business transactions.
If at any time in the future you decide to incorporate, the partnership is taken over by one of the partners who then decides to operate as a sole proprietorship, or you end one partnership and begin a new one, you will need to obtain a new EIN.
On the flip side, if your partnership declares bankruptcy, you change the name or location of your partnership, or 50% or more ownership (interests in capital and profits) of the partnership changes hands between the partners within one year, you don’t have to obtain a new EIN.
Keep in mind that some states also require a state ID number. Like the EIN, an ID number helps classify a business for tax purposes. If required, they’re available via your state’s Department of Revenue.
How to get all of the required licenses and permits
Federal, state, and local authorities require permits or licenses for specific companies to operate. These include occupational and trade licenses, zoning and health permits, as well as other required permits.
A useful database of federal and state business licenses and permits can be found on the U.S. Small Business Administration (SBA) website.
Information about any required county and town permits can be found at your local county business license office or City Hall.
Are there requirements after you form your limited partnership?
Short answer, yes. Limited partnerships typically must file annual reports. Depending on the state where you do business, additional records and fillings may also be required. You must also maintain books and records for your partnership and provide all partners access to that information.
A partner in business
Limited partnerships are a great way for a business to generate capital through partnerships without relinquishing management and property control. And, with limited partners in an LP acting as silent partners, your limited partnership can raise additional capital for your business by adding additional limited partners.
Partners come to the table with ideas and abilities that you may lack. A limited partnership can spur creativity and bring innovation into your business via a new product or service. Partnerships work together toward a common goal, and your partners are there to help you celebrate when your business succeeds.
While the process to form a limited partnership may seem a bit (or a lot) complicated, it could allow you to create a beneficial working relationship and get the funding you need for your business (or the investment opportunity you need as a limited partner). So set up your limited partnership and get down to business.