How to register a limited partnership and get it right.
A partnership is a formal or informal business structure that allows two or more entrepreneurs to work together to achieve a common business goal. One of the most popular types of legal partnerships is the limited partnership (LP).
This article covers the basics of what this type of partnership is, how it works, and how itâs different from other partnership structures. It will also explain where and how to form a limited partnership.
Limited partnerships: The basics
A limited partnership (LP), unlike informal partnerships, is a formal legal entity. You register your partnership with your stateâs Secretary of State. By registering with your state, the partnership gains liability protection for its owners, similar to business incorporation.
Individuals (sole proprietors), for-profit corporations, most types of businesses, and nonprofits can all form limited partnerships, taking either a limited or a general partner’s role. Startups, new businesses, and existing businesses can all form LPs.
A limited partnership is unique because it has two classes of partners: limited partners and general partners.
Limited partners are often referred to as passive investors. They contribute capital to the business but donât make decisions about the day-to-day operations of the business.
General partners manage the everyday business activities of the LP. They may also invest capital in the organization, but their primary purpose is to drive business success. General partners set direction, develop strategies, manage operations, enter contracts, hire and fire employees, and more. They are the hands-on leaders of the organization.
The other key difference between the two types of partners is their personal liability related to the business.
- Limited partners have limited personal liability when it comes to their personal assets if the business is sued or defaults on a contract. They can typically be held liable only for the total amount of their initial investment.
- General partners can be held personally liable when things go wrong in the business. Their personal liability results from the fact that they actively make business decisions.
Limited partners wonât be personally harmed by business decisions unless they overstep and start actively making decisions for the company. General partners have more responsibilities, which means they face more significant risks than limited partners.
Overview: Forming a limited partnership
A limited partnership has a formal startup process. It includes preparing and filing a Certificate of Limited Partnership. This document contains the roles of your partners and the identity of your registered agent. The registered agent can be an individual or professional service.
As part of the partnership formation process, the partners enter into a partnership agreement. This document is comparable to a Limited Liability Companyâs (LLC) operating agreement. It documents the details of the relationship among the companyâs partners.
A solid partnership agreement should clearly explain how the profits from the business will be split among the partners. If the limited partners get a cut of business income to compensate them for their investments, the partnership agreement explains how that happens.
The partnership agreement should also document how decisions are made in the organization. The general partner or partners make day-to-day decisions, similar to other small business owners. However, limited partners may need to be involved in significant decisions that impact the structure or functioning of the business. The partnership agreement must establish if, when, and how limited partners become involved in these decisions.
The partnership agreement must be clear, comprehensive, and complete. Itâs wise to work with a business legal expert to ensure yours is crafted correctly.
Why do businesses set up limited partnerships?
There are many advantages to LPs. There are also a few things to look out for.
Advantages of an LP
The assets of limited partners are protected
Limited partners have minimal liability in the business. If the business is sued or defaults on a debt, the only thing at risk for a limited partner is their financial investment in the LP. Their personal assets, including their house, car, personal bank account, artwork, and investments, are protected by the LP business structure. LPs reduce risk for passive business owners.
LPs are attractive to investors
One of the critical reasons LPs are popular is because theyâre attractive to outside investors. The personal assets of limited partners are protected, and they donât have to be involved in the day-to-day operation of the business. LPs make it relatively safe and easy to own a business and earn revenue.
Limited partnerships provide tax benefits
An LP has the same pass-through taxation structure as a general partnership. Instead of paying business taxes, the profits and losses of an LP pass through the business entity, and the partners pay taxes on this money based on their personal income tax situation. This avoids the double taxation issues that many corporations face.
Itâs relatively easy to form and maintain an LP
Compared with corporations, limited partnerships are relatively easy to form. Plus, the ongoing maintenance process for an LP is quite simple. The paperwork requirements are more straightforward. Record keeping needs are much simpler than corporations, including C-corporations. In most states, LPs arenât required to file annual reports. Articles of incorporation and articles of organization arenât required for LPs. You also donât need to create a board of directors. LP laws are simpler to navigate than corporate laws.
Limited partners can be easily replaced
If a limited partner wants to leave the business, itâs a simple process. The same is true if you wish to add limited partners. Other business entity types can make doing these changes challenging.
Disadvantages of an LP
The general partner can be held liable for business decisions
While limited partners enjoy personal asset protection under an LP, general partners have a heavy risk burden in an LP. If an LP is sued or defaults on a debt, a general partnerâs personal assets and business assets can be seized. The general partner is in total control of business operations. They also take on a great deal of risk.
Limited partners have limited power over the business
While a limited partner doesnât take on much risk in a limited partnership, they also donât have much control over the operation. Limited partners are usually only consulted on big decisions that affect the LPâs overall operations. This can be frustrating if they feel the business is heading in the wrong direction.
Top states for limited partnerships
The costs and requirements of registering a limited partnership differ by state. In most cases, the best state for small businesses to register in is their home state, especially if itâs a small operation working in a single region.
However, you may want to move to and register your limited partnership in a state with no income taxes or low income tax rates so you can limit the impact of taxes on the profits you earn from the LP. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming are states with no state income taxes. Delaware is also considered a business-friendly state that could be worth looking into.
Unlike incorporating a business, annual fees and other types of regular expenses are low for LPs and typically donât impact the decision of where to form an LP.
If you decide to form a limited partnership in another state, by law you may be required to file for foreign qualification to operate in the state legally. This is a highly complex area. If itâs something youâre thinking of doing, work with a lawyer, tax expert, and financial professional to find out if itâs possible and whether it makes sense for you.
How to form a limited partnership
Here are the steps you need to take when you decide that forming a limited partnership is the right option for your business. Theyâre identical for most states and will help ensure your business is compliant.
1. Name your LP
Come up with a business name for your new LP. Your LPâs name is crucial because it needs to make a great impression on the people or other businesses itâs targeting.
Another critical aspect of naming an LP is ensuring the name you want is available in your state and hasnât been claimed by another entrepreneur. Search your stateâs business database to ensure you can use the name you want.
2. Name a registered agent
All LPs in the United States must have a registered agent. Your registered agent is responsible for receiving document deliveries from your state, including paperwork you must complete and annual report reminders. They must alert you of their receipt and forward the documents to your business.
You can designate an individual or a professional service as your designated agent. The only limitation is that the LP cannot be the registered agent.
3. Prepare and file your Certificate of Limited Partnership
Completing this certificate and paying a filing fee registers your partnership with your state. The information required varies by state but usually includes:
- Names and addresses of your LPâs general partners.
- The name of your limited partnership
- Its principal office address
- The name and address of your LPâs registered agent
- The purpose of your LP
- Value of each partnerâs investment in the business.
4. Draft your partnership agreement
Not all states require that partnership agreements be submitted with the Certificate of Limited Partnership. However, every LP should have one to govern its operation. It can help prevent ownership and other types of disputes which can cripple an organization.
Typically, a partnership agreement includes:
- Details about the structure of the business
- Business purpose
- Role of each partner
- Capital contributions and revenue expectations, distributions, and withdrawals,
- Management and voting rights
- Book- and record-keeping practices
- Rights and duties of each partner
- Meeting procedures
- Conditions and procedures for ownership transfers
- Prohibited transaction
- And more.
Work with a business legal expert to ensure your partnership agreement is structured correctly.
5. Obtain an EIN
Acquire a federal tax ID number (often referred to as an EIN or employer identification number) from the Internal Revenue Service (IRS). An EIN is like a social security number for a business. Itâs a nine-digit number used to identify your business for tax purposes. An EIN can help with other things like opening business bank accounts, hiring employees, and more.
6. Set up the LPâs financial infrastructure
Set up a business bank account and your accounting system. Use your business bank account exclusively for business purposes. Commingling business and personal expenses could put your LP at serious risk. When it comes to an accounting system, you probably want to work with an experienced business accountant to ensure things are set up correctly.
7. Secure licenses and permits
State laws and municipal regulations typically require LPs to obtain a business license and permits before opening. Specific industries require federal licenses and permits to operate, as well. A lawyer familiar with your business sector and state can help ensure you get all the legal documents you need to conduct business compliantly.
8. Get business insurance
Work with a business insurer to ensure you get all the coverage you need to protect your LP. This could include workersâ compensation coverage, general liability protection, business property insurance, professional liability insurance, and commercial vehicle coverage.
Hire an LP formation service
If forming an LP on your own sounds too daunting, there are other options. You could hire a lawyer to help create your business, although this option is typically quite expensive, and the costs can be too high for startups on tight budgets.
If you canât afford a lawyer, check into online business formation services. They provide an automated way to form an LP that can make the process relatively easy.
How do LPs compare with other partnership types?
A limited partnership is not the only type of partnership â there are also general partnerships, limited liability partnerships, limited liability limited partnerships, and joint ventures. Hereâs a quick overview of each to help you feel confident that a limited partnership is right for you.
- General partnerships are the most basic partnership type. Theyâre comparable with sole proprietorships but involve more than one person. These partnerships donât have to register with the state. They form automatically when partners begin conducting business together. The issue with this type of partnership is that it provides no personal asset protection.
- Limited liability partnerships (LLP) are similar to an LLC in many ways. LLPs as a business structure are available to people working in specific professional fields, including lawyers, accountants, architects, dentists, and chiropractors. Under an LLP, the partners receive personal asset protection. However, this does not extend to malpractice lawsuits.
- Limited liability limited partnerships (LLLPs) are a relatively recent development. This business structure is a form of limited partnership, but the LLLPâs general partners enjoy the same level of personal liability protection as the limited partners. LLLPs arenât currently available in all states.
- Joint ventures are often referred to as partnerships. A joint venture is an agreement between two distinct business entities to work together on a project. A joint venture typically only exists temporarily until the project is complete. The joint venture is not a business structure in itself, but it is not uncommon to see its partners form an LLC or other entity to provide a framework for working on the project.
If you have any doubts about setting up an LP in your state or any other, get professional support to ensure itâs the right move for you and you set things up correctly.