Understanding General Partnerships vs. Limited Partnerships

 

Launching a small business with a friend or partner can be exciting, but comes with a lot of responsibility and risk for all parties involved. Partnership business structures exist for this very reason.

Two of the most common types of partnerships are general partnerships and limited partnerships. Though they are often conflated, there are key differences to note that will substantially affect how partners participate in running the company, how they benefit from the profits, and how they are  accountable for its losses.

What is a general partnership (GP)?

A general partnership is a business entity made up of two or more general partners who are responsible for the business. General partnerships are formed via an agreement—either verbal or written—made between two or more partners who all agree to share in the company’s profits, losses, and assets. General partnerships are:

• The default business structure for partners. Just like sole proprietorship is the default business structure for individual business owners, a general partnership is the default for multi-owner businesses. 
• Pass-through entities. Partners in a general partnership pay taxes on profits at the personal level. Compare this with corporations, in which profits are doubly taxed—first at the corporate level and then at the owners’ personal level. 
• Usually equal. Partners in a general partnership take on equal personal responsibility for the business. That means equal shares of profits and equal liability for debts or legal action. Partners can adjust the split of both profits and liabilities in their partnership agreement, but an equal split is the default.
• Not liability shields. Partners in a general partnership take on personal responsibility for the business and cannot shield their personal assets from legal claims or debts incurred by the business. 

What is a limited partnership (LP)?

A limited partnership is a business structure similar to a general partnership. However they have the addition of limited partners who invest in the business but who, unlike a general partner, are not involved in the day-to-day operations of the business.

How are limited partnerships used?

Limited partnerships are particularly applicable to businesses that have high startup costs or ventures that typically require investment from multiple parties. 

• Real estate. Limited partnerships are often used in real estate. In such a venture, there may be several limited partners who provide funds to purchase a piece of property. The general partner(s) may direct daily maintenance of the property, oversee rental tenancies, etc., whereas the limited partners likely will only benefit from a portion of the rental income or ultimate resale of the property.
• Private equity. Limited partnerships are also used in private equity. Private equity firms purchase portfolios of privately owned companies, work to increase their value, and then (hopefully) sell their ownership for a profit. Limited partners in a private equity context might offer seed funding for portfolio purchases, while general partners will engage in the day-to-day running of the firm and the nitty-gritty of growing the value of portfolio companies.
• Small business. The limited partnership business structure is relevant and applicable to small businesses, particularly those that have high overhead costs, such as a retail venture. Limited partners may offer investments to purchase inventory and rent a storefront, while a general partner might be in-store day-to-day to oversee operations and make sales.

General partnerships vs. limited partnerships: Similarities and differences

While general partnerships and limited partnerships share a number of core similarities—namely, the fact that they are partnerships—they are distinct in just as many important ways, particularly when it comes to liability protection and partners’ roles.

Establishment

How they’re similar: Setting up both a general and limited partnership requires that partners have an agreement between them to form and operate a partnership.

How they’re different: General partnerships only require an agreement (even just a verbal one) between the partners to get up and running. Limited partnerships require additional steps. You and your partner(s) will need to file a certificate of limited partnership with the secretary of state’s office in your state of operation. On this form, you’ll appoint a registered agent, which often can be the general partner.

Ownership and management

How they’re similar: Both general and limited partnerships have multiple owners.

How they’re different: All partners are general partners in a general partnership, and ownership responsibilities are spread equally among them. In a limited partnership, operations are handled by general partners, whereas limited partners do not take part in the day-to-day running of the business. Limited partners serve only as investors in the business. 

Profit, liability, and loss sharing

How they’re similar: Partners in both general and limited partnerships share in the profits, liabilities, and losses of the business.

How they’re different: Limited partners only share in losses and liabilities to the extent of their investment in the company. General partners have unlimited liability for debts and lawsuits. This means the business’s assets and a general partner’s personal assets can be used to pay off the company’s debts or may be reached by plaintiffs who successfully sue it.

Tax benefits

How they’re similar: Both general and limited partnerships are pass-through entities for tax purposes—meaning owners don’t need to file separate business taxes, but instead report the business’s profits and losses on their personal tax returns.

Other types of business entities for partners

Although general and limited partnerships are the more common choices, there are other partnership structures available to business owners as well.

Limited liability partnerships

A limited liability partnership, or LLP, is a type of business entity that affords partners personal liability protection. Partners in an LLP do not assume liability for wrongdoing or errors made by other partners. This makes the LLP structure popular with (and typically limited to) law firms, doctors, accountants, and other professionals who are licensed and can face malpractice lawsuits. Unlike limited partnerships, partners in LLPs can have oversight of day-to-day firm affairs while maintaining their liability shield. 

Joint venture partnerships

A joint venture partnership is a partnership temporarily formed by two or more parties who agree to pool resources for the purpose of accomplishing a specific objective. For example, if you own a coffee shop and the retail space next door becomes available, but you can’t afford the rent on your own, you might form a joint venture partnership with a bakery or bookshop to acquire the space. 

While each of the partners is responsible for profits, losses, and costs associated with pursuing the objective, the joint venture partnership is its own legal entity. Joint venture partnerships aren’t a business entity unto themselves, but a way of forming one. Joint venture partnerships can form corporations, traditional partnerships, or limited liability companies—and the tax treatment and liability limitation of the joint venture partnership will vary depending on the form it takes. If a joint venture coffee shop/bookstore forms as an LLC, for example, and a customer injures themselves on the premises, the joint venture LLC would assume liability and shield ownership from any legal payouts. Parties in a joint venture partnership can be two or more individuals, companies, or even other partnerships.

Final thoughts

When considering how to structure a limited partnership, here are some questions for you and your business partners to work through via research and potential consultation with an attorney:

• How many partners are you planning to include?
• Will the partners all be involved in daily operations, or will some partners be investors only? 
• Are general partners willing to be personally liable for the business? And the potential wrongdoings of each other? 
• What are the specific requirements for forming a limited partnership in your state?
• What professional licenses, if any, will you need to operate your limited partnership?