Small and large businesses can be formed in many different ways, depending on the needs and interests of the individuals involved in the business, the potential extent of their involvement, and any existing liability concerns. When two or more individuals join together to form a business, this common business structure is known as a partnership.
General partnerships are formed when two or more interested individuals form a business but do not file paperwork creating an official business entity, such as an S Corporation. In a general partnership, each business owner is considered a general partner. Each is personally liable for the debts and liabilities of the business, and each has full authority for the business, meaning that they can individually make business deals or decisions on behalf of the partnership as an “agent.”
In order to curb the liability that comes with a general partnership, many business owners now opt to create limited partnerships. This structure allows business owners to be either general partners or “limited partners,” who are not personally liable for business debts and have a reduced role in business decision-making and development.
In order to create a limited partnership, a business must still have at least one general partner who remains personally liable for debts and can make important decisions on behalf of the partnership. All remaining partners can be limited partners who still contribute financially to the organization but who cannot act as agents on behalf of the partnership or otherwise unilaterally make decisions for the business.
The Limited Partner Role
If you are considering the creation of a limited partnership, it is important to know what limited partners can and cannot do. Limited partners still provide financial input and backing to support the creation of the partnership. However, in so doing, they do not become liable for the financial debts of the partnership. This is a significant protection for potential partners because it avoids the possibility that an individual could be made to satisfy a business’ liabilities with personal assets. This does not mean, however, that a limited partner is entitled to always recoup his or her initial investment. If the business does poorly, this investment can be lost.
In exchange for limited liability, a limited partner gives up certain management powers in a limited partnership. A limited partner cannot complete business deals on behalf of the business and typically has a minimal management role in the partnership. Some states allow limited partners to vote on important business issues, such as the inclusion or removal of partners, while others do not.
Finally, limited partners have a different tax status from general partners. Since limited partners are not active participants in the operation of the business, they are not considered to be “employees” and are not required to pay an employment tax on the income they earn through their partnership. Conversely, active general partners are required to pay self-employment taxes on their share of profits.
If you are considering the formation of a business with one or more other individuals, you may be interested in the creation of a partnership to oversee business responsibilities. In order to limit personal exposure during this process and minimize liability, a limited partnership can be a good structural option for your needs, as can a limited liability partnership.