When a business is formed as a limited partnership, then there are at least two partners who are both responsible for the business. This means that every partner shares profits, assets, liabilities, and management responsibilities. Although a limited partnership is a rather easy and cost-effective business structure to form, there are certain advantages and disadvantages that must be considered. It is not always the right type of business to form, so here are the key points to consider.
The Pros of a Limited Partnership
1. There are very simple and flexible.
Compared to other business opportunities, the limited partnership is rather inexpensive and applications are fairly basic. They are also flexible enough that they can create management structures that are centralized like a corporation’s would be or not centralized at all where managing partners each have an equal stake in what needs to happen. This allows partners to share resources, limit their personal liabilities, and maximize their profits.
2. Any business costs can be directly deducted from personal income.
There can be numerous costs associated with running a business. In the structure of the limited partnership, those costs can be directly deducted from personal income that is reported. Those costs can be broken up into shares based on the partnership structure or may be able to be taken in full if one member fronted the costs for everything.
3. Limited partners are protected from high levels of liability.
As long as a limited partner stays passive in their involvement with a business opportunity, then they are protected by the limited liability clauses that are in the law today. This all changes, however, should the limited partner make any effort to materially participate in any way. If that doesn’t happen, then creditors can only pursue a limited partner for the amount of their investment only.
4. Limited partnership shares are considered securities.
The limited partnership interest that exist are considered to be securities. This means the shares of a limited partnership can be sold to any third party in other to raise capital that has an equity percentage. This removes the requirement for a company to go public in order to sell shares while still benefiting from the cash infusion of an equity payment. Limited partners can also directly sell their shares to others as long as they’ve made a first offer to the general partners.
5. Growth is ultimately scalable.
Most limited partnerships aren’t going to become as profitable as a publicly traded company, but that doesn’t mean the partnership can’t scale up to size to provide huge profits to every partner involved. The key to scalability is to have a great idea, have each general partner fulfill their responsibilities, and have limited partners remain passive at all costs. Even in a worst-case scenario, the business structure can be changed so that if a company needs to continue growing, it will be able to do so.
6. Turnover issues don’t have to become issues.
Unlike other investment opportunities, limited partners can quickly exit a business if they need arises. Limited partners can be replaced with others at any given time as long as the general partners have given their permission for this to happen or have refused to purchase the limited partnership stake. This means exit issues that venture capitalists see in other businesses don’t exist in this structure of business.
The Cons of a Limited Partnership
1. Profits are treated as personal income.
Every managing partner in a limited partnership is taxed on their personal income returns at the end of the tax year. This means that the taxes are considered to be pass-through, but that means needing to pay the self-employment tax in addition to regular income taxes. Business taxes aren’t imposed to the business itself and the limited partner only pays taxes on any profits that are distributed to them as they would with any other investment income.
2. General partners in a limited partnership are personally reliable for business debts.
This is actually a double disadvantage. Managing members of a limited partnership are personally responsible for any debts that their business creates. This means their personal assets can be ordered to be used to pay for outstanding business debts, just as a sole proprietorship can have this happen. The second issue here is that partners are also personally responsible for the debts created by one another. If one partner creates $100,000 of debt while the other creates $30k of profits, both partners are liable for $35k of debt each.
3. Fundraising can be extremely difficult.
There is a lot of potential liability when it comes to a limited partnership, which means there isn’t a lot of opportunities to raise money or find investors to back a good idea. Investors coming into a limited partnership automatically assume a share of the debt if they become a general partner and that’s not something most investors are going to wanted to do if they want to have any control over how the business is operated. The only hope here is to sell more equity to another passive investor.
4. The business typically needs to be registered with a business registration office.
Unlike a general partnership, limited partnerships still typically require a certain level of state registration. This is because this structure requires one general partner and one limited partner in order to exist. This means the one limited partner is more of a passive investor while the general partner gets to take advantage of all the benefits of being in the structure. For the limited partner, it’s a lot like owning stocks or bonds
5. Limited partners have no voting power.
The only thing that limited partners typically receive for their investment into a partnership is a dividend payment that is based on the profits received. This means they don’t have to pay self-employment taxes on money that is received, but they may have to pay a capital gains tax on any earnings. This is the price to be paid for not having their personal assets be placed at risk assuming they stay out of the day-to-day operations of the business.
6. General partners carry all of the risk.
In many ways, a general partner is just a sole proprietor in this business structure. This is especially true if they are the only general partner in the relationship. This means all liabilities and debts become their personal responsibility because they are seen as the only active management members of the business.
The limited partnership pros and cons show that if compliance issues can be resolved, it can be a relationship that provides a win/win situation. Although there are more personal risks assumed in this business structure than others, the end result can be profitable for everyone involved, especially the limited partner.
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