What is a Limited Partnership?
When two or more individuals form an entity to undertake business activities and share profits with at least one person acting as a general partner as against to one limited partner who will have limited liability only up to the capital invested by such partner enjoying the benefits of less stringent tax laws is known as the Limited Partnership. It is also known as a silent partnership or limited liability partnership.
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For eg:
Source: Limited Partnership (LP) (wallstreetmojo.com)
Advantages
- Distributions – The income received is in the form of distributions. And the plus of having distributions is that part of it may be taxed as ordinary incomeOrdinary IncomeOrdinary income refers to an individual's or business entity's earnings that are taxable at the regular rates. Such earnings include salary, wages, rent received, royalty, commission, interest received, profit, etc. It excludes all incomes with tax deducted at source and capital gain.read more, the part may be treated as capital gains, and part may remain untaxed if it is the return on invested capital.
- Limited risk – In case the business suffers losses or incur debt, the limited partner has to give up only the capital invested.
- Tax benefit – The limited partnership classifies as a flow-through entity, wherein the investor is taxed for the profit or losses made and not the business. This avoids double taxation, unlike stock dividendsStock DividendsStock dividend is the dividend declared from the company's profits, which the company discharges by issuing additional shares to the company's shareholders rather than paying such an amount in cash. Generally, the company opts for stock dividend payout when there is a cash shortage in the company.read more. Since the limited partnership is a passive income, the losses can be used to offset other such income.
- Passive Income – It has the scope for passive income because there are businesses that require investor’s money without ownership dilution. For example, a commercial real estate project, wherein the General Partner manages the entire project and the Limited Partner invest money and gets a return out of the finished project.
- Safeguards personal assets – A limited partner’s personal assets cannot be seized in case the business meets bankruptcy or becomes insolvent.
- No Managerial burden – In a Limited Liability partnership, it is the General partner who makes all the day to day managerial decisions, and a limited partner is only informed of all the business activities. For example, the general partner keeps the limited partner updated about all the financials but expects nothing more in return.
Example
Let’s say, “X” runs a food café business and has “Y” as his partner. In this business, X is the general partner whereas Y is a limited partner. “Y”, has infused $1 million in the business as capital investmentCapital InvestmentCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc.read more. The money helps “X”, pay for his staff expenses and purchase raw material. “Y”, does not participate in running the business but receives monthly share out of the profits.
Therefore, Yearns a passive income from the food café business and X, keeps his limited partner updated about the finances and position of business but expects nothing more in return. Y’s investment riskInvestment RiskInvestment risk is the probability or uncertainty of losses rather than expected profit from investment due to a fall in the fair price of securities such as bonds, stocks, real estate. In addition, each type of investment is prone to some degree of investment or default risk.read more is limited to the chance of food café business running into losses. Y is not liable for the business debt in case “X” fails to pay his suppliers. In nutshell, Y’s investment has greater upside potential with the profit business makes but limited downside riskDownside RiskDownside Risk is a statistical measure to calculate the loss in a security’s value due to variations in the market conditions. Also, it refers to the uncertainty level of realized returns being much lesser than the anticipated ones. read more with the money he invests.
Difference between General Partnership and Limited Partnership
| Particulars – General Partnership vs Limited Partnership | General Partnership | Limited partnership |
|---|---|---|
| Definition | It is when partners agree to share all profit, assets, financial and legal liabilities of the business. | It is when the partner’s liability is limited to the amount of capital invested. |
| Profit-sharing | Profit and losses are shared equally between the partners. | Profit and losses are shared based on the amount of capital invested. |
| Management | The general partner has complete control over the business and sits over the management. | No control over the management. |
| Personal Liability | The general partner is held liable for any debt incurred by the business, as well as their assets can be taken over in case of bankruptcy. | Neither their assets can be seized nor they face a debt burden of the business. |
| Legal power | General partners can legally bind decisions and deals. | No such legal power |
| Business structure | Simple | Complex, as it involves both types of partners – General and limited. |
Conclusion
With all said and done about the limited liability partnership, we can easily conclude that it is best suited when you are planning to start a business on your own and have friends or family members interested in investing money into it but not active there to participate in it.
A few examples of businesses where limited partnership works best are the real estate industry, small and medium scale business, professional knowledge ones like a lawyer and so on. And if you are looking for active participation as well as control in the business and don’t require to raise capital then the limited partnership is not the right choice.
So, it is a matter of what your objective is and resources available at your disposal before you plan a business.
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This has been a guide to what is Limited Partnership. Here we have discussed the advantages and the difference between general vs limited liability partnership along with an example of a limited partnership. You may learn more about our articles below on corporate finance –
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