Limited Partner

What is a limited partner?

Limited partners (LPs), also known as passive investors or silent partners, are participants in a partnership with no personal obligations to a company other than their initial investment. Such partners stay protected from third-party creditors and litigants as they have limited liability in a partnership.

A limited partner invests financially in company shares but has little voting power and no regular engagement in the business. They aren't personally liable if the company goes bankrupt or a consumer sues for libel. Creditors and consumers can only sue the company, not the LPs directly.

Businesses use venture capital (VC) management software to manage investments and relationships with limited partners.

Types of partnership

A limited partnership differs from a general partnership in that a general partnership only has participants who manage the business. All general partners are liable and share in both profits and losses.

A limited liability partnership is a hybrid of a partnership and a corporation. All members in this form of partnership are limited partners with limited responsibility. They can all engage in business management.

Instead of delegating personal responsibility, a company can establish a limited liability company (LLC) that functions as the general partner and assumes all liabilities.

Limited partnership examples

Limited partnerships are commonly used for time-sensitive initiatives. Filmmaking and real estate are two of the most notable examples.

• Filmmaking: Limited partnerships are widespread in the entertainment sector, particularly filmmaking. They're a fantastic platform for independent filmmakers who require financial backing but want to retain creative control over their work. Limited partners provide the necessary funds to support a film, but they don't interfere with the creative process or the filmmaker's day-to-day operations. The filmmaker is a general partner and assumes all liability.
• Real estate: Investor groups often combine resources to engage in development projects, property purchases, or leasing possibilities. These parties form a partnership with a general partner and entrust them with their investments in exchange for liability limited to the amount invested.

When are limited partnerships useful?

Limited partnerships are not as common among small-company owners as other business structures. However, they’re prevalent in some cases. Here are some instances where limited partnerships are useful:

• Family businesses: Many family-owned organizations appoint one or two family members as general partners with managerial roles. The other members are LPs who only share the company's profits. Management responsibility is passed on to younger family members who inherit the organization. This is known as a family limited partnership. If one family member has an asset they don't want to be sold after their demise, the family can form a limited partnership as an estate planning strategy.
• Commercial real estate businesses: Large commercial real estate developments, such as shopping malls and housing complexes, are frequently backed by a limited partner. With the LP structure, these firms can give passive revenue to the limited partners through rent, while only the general partner is responsible for tenants and repairs.
• Professional businesses: Older, aging individuals can remain active as limited partners in professional sectors like hospitals and law firms. They only need to hand over managerial control to general partners.
• Hedge funds: Most hedge funds in the United States are limited partnerships with an LLC as the general partner, allowing investors who join as limited partners some legal buffer between their assets and the hedge fund's performance.

Benefits of limited partnership

An LP has the same benefits as other business partnerships but with added features.

• Limited liability: Limited partners are not liable for more than their investment in the company.
• Simple transitions: Limited partners can easily quit the business without any management challenges.
• Simple tax filing: Limited partners have a simple pass-through tax filing, with each partner declaring their share of the business revenue and losses on their personal tax return.

How a limited partner works

A limited partnership must have one general partner and one limited partner. The general partner(s) runs the company daily and can be an individual or legal body like another business entity. These types of partners make business-related decisions and are therefore fully accountable for the company's obligations and litigation.

An LP structure can also have one or more limited partners. They’re passive shareholders who don’t participate in business management. Like owners, their liability is limited to their stake in the partnership.

Although state regulations may differ, a limited partner typically doesn’t have the same voting authority as a general partner over the company's operations. As a result, the Internal Revenue Service (IRS) considers the limited partner's earnings as passive income. A limited partner who works more than 500 hours per year in a partnership becomes a general partner.

Some states permit limited partners to vote on matters affecting a partnership's basic structure or existence. This includes removing general partners, dissolving the partnership, changing the partnership agreement, or liquidating most or all of the partnership's assets.

Limited partnerships are taxable as pass-through or flow-through business entities. Rather than the partnership itself, all partners are taxable on their share of the partnership’s revenue. This portion, known as the distributive share, is included in the owner's tax return assessed at the individual tax rate.

Limited partners don't pay self-employment taxes. The IRS doesn’t regard limited partners' income as earned income since they’re not actively involved in the company. The revenue earned is considered passive income. Under the Taxpayer Relief Act 1986, limited partners can deduct reported losses from passive income.

General partner vs. limited partner

A general partner is a partnership's owner. They’re either an active participant in the company's daily activities or a managing partner. A company's general partner has the authority to act on its behalf. While a general partner has significant obligations and duties in the partnership, they’re also fully liable for the business's financial activities.

If the partnership incurs a significant financial debt or obligation, the liability is passed on to the general partners. The only exception is if the company is structured as a limited partnership. That means that just one of the owners is considered a general partner.

A limited partner is only liable for part of the company's responsibilities and debts. Unlike a general partner, a limited partner’s level of responsibility is determined by the capital they contribute to the company. In addition to the limited liabilities, the silent partner has finite duties for the company's daily operations. These restrictions depend on a limited partner’s shares in the company.