Financing Limited Partnerships

A limited partnership is a partnership that requires only one partner to assume personal liability for the business's liabilities (the general partner). There may be more than one general partner. However, there are other partners (limited partners) who are passive investors and do not incur personal liability.

Work Smart Formation of a limited partnership requires compliance with state law. Otherwise most states will treat all partners as general partners for purposes of personal liability for the business's obligations. We recommend that you contact your attorney if you're contemplating this business form.

What's Limited?

A limited partnership encourages contributions from investors who might be reluctant to assume the personal liability associated with a general partnership. A limited partner is merely an investor. He or she supplies the capital but is not involved in the day-to-day management of the business. In fact, limited partners are prohibited from becoming actively involved in the on-going management of the business or they forfeit their limited liability. The business must have at least one general partner who is responsible for overseeing operations and for making daily management decisions.

Warning Sale of ownership interests in a limited partnership may be treated as a sale of securities. State and federal securities laws must be consulted.

Some Drawbacks

For purposes of equity investing, a limited partnership is appealing because an investor has limited personal exposure and does not need to be actively involved in management responsibilities. In the past, limited partnerships were especially popular in certain industries, such as real estate, because of the generous passive loss rules of prior tax laws. The current tax code reduces the appeal of limited partnerships to many investors by restricting passive loss deductions. Moreover, limited partners may find themselves hit with the new 3.8 percent tax on net investment income that is imposed on higher-income taxpayers, starting in 2013.

New Alternatives

In addition, the limited partnership's feature of limited liability is available through other entity forms (a corporation, a limited liability company, or a limited liability partnership), and unlike a limited partnership, these alternative entities also allow each participant the option of being actively involved in the business without forgoing their limited liability.

For more information on limited partnerships and partnership agreements, see our discussion of establishing a limited partnership.