If you’re thinking about starting a business with one or more people, you may decide to form a limited partnership. What is a limited partnership? Understand how limited partnerships operate, and find out what you need to know before establishing one.

What is a limited partnership?

When you form a partnership, you can either establish a general or limited partnership. In a limited partnership, at least one partner has limited liability, as well as little to no control over the business.

Limited partnerships must have both general and limited partners. The limited partner, or partners, is only liable for their investment. The general partner, or partners, is responsible for the business’s debts.

The limited partner is similar to a silent investor. A limited partner invests their money or property in the business, but they do not make decisions about the company or manage day-to-day operations.

Unlike limited partnerships, general partnerships are owned by two or more general partners. There is not a limited partner in a general partnership. Generally, all owners exert the same control and have the same risk in a general partnership.

Limited partnerships are more structured than general partnerships. You must have at least one limited and one general partner to operate. General partnerships are more informal, as you can form one with as little as a handshake.

Should you form a limited partnership?

For some business owners, forming a limited partnership is the right decision. But before structuring as a limited partnership, you must weigh the pros and cons. There are limited partnership pros and cons for both the limited and general partners.

If you are the limited partner, you enjoy limited liability in the business. However, you do not play an integral role in running your company. You are not involved in the daily operations and you cannot make business decisions. If you disagree with how your partner runs the business, you generally can’t do anything.

If you are the general partner in a limited partnership, the opposite is true. You get to exert control over your business. You receive an investment from your partner, but you do not have to share decision making. On the other hand, you are liable for your small business debts. If your business owes money, your personal assets are at risk.

After weighing the pros and cons of a limited partnership, consider an alternative. You could form a partnership that is structured as a limited liability company (LLC). If you form a multi-member LLC, all partners enjoy limited liability.

How to form a limited partnership

To structure as a limited partnership, you must take many of the same steps as you would to form another entity. You should apply for a federal employer identification number (FEIN) with the IRS, register your business with your state, and obtain licenses and permits.

Your state may require you to select a doing business as (DBA) name. A business DBA is a name you operate under, and it must be unique.

To form a limited partnership, you will also need to familiarize yourself with two specific documents:

1. Limited partnership agreement

With the help of a small business lawyer, draft a limited partnership agreement.

A business partnership agreement is a contract that defines general and limited partners, as well as your business’s goals. It should also disclose each partner’s investments and distributions.

If you and your partner agree that the limited partner can partake in some decision making, include it in the contract.

2. Certificate of limited partnership

You must also file a certificate of limited partnership with your state. This registers your limited partnership as a legal business in your state.

Like the partnership agreement, the certificate of limited partnership details information about your partnership, including general and limited partners, contributions, and distributions.

If anything changes within your partnership, be sure to amend your certificate of limited partnership.

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This is not intended as legal advice; for more information, please click here.