Limited Partnerships: What Are They and Should I Form One?

In this month’s post, we continue our discussion of various business structures. In the third of this series, we discuss limited partnerships. The limited partnership is a specialized entity best deployed for particular business types and industries.

Unique Management and Investment Structure

The limited partnership distinguishes itself in its management and investment structure. At a basic level, the limited partnership features two levels of involvement: general partners and limited partners. General partners not only hold an ownership interest in the business but also manage the business. For example, they carry the authority to appoint officers, hire employees, set business policies, and so on. By contrast, limited partners constitute essentially passive investors in the business and cannot manage the business, unless the limited partner is also a general partner. A limited partner generally makes a capital contribution to the business in anticipation of the entity’s success and in hopes of seeing a future return on the investment. Without other arrangements, limited partners cannot hire employees, set business policies, or otherwise manage the business.

Dichotomy of Liability

The choice of joining a limited partnership as a general partner or as a limited partner carries significant liability consequences in addition to the management distinctions discussed above. General partners carry unlimited liability in addition to joint and several liability. The unlimited extent of a general partner’s liability means that the general partner’s liability does not end at the extent of his investment in the business. In other words, he or she will be personally liable for the liabilities of the business, and his or her personal assets are at risk. The joint and several liability component of a general partner’s liability means that each general partner is liable in full for the other general partners’ acts, omissions, and errors that cause liability. In other words, if the business is sued or incurs debts due to the mistake of one general partner, the other general partners will also be responsible for the error in full notwithstanding the extent of the other partners’ involvement in the error.

Formation Fees, Governance Documents, and Other Considerations

At the time of this writing, the limited partnership’s formation fee is over twice as much as that of corporations and limited liability companies. Companies in industries suitable for the limited partnership structure consider and select the entity type despite the fee because few other options offer a similar structure by default. The limited partnership’s governance document is a general partnership agreement. Partners may exercise significant discretion in waiving and in modifying the default rules of Texas law, although the law prohibits modification or waiver of some provisions. Although the corporate structure offers a lower formation fee, limited partnerships, like limited liability companies, enjoy fewer recordkeeping requirements and other formalities compared to corporations.

Suitable Industries and Businesses

Limited partnerships are often suitable for very particular industries and businesses. Most broadly, any business featuring investors who manage the business alongside passive investors without management authority may consider this entity type. Real estate investment, development, and redevelopment companies and oil and gas ventures, for example, may seriously consider the limited partnership. The limited partnership's two-tiered management and investment structure allow these companies to acquire their costly assets using passive investors’ capital without worrying about additional management conflicts. In this regard, one may consider the limited partnership a highly specialized structure. Its strengths do not always outweigh the high formation fee and the dangers of unlimited liability and joint and several liability, particularly when other entities offer a lower formation fee, similarly few recordkeeping and formality requirements, and limited liability protections.

Samy Diab

Attorney

Diab Law Firm, PLLC