A limited partnership occurs when one or more partners in a business has a non-active, investment-based role. This structure still requires at least one general partner who assumes an active role and takes on personal liability risks.
Limited Partnership Pros
A limited partnership has a few core advantages over a general partnership, which is why partners would opt for this structure as opposed to a general partnership. Primary benefits include:
- Limited liability - The centerpiece of a limited partnerships is that limited partners make investments in the business, but don't take on an active role. Therefore, limited partners don't face personal financial liability for business debts as general partners do.
- Equity investment - Because of the limited risk, general partners can invite limited partner investment as a way to raise capital. A sole proprietor might opt for a limited partnership as a way to share the financial risk in a company without giving up primary oversight.
- No self-employment tax - Unlike sole proprietors and general partners, limited partners don't pay self-employment taxes on income. This benefit could save hundreds or thousands of dollars a year in taxes from a profit company.
Limited Partnerships Cons
Relative to a general partnership, limited partnerships face the following drawbacks:
- Involvement uncertainty - A common motive for a partnership is to bring in people with additional strengths and backgrounds to develop a business. With a limited partner, the general partner gets the financial contribution, but not the active involvement in most cases.
- Paperwork errors - The documentation requirements for limited partnerships are confusing in some states. Therefore, partners inadvertently changing their role from that of limited partner to general partner is a common problem.
- Setup restrictions - Because of the risks and complexity, some states restrict limited partnerships to certain types of professionals, such as lawyers and accountants. This restriction reduces the pool of potential limited investors that a general partner can take on.