General Partner vs. Limited Partner: Everything You Need to Know
The difference between a general partner vs. limited partner is that a general partner is the partnership owner, and a limited partner is a silent partner.9 min read
Updated August 12, 2020:
The difference between a general partner vs. limited partner is a general partner is an owner of the partnership, and a limited partner is a silent partner in the business. A general partner is an owner of a partnership. Usually, a general partner is either a managing partner or active in the daily operations of the company.
General Partner: What Is It?
A general partner is an owner of a partnership. Often, a general partner either plays an active role in the company's daily operations or is a managing partner. A general partner for a business can act on the company's behalf. While a general partner has important responsibilities and duties in the partnership, they also have unlimited liability regarding the financial dealings of a partnership.
That means if the partnership acquires a large amount of financial debt or liability, this liability might pass through to the general partners. The exception to this is if the business runs as a limited partnership. That means only one of the owners will be regarded as a general partner and therefore have unlimited liability.
Limited Partner: What Is It?
A limited partner, also known as a silent partner, has limited liability for the company's liabilities and debts. Different from a general partner, how much liability a limited partner acquires is based on how much capital they contribute to the business. On top of having limited liability, the partner has restricted responsibilities regarding the daily operations of the company. These limitations depend on how many shares the limited partner owns.
Usually, limited partners are not involved in the company's daily operations and they don't participate in management meetings. However, if a limited partner spends over 500 hours in one year helping the limited partnership in its operations, they may be considered to be a general partner.
A partnership is an entity formed when at least two or more individuals agree to go into business with one another. More specifically, there are two main types of partnership structures:
- General partnership
- Limited liability partnership, also referred to as a limited partnership
There are no filing fees associated with establishing a partnership nor are partnerships required to hold meetings, prepare meeting minutes, appoint officers, or issue shares of stock. Keep in mind, however, that creditors can initiate legal proceedings against the partnership itself, including the assets of the partners, i.e. house or automobile.
General Partnership: An Overview
The most common type of partnership, a general partnership is arranged by two partners who will have unlimited liability, which means that their personal assets are liable to the partnership's obligations and debts. As long as the agreement is put into a written contract, you can create a general partnership.
There are no requirements for business formation with general partnerships. It is entirely up to the partners themselves to determine how to run the business. General partnerships are a particularly attractive type of business for those operating in the legal or medical field. For example, if two attorneys who operate as sole practitioners wish to expand their networks, they may choose to form a general partnership with the purpose of bringing their own specialized knowledge, expertise, and expansive network in hopes to further expand and develop their business.
However, a disadvantage of being a general partner, as previously noted, is the unlimited liability that you face. Therefore, you can be personally liable for the general partnership's debts and obligations to creditors, legal suits, and any other financial obligations that the general partnership is responsible for. For example, if someone brings a legal suit against the general partnership, both partners will be defendants in the suit. Moreover, even if you did not engage in any misconduct, if the court finds the general partnership guilty, then both general partners will be held financially responsible for the outcome of the suit.
What Is Included in the Partnership Terms?
General partners will share their company's losses and profits equally unless it's stated otherwise in the partnership agreement. Extra partnership terms often have provisions about how the partnership shares that are remaining are divided when one partner leaves the business. The state partnership law is applicable when general partners don't spell out clear terms in the partnership agreement. All rules for the partnership must be stated in this agreement.
Liability for General Partners
Usually, a general partner gets paid for controlling the daily operations of the business and making decisions that are legally binding. This partner is liable personally for legal proceedings and business debts. If a general partner can't pay off a creditor's debt, the creditor can collect from another partner.
Limited Partnership: Overview
Limited partnerships, or limited liability partnerships, are generally established for real estate purposes. When two or more partners form this kind of business, such partners will be liable only for the amount of capital each one invested into the business. Limited partners do not receive dividends but do in fact enjoy direct access to the flow of income and expenses. Generally, limited partners are not liable for the total and complete debts and obligations of the company.
While the limited partnership is different than a general partnership, the limited partners can enjoy general partner-like qualities, including the ability to manage the business like a general partner would as long as a formal contract is in place. Be mindful that limited partnerships will have at least one general partner who controls the daily operations of the business, and who will become ultimately liable for all business debts.
Advantages to Becoming a Limited Partner
Below are some advantages to becoming a limited partner:
- A limited partner can contribute financially to the business in exchange for a percentage of the partnership's profits.
- A limited partner cannot incur the debts or obligations of the partnership in excess of the amount of capital invested into the business.
- A limited partner need not participate in the daily operations of the business or in management meetings.
- If a limited partner works in excess of 500 hours in a given year, he or she may be deemed a general partner. This can be an advantage for a limited partner who wishes to have more of a say in the company's growth and development.
Disadvantages to Becoming a Limited Partner
- While it may be advantageous for you not to spend additional time participating in the daily operations of the business, it may also be disadvantageous, as you generally cannot make any important decisions regarding the company's growth.
- A limited partner can invest a lot of money but still have no say in the business decisions.
- While working in excess of 500 hours/year can deem someone a general partner, the disadvantage will be the unlimited liability that a general partner incurs. Further, a limited partner may also be deemed a general partner in other circumstances as well. If, for example, a creditor can prove that the limited partner took action in the dealings of the company, then the partner may be deemed a general partner and thereby liable for such debts and obligations.
- A limited partner may lose his or her financial investment in the partnership.
What Is the Liability for Limited Partners?
A limited partner is in charge of contributing financially to the company, and in exchange, they get part of the profits of the partnership. The partner can't have obligations on the partnership's behalf or participate in daily management or operations. The limited partner might invest $100,000 in a partnership for real estate, but they still won't have a say in any company decisions. The partner can't be forced to pay off any debts of the company with their personal assets.
For example, if a partner owns a truck and it injures a person by accident, the injured party can go after the limited partner's business investment and the general partner's personal assets. Limited partners are also liable for any losses up to the amount of invested capital in addition to liability they assumed for part of the creation of the company.
LP Tax Treatment
The Internal Revenue Service (IRS) doesn't treat limited partners' shares of stock as earned income due to the fact that limited partners are not active in the daily operations of the business. But, the IRS does treat limited partnerships like general partnerships, and all partners must individually report and pay taxes on their share of profits since limited partners do not pay self-employment taxes.
Publicly Traded Partnership Overview
A publicly traded partnership, also referred to as master limited partnership, is a limited partnership managed by two or more general partners that can be individuals, corporations, other partnerships. The business itself is funded by limited partners who provide financial assistance but have no management role in the development and growth of the partnership. Another name for a publicly traded partnership is MLPs.
This type of partnership combines those tax benefits of a limited partnership with the liquidity of a publicly traded security. Due to certain limitations identified in the U.S. Code, publicly traded partnerships must operate in a specific type of business, i.e. petroleum or natural gas. To qualify as a publicly traded partnership, the partnership must generate at least 90 percent of its income from qualifying sources, which are determined by the IRS.
While there is no legal requirement to draft a written partnership agreement, you should still do so. If you fail to draft a written agreement, you risk potential legal issues in the future. You'll be forced to abide by the default rules in your state's partnership, which may not be favorable for you or your partner.
In addition, creating a partnership agreement will help you and your partner to discuss all aspects of the business, including the operation, accounting records, as well as any other issues that may arise in the development and growth of your partnership. With that being said, the agreement doesn't have to be lengthy or complex; it can be a rather simple one.
Differences Between a Partnership and an LLC
While a partnership is rather straightforward, there are unique qualities in establishing a limited liability company (LLC). While a partnership doesn't require any paperwork, aside from a written agreement between the parties, an LLC is required to file additional paperwork, which includes the articles of organization. This document must be filed with the respective state's Secretary of State or Department of Corporations. You must also comply with all other requirements for that particular state.
Another difference between a partnership and an LLC is that partners are personally liable to the business's debts whereas partners in a limited liability company cannot be held personally liable for the financial obligations of the LLC. Therefore, creditors cannot go after the partners' personal assets for those operating an LLC.
While there are key differences in a general partnership and an LLC, there is one similarity. Both types of entities offer pass-through taxation, which means that the owners will report business earnings and losses on their individual tax returns. The partnership and LLC do not pay taxes.
A subscription agreement is when an investor applies to have part of the limited partnership. It can also be used to sell various stock shares in a company that's private. All limited partners who are in a subscription agreement need to be first approved by the general partner. The potential new limited partner fills out a form that lists the investor's suitability for investing in this partnership.
All limited partners who are in a subscription agreement need to be first approved by the general partner. The potential new limited partner fills out a form that lists the investor's suitability for investing in this partnership. Private investors put their money in companies by filling out a subscription agreement. This is between the investor and issuing company which states the price of the shares and how many shares are sold.
What are the Guaranteed Payments To Partners?
These payments are made to partners no matter if a profit is made or not. They are still guaranteed in either case. The purpose of guaranteed payments is to make sure all partners are fairly compensated for certain contributions that are made to the partnership, whether this is in the form of services or goods. Having guaranteed payments to the partners takes out any risk of making a personal contribution of property or time which they won't be paid for if the partnership fails.
These payments are identical to the salary that partners get. Guaranteed payments tend to be subject to self-employment tax, depending on what the terms of payment are. These payments are regarded as distributions that are the first priority and get paid out even if the partnership is continuing to lose money.
Are There Special Rules for Running Partnerships?
Different from corporations, partnerships are business structures that are fairly informal. They don't have requirements to prepare minutes, issue stock certificates, hold meetings, or elect officers. Partners tend to share the partnership's management and profits and losses equally. They're also equivalently responsible for its liabilities and debts. These details are often stated in the partnership agreement.
Is a Written Partnership Agreement Required for Every Partnership?
There isn't any law that makes it mandatory for partners to form a written partnership agreement, but it's in your best interest to do so. If a partnership agreement isn't formed, you might run into the problem of the standard rules in the state's partnership laws governing your partnerships in certain ways that you and your partners will not like. Establishing a partnership agreement will also give your partners and yourself a time to go over the expectations you have of each other and how you all will participate in the company.
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