As the oldest business organization in the world, you might think that a general partnership is the best type of organization to choose, but actually, this couldn’t be further from the truth. Without the right insight and skill (and a degree of luck), your organization could fall prey to a whole host of traps with the potential to cause financial ruin for everyone involved.
With this in mind, a Limited Partnership is by far the safer option for protecting investors. However, you might be puzzled as to why a limited partnership law was developed to protect investors, and be keen to know how to avoid being considered a general partnership:
What is a general partnership?
Formed through implied conduct, a general partnership is when two or more individuals agree to engage in business, working towards a common goal. Whenever two or more people opt not to file a limited liability business entity before going into business together, a general partnership becomes the applied default, and at this pre-incorporation stage, liability is known as ‘promoter liability’.
With partners liable not just for their own actions, but for those of their business partner, general partnerships really are fraught with liability risks, and each partner is authorized to make and enforce legally binding decisions on behalf of the general partnership, sharing all profits and losses equally by default.
Irrespective of whether a liability agreement has been put into place by both sets of partners, liabilities against partners remain ‘joint and several’, meaning that a 1% partner can be subjected personally to liens and asset attachments for 100% of the general partnership liability. Only once/if the creditor is paid, is the 1% partner able to collect proportionate shares of liability from their partners, to recover their losses of 99%.
What is a limited partnership?
The responsibilities of one or more of the silent investment partners are limited in a limited partnership, making them limited partners who do not get involved with the businesses day-to-day activities. Additionally, their investment in the company is also limited, different to a general partner in a limited partnership, who is the manager and holds onto unlimited personal liability beyond their own investments within the business.
Nowadays, many limited partnerships use a separate corporation or LLC as the general partner to address the unlimited liability of a general partner. Limiting liability for the general partner, the dual entity structure is often used in real estate investments and private equity, with the term ‘master limited partnership’ used when the limited partnership is big enough and solicits institutional investors.
Why should you form a Limited Partnership?
General partnerships are best not used by entrepreneurs and small investment businesses, as the potential risks of unlimited personal liability could lead to bankruptcy. Forming a limited partnership with an LLC setup to serve as its general partner, is a far safer structure to form. In this way, an LLC affords everyone included by default, liability protection, without the need to form a separate entity for the manager.
It’s important to think long and hard about the type of entity you choose to form, and professional guidance is recommended, so that you can get it right and avoid costly risks, right from the get-go.