When two or more people join together to operate a business, they often choose a limited partnership as their legal structure. While it is fairly simple process to start a limited partnership, provisions regarding liability can sometimes pose major challenges to shareholders. Whoever enters into a limited partnership doesn’t just take over a part of the management duties, they also become...What is a limited partnership?
Establishing a limited partnership: liability, costs, and more
Particularly when it comes to operating a trading company, there are many benefits to forming a limited partnership. With this legal form, capital providers can be integrated into a project as limited partners without participating directly in the business. They normally do not have a voice (unless there are corresponding regulations in the articles of association), so that general partners can focus on running the business undisturbed. So, how do you set up a limited partnership? What should shareholders bear in mind in terms of tasks, costs, and liability?
How to form a limited partnership
The legal structure of a limited partnership is outlined in the Uniform Limited Partnership Act 2001. Limited partnerships are comprised of limited (silent) partners and general partners. Limited partners are only responsible for contributing capital towards the enterprise and are only liable for debts up to that amount. On the other hand, general partners are liable with their entire assets, but are fully responsible for running the company. In this regard, a limited partnership can be seen as a hybrid between a partnership and corporation.
This means that the formation of a limited partnership requires at least two partners – one limited partner and one general partner. These can be natural or legal persons, as well as other partnerships. There is no upper limit to the number of shareholders.
One of the advantages of a limited partnership is that there are only a few requirements for its formation. For example, there is no minimum capital requirement – neither for the formation itself, nor for the individual shareholders. In principle, there is also freedom to choose the company name. Personal names can be used, as well as factual or fantasy names. A combination of these components is permitted. Make sure, however, that your company also appears in business operations under the name registered when the limited partnership was founded.
If you choose a name for your limited partnership you should check its availability. To do this, just check with the Secretary of State in the state where your business is located. It may also be worth checking the search trademark database. If you don’t want to take the trouble yourself, you can hire an external service provider to assist with business name verification.
Forming a limited partnership: an overview of the steps required
Once you have found a suitable name for your limited partnership, and the roles of limited partners and general partners have been distributed, you are ready to start setting it up. The first step is to draw up a partnership agreement, which describes in detail the structures and powers, rights and obligations of the shareholders involved. Once the contract has been finalized, you can then go register your business with your Secretary of State. Once you have received your founding documents from the Secretary of State, you can register with the Internal Revenue Service (IRS) and receive a Tax Identification Number (TIN) or an Employer Identification Number (EIN). This will allow you to begin financial operations.
Drafting a partnership agreement
The basic components of rights, obligations, and areas of responsibility in a limited partnership are regulated in your local states partnership legislation. The partnership agreement is the decisive means for determining all areas in which your limited partnership may choose to deviate from the legal basis. Before drawing up the contract, you and your partners should first ask yourself the following questions:
- Is a limited partnership the right legal form for your planned business?
- What exactly is the purpose of the company?
- Which business goals do you want to pursue?
- Where should the company’s registered office be?
- How much start-up capital do you need?
Once these basic requirements have been clarified, you can draw up a memorandum and articles of association, which are not bound by any formal requirements. However, it is always advisable to include a written contract. The contract should at least define the common business purpose, the company name and registered office, the names of general and limited partners, as well as the amount of their respective capital contributions. Further points you should include are:
- Regulations on management and voting rights
- Powers of representation
- Regulations in the event of withdrawal and termination of shareholders
- Determination of withdrawal rights
- Profit and loss participation
- Conciliation clause (mediation in case of disagreement)
The articles of association must be signed by all shareholders.
Do not be afraid to seek legal advice if there are any ambiguities in the articles of association’s wording. This applies in particular if you are unsure whether the articles of association are complete and cover all the important points like liability, management, and profit sharing to your satisfaction.
Registering with the Secretary of State
Those who wish to form a limited partnership are obliged to register their business with their local Secretary of State. Forms and requirements for the registration process vary from state to state. In the state of California, for example, you are required to fill out Form LP-1 Certificate of Limited Partnership for domestic limited partnerships, or Form LP-5 Application for Registration of Foreign Limited Partnership. The California Secretary of State office also charges a $70 filing fee for any applicable general documents, and additional charges for copies.
The registration form must include the limited partnership’s name (which must end in “Limited Partnership” or “LP”), an address for the company’s office, their legal agent, the name and address of each general partner, and the signatures of all partners. However, Secretary of State regulations vary from state to state, so it is important to check with your local office as their filing requirements may be different.
Registering with the IRS
If you set up a limited partnership, you need to register with the IRS to receive your Tax Identification Number (TIN) or an Employer Identification Number (EIN). You will also be liable for taxes to the IRS. Limited partnerships are required to file for annual income returns, employment taxes, and excise taxes. More information on the relevant taxes and the relevant forms are available on the IRS website.
Founding a limited partnership: the shareholders
After you have successfully formed your limited partnership and registered it with all the relevant authorities, you can now officially begin business operations! Limited partners are excluded from this by default. They only have a say in transactions and decisions that go beyond the actual purpose of the company. Their participation in the limited partnership only goes as far as what is contractually agreed upon – usually as financial investors. Limited partners are liable for debts incurred to the value of their capital contributions. General partners are liable with the full extent of their assets.
The articles of association can also provide limited partners with executive powers. However, their role is limited to that of a silent representative rather than one who can engage with business matters in the company. A separate power of attorney is required if limited partners wish to engage with the business and be agreed upon by the general partners.
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