Limited partnership
General Definition
A partnership is one of several forms of business ownership. It involves two or more people, more specifically known as partners (Essentials of Corporate Finance). A limited partnership involves general and limited partners. General partners are typically involved in the management of the business organization. General partners also assume all legal debts and obligations (investorwords.com). On the other hand, limited partners have limited liability. That is, limited partners are only financially responsible up to the amount they have contributed to, or invested in the business. While general partners are actively involved in management activities, limited partners generally are not. However, if stipulated in the Partnership Agreement, limited partners may take on a more active management role. (Strategic Partnerships: An Entrepreneur’s Guide to Joint Ventures and Alliances, page 161)
Basic Rights of Partners
Partners are guaranteed certain, basic rights. Each is listed and explained below:
1. “Accounting on Demand.” Each partner has the right to view all financial information that is relevant to the partnership.
2. “Use of Partnership Property.” All partnership property must be available to all partners, in order to carry out everyday business functions.
3. “Inspection of Books and Records.” All significant records and documents must be available at any time for review to ensure full disclosure between partners.
4. “Participation in Management.” All general partners fully participate in the management of the business.
5. “Adding New Partners.” The addition of a new partner must be agreed upon by all existing partners. Approval should be unanimous.
6. “Sharing Profits and Losses.” Profits should be distributed, and losses absorbed, based upon the agreed percentage of ownership. This is specified in the Partnership Agreement.
7. “Return of Capital.” In the event that the business in terminated, each partner has the right to be repaid their capital contribution, as long as business liabilities are covered and paid for.
8. “Return of Advances.” A general partner may make loans to the business. This loan can be treated like a “regular loan from a traditional lending service.” The lending partner essentially becomes a creditor.
9. “Indemnification.” Partners have the responsibility to “protect” each other. (Strategic Partnerships, pages 160 – 161)
General partners are fully guaranteed these basic rights. For the most part, limited partners are guaranteed these rights as well. However, certain stipulations do apply. For example, while limited partners have the right to view all pertinent financial documents, they must give general partners 10 days notice. Documents must then be reviewed at the place of business, during regular business hours, as stated in the Uniform Limited Partnership Act of 2001.
The Uniform Limited Partnership Act
The Uniform Limited Partnership Act (ULPA) was originally drafted by the National Conference of Commissioners on Uniform State Laws in 1916 to ensure uniformity of business partnerships in all US states. In an explanatory note, the ULPA states “that men in business often desire to secure capital from others.” It continues in saying, “a man may now lend money to a partnership and take share in the profits in lieu of interest without running serious danger of becoming bound for partnership obligations.” (Uniform Limited Partnership Act 1916)
The ULPA was revised in 1976 and 1985. However, the most recent revision occurred in 2001 to accommodate “changes in modern business practices.” The ULPA of 2001, similar to the original Act, established the framework for the organization of limited partnerships, identified the rights and obligations of general and limited partners, and declared proper procedures for the creation of limited partnerships in different states. What truly differentiates this Act from its predecessors is that “this Act assumes that people utilizing it will want both strong centralized, entrenched management, and passive investors or limited partners with little capacity to exit the entity.” (Uniform Law Commissioners).
The History of Limited Partnerships
“The business reason for the adoption of acts making provisions for limited or special partners is that men in business often desire to secure capital from others… One of the causes forcing business into the corporate form, in spite of the fact that the corporate form is ill suited to many business conditions, is the failure of the existing limited partnership acts to meet the desire of the owners of a business to secure necessary capital under the existing limited partnership form of business association.”
This portion of the Uniform Limited Partnership Act of 1916 is located under its “Explanatory Note.” It suggests that prior to the Act’s creation, businessmen felt compelled to incorporate if they wished to expand their capital. While incorporating does expand capital, the business owner forfeits his authority to manage the business. Therefore, limited partnerships were created so these business owners could acquire capital from investors, or limited partners, without sacrificing their right to directly manage their business operations.
The Limited Partnership Agreement
Although the ULPA has evolved, each requires the partners to draft a Limited Partnership Agreement. This typically requires the partners to hire a 3rd party legal professional to negotiate the terms of and structure the agreement (Joint Ventures and Corporate Partnerships, page 32). The Limited Partnership Agreement includes:
1. Formation – Includes the state in which the partnership will be established
2. Names and Place of Business – Identifies the name of the business, its primary location, and the names and addresses of the general partners
3. Term of Partnership – Establishes the intended end of the life of the business. If a date is not specified, according the 2001 ULPA, the partnership is considered a perpetual entity.
4. Contributions of Capital – Includes the amount of capital invested by each partner and states that each partner is “personally liable” for the amount of his or her investment.
5. Profits and Losses – Describes the allocation of profits and absorption of losses for each partner.
6. Ownership of Partnership Property – States that all property “acquired by the partnership shall be owned by the partnership.”
7. Fiscal Matters – Requires that the partnership maintain relevant financial information, including income tax returns, on an annual basis. This section further established the accounting methods the partnership intends to utilize.
8. Management of Partnership Affairs – States that general partners have “sole and exclusive control of the limited partnership.”
9. Liabilities – Describes the general partner’s liability as “unrestricted” while the liability of the limited partners is “restricted and limited to the amount” of capital investments made to the partnership.
10. Prohibited Transactions – Forbids both limited and general partners from engaging in activities “with the intention of harming the business operations” including, but not limited to: the wrongful use or disposal of partnership property or assets, the admission of “business practices” to a “non-partner,” and doing anything in conflict with the Partnership Agreement, unless approved by all partners.
11. Restrictions on Transfers – Includes the prohibition of limited partners from removing themselves from the business without permission from the general partners.
12. Termination of the Partnership - States that the inability of a general partner, whether willful or otherwise, will terminate the partnership. On the other hand, the partnership will continue should the limited partner meet the same conditions.
13. Representations and Warranties of Limited Partners – Likely for legal purposes, this sections makes limited partners declare their knowledge of any relative laws and that they are familiar with the nature of the business in which they are investing in.
14. Compensation of General Partners – Upon the “ultimate sale of the partnership’s property,” this section stipulates the minimum percentage owed to general partners.
15. Limited Partners’ Right to Sell Partnership Property – Allows limited partners owning a minimum set percentage of interest (which is negotiated and specified in this section) to make the general partners sell partnership property.
16. Miscellaneous Provisions – This section provides the necessary criteria for any future modifications of the Partnership Agreement.
All terms must be agreed upon by all general and limited partners, and are subject to negotiation. Once the conditions are approved, all partners sign and date the contract. (www.worldlawdirect.com)
Distinction Between Limited Partnership and Limited Liability Partnership
Limited Liability Partnerships, also known as LLPs, contain some fundamental components of partnerships and corporations. The partners involved are considered to be investors, and each has some type of limited liability (wikipedia). The true distinction between a limited partnership and a limited liability partnership is derived from partners' liability and management obligations.
Recall that Limited Partnerships have general partners and limited partners. General partners have unlimited liability and are actively involved in managment, while limited partners' liability is to the extent of their individual investments into the business, and generally do not take an active management role. Alternatively, all partners in Limited Liability Partnerships are only liable up to the amount they have contributed to the business. Concurrently, all partners take on an active managment role. (wikipedia)
Because of its structure, LLPs are well suited for investors who desire a more direct role in supervising the business (Free Advice). LLPs are quite popular among certain business professionals, such as accountants, lawyers, and doctors. This form of business protects these professionals from issues of negligence, malpractice, or the misconduct of one or more partners. Similar to a Limited Partnership, LLPs require a partnership agreement stipulating the allocation of income, losses, and gains. (Lawyers.com).