A limited partnership (LP) is a business with a minimum of one general partner (GP) and at least one limited partner (LP). Limited partners are considered silent partners because they invest in the company but don't serve any management role.
Setting up an LP requires some careful thought so that you do everything in a legal way that minimizes your risks.
Read the rest of this article to learn how to set up an LP correctly. We’ll feature the steps to follow, the benefits of LPs, mistakes to avoid, and more.
What Steps Should You Follow to Set Up an LP?
When establishing an LP, you’ll have to follow these guidelines.
- Register your LP in the most favorable state. This can be in your current location or other states that offer benefits, such as tax relief.
- Choose a name. You’ll have to come up with a name for your business, which will include “Limited” or “Ltd.”
- Draft a partnership agreement. You’ll include important information in this agreement to establish smooth operations and solid working relationships, such as every partner’s obligations and duties.
- File a certificate of limited partnership. Check guidelines for filing in your state, as the rules can vary in different locations.
- Receive an employer identification number (EIN). This enables you to file federal taxes. You can get your EIN on the IRS website.
- Organize licenses and permits for running your business. What you require will vary depending on the state in which you’re operating.
What are Benefits of Setting Up an LP?
There are specific advantages you can make use of by setting up an LP. These include the following:
- Taxation benefits. LPs can be exempt from tax because partners receive profits and then pay taxes on their own tax returns. This is called pass-through taxation.
- Ease of establishment. LPs can be formed for one project before being dissolved, providing flexibility.
- Limited liability. Limited partners will have reduced liability as they are only responsible for their investments in the business.
What’s the Difference Between Partnership Types?
There are general, limited, and limited liability partnerships to know about. Here is a basic definition of how they differ.
- General partnership : this is when all owners run and own the business, sharing in both the profits and losses.
- Limited partnership : this requires at least one general and one limited partner. They have different roles, such as that the general partner runs the business and has unlimited liability.
- Limited liability partnership : All partners in this setup have limited liability, based on what they invest in the business.
What Should Be Included in a LP Agreement?
An LP agreement is essential when forming the company as it will guide operations and prevent disputes. It should contain key aspects such as the following:
- Allocation of profits and losses. This section will clearly define how profits and losses will be distributed between members, such as by mentioning schedules and processes.
- Partner rights. The contract will specify what authority partners have when it comes to making decisions for the company.
- Transfer and exit terms. There should be rules for transfers, such as right of first refusal and buyout processes that partners should follow.
- Clarity on contributions. An LP agreement should specify what capital contributions have been made by each partner as well as how these were made, such as with cash or property.
- Dispute resolution. It’s essential to have plans in place should there be disagreements that can threaten working relationships or the LP as a whole. This could include alternative dispute-resolution methods, such as mediation or arbitration.
What Mistakes Should You Avoid When Forming a LP?
There are mistakes to avoid when setting up a LP, as they can have legal or financial consequences. These include the following.
Lacking a Clear Partnership Agreement
If your agreement isn’t clear and easy for all partners to understand, this could have consequences at a later stage. There could be disputes between partners or a misinterpretation of terms that affects business operations. For example, if duties and expectations aren’t clearly specified.
Not Filing Important Documents
When setting up an LP, you need to consider your state laws. If you don’t meet the correct deadlines for filing paperwork or your submissions lack important information, this could result in problems, such as penalties.
Lack of Compliance
You could encounter fines or legal issues if you don’t ensure that your LP meets all the general and industry laws, as well as securities laws. Check what’s required, such as renewing your registration at specific times and filing annually.
Not Planning Enough
If you’re rushing through setting up your LP, you could have ignored important planning. The result is that you might wind up with unclear goals or not identify partner duties effectively, resulting in problems and lack of revenue.
Should You Hire a Lawyer for LP Formation?
It’s advisable to hire a lawyer when you want to create an LP. This is because, although the process can be simple, there could be aspects of the process you’re unaware of but which could land you in financial or legal trouble.
Here is how a lawyer will assist you.
- They’ll consider your situation so you can see if an LP or different type of partnership is best for you.
- They’ll draft an agreement that’s legal and enforceable, while being fair to all parties concerned. They will avoid any vague or generic language that can cause the contract to have loopholes or red flags.
- They’ll guide you on complex legal compliance issues and rules, such as concerning securities law.
- They’ll coordinate with other professionals, such as tax advisors, to prioritize your interests.
Do you need to hire a lawyer for help with setting up a LP partnership?
You can hire a lawyer from ContractsCounsel, an online legal network for clients to hire vetted, experienced lawyers. They have years of experience in assisting clients to form LPs and draft LP agreements so that they are legally compliant, fair to all partners, and filled with clarity to guide business operations.
