A limited partnership (LP) is a type of business partnership that has two types of partners — general and limited — and there are different liabilities for the two.

In order to qualify as an LP, a business has to have at least one general partner and one limited partner.

General partners in an LP are personally liable for the business. Because the general partner of a business can be a person or entity, many people choose to set up an LLC to act as the general partner, thereby avoiding personal liability. General partners are also involved the actual running of the business.

Limited partners, on the other hand, aren’t personally liable. Limited partners can’t contribute to the day-to-day operation of the business — their involvement is strictly monetary. In fact, if they’re found to be trying to influence how the business is run, they can be stripped of their protections and also held personally liable.

When it comes to taxes, LPs avoid the double taxation that some types of corporations are subject to. General partners pay self employment tax, while limited partners don’t pay self employment tax because they don’t actually run the business and therefore get their share of profits in dividends.

How do you set up an LP?

The process for setting up an LP differs from state to state but you’ll likely have to submit documents and a fee. Additionally, many states ask for annual reports that included updated information about the

LP. Here’s a general overview of what it takes to set up an LP.

1. Choose a name

Pick a name and make sure it’s not already taken by a business in your state.

2. Create a Limited Partnership Agreement

While not all states require a Limited Partnership Agreement, it’s a good idea to draft one up regardless. Your Limited Partnership Agreement needs to cover:

Profit sharing
Loss distribution
Asset distribution
Participation rights
Distribution prevention
Buyout agreement
Asset appraisal
Expulsion or addition of partners

3. Designate a registered agent

Who’s going to be in charge of all the legal documents once you’re incorporated?

That’s your registered agent and the government is probably going to want to know that name. Your registered agent has to have a physical address within the state where you’re registering.

Because they’re in charge of getting all the legal documents, most companies choose to name their lawyer as their registered agent.

4. File a Certificate of Limited Partnership

Regardless of whether or not your state requires a Limited Partnership Agreement, they’re definitely going to require a certificate of limited partnership.

5. Register for an Employer Identification Number (EIN)

The Employer Identification Number (EIN) is the number the government uses to identify you for tax purposes.

Think of it like your company’s Social Security Number. You’ll need it for everything money related — from opening bank accounts to paying your employees.

You can file an IRS Form SS-4 or apply via the IRS’ online application for an EIN.

6. Get a state ID number

In addition to an EIN, some states want you to have a state ID number. If that’s a thing your state requires, you can check in with state Department of Revenue for more info.

7. Get all your licenses and permits

What kinds of licenses and permits does your brand new LP need? Do you need an occupational license? Trade licenses? Zoning permits? Health permits?

You may know off the top of your head or you may need to consult the Small Business Association (SBA) database of federal and state business licenses. Another good resource is your local City Hall.

Advantages of LPs

1. Limited partners are not liable

In an LP, limited partners are not personally liable if anything goes wrong with the company.

2. No double taxation

Unlike some other types of business entities (notably, C corps), LPs aren’t subject to double taxation.

In a partnership, the profits are taxed solely on the partners’ personal tax returns. In some other types of business formations, the profits are taxed first as corporate income tax and then the shareholders’ dividends are taxed on their personal tax returns.

3. Less paperwork

LPs have significantly less paperwork than corporations.

4. More capital, without loss of control

In an LP, you can add on more limited partners in order to raise more capital, without losing control of the business. (Because limited partners can’t get involved in running the business, remember?)

5. You don’t need a lawyer

While some other types of business entities absolutely require a lawyer for formation, you don’t need one to set up an LP. Obviously it’s a good idea to bone up on all the facts before becoming an LP, but it’s nice to know you can avoid that extra cost!

##Disadvantages of LPs

1. General partners are liable

While limited partners aren’t liable in an LP, general partners are. That means their personal assets may be forfeitted if anything happens to the company.

2. Shares can’t be traded publicly

An LP can’t publicly trade their shares. While this might be fine for some companies, going public is a popular way for successful startups to give their investors a return on their investments.

If your trajectory for your startup includes an IPO, an LP is not the right business formation for you.

3. Limited partners can’t participate

The “limited” in “limited partners” refers to the fact that partners are limited from participating in the daily running of the business.

If they do try to interfere, they can be converted to general partners — and held personally liable. So you have to be willing to take a hands-off approach if you’re going to be a limited partner in an LP.

LP versus other types of business entities

LP vs. LLP

LLPs and LPs are very similar, with a few key differences.

While an LLP provides limited liability protection to all of its partners, a limited partnership (LP) is a type of business partnership that has two types of partners — general and limited — and there are different liabilities for the two.

General partners can be held personally liable, while limited partners cannot.

Both LLPs and LPs avoid double taxation.

LP vs. LLC

LLC means “limited liability corporation,” which is a type of business structure that creates a legal entity for the business separate from the business owner(s) — meaning the owner(s) are usually not personally liable for the company’s debts or lawsuits.

Other common business entity structures such as corporation, general partnership, or sole proprietorship do not offer the same protections — but, as you now know, LPs do. At least for limited partners.

While LPs have to have at least two partners — one general and one limited — LLCs can be sole proprietorships.

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