Difference Between General and Limited Partnership

Edited by Diffzy | Updated on: September 28, 2023

       

Difference Between General and Limited Partnership

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Introduction

When two or more people enter into a formal arrangement it is called a partnership. In this partnership, the parties involved manage the business assets and liabilities and also share their profits. The parties usually involved are governments, nonprofit organizations, and private individuals and their objectives also vary. The share of profits also depends on the percentage owned by each member of the business, which can vary depending on the type of partnership arrangements agreed upon during the meeting and depending on how the profits are shared.

General Partnership vs. Limited Partnership

In a general partnership, the parties involved share the profits, losses, and assets of the company equally unless stated otherwise during the formulation of the partnership. Meanwhile, in a limited partnership, the parties involved have at least one general member who has unlimited liability, and the rest of the partners have limited liability up to the amount of their investment in the company.

Difference Between General Partnership and Limited Partnership in Tabular Form

Basis of ComparisonGeneral PartnershipLimited Partnership
Control/ManagementFull ControlMinimal to no control
Profit and Loss SharingEqualAs stated in the agreement
Personal LiabilityUnlimitedLimited
Agency PowersHaveDon’t have
StructureSimpleMore complex
OwnershipEqualAs listed on the agreement

What is a General Partnership?

General Partnership is the most common form of business partnership, It comes to fruition when two or more members make a formal agreement to share the company’s assets, profits, losses, financial risks, and the financial responsibilities that come with it. As with other forms of partnerships, the liabilities are not capped which means that the members have unlimited liability. Each partner is held liable for their actions, they are responsible for business debts and can be sued for the same.

One of the main features of a general partnership is the shared responsibilities and decision-making powers that each individual holds, as opposed to other forms of partnership where all the decision-making power is held by an individual or a group of individuals. General Partnership is relatively easy to form because of its simplicity and tax benefits. All it requires is to have a verbal agreement between the interested members without filing much paperwork, and taxes are taxed personally on each member, not the partnership itself.

Since in a general partnership the operations and managerial decisions are not made by one person or a group of people but by all parties as a whole, it gives the parties more flexibility as to how they would want the business to run as they see fit. Giving the parties involved direct control over decision-making leads to faster and quicker management decisions, eliminating the process of going through long formalities and implementations of new ideas.

Elements of a General Partnership

Agreement

Even though an oral agreement is enough to form a general partnership, it is usually advised to have a formal written agreement. In the agreement, the involved parties should discuss details such as the responsibilities of each member involved, how to share the profits, and what should happen if a partner is unable to function due to reasons like death, leave, etc. After all, this is discussed, and only then all the parties are to sign the written agreement.

Decision Making

In a general partnership, each member has full freedom to make their own decisions and can also enter into various deals with other businesses. As stated before, this brings about a quicker way to implement new ideas and quicker management decisions, but it can also backfire as any deal entered by a member, all the other members are also bound by it. This can lead to disagreements among the party members, so to avoid situations like this, all the members usually have a meeting to discuss and vote before making any major decisions.

Management

Usually during the formation of the partnership, the members involved will have already created an agreement that addresses other details, and among them, the ones discussed are the topic of management and control.

But if there is no agreement in the partnership that lays down how the partnership should be managed and who should manage it, it can follow the instructions in the Revised Uniform Partnership Act (RUPA), which most states have adopted. This act provides a standard of governance for partnership. It defines:

  • How a partnership is created
  • The rights and duties of partners
  • Partnership assets and liabilities
  • Fiduciary duties of partners and the partnership
  • Profit allocations and voting rights

Partnership Duties

All the members must work in the best interest of the company and are obliged in their agreement to disclose any information that involves the partnership. Below are some of the main duties of a partner

  • Partners must act honestly in all dealings involving the company and not get into any deals that would harm the partnership.
  • Partners are to disclose all information to each other and not hide any information regarding dealings that would harm the partnership.
  • Partners are to act with the utmost care when managing the company's affairs.

Advantages and Disadvantages of a General Partnership

Advantages

  • A general partnership can be created verbally between two or more members, but it is always advised to have a written agreement, and with no startup cost, it is less expensive and easier to set it up.
  • General Partnership is a pass-through entity for taxation, meaning the members will be taxed for their ordinary and not business income in that way, the members avoid double taxation.
  • A general partnership can be dissolved anytime, and it is an easy and short process.
  • No such annual reports are required in this partnership.
  • A general partnership has a simple operating structure; each partner's roles in managing the business operations have already been discussed during its formation.

Disadvantages

  • All the members' liability is unlimited, which means that all members can have their assets seized to pay their debts.
  • Partners are liable for the actions of each other meaning the partners must deal with the consequences of each other’s decision.
  • If not already properly agreed in the partnership agreement, in the future discord among members will be harder to address.

What is a Limited Partnership?

A Limited Partnership is a partnership made up of two or more members. A limited partnership is required to have a general partner and limited partners, a general partner is the one who makes decisions and manages the operations of the business, and the limited partners do not take part in the affairs of the business. The general partner has unlimited liability for debts while the limited partners have liability in accordance to the amount of their investment.

In a limited partnership, a return on investment is provided to the limited partners where the nature and extent of it are already defined during the process of a partnership agreement. The general partner is more exposed to economic risk than limited partners, which leads to the general partner being personally liable in case of any financial loss. Also, a limited partner can probably become liable for the expenses caused by their actions. For a partnership to be created a limited partner must be registered with the appropriate state agency and the limited partners have flexibility in drafting due to being governed by the partnership agreement. A limited partner can leave the partnership in most jurisdictions with the approval of other partners.

Formation of a Limited Partnership

Choose a state to be registered in

It is crucial to identify what state to be registered in since all states have their laws and have different requirements for the formation of a limited partnership. Some states also offer different advantages as compared to other states.

Registration in the identified state

The next step after deciding on what state to be registered in is filing with a state agency and paying the filing fees. Also, most states would make it a requirement to add “LP” or “Limited Partnership” in the business name.

Write up a limited partnership agreement

Creating a legal partnership agreement, also called an operating agreement, will create roles for each partner and establish the partnership's name, how the profits and losses are to be allocated, and what to do when someone wants to sell their stake in the partnership.

Obtaining permits and license

The final step after creating a legal partnership document is to obtain the proper permits and licenses to operate the business legally, which will vary depending on the state the partnership is registered in.

Advantages and Disadvantages of a Limited Partnership

Advantages

  • A huge amount of capital can be acquired without having to share ownership of the business because the major decisions and managerial operations are managed by the general partner.
  • Even if the limited partners cannot make major decisions in the workings of the business, they can still give suggestions and provide mentorship, in that way, you get access to the limited partner's skills and also their financial resources.
  • Limited partnership is considered a pass-through entity for taxation meaning they pay tax on their ordinary income and not business income, in that way they avoid double taxation.
  • The financial liability of the limited partners is limited to their invested amount, so they don’t have to worry about any liability that extends over their initial investment. This notably reduces the risks of investing in the business, so this option is great for investors who are okay with minimal control over the day-to-day operations in exchange for extra financial security.

Disadvantages

  • A longer formulation process and more paperwork are required.
  • Limited partnerships require the general partners to have unlimited liability because they are fully responsible for the management of the business and are usually the ones in trouble for any debts or mishandling of business dealings. Also, the limited partners are only allowed minimal involvement in the operations of the business, so if they overstep their boundaries and their role is deemed too active, they lose personal liability protection.
  • If the company incurs losses, this may lead to discord among the partners, and this will lead to some serious disputes, which can even break the partnership.

Main Difference Between General Partnership and Limited Partnership in Points

  • A general partnership is easier to form since only a verbal agreement is required and does not involve much paperwork compared to a limited partnership which comparatively has a longer formulation process and much more paperwork.
  • In a general partnership, all the members have unlimited liability, while in a limited partnership, there is a general partner who is the only one with unlimited liability, the rest of the members have a limited liability equaling the amount invested.
  • In a limited partnership, the limited members share the losses only to the extent of their amount invested meanwhile in a general partnership, the general partner has unlimited liability meaning a general partner’s assets can be used to pay off the business’s debts.
  • In a general partnership, all the members have the same power when it comes to making managerial decisions for the business but in a limited partnership the decision-making power is held by only the general partner, and limited members don’t have much power in the decision-making department.

Conclusion

A general partnership and a limited partnership are very similar in many aspects but at the same time, each of them has their differences which separates both of them. A general partnership is easier to form with only verbal agreement needed, and all the members will have equal power to manage day-to-day operations and will have unlimited liability, on the other hand limited partnership is usually formed to pool in huge capital from investors without giving up ownership and control of the business. So when contemplating what partnership to form one must usually go through what partnership structure will help them achieve their goals and ask themselves questions like will the partners be involved in daily operations or will they be investors only? Are the partners willing to be liable personally for the business and each other’s actions? How many partners to include? All these questions will be important when considering how to organize a partnership and composing partnership agreements.

References

  • teammarquee, "The Difference Between Limited Partner vs General Partner," 15 December 2021. [Online]. Available: https://marquee-equity.com/blog/limited-partner-vs-general-partner/.
  • A. Bloomenthal, "General Partnerships: Definition, Features, and Example," 14 August 2023. [Online]. Available: https://www.investopedia.com/terms/g/generalpartnership.asp.
  • Wikipedia. [Online]. Available: https://en.wikipedia.org/wiki/Limited_partnership.
  • W. D. Team, "Limited Partnership," March 2022. [Online]. Available: https://www.law.cornell.edu/wex/limited_partnership.
  • E. Tarver, "Limited Partnership: What It Is, Pros and Cons, How to Form One," 5 September 2022. [Online]. Available: https://www.investopedia.com/terms/l/limitedpartnership.asp#toc-lp-vs-llc.

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"Difference Between General and Limited Partnership." Diffzy.com, 2024. Sun. 14 Apr. 2024. <https://www.diffzy.com/article/difference-between-general-and-limited-partnership>.



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