A limited partnership investment is a common agreement in the business world, particularly in the real estate industry. While the name seems fairly straightforward, certain parts of it need further clarification. Knowing all the nuances is an important step in determining whether it is an appropriate strategy for your company.
What Is a Partnership?
Simply put, a partnership in the business world is an agreement between two or more parties who share the common goal of managing and operating a business. Like virtually every other aspect of the business world, there are different varieties of partnership agreements. These include the general partnership, limited liability partnership and limited liability company. All these variations have a place in the business world and involve different roles as well as different rules and regulations.
What Is a Limited Partnership?
First, let’s break down the phrase to help us fully understand the LPS meaning in finance. A limited partnership (commonly abbreviated as LP — not to be confused with Limited Liability Protection) is a partnership involving two or more partners. But as the name implies, these partners do not have equal stature; the general partner is the party that runs the show, whereas the limited partners are not involved in that aspect of the business. A partner (either a general partner or a limited partner) may be an individual or a business entity, such as a corporation.
A lot of this boils down to finances. In the big picture, the general partner has a far larger liability exposure, as it usually has unlimited liability for any business debts; a limited partner only has liability equal to its investment in the business. That’s where the name “limited partnerships” comes in.
With that greater exposure to risk, the general partner has far more control of matters in the company, but both share in the profits of the partnership and both are considered owners. In some instances, a limited partner is referred to as a “silent partner.”
Where Does the “Investment” Part Come In?
- A limited partner becomes involved in the business by making an investment in the company, usually with cash, but in some cases with other capital. Private equity investments are often used in these scenarios.
- Limited partners have invested capital of some sort into the company. Any income earned by the silent partner is classified as passive income by the IRS (similar to dividend-yielding stocks).
- A limited partner doesn’t pay self-employment taxes on any income earned through the business; however, there are some tax regulations for limited partners who have lost money in the business.
However, you must remember that different states have different regulations about the power of voting, so there aren’t across-the-board rules about a limited partner’s ability to vote on certain matters, such as removing general partners, terminating the partnership agreement or selling any company assets.
What Are the Advantages of a Limited Partnership Investment?
Understanding the management fee structure and internal rate of return expectations for your investment is crucial to making informed decisions in this type of partnership.The advantages of a limited partnership agreement are numerous and include the following:
- Asset protection. Personal assets of the limited partner are limited to the investment in the company.
- Tax incentives. There are tax incentives that encourage these types of partnerships.
- Return on investment. In commercial real estate, there is a potential for passive income in perpetuity.
- Estate planning. Limited partnership investments have advantages for heirs who continue to receive income from the partnership.
- Ownership. The general partner controls 100% of the entity and its assets, providing LP investors with valuable insight into the company’s operations.
What Type of Company Would Consider a Limited Partnership Investment?
In most instances, limited partnership investments are used in real estate. An example of this is the creation of a new apartment building, with the goal of leasing the units to tenants. The general partner would be the overseer of the project, managing the construction and dealing with all the items that are necessary, such as zoning, leasing and maintaining the property once the initial construction phase is completed. The limited partner is the investor who infused capital into the project and will share in the profits of the venture according to the original partnership agreement. This works out perfectly for both parties.
To sum it all up:
- The general partner, who holds expertise in the industry, is the one responsible for the nuts and bolts of the business and handles all the day-to-day aspects of keeping the machine running.
- The limited partner deals with none of that, simply providing an investment to (hopefully) receive a share of the profits as stipulated in the partnership agreement.
Any liability for the partnership falls squarely on the general partner, as the limited partner’s liability extends only to the amount of capital originally invested.
What Else Is Required for an LPS Investment?
Needless to say, forming a partnership of any kind requires knowing the business and the laws surrounding it, so there will be plenty of legal (and, quite frankly, confidential) documents necessary for the process. Because forming a partnership takes resources (namely time and money), using a virtual data room (VDR) for the formation of the partnership is vital. A VDR is a secure online location, easily accessible to the appropriate parties, where all participants can store and share the required documentation.
Where CapLinked Comes Into the Picture
CapLinked, a provider of VDRs, is a trusted partner to anyone looking to form a limited partnership. The tools that CapLinked provides with its VDRs include high-level admin controls, document and version management, multiple layers of security and 24/7 customer support. Its user-friendly interface and ability to work on virtually every type of computer or internet-connected device make CapLinked the best choice for anyone dealing with an LPS investment. Contact CapLinked today for a free trial of a VDR solution that will help streamline the entire partnership process.
Chris Capelle is a technology expert, writer and instructor. For over 25 years, he has worked in the publishing, advertising and consumer products industries.
Sources
Investopedia — Limited Partnership (LP)
The Balance — A New Investor’s Guide to Limited Partnerships
CrowdStreet — Limited Partner
NerdWallet — Limited Partnership: What Is a Limited Partnership, and How to Form One
