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The Small Business Partnership: General and Limited Partnerships

Two people shaking hands.

In a business partnership, two or more parties join to go into business for profit. The partners share in the business losses and profits that they earn.

There are several different types of partnerships with various advantages and disadvantages. The business structure you choose will depend on your business preferences and your need for liability protection.

Types of Partnerships

The names of the different forms of partnerships are similar, but they should not be confused. They offer very different liability protections and other benefits. The rules and filing requirements also vary by state.

You should check your state's laws or consult a local business attorney to see what partnerships are available to you. To understand partnerships, it helps first to understand general and limited partners.

General Versus Limited Partners

A general partner manages the day-to-day operations of the business. They have authority and are responsible for the company.

General partnerships, LLPs, and LLLPs all have general partners. Being a general partner usually comes with a risk of personal financial liability.

A limited partner is a silent partner. Their primary role is that of investor, and they do not get involved in everyday business decisions. Investors might want to be limited partners to shield their personal assets from business liabilities. LPs and LLLPs both have limited partners.

General Partnership

General partnerships are common because they are the most accessible type of partnership to form. They do not require registration or a lot of paperwork. But all partnerships benefit from having a partnership agreement in place.

In a general partnership, partners are all personally liable for the business's obligations. So, your personal assets could be at risk if someone sues your general partnership. This is one of the significant drawbacks of the general partnership business structure.

You should only go into a general partnership if you have a trusting business relationship with your partners. You could be liable for their mistakes and poor business decisions, so you should choose your general partners with care.

Several other types of partnerships offer limited liability for partners.

Limited Partnership

A limited partnership (LP) has two types of partners: general and limited partners. The limited partners invest in the business, but they are silent business partners. They do not manage the business or get involved in its day-to-day business operations. Limited partners in an LP have the advantage of limited liability. Limited partners are only responsible for the business's liabilities up to the amount of money they invested.

The general partners in an LP have unlimited liability. So, if someone sues the business or tries to collect on its debts, the general partners' personal assets can be at risk.

Limited partners should be careful not to begin managing the day-to-day business activities. If they do, their personal assets could be at risk too.

Limited Liability Partnership

limited liability partnership (LLP) is not the same thing as an LP. LPs must have a general partner who has unlimited personal liability. But in an LLP, all partners have limited liability. This is like the limitation of liability that a limited liability company (LLC) offers.

However, this limitation can vary by state. Some state laws give limited liability to LLP partners for all business obligations. In other states, partners only receive limited liability for the other partners' negligence.

In some states, only certain types of businesses can form LLPs. They are usually allowed for professionals like attorneys, architects, and accountants. LLPs make sense for those professions because it is so easy to bring in and release partners. It allows them to pool their resources and maintain some flexibility in the partnership structure. It also allows all the partners to manage the business with limited liability.

Limited Liability Limited Partnership

A limited liability limited partnership (LLLP) is a newer form of partnership. It also offers a different spin on liability protection for partners.

An LLLP has at least one general partner and at least one limited partner. In LLLPs, all partners have liability protection, even the general partners. This contrasts with an LP, where the general partner assumes unlimited personal liability. The limited partners in LLLPs are silent partners, like the limited partners in LPs.

The difference between an LLP and LLLP is that an LLP does not have limited partners, and an LLLP does. LLLPs are common among real estate investors. It allows them to limit their financial liabilities even if they get involved in the business's day-to-day operations.

LLLPs are not recognized in all states. You should check with your secretary of state to see if it is available where you do business. If you do business in many different states, you should probably opt for a different business structure.

Partnerships Overview

Partnerships come with varying forms of liability limitations, and they can be easy to confuse. For a quick overview of the different forms of partnerships, see the table below.

Types of Partnership

Liability Limitation

Limited Partners

General Partners

General Partnership

No

No

Yes. All partners are general partners.

Limited Partnership

Yes. Only for the limited partners.

Yes. At least one.

Yes. At least one.

Limited Liability Partnership

Yes. For all members.

No

No

Limited Liability Limited Partnership

Yes. For all members (even general partners).

Yes

Yes. At least one.

The Basics

Because partnerships are so easily created, you'll want to choose your partners carefully and, wherever possible, enter into a partnership with a written document that guides the behavior of all parties.

Without a written agreement, partners are required to follow specific rules for partnerships. Another reason to choose partners wisely is that all partners share equal authority to bind the partnership to business deals and debt obligations.

Joint Ventures

Many people think of a joint venture as a partnership. But in a joint venture, two or more parties join forces for a specific business project. Unlike most partnerships, joint ventures are devoted to a defined objective. A typical partnership, on the other hand, usually has a more long-term outlook.

The parties in joint ventures are often businesses. Through the joint venture, the companies can combine their strengths to go into a new line of business or research. They also use joint ventures to break into new geographical markets.

Joint venture members govern themselves with a contract between the members that spells out their responsibilities and liabilities. They can choose any legal structure, including a partnership or a corporation. When the joint venture's project or purpose is complete, it usually dissolves.

Partnership Agreements

All partnerships should have a written partnership/operating agreement between partners. This contract can help to safeguard against future disputes. It should give a detailed explanation of:

  • How to distribute profits.
  • The partners' responsibilities.
  • The partners' powers to make business decisions.
  • dispute resolution clause.
  • How the partnership can bring in a new business partner.
  • buyout agreement.
  • An exit strategy. The partnership agreement should contain a detailed description of how partners can withdraw. It should also specify how much notice they need to give. This provision should also include details on how the partnership will handle a partner's death or retirement.
  • Any other issues that are important to your business.

Without a partnership agreement, your state's default partnership rules will govern. These default rules might not be appropriate for your type of business. A good partnership agreement allows you to operate your business as you see fit.

Liabilities to Creditors

Probably the most important thing to know about partnerships is that owners are personally liable for all of the partnership's obligations. Creditors can go after the partners' personal assets, including bank accounts, cars, and homes. It is a frightening proposition and is the main drawback to partnerships.

There is an exception to personal liability in limited partners who have only invested money into the partnership. Limited partners must file a limited partnership certificate that includes the names of all general partners. Without filing this document, even if all parties intend to have general partners who run the business and limited partners who only invest money, the limited partners may still be personally sued by creditors.

Any debt that is owed to creditors can be collected from a single partner. The legal term is "joint and several liability." It means that each partner is individually responsible for the entire debt. It's a legal method that prevents passing the buck between possible defendants (or, here, partners). Of course, if one partner does end up paying for the entire debt, they can sue the other partners to collect their fair share.

Responsibilities to Other Partners

As in any legal relationship, you owe specific duties and bear responsibilities to your partner(s). These responsibilities include:

  • A duty of loyalty and fiduciary duty.
  • Equal profit sharing (unless there's an agreement that says otherwise).
  • Equal control and no salary (unless there's an agreement).

The fiduciary duty and duty of loyalty that all partners owe each other means a partner must act in the partnership's best interest. They can't act primarily to enrich themselves.

Partners must provide a proper financial accounting of their actions, and the partnership can sue individual partners for any financial wrongdoing.

Partnership Taxes

For tax purposes, a partnership has the advantage of being a pass-through entity. This means the partnership itself does not pay taxes. Like sole proprietors, the individual partners each pay taxes on their share of profits. They do this through their personal income tax returns.

In other words, because the partnership isn't a special corporate entity (like an LLC), taxes on profits are paid through the partners' personal income tax. The partnership reports its profits to the IRS (though it doesn't pay taxes on them), and this way, the IRS can be sure it collects the proper amount.

Businesses sometimes choose partnerships instead of corporations because of pass-through tax status. Corporations can be subject to double taxation. Double taxation is when corporations pay corporate taxes and shareholders also pay taxes on dividends.

Terminating a Partnership

In the absence of a written agreement, a partnership ends when a partner gives notice of their express will to leave (called "dissociation").

When there's a written agreement, the partnership ends when an event outlined by the agreement occurs or when a majority of the partners decide to end the partnership after a single partner dissociates.

Whether there is a written agreement or not, it's fairly easy to leave a partnership. You'll still be responsible for obligations that the partnership incurred while you were there.

Terminating a partnership is more of a process than a single moment in time. There generally remains a business that needs to be wound down (i.e., debts to be paid, obligations to be fulfilled).

How a Business Organizations Lawyer Can Help

The laws that govern partnerships are subject to change and vary by state. If you have questions about the partnerships available to you, call a business organization attorney today.

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