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General partnership is the default legal structure of a business with two or more owners; it comes into existence even without an agreement. A limited partnership requires a partnership agreement and the filing of information regarding the business and the identity of the general and limited partners with the appropriate state agency. Each state has specific statutes that regulate the responsibilities and obligations of each of the partners in the limited partnership arrangement.
Image Credit: flickr.com/Aidan Jones
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Authority and Responsibility
A primary limited partnership/general partnership difference concerns the authority and responsibility of the partners.
In a general partnership, all partners actively manage or control the business, with each partner having the authority to make legally binding business-related decisions or sign agreements that bind all other partners.
Limited partnerships have one and sometimes more than one general partner who manages the business operations and retains the authority to make operational decisions. The other limited partners are silent investors who do not control business operations and who do not have the authority to take decisions or make agreements for the business. The decisions or agreement made by one limited partner is not binding on other partners. The decisions made by the general partner for carrying on in the ordinary course of business activity is binding on all partners, but the decisions made by the general partner outside the normal course of business operations bind the limited partners only if all other partners authorize this decision.
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The fundamental differences between general partnership and limited partnership relate to the liability and obligations of partners.
General partnership mandates each partner being "jointly and severally" liable for debts of the business or each partner assuming unlimited liability for the partnership's debts. A partner is not just liable for the contracts entered by other partners, but also responsible for any negligence on the other partners' part.
For instance, one partner taking on a debt makes all partners liable to repay the debt. If one or more partners do not repay the debt, the creditor realizes the outstanding amount from other partners' personal assets even if those partners have already paid their share of the debt. Similarly, if someone sues the partnership and forces it to pay a huge compensation, one partner becomes liable to pay up the entire amount from personal assets if the other partners do not have the money to pay their share, irrespective of the partner’s share in the partnership.
In a limited partnership, the obligations fall only on the general partner’s personal assets, with the liability of the limited partner limited only to his actual financial contribution to the partnership. Thus, a creditor unable to recover a debt from one partner can take away from another partner only the amount invested by that partner in the partnership. A compensation lawsuit that exceeds the assets of the partnership might cause the general partner to lose personal assets, but the loss for the limited partner is limited only to the investment made.
The 2001 amendments to the Uniform Limited Partnership Act has removed the general-partner liability for partnership obligations and made debts of limited partnerships the sole responsibility of the partnership. This equates Limited Partnership with Limited Liability Partnerships.
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What to Choose
General partnerships and limited partnerships are the two common types of partnerships. In a trade-off between general partnership vs limited partnership, the scenario of each partner becoming liable for the total debts of the partnership makes people shy away from general partnerships.
General partnership as a business legal structure works best only when:
- Trust exists among all partners.
- All partners are competent and their expertise contributes to the smooth running of the business.
Opting for limited partnership as the business legal structure works best when:
- The general partner wants freedom to run the business without interference.
- The other partners are investors in general, and are not inclined to manage the company.
- Other partners' personal assets require protection
Limited partnership finds favor with the film industry, real estate investment projects, and other businesses that focus on a single or limited-term project, where one or more financial backers contribute money or resources and the other partner performs the actual work. Limited Partnership is also attractive for:
- Firms looking to provide shares to many individuals without the additional tax liability of a corporation.
- Families looking to transfer wealth from parents to children without attracting wealth tax.