When you decide to form a business entity, you will have some decisions to make. Understanding the difference between a general partner and a limited partner is rather important. You will also need to decide between a sole proprietorship, partnership, joint venture, Private Limited Company (PVT), estate, trust, and limited liability company (LLP).
Starting a business comes with many decisions and it starts with how you organize the business entity. With a better understanding of what a general partner is and what a limited partner is, you can make the right decision. Let’s look at both and the advantages of each.
Defining a Partnership
Since a general partner and a limited partner are types of partnerships, it’s important to define a partnership. a partnership is legally defined as a formed entity with two or more individuals operating a business. You can establish a partnership without any type of filing fee.
General Partner vs. Limited Partner: Pros and Cons to Consider
What is a General Partner?
A general partner of a company is an owner. They may place an active role in the daily operations or they may be a managing partner. A general partner has the ability to act on behalf of the company. They also take on unlimited liability when it comes to the financial dealings of the business.
A general partner takes on financial debt or liability that may pass through the business to the general partners. However, if the company is a limited partnership, only one of the partners will take on unlimited liability.
What is a Limited Partner?
A limited partner may also be called a silent partner. They have limited liability when it comes to the debts and liabilities of the company. The amount of liability a limited partner take on is often determined by the amount of capital they invest in the business.
Along with the limited liability of a limited partner, they also have restricted responsibilities when it comes to the daily operations. Most limited partners are not involved in the daily operations or management of the company at all.
In some cases, a limited partner may be involved in the daily operations. However, if they spend more than 500 hours in a year helping with operations, they may become a general partner.
General Partner vs Limited Partner: The Advantages
Advantages of Becoming a General Partner
- You will have control over business decisions
- You will be able to shape the business on a day-to-day basis
- Very attractive option for legal and medical businesses
- Share profits and losses equally with other partners
Advantages of Becoming a Limited Partner
- You get to financially contribute to the business and gain a percentage of the profits
- You won’t have to take on the debts or obligations outside the amount of capital you invest
- You won’t have to participate in the daily operations of the business
If you want more say in the company, you can become a general partner by working more than 500 hours in a year for the business.
General Partner vs Limited Partner: The Disadvantages
Disadvantages of Becoming a General Partner
- You will take on unlimited liability
- You might be personally liable for the obligations and debts of the general partnership
- You may be personally liable in legal suits brought against the business
Disadvantages of Becoming a Limited Partner
- You won’t work in the business every day, which can be a disadvantage
- As a limited partner, you may put up a ton of capital without any say in business decisions
- If you work 500 hours or more in a year and become a general partner, you will end up with unlimited liability
- You may lose your financial investment
General Partner vs Limited Partner: A Quick Comparison
- General partners take on unlimited liability, while limited partners don’t.
- Ownership for general partners is equal between the partners unless stated differently in the agreement. For limited partners, it’s predefined, usually based on the size of the investment.
- General partners have control over the operation and management of the business. Limited partners often have very minimal power.
- General partners will share in the profits and losses equally, while limited partners share based on their investment.
- The structure of a general partnership is very simple. The structure of a limited partnership is rather complex.
- General partnerships require less paperwork than limited partnerships.
- General partners will participate in the day-to-day operations, while limited partners don’t.
Frequently Asked Questions About General and Limited Partnerships
What will be stated in the terms of the partnership?
When a general partnership or limited partnership is formed, terms must be set in an agreement. The partnership terms will state the following:
- How the profits and losses will be shared
- The division of shares if a partner leaves the company
- All the rules for the partnership
- General partner or limited partner obligations
- Anything else important to the partnership
The terms of the partnership will depend on the type of agreement, but both types will spell out the actual agreement.
Is a partnership agreement necessary?
While you legally don’t have to create a partnership agreement, you should have one, if you want to stay out of legal trouble. Without a written contract, you could face future legal issues. A written partnership agreement will define the rules of the partnership. Without an agreement, you will need to follow the default partnership rules of your state.
Which type of partnership takes the largest financial risk?
While a limited partner takes on the risk of the money they have invested, a general partner takes a larger risk. A general partner can lose their personal assets if the company defaults or is sued. They take on a larger financial risk, in most cases.
Understanding the difference between a general partner and a limited partner is very helpful. Whether you’re planning to start a business, merge two current businesses, or invest in a business, you should understand what a general partner and a limited partner are before you move forward. Make sure you’re getting the deal you want without taking on more risk than you prefer.
Jordan Fabel
Covering different 'paths' that people's lives can take. Creative, foster parent, ticket dismissal, you get the idea. Exploring the requirements, certifications, exams, and obviously, approved courses along each path. I, personally, am the high school dropout son of two teacher parents. So how did I get here? That story is coming soon!