Limited Partnerships – What, Why, and How?

I don’t often recommend that a client form a limited partnership (“LP”). In many situations, a limited liability company will accomplish the same goals with fewer moving parts and more flexibility. In the right context, they remain useful and often preferred tool. This is especially true for outside investors, joint ventures, or certain family or fund structures. If someone suggests using an LP, it’s worth understanding why before dismissing it in favor of an LLC or other entity.

What is an LP?

An LP is a partnership involving at least two partners: one a "limited partner" and another the "general partner." The limited partners are passive investors whose liability is generally limited to their investment. The general partner manages the business and has general liability for the obligations of the partnership (in addition to owing fiduciary duties to the limited partners).

It's a combination of a general partnership (no owners have limited liability) and a corporation (all owners have limited liability). But there must be at least one partner with limited liability, and at least one partner without limited liability.

You can think of it as a hybrid: operational control sits with the general partner (similar to a managing member), while limited partners resemble passive investors with liability protection. In modern practice, the general partner is almost never an individual. It is typically an LLC or corporation, which effectively restores limited liability at that level.

Why form an LP?

The rise of LLCs understandably pushed LPs out of the spotlight. LLCs offer limited liability for all owners and tremendous contractual flexibility. So why do LPs persist? The short answer: investor expectations and structural clarity.

From an investor’s perspective, LPs offer a familiar and well-understood framework, providing:

1. Clear separation of roles: the general partner manages; the limited partners invest. That division is fundamental to the structure;

2. Passive investment posture: limited partners are not expected (and are usually restricted) from participating in management;

3. Liability protection: limited partners are generally shielded from entity-level liabilities;

4. Tax treatment: LPs are typically taxed as partnerships, and limited partners often receive passive income treatment (subject to the usual caveats and individual circumstances);

5. Creditor focus on the GP: in practice, claims are often directed at the general partner, especially where it is the operating entity.

There’s also a practical point: many institutional and sophisticated investors are simply accustomed to LP structures, particularly in real estate and private equity. Sometimes the preference is less about technical superiority and more about familiarity and market convention.

Why would a sponsor use an LP instead of an LLC?

They don't have to, but they might choose to for the reasons above. Moreover, an LP can be an efficient way to: bring in passive investors (without inviting governance disputes), signal a conventional or comfortable structure, align with investor expectations, and use a known template that reduces negotiation friction.

That last point is easy to underestimate. In some deals, using an LP avoids re-litigating control and fiduciary issues that would otherwise be heavily negotiated in an LLC operating agreement.

Can you give an example?

An existing LLC has four potential investors. The investors want passive income, and know the LLC operates well. And the LLC does not want the investors trying to step in and operate the LLC.

In this example, the existing LLC could set up an LP where the LLC is the general partner. And the four investors can then become limited partners of the LP. Rather than spend time negotiating and drafting a complex operating agreement, the partners agree to a comparatively simple partnership agreement. The roles and expectations are, to a large extent, baked in.

Notice, in this example, the members of the LLC still have limited liability as members of the LLC. But the LLC itself does not have an extra layer of limited liability. It is unusual (at least today) to have an individual as a general partner of an LP; the general partners are more typically LLCs or corporations.

A Note on Liability Layering

Using an entity as the general partner is standard practice. That way individuals behind the deal retain limited liability through the GP entity, and the LP structure still provides the expected investor framework. It’s not that the LP itself creates “extra” liability, but that the structure deliberately places responsibility at, and allocates that risk to, the GP level.

How do you form an LP?

As with LLCs, formation is fairly simple. In California and Texas, you register your LP with the Secretary of State by filing a certificate and paying the fee. Although neither state explicitly requires a partnership agreement, the partners should set forth their agreements and understandings in a writing. This should include economic terms as to distributions and allocations, management authority, transfer restrictions, exit rights, and fiduciary duties.

Common Uses of LPs

Families often use LPs as an estate planning device (or pseudo-estate planning device, depending on whom you ask). If a family has a business (no matter the entity type: partnership, LLC, etc.), those operating the business may form a family limited partnership ("FLP"), in which the business is the general partner, or the parents are the general partners, and the children or other family members are the limited partners. This can get complex, especially if the goal is to avoid tax liability, so consulting with an estate planning attorney and an accountant is critical.

Historically, they've been common for real estate developers. They are very common in syndicated investments and development projects.

Investment funds make use of LPs when dealing with private equity or venture structures.

Apparently, they are also fairly common in film production, Disney's Silver Screen Partners being the most prominent of which I'm aware.

Quick Summary: LPs are often attractive to investors, and sometimes to families as a wealth transfer device. And you can always form an LLC or corporation to act as the general partner (that is, you can form an entity to serve as the general partner, while you still have limited liability).