Limited partner: Overview, definition, and example
What is a limited partner?
A limited partner is an individual or entity that invests capital into a partnership but has limited liability and does not take part in the day-to-day management or operations of the business. Limited partners are typically passive investors who provide financial backing for the business in exchange for a share of the profits. Their liability is restricted to the amount of their investment in the partnership, meaning they are not personally responsible for the partnership's debts or liabilities beyond the capital they have contributed.
Limited partners are a key feature in limited partnerships (LPs), where there are at least one general partner (who has unlimited liability and manages the business) and one or more limited partners (who have limited liability and are not involved in management).
Why is being a limited partner important?
Being a limited partner is important because it offers a way for individuals or entities to invest in a business venture while limiting their exposure to financial risk. Limited partners can enjoy the benefits of business profits without taking on the responsibility of managing the business or assuming personal liability for the company’s debts. This makes limited partnerships a popular structure for passive investors, particularly in industries such as real estate or private equity.
For businesses, having limited partners can provide access to capital without relinquishing control over the management of the business. It also offers a way to attract investors who want to participate financially but do not wish to take on the risks or responsibilities of active management.
Understanding limited partner through an example
Imagine a real estate development company, XYZ Properties, is planning to build a new apartment complex. The company needs additional capital to fund the project, so it forms a limited partnership. The general partner, ABC Corp., manages the project, makes day-to-day decisions, and assumes full liability for the business’s debts. Meanwhile, five individuals invest as limited partners, each contributing $100,000. These limited partners are passive investors and do not get involved in the management of the project. If the project runs into financial trouble or liabilities, their personal assets are protected, and their loss is limited to the amount they invested ($100,000 each).
In another example, a limited partnership might be formed in the private equity sector. A venture capital firm (general partner) raises capital from limited partners (individuals or institutional investors) to fund startups. The limited partners provide financial backing but are not involved in making investment decisions or running the portfolio companies. They share in the profits, but their liability is limited to their initial investment.
An example of a "limited partner" clause
Here’s how a "limited partner" clause might appear in a partnership agreement:
“The Limited Partner shall contribute capital to the Partnership in the amount of $[insert amount], and in return, the Limited Partner’s liability shall be limited to the amount of their capital contribution. The Limited Partner shall not participate in the management or operations of the Partnership and shall have no authority to make decisions regarding the day-to-day activities of the Partnership.”
Conclusion
A limited partner is an investor in a partnership who provides capital in exchange for a share of the profits but does not participate in the management of the business. Their liability is limited to their investment in the partnership, offering them protection from personal liability for the partnership’s debts. This structure makes limited partnerships an attractive option for passive investors who want to limit their risk while still benefiting from the potential upside of the business. For businesses, having limited partners can provide valuable capital without sacrificing control over operations.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.