limited partner

What It Is

A limited partner is a member of a partnership who cannot incur debt or obligations on behalf of the partnership and is not personally liable for those debts or obligations. Limited partners contrast with general partners, who can incur debt or obligations on behalf of the partnership and are personally liable for those debts or obligations.

How It Works

In some partnerships, all the partners are general partners. That is, they are all liable for the debts and obligations of the business. In other partnerships, some of the partners are general partners and others are limited partners. In those cases (called limited partnerships, or LPs), one or a handful of general partners manage the day-to-day operations of the business and are personally liable for the business's debts. They act as the core management team for the business and are obligated to keep the limited partners informed about the condition and performance of the business.

Unlike general partners, limited partners have no daily management role, cannot encumber the business and are not personally liable for the business's debts. Instead, they receive a share of the firm's profits in exchange for their capital investments, and usually the worst that can happen is that the value of their investment falls to zero. (It is important to note that limited partners who take managerial roles could be considered general partners in the eyes of the law.) This limited liability is what often attracts investors to limited partnerships.

General partners, on the other hand, are personally liable for the actions of the business and the other general partners, even if those actions appear unreasonable, excessive or if they result in legal judgments against the business. General partners can lose far more than their initial investments.

Why It Matters

General partners bear the lion's share of the risk in a partnership. Limited partners are more like silent investors. General partners must make important decisions about the company, they must be able to trust each other's judgment, and they must be prepared to forfeit their personal assets in a worst-case scenario. These management and risk burdens are two reasons general partners usually receive management fees as well as a larger percentage of the partnership's profits above a certain level.

Partnerships are generally not taxable entities; rather, the income is passed in a pro rata fashion to the partners, who pay applicable federal, state and local income taxes.

Source: Investing Answers