The following sections explain the relationship the respective class has to the other classes and to the partnership. For the reader it seems to appear as definitions of terms used. But in reality, the sections are explaining in detail the particular responsibilities and the rights these partners have to all the other partners.
Limited partners are strictly in the relationship for the financial value risk. Basically a limited partner invests money referred to as their capital investment and recorded in their capital account. In exchange for this investment, the limited partners are in hopes of financial return on the investment. On the flip side of this is the fact that the limited partner is limited to his investment if the partnership financially fails.
This investment is used by the operating partners to conduct business. Many large scale partnerships have limited partners. There are even publicly traded partnerships whereby the limited holders (equity investors) can trade their ownership rights. The most common publically traded partnerships are in the mining and extraction industries (oil, natural gas, metal extraction and precious stones). Numerically, most partnerships are referred to as general partnerships. But the large capital intensive partnerships include limited partners.
By law, the name of the partnership includes the term ‘Limited’ in its title. This means that the partnership includes this class of partners. In addition, the partnership agreement is written differently by incorporating certain rights and obligations of the limited partners. The following list of rights and obligations is just a short list but hits on most of the major points related to limited partners:
- No Financial Obligation in Case of Bankruptcy or Insolvency
- No Control over Management – many of your smaller limited partnerships provide for some form of voting rights in an annual election, but the larger capital intensive partnerships, no rights at all
- Can Vote to Admit New or Replace General Partners
- Can Vote to Amend the Partnership Agreement
The partnership agreement has clauses (sometimes referred to as articles or covenants) that spell out the exact powers granted to the limited partners. In many limited partnership relationships, the initial dynamic relates to the losses the business will incur in regards to operations. Many of these limited partnerships are structured to comply with the tax code allowing the losses to pass to the limited investors. Later on as the partnership begins to generate profits and make market gains, the limited partners are sometimes restricted to their share of the wealth. In other agreements, the limited partners get preferred status as success builds and there is some form of a buyout or termination of the limited partner’s rights to the earnings.
Each situation is different and the partnership agreement spells out the legal rights and the associated financial relationship.
All partnerships (regular and limited) have at least one general partner. In a regular partnership, all the partners are referred to as general partners. You see this frequently in the professional arrangements such as law firms, accounting practices, medical arrangements, and engineering firms. Every partner is considered a general partner. The partnership agreement is usually structured to set the control elements of the relationship between the partners by granting voting and financial restrictions.
In some partnerships, the relationships may have levels, such as associate partners, general partners and senior partners. Each of these subgroups is assigned voting rights and financial rights in the partnership relationship. Even though this relationship exists, the one single most important characteristic is the fact that every partner has some level of financial obligation in case of failure. The following illustrates this importance of this financial obligation:
The partnership agreement spells out the financial obligations each partner has to the partnership.
The most important right held by the general partner is the right to vote. Most often this right mirrors their respective percentage of ownership based on their capital account. Partners with more capital in the equity section of the balance sheet have more control over the operation of the partnership. This control is exercised via the election of the managing team. The management team is referred to as the managing partner(s).
Unlike what most folks think when they read the term managing partner, it doesn’t mean that they are necessarily the boss. What it really means is that this person or team is responsible for the partnership as a whole. They have to make sure the accounting is completed, contracts are negotiated, human resources management is carried out and so on. In general, they only receive higher compensation usually through guaranteed payments or a straightforward bonus. There are no additional voting rights or other positive attributes provided unless written in the partnership agreement. You will rarely see any special privileges granted to this person or team.
One final note, the managing partner(s) do have the right to vote as a general partner, but not as a managing partner. Remember, all managing partners come from the pool of general partners.
Summary – Limited, General and Managing Partners
The following chart illustrates the various fiduciary, financial and appointed powers related to each of the three classes of partners:
Although the general partner as full voting rights, they take on the full responsibility related to the financial well-being of the partnership. In their case, they are liable for any financial deficiencies with the partnership when they exist. Prior to entering into a partnership agreement, I implore upon you to do your research by reading more articles. I have more information available on my legal page on the website. Act on Knowledge.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you.