Thanks to Scott Yorke for this article.
Limited partnerships (LPs) are commonplace in many countries, but have only been available in New Zealand since 2008. However, we are seeing more and more companies adopt LP structures in the technology sector, including software businesses and franchise owners. The flow-through tax status of the LP, combined with its limited liability and confidentiality features, makes LPs an attractive structure for many new business ventures. So how does it work?
An LP is an entity that combines the limited liability advantages of a company with the tax and confidentiality advantages more typically associated with a partnership. LPs are particularly suited to investment funds, but can also be effective structures for small start-up companies that expect to make substantial losses early on.
Like a company, an LP is a legal entity that exists separately from its owners. Contracts may be entered into in the name of the LP, and an LP may hold property in its own name. The limited liability protection available to the LP means that if limited partners are not involved in management of the LP their liability will be limited to the amount of their capital contributions. Because the LP has separate legal personality, there is no technical dissolution of the partnership when partners exit.
Like a general partnership under New Zealand tax law, an LP is transparent for tax purposes. Any losses or gains from the LP flow through (on a pre-tax basis) and are attributed directly to the partners to the extent of their economic interest in the LP. This is commonly known as “flow through” tax status. This tax status is what makes LPs so attractive to many investors.
An LP must have at least one general partner and one limited partner. Any person (including a company or another LP) may be a partner of an LP, but a person cannot be both a general partner and limited partner of the same LP at the same time.
The general partner is responsible for day-to-day management of the LP and has authority to bind the LP. The general partner has a “residual liability”. This means that the general partner is liable for the debts and obligations of the LP, but only if the LP is unable to meet them itself.
Limited partners are usually passive investors in the LP, and their details are kept confidential. They should not take part in the management of the LP if they wish to retain limited liability. However, they may participate in certain “safe harbour” activities. The distinction between managing the LP and taking part in safe harbour practices can often be difficult to draw, particularly with start-up LPs. For this reason, the general partner will often be set up as a company to manage the affairs of the LP, with limited partners taking shares in that company.
Every LP must have a limited partnership agreement. This agreement documents how the LP is to be administered and what the rights and obligations of the partners are. The agreement is not a public document.