Over the past 10 years, limited partnerships have proven to be a popular tool in many business projects. This article explains in a simple way what a limited partnership is, how it is formed and when it is most often used.
What is a limited partnership?
Limited partnerships are separate legal entities governed by the New Zealand Limited Partnerships Act 2008 (the Act).
limited partnership:
- has one or more general partners who are responsible for managing the company's activities;
- has one or more limited partners who do not participate in running the business on a daily basis, do not conclude contracts on behalf of the company and whose name is not used in connection with the business activity;
- compulsion to conduct business solely in the name of the general partner(s) and must contain the words "limited partnership" or "LP" at the end of the company's name to recognize the existence of limited partners;
- begins its existence upon registration of a limited partnership. There is no legal requirement to submit a partnership agreement. However, in order to be registered, partners must certify that there is a written partnership agreement between them.
The limited partner's liability is limited to the amount of the capital contribution that such partner has paid for the opening of such an entity. In conditions where the law is complied with and the limited partner does not assume the management board of the company, then the limited partner is not personally liable for the company's obligations.
A limited partnership is significantly different from a limited liability company. This is primarily because the limited partners have a direct legal interest in the assets of the limited partnership, and not shares in the company as is the case with a limited liability company. Limited partners also have the right to participate in the profits or potential losses of the limited partnership, instead of receiving dividends depending on the decision of the management board.
Although limited partnerships are a separate legal entity, for tax purposes, partners in a limited partnership account for tax according to their personal status, similarly to a traditional partnership.
What is involved in setting up a limited partnership
As mentioned, a limited partnership consists of two types of partners, i.e. a general partner and a limited partner (limited partners). The general partner is usually a partnership because in this way he has limited liability. Usually, the general partner will be a joint-stock company owned by the limited partners in proportion to their shares in the limited partnership with representatives of specially appointed directors of the limited partnership. Sometimes it happens that the general partner is a person with special skills in managing the business activities of a limited partnership.
The articles of association of a general partner (in the case of a partnership) should always reflect the provisions of the Act, as well as the requirements of a limited partnership.
The articles of association are always drawn up between the general partner and the limited partners. This agreement primarily reflects the provisions of the act dedicated to this purpose and stipulates the capital contributions of each limited partner.
Limited partners can be natural persons, partnerships, capital companies or trusts.
After concluding the articles of association of a limited partnership, an application for transformation of the company into a limited partnership should be submitted. After registering a limited partnership, a certificate of registration of such an entity is issued. It is a separate document from the certificate issued earlier for the general partner if it is a joint-stock company.
When and for what reason limited partnerships are used in business
Limited partnerships are generally used in development projects that contain an element of risk and are additionally capital intensive. This makes it necessary for many partners to cooperate in order to finance the investment project with equity and debt, and thus share the risk between the partners.
Individual projects often need to be developed over an extended period of time where there is significant capital outlay before the project becomes cash positive. The legal architecture of a limited partnership allows for the limitation of liability as in the case of capital companies, but unlike capital companies, limited partnerships allow losses to be transferred to limited partners at the development stage.
Potential financial losses are limited to the value of the capital investment incurred by the limited partners. This loss includes equity and their pro rata share of debt, e.g. if they invest $500,000 and are jointly and severally liable as a bank guarantor for $1,000,000 of bank debt, they could stream development stage losses of $1,500,000 in order to offset the profits in their own hands from other business interests of the limited partnership.
Disadvantages of Limited Partnerships in New Zealand
While the benefits of a limited liability company and the tax benefits of a partnership are attractive, limited partnerships are relatively complex legal structures compared to a simple company or partnership. Establishing this type of company is associated with higher costs, and the legal conditions between the general partner and the limited partners are not easy to understand for a person who is not a qualified lawyer.
As with a simple partnership, there is a practical limit to the number of limited partners, as entry and exit mechanisms can be difficult compared to a partnership. This legal solution, however, works decently for three to fifteen arm-length partners.
Final remarks
It is highly advisable to obtain specialist legal and accounting advice in relation to limited partnerships and our above considerations regarding tax benefits are generalized for the purposes of this publication. Each legal case involving the use of a limited partnership requires separate consideration and therefore we encourage you to contact the Eberhard Advisory Team.
