What Is a Limited Partnership Agreement?
A limited partnership (LP) agreement is the governing document for a limited partnership — a business structure that includes at least one general partner (GP) who manages the business and bears unlimited liability, and at least one limited partner (LP) who invests capital but has limited involvement in management and limited liability.
The LP agreement defines the rights, responsibilities, and economic arrangements between these two classes of partners. It's a more complex document than a general partnership agreement because it must balance the interests of active managers with those of passive investors.
Formation Requirements
Unlike general partnerships, limited partnerships require formal state registration:
Filing the Certificate of Limited Partnership
To form an LP, you must file a certificate of limited partnership (sometimes called a certificate of formation) with your state's secretary of state. This typically includes:
- The partnership's name (must include "Limited Partnership," "LP," or similar designation)
- The principal office address
- The registered agent's name and address
- The names and addresses of all general partners
- The effective date of the LP
The LP Agreement
While the certificate creates the LP with the state, the LP agreement governs the internal workings. This document is not filed with the state — it's a private agreement among the partners.
Most state LP laws are "default" statutes, meaning they apply only when the LP agreement is silent on a topic. This gives partners enormous flexibility to customize their arrangement.
General Partner Rights and Obligations
Management Authority
The general partner has exclusive authority to manage the LP's day-to-day operations. This typically includes:
- Making business decisions and setting strategy
- Entering contracts on behalf of the LP
- Hiring and managing employees
- Managing finances, including bank accounts and investments
- Dealing with third parties, vendors, and service providers
- Making tax elections and filing returns
Fiduciary Duties
General partners owe fiduciary duties to the LP and its limited partners:
- Duty of care — Making informed, reasonable decisions
- Duty of loyalty — Putting the partnership's interests above personal interests
- Duty of good faith — Acting honestly and fairly
Many LP agreements modify these fiduciary duties to some degree, which is permissible in most states. Common modifications include:
- Allowing the GP to engage in competing businesses
- Permitting related-party transactions with appropriate disclosure
- Defining the standard for liability (gross negligence vs. ordinary negligence)
Unlimited Liability
The general partner is personally liable for all partnership debts and obligations. This is why many LPs use an LLC or corporation as the general partner — the entity structure provides a liability shield while maintaining the LP's pass-through tax treatment.
Using an LLC as the general partner of a limited partnership is a common strategy that provides liability protection for the individuals managing the LP. The LLC serves as a shield between the GP role's unlimited liability and the managing individuals' personal assets.
Limited Partner Rights and Restrictions
Economic Rights
Limited partners are primarily investors. Their rights are mainly economic:
- Receive distributions and allocations of profit and loss
- Receive information about partnership finances and operations
- Transfer their interest (subject to agreement restrictions)
- Receive their share of assets upon dissolution
Management Restrictions
This is the critical trade-off in a limited partnership: limited partners receive liability protection in exchange for giving up management control. Limited partners generally cannot:
- Participate in day-to-day management
- Sign contracts on behalf of the LP
- Make hiring or operational decisions
- Represent the LP to third parties
Safe Harbor Activities
Most states define "safe harbor" activities that limited partners can engage in without losing their limited liability status:
- Voting on major partnership decisions (admission of partners, dissolution, amendments)
- Requesting or attending partner meetings
- Reviewing financial statements and partnership records
- Approving or disapproving the sale of all or substantially all assets
- Serving as an officer or director of the GP (if the GP is an entity)
The Control Rule
If a limited partner participates too actively in management, they risk losing their limited liability protection. This is known as the "control rule." A limited partner who crosses the line may be treated as a general partner for liability purposes.
The Revised Uniform Limited Partnership Act (RULPA) has relaxed this rule significantly, and many states provide that a limited partner's liability is not affected by participating in management. Check your state's specific rules.
Economic Provisions
Capital Contributions
The LP agreement should detail:
- Each partner's initial capital contribution
- Whether contributions are cash, property, or services
- The schedule for capital contributions (lump sum vs. installments)
- Capital call provisions for future funding needs
- Consequences of failing to meet a capital call
Distribution Waterfall
LP agreements commonly use tiered distribution structures:
Level 1: Return of Capital Limited partners receive distributions until their capital contributions are returned.
Level 2: Preferred Return Limited partners receive a preferred return (typically 6-12% annually) on their unreturned capital. This compensates them for the time value of their money and the risk of their investment.
Level 3: GP Catch-Up The general partner receives distributions until they've received a specified percentage of total profits (often 20%).
Level 4: Carried Interest Split Remaining profits are split between the GP and LPs according to an agreed ratio (commonly 80/20 or 70/30, LP/GP).
Management Fees
General partners often charge management fees for their services — typically 1-2% of committed capital or assets under management per year. The LP agreement should specify:
- The management fee amount and calculation method
- When fees are paid and how they're reported
- Whether fees are offset against profit distributions
- Whether fees continue during the winding-up period
In investment-focused LPs, the management fee structure and carried interest arrangement are often the most negotiated terms. Limited partners should pay close attention to how these provisions affect their net returns.
Governance and Voting
GP Decisions
Most day-to-day decisions are made exclusively by the GP without any LP input required. These include operational, financial, and strategic decisions within the scope of the LP's business.
Decisions Requiring LP Consent
Major structural decisions typically require LP approval, either by majority or supermajority vote:
- Amending the LP agreement
- Admitting new general or limited partners
- Removing the general partner
- Dissolving the LP
- Selling all or substantially all assets
- Merging or converting the LP
- Changing the fundamental nature of the business
Advisory Committees
Many LPs establish an advisory committee of limited partners who provide non-binding guidance to the GP on key decisions like conflicts of interest, valuations, and investment strategy. Advisory committee membership doesn't typically compromise limited liability status.
Transfer Provisions
GP Transfers
General partner interests are usually non-transferable without LP consent. The identity and competence of the GP is central to the limited partners' investment decision.
LP Transfers
Limited partner transfers are more common but typically subject to:
- Right of first refusal for the GP and existing LPs
- GP consent requirements
- Restrictions on transferees (minimum investment requirements, accredited investor status)
- Compliance with securities laws
- No transfers that would cause adverse tax consequences to the LP
Dissolution and Winding Up
LP agreements should specify dissolution triggers and procedures:
Events Triggering Dissolution
- Expiration of the LP's stated term
- Vote of partners (usually supermajority)
- Sale of all LP assets
- Bankruptcy or dissolution of the general partner (unless a replacement is appointed)
- Judicial decree
Winding-Up Process
- Complete or wind down pending business
- Liquidate LP assets
- Pay outside creditors
- Return LP capital contributions (with any unpaid preferred returns)
- Distribute remaining proceeds according to the agreement
Creating Your Limited Partnership Agreement
Limited partnerships offer a powerful structure for businesses that combine active management with passive investment. The LP agreement is the document that makes this structure work — defining the balance between the general partner's management authority and the limited partners' investment protection.
PactDraft's partnership agreement generator helps you create a comprehensive agreement tailored to your limited partnership's specific needs — get started today.