When you studied for the SIE exam, you may remember learning about the process of incorporating a business, which creates a corporation. A corporate charter, also known as the articles of incorporation, must be filed in the state where the business is headquartered. This document establishes the legitimacy of the business and discloses the corporation’s name, business structure, and authorizes shares that represent the ownership of the company.
To create a limited partnership, paperwork must be filed with the state where the limited partnership will primarily operate. This information includes the name of the business, address, and information on the partners (general and limited partners). When this is filed with the state, the partnership will receive a certificate of limited partnership from the state. Once this document is in possession of the limited partnership, it’s a legitimate business.
Each state has unique requirements and protocols for establishing limited partnerships. For a real-world look into the information requested by a state to legally form a limited partnership, here are the protocols from the state of Colorado.
An agreement between the general and limited partners must also be put in writing. Known as the agreement of limited partnership, this document details the rights, duties, and restrictions imposed on each type of partner. Additionally, it establishes how revenues and losses are allocated. If you’re interested, here’s a boilerplate version of an agreement of limited partnership provided by a law firm in California.
It’s important to understand the overall roles of the general and limited partners. General partners must act in a fiduciary capacity when managing the business, which prevents them from competing with, borrowing from, or working against the business in any way. As a fiduciary, they must always act in the best interest of the business.
Limited partners can be summed up as “the investors.” While they do not have management authority, limited partners have similar voting rights to common stockholders. They have the right to vote on changes to the overall objectives and large financial moves of the business, while also having access to the books and records of the partnership.
Unlike traditional equity and debt offerings, there are several steps investors must go through in order to become limited partners. A subscription agreement, which is basically an application to invest, establishes the potential investor’s suitability in regards to the partnership. General partners prefer to have wealthy investors not concerned with liquidity, which will allow them to obtain large amounts of capital without worrying about making payouts. It’s also optimal to have limited partners with these characteristics in case of a capital call or the need for the limited partners to take on recourse notes/debts.
In addition to suitability, the subscription agreement requires the investor to explicitly state they are aware of the risks involved. Registered representatives (like you) typically help their clients build the necessary knowledge to judge the merits of the potential investment. If a registered representative wants to recommend a limited partnership, they should do a thorough suitability determination. This is accomplished by obtaining their client’s investment objectives, risk tolerance, tax status, net worth, annual income, personal liabilities, and investment goals. Some subscription agreements require registered representatives to certify their client understands the necessary facts and is suitable for the investment.
In order to solicit interest from potential investors, limited partnerships utilize investment banking services. If offered privately, limited partnerships are typically sold through Regulation D private placements, where unlimited numbers of accredited investors can participate. Limited partnerships can be sold through public offerings as well. When this occurs, registration with the SEC must occur and a prospectus must be offered to investors.
One defining characteristic of limited partnerships is their limited lifespans. Unlike corporations, which can last in perpetuity (forever), limited partnerships are always dissolved at some point. Whether the dissolution is voluntary or required (typically because of bankruptcy), limited partnerships are always liquidated in the same way. All of the business debts are paid off, the leftover assets are liquidated, and cash is distributed in this order:
Secured creditors
Unsecured creditors
Limited partners
General partners
Sign up for free to take 9 quiz questions on this topic
