With the rise of private equity and venture capital, more investors are interested in forming or joining an investment partnership. An investment partnership provides a structure for investors to pool their capital and make collective investment decisions. However, not all partnership structures are created equal. Investors need to consider legal, tax and operational factors when electing an investment partnership structure. This article provides an overview of common partnership structures like general partnerships, limited partnerships and offshore partnerships and key factors to consider when electing one.
General partnerships have unlimited liability but allow pass-through taxation
A general partnership is the simplest partnership structure where partners share unlimited personal liability. All partners have equal rights in managing the partnership. A general partnership allows pass-through taxation where income and losses flow directly to partners’ personal returns. This avoids double taxation. General partnerships are easy to set up with minimal legal paperwork. However, the unlimited liability is a major downside for investment partnerships.
Limited partnerships limit liability while allowing fund managers control
A limited partnership consists of general partners who control the fund and limited partners whose liability is limited to their investment. Limited partners enjoy pass-through taxation benefits but have limited control. The separation of responsibilities allows fund managers (general partners) to retain full control while limiting investor liability. Setting up a limited partnership is more complex and requires drafting a partnership agreement.
Offshore partnerships offer tax efficiency for foreign investors
Many investment funds are set up as offshore partnerships in tax havens like the Cayman Islands. Offshore partnerships allow pass-through taxation and investor anonymity. They also avoid local regulations and restrictions. However, offshore structures are more complex with higher setup and maintenance costs. They require working with legal and tax advisors in multiple jurisdictions.
LLCs combine limited liability with pass-through taxation
A limited liability company (LLC) offers the limited liability protection of a corporation with the pass-through taxation of a partnership. Members’ personal assets are protected from business debts and liabilities. LLCs avoid double taxation and allow flexible profit/loss allocation. However, LLC regulations vary across different states in the US. So investors need to consider the tradeoffs carefully when choosing between LLC and limited partnership.
In summary, investment partnerships need to balance limited liability, tax efficiency, regulatory requirements and ease of administration when electing a legal structure. For real estate and private equity funds, limited partnerships are the most common choice. LLCs also offer a good combination of limited liability and pass-through taxation. Offshore partnerships work for international investment funds. Consulting legal and tax advisors early on is key.