A limited partnership is a good fit for entrepreneurs who want to raise capital from third parties without giving them influence over business management. The limited partnership—known as a Kommanditgesellschaft (KG)—is popular with family businesses and medium-sized businesses, among others.

However, the advantages of limited partnerships also come with risks. In this article, we’ll explain what a limited partnership is, what rights and responsibilities partners have, how this type of business is formed, and its main pros and cons.

What’s in this article?

• What is a limited partnership?
  
• What rights and responsibilities does a general partner have?
  
• What rights and responsibilities does a limited partner have?
  
• How does the formation of a limited partnership work?
  
• What are the pros and cons of a limited partnership?
  

What is a limited partnership?

The German Commercial Code (HGB) defines a limited partnership as a partnership in which at least two partners operate a commercial business (see Section 161 of the HGB). These can be individuals or legal entities. However, the distribution of roles is important: there must be at least one general partner and one limited partner. The roles differ in their liability and whether they involve management tasks.

How is liability regulated in a limited partnership?

In a limited partnership, the partners are called general and limited partners, respectively, and each has a different role. General partners are personally liable with their own assets and typically manage the limited partnership. Limited partners are liable only up to the amount they have invested, and they do not participate in management. However, both partners are entitled to an annual profit of 4% of their contribution. The contribution, also called the liability amount or limited partner’s contribution, is considered part of the business’s assets. No minimum capital is required to form a limited partnership.

The KG is a special form of general partnership (Offene Handelsgesellschaft [OHG]). Unlike KGs, all OHG partners have unlimited liability with their personal assets. Under Section 116 of the HGB, all partners in an OHG have the right and duty to manage the business, unless the articles of association state otherwise. This makes the OHG ideal for partners who want to jointly manage a business and equally share the risks. Conversely, a limited partnership can attract investors who provide capital, have limited decision-making power, and are only liable up to their investment amount.

Special forms of limited partnerships

A KG can take various forms, which have specific features. If the founders form a partnership with a GmbH (a limited liability business) as a limited partner, this legal form is called a GmbH & Co. KG. In this setup, the GmbH takes on the role of the general partner, creating a partnership with limited liability. Liability is restricted to the business’s assets, protecting individuals from personal liability. The AG & Co. KG and UG & Co. KG operate the same way.

KGs can also take the form of a partnership limited by shares (KGaA, from Kommanditgesellschaft auf Aktien). This is a corporation, though it contains some features of a partnership. This hybrid legal form is ideal for raising capital easily while retaining decision-making powers. Limited partners are also shareholders; they can trade their capital as shares on the stock exchange and have limited liability. General partners, who are fully liable, can be individuals or corporations. A KGaA also requires a minimum capital of €50,000, and it must have a supervisory board.

What rights and responsibilities does a general partner have?

General partners in a limited partnership have various rights and responsibilities because of their role as personally liable partners. Here is an overview of the key rights and responsibilities:

Rights of a general partner

General partners have the right to manage the business of the limited partnership. They can also represent the KG in external matters and sign contracts on behalf of the business. They have the right to veto major decisions, whether related to business operations or at general meetings. They also have the right to inspect key documents, such as commercial books, at any time and can request information about important business processes. General partners are also entitled to receive their share of profits as specified in the partnership agreement.

Responsibilities of a general partner

General partners have unlimited personal liability for the debts of the limited partnership, which includes their capital, real estate, and securities. They are also required to make a capital contribution: though a limited partnership doesn’t require a minimum capital contribution, partners must still contribute enough to operate the business. The amount of the contribution is specified in the partnership agreement.

The duty of care requires general partners to conduct the business’s affairs with the care of a responsible businessperson. They are also responsible for preparing balance sheets and financial statements. In addition, general partners must be loyal to the business; they must always act in the best interests of the partnership and avoid any actions that could harm the partnership. Under the noncompetition clause, general partners are prohibited from serving as general partners for similar businesses.

What rights and responsibilities does a limited partner have?

Limited partners in a KG have different rights and responsibilities compared with those of general partners. Here is an overview of the key rights and responsibilities:

Rights of a limited partner

Because they are investors, limited partners cannot vote or challenge daily business decisions. However, this changes for major decisions, such as starting a subsidiary or adding partners. If they are appointed as authorized signatories, they can handle legal transactions and represent the partnership. Limited partners typically have the right to inspect accounts and important business documents. If they suspect dishonest management, they can request an audit of the relevant business transactions. Limited partners are entitled to their share of the profits as defined in the partnership agreement. If the limited partnership is dissolved, they have the right to recover their contribution, if the business’s finances permit. They always have the right to transfer their shares to other limited partners.

Responsibilities of a limited partner

The primary duty of limited partners is to provide the agreed-upon contribution. They must also remain loyal to the business and always act in the best interests of the limited partnership. They cannot conduct any business in the partnership’s field for themselves or others without the permission mentioned in the partnership agreement or the explicit consent of the other partners; this is because of the noncompetition clause, which prevents any activities that would compete with the limited partnership.

How does the formation of a limited partnership work?

Creating a limited partnership requires thorough planning and several legal steps.

• Choosing partners: To form a limited partnership, at least two partners are needed: a general partner and a limited partner. Ideally, the two parties should trust each other because the limited partnership is more likely to succeed if they collaborate well.
  
• Choose the business name and registered office: Next, choose a business name that includes “Kommanditgesellschaft” or “KG.” Then choose the business’s registered office.
  
• Prepare a business plan: When starting a business, creating a business plan is key. This clearly outlines the business idea and compares projected income and expenses. The business plan guides shareholders in day-to-day operations and can attract potential investors.
  
• Prepare the partnership agreement: A limited partnership is officially created when the partners sign a partnership agreement. The agreement governs the internal operations of the limited partnership. It must be in writing, but it doesn’t need to follow a specific format or be notarized. That is necessary only if the agreement includes provisions that need a specific form, such as contributing property as capital. The partnership agreement should include the following points, among others:
  
  • Business name and registered office
    
  • Object of the KG
    
  • Names of the partners
    
  • Amount and type of contributions
    
  • Profit and loss sharing terms
    
  • Rights and responsibilities of the partners
    
  • Regulations on the dissolution of the business and succession
    
• Entry in the commercial register: The general partners need to register the KG in the commercial register. Ideally, this should be done before beginning business operations. The KG can be registered shortly after starting business operations, but until registration, limited partners are liable with all their personal assets. The registration in the commercial register must be notarized. It is then sent to the responsible local court, which reviews the details and records it in the commercial register.
  
• Register with the trade office: If the limited partnership conducts a commercial activity, it must be registered with the appropriate trade office. The trade office automatically notifies other authorities such as the Chamber of Commerce and Industry (IHK), the Chamber of Crafts (HWK), the employers’ liability insurance association, and the tax office.
  
• Fill out the tax registration questionnaire from the tax office: The next step is to apply for a tax number from the tax office. To do this, the business must fill out a tax registration questionnaire sent by the authorities.
  
• Become a member of the IHK or HWK: Once the KG has received its trade license and is registered for tax purposes, the relevant IHK or HWK will get in touch with you. When establishing a limited partnership, joining one of the two chambers is mandatory. This must be done by completing the relevant documents.
  

Forming a limited partnership: Step by step

What are the pros and cons of a limited partnership?

Forming a limited partnership has pros and cons. Here are the most important ones:

Pros of a limited partnership

• Straightforward formation: Forming a limited partnership is simple. Most importantly, because the partnership agreement doesn’t need to follow a strict format, the founders can be flexible in how they draft it.
  
• No minimum capital: A limited partnership can be established without minimum capital, so starting a KG has low financial barriers.
  
• Flexibility in raising capital: A KG can easily raise more money by bringing in limited partners. The limited liability makes it appealing to investors.
  
• Flexibility in profit distribution: The partnership agreement of the KG allows for flexible profit distribution, which doesn’t have to match the capital shares.
  
• High creditworthiness: Limited partnerships have a high credit rating mainly because the general partners are personally liable. Additionally, the limited partners’ capital contributions improve the business’s chances of obtaining bank loans.
  
• Input tax can be deducted: Limited partnerships are subject to value-added tax (VAT) and can deduct input tax.
  
• Trade tax allowance: Like a sole proprietorship, the KG has a trade tax allowance of €24,500. Trade tax needs to be paid only if the annual profits exceed this amount. With Stripe Tax, the correct tax amount is calculated automatically, and you can access the necessary documents for tax refunds. You can also collect and report taxes for global payments with a single integration.
  
• Limited partners have limited liability: Investors in a limited partnership face limited personal risk because they are liable only up to the amount of their contribution.
  
• Management and investors are clearly separated: The distribution of roles in a KG is clearly defined. The general partners manage the business, while the limited partners provide capital and do not participate in day-to-day operations.
  
• No annual financial statements: If the general partner is an individual, the limited partnership is not required to disclose its annual financial statements.
  

Cons of a limited partnership

• Two parties are required: To form a limited partnership, at least two partners are required. Because it can be challenging to find suitable partners, this requirement might be seen as a disadvantage compared with legal forms that can be established by one person.
  
• Formation costs: Though forming a limited partnership is straightforward, there are costs involved, such as those for registering in the commercial register and notary fees.
  
• Partnership agreement contains complex regulations: Though the partnership agreement for a limited partnership can be informal, in some cases it can be detailed and complex. This is the case, for example, when the rights and responsibilities of the partners or the distribution of profits have special provisions. The involvement of multiple limited partners can also add to the complexity of the partnership agreement.
  
• General partners have personal liability: General partners have unlimited liability with their entire personal assets, which poses a significant personal risk.
  
• Limited partners have limited influence: Because the general partners are solely responsible for managing the business, limited partners have only limited rights of control and decision-making. This can lead to conflicts if they disagree with the management’s decisions.
  

Pros and cons of forming a limited partnership