Family Limited Partnership as a Business Structure?
Updated: Jul 1, 2020
This post is not legal advice.
I’ve written about limited partnerships as a business structure previously, but let’s review. A limited partnership is made up of at least one general partner and one or more limited partners. General partners manage the business and take all the business risks. (See the previous post on general partnerships to get an idea of the types potential risks general partners face). Limited partners have no management responsibilities, and their liability is limited to what they have invested.
A family limited partnership (FLP) is a limited partnership with memberships/partnerships limited to family members. FLPs offer a potential strategy for family farms to transition the farm on to the next generation. For example, the farm could be set up as an FLP which places the older generation as the general partners and the younger generation as the limited partners. The older generation can continue to participate in the operation, and the younger generation can, over time, take over the day-to-day management of the operation.
FLPs provide some benefits but they do have drawbacks. An FLP can be used to transfer control from the older generation to the younger generation. One way to set up the FLP would be to make the older generation the general partners and the younger generation the limited partners. The older generation would make the day-to-day decisions on the farm but gradually pass control to the younger generation over time. In this scenario, the older generation would transition into limited partners, and the younger generation would transition into the role of general partners.
Because membership in the FLP is limited to family members, shares in a FLP are difficult to sell. Because the market is limited (or non-existent), the value of the shares can be discounted, allowing control of the FLP to pass to the next generation at a lower cost. Being able to discount the value of shares also allows the older generation to avoid gift tax consequences.
FLPs have a drawback: the limited partner can become a general partner if the limited partner takes part in control of the FLP. Limited partners are viewed like stockholders– investors with no voice in the operation of the business. Within the FLP, it may be hard once the older generation has “retired” and moved to the limited partner role to stay out of decisions in the operation. How a limited partner becomes a general partner will require another whole post, but the takeaway point should be: If you cannot keep quiet on how your children are running the business, then an FLP may not be the business entity for you. You should talk with your attorney about utilizing a Family Limited Liability Company or another family business entity that works for your situation.
FLPs have benefits for a family to consider when developing a succession plan. The entity allows for some limiting of liability protections for limited partners. Allowing for discounted valuations when passing farm management to the younger generation can have tax benefits. But these benefits may be outweighed when considering family dynamics and whether the older generation will be able to keep limited partnership status in “retirement.”
*Special note: As Shannon Ferrell at Oklahoma State University reminds me, no farmer ever truly retires. For that reason, I put retirement in quotes.