A limited partnership is a formal legal entity formed under state law, but is not considered a legal entity for tax purposes. It is called a flow-through entity for tax purposes. This means that the profits and losses produced by the limited partnership are passed through to the owners of the limited partnership.A limited partnership has two classifications of partners –general and limited. The general partner of a limited partnership assumes unlimited liability for the partnership’s debts and obligations; however, the general partner is often formed as an entity, which, in effect, shields the general partner from any liability. If properly structured, the limited partners of a limited partnership are not involved in the management of the entity and are not responsible for the entity’s debts and liabilities (similar to stockholders of a corporation in their capacities as stockholders) and the total losses of limited partners are limited to their respective investments in the limited partnership.

Profits and losses of a limited partnership may be allocated among the partners under a formula determined by the partners, subject to detailed IRS rules and regulations. In general, the allocations must have “substantial economic effect.”

Often the limited partnership’s losses in the start-up phase are allocated to members with deeper pockets who can utilize tax losses to offset income. As the limited partnership produces profits over time, the profits usually are allocated among all members. The ability for certain limited partners to utilize the limited partnership’s losses is a beneficial feature of a pass-through entity versus a corporation where stockholders of a corporation cannot deduct losses until their stock is sold or is determined to be worthless. In a partnership, the losses can be recognized and used by the owners as the losses are incurred.Limited partnerships are common entities for private investment funds and familiar and to individuals who manage or work with private investment funds. Limited partnerships are not well understood by stakeholders in technology companies (including lawyers who represent startup companies), which is one of the reasons why these entities are not often used for startup technology companies.