Silent partners can provide resources for start-up businesses
Silent partners bring cash to the table and have limited liability.
We have all heard the term “silent partner,” but most of us do not really know what that means. In fact, there is no such thing as a "silent partner." The legal term is actually limited partner. One can be a limited partner as long as they are “silent” in the management of the business.
In the state of Michigan, many business ownership structures are allowed. One such structure is called a limited partnership. This form of ownership structure has at least two individuals (not typically husband and wife), one who is a general partner, and the remainder can be limited partners. It is the limited partners that we commonly refer to as silent partners.
General partnerships exist as businesses. For example, two neighbors may decide to open a café and share in the management of the business, share the workload of the business and share in the profits of the business. This is a typical general partnership. Partnerships are typically created to increase the amount of start-up cash, because the cash combination of two founders is larger that the cash available for a single founder. General partnerships are regulated, mired in what’s called agency law. If you are considering forming a general partnership, please proceed under the guidance of a knowledgeable attorney.
In its basic form, agency law states that whatever one partner does, that action is automatically approved by the other partner, with or without prior consent. So if one partner makes a business decision that brings on a lawsuit, the other partner is automatically involved, and there is no limit on the liability of either partner. For this reason, limited partnerships are formed.
A limited partnership is where the general partner is the manager of the business and makes all day-to-day operating decisions. The limited partner, however, cannot make day-to-day management decisions—hence the silent partner moniker. The limited partner simply supplies start-up cash to get the business going. If the general partner makes a mistake, and the business is involved in a lawsuit, the general partner has unlimited liability, yet the limited partner can only lose the amount invested in the business.
Most limited partners have a vested interest in making the business successful. Their business purpose include wealth protection and investment income. If the limited partner wants to make changes to the business, and makes decisions about the operations of the business, the limited partner loses their limited status and becomes a general partner. Partnership rules are complex, and without a competent attorney to assist in the writing of a partnership agreement, the partnership may find the complexity of a partnership overwhelming.
Limited partnerships are a good way to organize your business as long as you do it properly under the guidance of an experienced attorney. There are also other ways to organize your business, and I encourage you to find the resources in your neighborhood to assist you in deciding what organizational structure is best for your situation.
Paul J. Werner is an Michigan State University Extension educator from L’Anse, Michigan. Werner has many years experience in small business ownership and entrepreneurship. He and his wife currently own two small businesses in the Upper Peninsula of Michigan. You can obtain free business counseling by registering with the MSU Product Center.