A successful start-up business often requires both active and silent partners. Active partners are involved in day-to-day business operations. Silent partners are typically limited partners who provide financial support to a business and, therefore, become part owners in the company. In a general partnership, each partner is responsible for the business debts and has unlimited liability. In a limited liability partnership, general and silent partners collaborate to expand the business, but they have different roles.
Silent partners are commonly called limited partners because their liabilities are limited to the amount of money they invest in the business. The silent partner, while inactive in routine business operations and management, has the same rights to share in the business profits as the general partner.
The Question of Liability
Active and silent partners work together for business success and incur losses if a business does poorly. Active partners make decisions and are therefore responsible for their decisions. As a result, they have unlimited liability. If a business declares bankruptcy, general partners are fully liable for the business debts. Depending on how the business is structured, general partners may be required to liquidate their personal assets to pay creditors.
Silent investors are only liable to the extent of their investment. For example, if a silent partner has a 20% stake in the business, they are liable for 20% of the losses and debts incurred.
A silent partner’s personal assets are protected. If the business declares bankruptcy, creditors cannot seize a silent partner’s personal assets, such as their home or accounts.
Concerns about liability and protecting personal assets are a primary reason many partners choose to form a limited liability company (LLC). This business structure involves membership in the LLC instead of partnerships. The role and relationships of managing partners in an LLC are formalized in a partnership agreement. Because an LLC is a separate business entity from its owners, LLC members are not personally liable for the business’s debts.
The Perks of Being a Silent Partner
A silent partner invests in the business but is not responsible for running the business. They may be asked to help navigate complex decisions or use their connections to contribute to business success.
Many investors invest in businesses as silent partners to diversify their income streams. Being a silent partner can be a great way to earn passive income.
Contact Us to Speak with a
CERTIFIED FINANCIAL PLANNER™ professional.
The Drawbacks of Being a Silent Investor
By definition, being a silent partner means having a passive role. If you are a person who enjoys making decisions and actively running a business, you may not be satisfied with being a silent partner. It can be especially difficult to pay business debts if you had nothing to do with the decisions that led to the debts.
When a silent partner disagrees with a business decision, they may be tempted to overstep their role, which can lead to strained relationships. Unless the partnership agreement spells out the steps partners should take if they disagree with business decisions, it may be challenging for a silent partner to stay within their boundaries. For this reason, it is important for silent partners to understand the buyout process when leaving the partnership.
Investors invest in companies to make a profit, but there is no guarantee that a business will succeed. While you can research your investment and use your experience and intuition when choosing businesses to invest in, there is always the possibility that the active partners will not make the best decisions or that they will run into a string of bad luck.
Legal Protections
Formal business agreements that specify the roles of active and silent partners are essential to safeguard investment and provide some degree of legal protection.
If you are considering investing in a business as a silent partner:
- Verify whether there are set limits on how much active partners can spend.
- Require joint decision making between active and silent partners for major financial decisions.
- Ensure that the partnership agreement includes a well-defined exit strategy or buyout clause.
- Have partnership agreements and contracts reviewed by legal counsel.
- Negotiate for regular, guaranteed payments to ensure that there is an understanding that you require some return on investment, regardless of the business’s performance.
A fee-based financial advisor can provide valuable insight and guidance when you are choosing companies to invest in.
There is no one-size-fits-all guide to investment. Working with a wealth manager who uses a fee-only financial planning structure can ensure you make the best financial decisions for yourself and your loved ones. Ready to secure your financial future? Call us today at 866-395-1786 to get started.
