Posted by Robert on October 31, 2011
This is a guest post by Robert, who lives in Calgary and
works as a financial adviser retired at 34. He is married, has three kids. Robert and his wife then plan to return to school and become teachers, eventually living and working overseas.
I saw that last week, the Blunt Bean Counter wrote a blog post about flow-through shares. I have used flow-through shares in order to save tax, and I agree that they can be a good idea. What struck me, however, was that the author assumed that flow-through shares all come as a limited partnership. In fact, he only even mentioned the term “limited partnership” in passing once. This is hardly a criticism, as the flow-through shares in the office where I worked were all sold as limited partnerships. The only exception was when I once wanted the tax break, but no limited partnerships were available. I bought individual flow-through shares and held them for 1.5 years before they were (very) profitable.
Many investments are available either on their own, within a corporation, within a mutual fund or within a limited partnership. Buying a business, for example, can be done privately, when one person buys an operating business from its owner. Alternatively, the business can be structured as a corporation, and shares can be used to buy and sell ownership. A business that is structured as an income trust usually has two portions: a limited partnership and a mutual fund. The mutual funds that most of us are familiar with generally hold the shares of a number of corporations. Most of us are familiar with corporations and mutual funds.
Limited partnerships constitute a different structure that can be used for ownership, and it has its own pros and cons. A partnership consists of one or more general partners. These are the managing partners who manage the operations of the partnership. These are the people who buy and sell the holdings and manage any employees. Limited partners usually simply buy into the partnership by putting up funds, and then have little say in the operations. Investments in flow-through shares and especially real estate are often structured as limited partnerships.
Limited partners don’t benefit from the same limited liability as shareholders of a corporation. Have you ever wondered what the “Ltd.” at the end of a company name meant? It’s short for “limited liability corporation,” meaning that the owners of the company are not individually responsible for the debts or actions of the company. This was an issue that the media raised in regards to income trusts, when they became popular in Canada. The company was a limited partnership, held within a mutual fund (whose units traded on the market), so unit holders could potentially be held individually (and severally) liable for the debts and actions of the company. In practice, I never saw an example of this. With real estate, however, I have a family member who invested $20,000, which was lost, and ended up owing another $40,000 as his share of the mortgage.
Corporations are also required to supply certain information and file certain returns at regular intervals, with the goal of keeping shareholders, and the broader public, informed of their activities and their financial situation. Limited partnerships, especially those that don’t trade (such as flow-through shares and real estate) are not subject to the same obligation to report financial information. The best ones will inform investors of their affairs, but it is not required. In fact, certain limited partnerships chose that structure in order to obscure information and protect their proprietary strategy, as in the case of an investment fund.
With limited partnerships that don’t trade on the market, investors have little control over the operations of the partnership and have little or no say in the liquidity of their investment. It’s not possible to decide to sell today, this week, this month or even this year. Often, the limited partnership has a definite plan to wind up operations after a specified time frame. However, limited partners can vote to extend the time frame, or could, in theory, vote to sell out early.
There is no inherent problem or risk with an investment, just because it is held inside a limited partnership. But it helps to be sure that you are comfortable with the characteristics of unlimited liability, opacity and illiquidity that qualify this structure. I’m curious to hear experiences readers have had investing in limited partnerships.