When you're starting a business, there are a lot of things to think about. One important consideration is how to protect your personal assets.
If the business incurs debts, will you have to pay them out of your own pocket? One of the best ways to protect your assets is to form an entity, such as a limited liability company (LLC), corporation, limited-partnership (LP), limited liability partnerships (LLP), or limited liability limited partnerships (LLLP). You can think of these entities as artificial persons. They can own their own businesses and properties, enter into their own contracts, and incur their own debts. And they are liable for their own debts. So if, for example, you form an LLC, the LLC owns the business, the LLC incurs the debts to operate the business, and the LLC is liable for those debts. You, as the owner of the LLC, are not liable.
On the other hand, if you're the sole owner of a business and haven't created a corporation, LLC, or other entity, you're operating as a sole proprietorship. This means there is no separation between you and the business. Your business can't own any assets itself, so all business assets are considered your personal property. And all the debts incurred in running the business are your debts. As a result, all your assets are at risk from any of your creditors.
Asset protection for sole proprietors
Forming and maintaining an entity can be more expensive and complicated than some people may want. If you decide that you still want to operate as a sole proprietorship you should look into some other asset protection strategies, such as obtaining adequate insurance. You may wish to consult with a professional on this.
General partnership liability is a major risk
Suppose you are a business co-owner, and have not formally created a corporation, LLC, limited liability partnership, limited partnership, or a limited liability limited partnership. In that case, you are operating a general partnership. Since you haven’t created a separate entity to own the business, you have unlimited personal liability for all of your business debts, including the acts of employees. In addition, as a general partner, you are also personally liable for the acts of all of the other partners.
Limited partnerships provide asset protection for non-managing partners
A limited partnership should not be confused with a general partnership. In a general partnership, all partners have unlimited personal liability for their own actions (or inactions) and those of each partner. In contrast, a limited partnership (LP) has two types of partners: general and limited. In an LP, there is at least one general partner who has unlimited personal liability, and at least one limited partner whose liability is limited to the investment he or she has made in the business. A general partnership is formed simply by two or more people agreeing to do business together. A limited partnership is a statutory entity. It is formed by filing a certificate of limited partnership with the Secretary of State (or equivalent office) and complying with the requirements of the formation state’s LP statute.
Limited partners are "silent" investors
Limited partners are "silent partners" who make an investment of capital, just as a shareholder does in a large, publicly traded corporation. Along with the positive aspect of limited liability, there is a negative aspect as well: limited partners are prohibited from making day-to-day management decisions. Because all of the owners usually want to participate in the management of the business, an LP is not a suitable form for operating many small businesses. On the other hand, the fact that limited partners cannot participate in management means that this form can be useful for estate planning and succession planning. Because general partners have unlimited liability, in many LPs, the general partner will be a corporation or LLC, instead of an individual.
Limited liability partnerships offer asset protection for all partners
When choosing a business form, you may want to consider the limited liability partnership (LLP). An LLP is a special kind of general partnership. As we mentioned, in a general partnership, the partners do not have limited liability. However, in an LLP, the partners do have limited liability. In most states the partners have the same liability protection as members of an LLC or corporate shareholders – that is, they are not liable for any of the business’ debts, whether based on contracts, negligence, or otherwise. A few states, however, provide liability protection from the misconduct or negligence of other partners but not from the LLP’s contractual debts. LLPs have proven particularly popular for professionals, such as lawyers, doctors, and accountants, who prefer to operate as partnerships but who want the asset protection that the LLP provides, particularly from the malpractice of co-partners. And in fact, in some states, LLPs can only be formed by professionals.
Comparing LLP and LLC
Although there are similarities between an LLC and an LLP, an LLP is not the same as an LLC. LLCs are generally considered a better choice for the small business owner for several reasons. As we noted, in some states partners in LLPs may still be liable for the LLP’s contracts and in some states the LLP is limited to professionals. Also, because an LLP is a partnership it must have more than owner, while an LLC can be solely owned. LLCs are also a better choice where there are owners who do not want to participate in management.
Converting a general partnership to an LLP
If you have been operating as a general partnership and want to convert to an LLP you need to follow the partnership law of the state that will be the LLP’s home, or domestic, state. Your general partnership will have to file a document that may be called, for example, an application for registration of an LLP, with the Secretary of State (or equivalent office). Technically, the old partnership does not dissolve. It continues to exist but is now subject to a new set of laws (i.e., those governing the LLP). The conversion does not trigger a taxable event because there is no change in the tax status of the partnership. Moreover, none of the assets need to be re-titled, making the conversion especially simple and inexpensive.
Limited liability limited partnerships can protect assets
What an LLP is to a general partnership, an LLLP is to a limited partnership. A limited liability limited partnership (LLLP) is a limited partnership (LP) in which the general partners will have limited liability, similar to the limited partners. An LP can become an LLLP through a statutory process similar to the process of a general partnership registering to be recognized as a limited liability partnership (LLP). That means the LP has to file a document with the Secretary of State (or equivalent office) applying to be an LLLP.
While both LLPs and LLLPs provide asset protection for all partners, there are differences. An LLP is a general partnership, meaning, in general, all partners participate in management. An LLLP is a limited partnership, meaning its limited partners do not manage. An LLLP is also subject to the requirements of the home state’s limited partnership statute. Most importantly, while all states authorize LLPs, only slightly more than half the states authorize LLLPs. So you have to check with the state law before converting your LP into an LLLP to see if it’s possible.
LLCs and corporations provide protection
If you are already operating a business as a sole proprietorship or general partnership, you may want to consider converting the business to an LLC or corporation. This change converts your liability from unlimited personal liability for the business's debts to limited liability, and the conversion may be accomplished tax-free.
In some cases, there may be a tax bill due upon the conversion of a general partnership to a corporation, so consult a tax professional first if you are considering this step.
The IRS will automatically treat a single-owner LLC as a sole proprietorship for tax purposes, so you retain all the simplicity and tax savings of the simpler business form. Similarly, a multiple-owner LLC will be treated as if it were a partnership for tax purposes, so after a conversion you would continue to file a partnership tax return and retain the favorable pass-through tax treatment that goes along with partnership status.
LLCs and corporations are statutory entities, meaning you must follow the procedure of your formation state’s LLC or corporation statute to create one. That includes choosing a name for the LLC or corporation and making sure it is available for your use, choosing a registered agent, and filing a formation document with the Secretary of State (or equivalent office). In some cases the formation state may have a statutory conversion provision that can be used by general partnerships to convert to an LLC, and in some states to a corporation as well. This requires the filing of a conversion document along with the LLC or corporation’s formation document.
Own the business yourself or create a separate entity to own it? It’s one of the biggest decisions any business owner will make
Choosing whether to operate your business as a sole proprietorship or general partnership or to create a separate entity like an LLC, corporation, LP, LLP, or LLLP, is one of the most important decisions any small business owner will make. Factors include not only asset protection but taxation, initial and annual costs, and more. Getting legal or tax advice is an option you might want to consider to help you make that decision.
