- What is a partnership?
- What is an LLC?
- Reasons for forming a partnership
- Disadvantages of partnerships
- Reasons for forming an LLC
- Disadvantages of forming an LLC
- Comparing LLCs versus partnerships: The main differences
- Conclusion: Which business type is right for you?
What is a partnership?
A partnership is a business form where two or more individuals agree to operate as co-owners. Partners can have any share of ownership, but the total percentages must equal 100 percent.
When it comes to partnerships, many people tend to think of the general partnership (GP). There are also two other common partnership types: the limited partnership (LP) and the limited liability partnership (LLP).
General Partnership (GP)
In a general partnership, two or more individuals share the management of and personal responsibilities for a business. This is the simplest structure you can choose when starting a business with one or more partners.
The requirements for creating a general partnership are straight forward.
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There’s no need to file specific state statutes before creating a general partnership because a general partnership is not a statutory business organization.
(Note: States do have statutes or laws that deal with partnerships, although these are usually default provisions addressing issues not covered in an agreement.) -
To form a general partnership, you establish an agreement with your one or more partners. The agreement can be oral, but it is advised to have it written and signed by all partners to help avoid conflicts down the road. This agreement should establish each partner's responsibilities, duties, and rights.
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Essentially anyone can be a partner. A partner can be an individual, or a partnership, limited liability company, corporation, or trust.
Limited Partnership (LP)
The limited partnership is made up of two types of partners: general partners and limited partners. This business structure can be seen as a cross between a general partnership and a corporation, where limited liability protection exists for some partners.
In the case of a limited partnership -
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At least one partner must be a general partner with unlimited liability.
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At least one partner must be a limited partner. This person’s liability is typically limited to the amount of his or her investment.
This means that in an LP, the general partners are personally responsible for the obligations of the business, leaving them open to greater liability should anything happen to the business. However, general partners theoretically wield the most control in how the business is run.
Anyone holding a limited partner role is more like a passive shareholder of a corporation—making investments to support business objectives but not being directly involved in the management decisions.
As such, this type of business structure is often only used in single, limited-term situations—such as film and real estate projects—as well as in family estate planning.
When creating a limited partnership, there are a few requirements to understand:
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This business structure is organized under state law. Various documents—including a certificate of limited partnership (or similarly named document) -- must be filed with the state. Any state can be chosen as the formation state.
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LPs are required to have a partnership agreement and must publicly disclose their status by having the LP designation in the company name.
Limited Liability Partnership (LLP)
A limited liability partnership is similar to a limited liability company (LLC) in that all partners are granted limited liability protection. However, in some states the partners in an LLP get less liability protection than in an LLC.
LLP requirements vary from state to state.
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In some states, the option for an LLP is limited to certain professional services—usually ones that require a state license—such as accountants, attorneys, doctors, among others.
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In a similar fashion, an LLP may be one of the few or only option for certain professions when forming a group practice. In California, licensed professionals such as architects, doctors, and lawyers can form an LLP or a PC (professional corporation) but cannot form an LLC.
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Other states allow an LLP to be used for any business purpose.
When comparing the differences between LLCs and partnerships, note that the owners of an LLP, limited partnership or general partnership are called partners. LLC owners are called members.
An LLP must have an entity indicator in its name such as Limited Liability Partnership, LLP or L.L.P. This is also the case with an LLC, limited partnership, or any other statutory business entity where some or all owners have liability protection.
Here are some of the requirements for creating a limited liability partnership. (Again, please keep in mind that laws vary from state to state.)
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Formation documents are required when registering a business as an LLP. This must be filed with the appropriate state agency, along with the appropriate filing fees. One of the required documents is sometimes called a statement of qualification or a certificate of limited liability partnership.
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Any state can be chosen as the formation state (if you meet the state criteria for an LLP).
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Some states require one or more legal notices of the new LLP published in one or more local newspapers.
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The business must have two or more partners in order to form an LLP business structure.
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A converting general partnership retains its original partnership agreement. The LLP is governed by state law on general partnerships, as well as the specific provisions of the partnership law governing LLPs.
What is an LLC?
The limited liability company (LLC) exists as a separate entity from its owners, legally ensuring that the members cannot be held personally responsible for business debts and liabilities in most cases.
An LLC also allows for pass-through taxation because income earned is not taxed at the entity level. Members are still required to file a tax return for the LLC if it has more than one owner. Once filed, the income or loss from the LLC, as specified in the return, is passed through to the owner(s).
All LLC members must personally report the income or loss on tax returns and pay the necessary taxes and fees.
Here are some of the requirements of forming an LLC:
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Filing Articles of Organization with the Secretary of State,
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Selecting a qualifying business name,
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Preparing an operating agreement,
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Choosing a registered agent.
Reasons for forming a partnership
General Partnership
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Easy set-up. Creating a general partnership is relatively easy. There’s no state filing paperwork required, and the partnership is simply created when the partners begin business activities.
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Low cost of operation. There are also lower start-up and on-going costs. Because a GP is not formed with a state filing, you don’t have to deal with an initial filing fee, ongoing state fees or franchise taxes.
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Few ongoing requirements. As a general partnership, the business is not required to -
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Hold annual meetings of the owners.
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Issue partnership interest.
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Keep personal assets separate from business assets.
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A partnership agreement is recommended, but not required. When forming a GP, it’s suggested that an agreement is created that outlines management, roles and potential business-dissolving events.
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Limited Partnership
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Limited liability for limited partners. For limited partners, their personal assets are separate from the business; these partners are not personally liable for business debts. The amount of their liability is limited to their investment in the LP.
Note: To limit the liability for general partners, many LPs use an LLC or corporation as the general partner because of their limited liability. -
Control over business decisions. Limited partners are not involved in management. The general partners oversee the day-to-day operations.
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Pass-through taxation. Income tax is not paid by the business. Profits and losses are reported on the partners’ tax returns, and any tax due is paid at the individual level.
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Short-term projects. Limited partnerships are most often used for short-term business ventures. For example, films are often formalized as LPs and family estate planning often leverage the benefits of LPs.
Limited Liability Partnership
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Personal asset protection. All partners in an LLP typically are not required to use personal assets to resolve business debts and liabilities.
Note: The LLP does not shield partners for liability for their personal acts. For example, the LLP cannot limit the liability of owners for their own malpractice. -
Pass-through taxation. Income tax is not paid by the business. Profits and losses are reported on the partners’ tax returns, and any tax due is paid at the individual level.
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Easier conversion from general partnership. LLPs typically offer easier conversion from a general partnership to an LLP than to an LLC or corporation.
Disadvantages of partnerships
Liability (GP, LP)
The greatest disadvantage of a partnership is the potential liability. In a general partnership, all partners are personally liable for the business’s debts and obligations. The owners are legally considered the same as the business, and personal assets can therefore be considered business assets.
Additionally, every partner in a general partnership is responsible for the actions of the other partners. General partnerships are the easiest to create and provide the lowest ongoing costs, but they’re also the highest risk option for business partners.
In the case of a limited partnership, the general partners have unlimited liability. And while a limited partnership provides the limited partners with minimal liability, they have to be careful not to participate in management or risk losing their limited liability status.
Management (GP, LP, LLP)
Although partnerships offer flexibility in terms of management, the decisions of one partner in a general partnership or limited liability partnership can bind the other partners.
For example, one partner may decide to enter into an agreement without informing the other partners. The other partners would still be obligated to the terms of the agreement.
It is the same case with credit obligations. A loan secured by one partner becomes the responsibility of all partners.
In the case of a limited partnership, the limited partners take no part in management decisions and are only liable for their initial investment.
Unexpected dissolution (GP, LP, LLP)
A general partnership dissolves upon the death or withdrawal of a partner unless safeguards are in place at the time of formation. Otherwise, the formation state’s laws will define the events that trigger dissolution, which can include a partner dissociating.
Similarly, in the case of an LP or LLP, the state statute may state that the disassociation of a partner triggers dissolution unless the partnership agreement has provisions that address this scenario.
Raising capital (GP)
Due to the potential personal liability, general partnerships can be limited in their ability to raise money and attract investors. When a partner contributes capital to a partnership, the partner receives an ownership percentage in all assets of the partnership, not just in the property contributed.
Reasons for forming an LLC
There are many reasons for forming an LLC versus a partnership, including liability, ownership roles, and more. Most significantly, an LLC provides business owners with the benefits of both the corporation and partnership business structures.
This makes LLCs a great business structure for both medium- and higher-risk businesses because owners with significant personal assets are protected.
Limited liability
The owners (or members) of an LLC are protected from personal liability for the acts of the LLC and other members. Because of this, creditors cannot pursue the members’ personal assets, like a house or savings accounts, to pay business debts. This is in comparison to general partners, whose personal assets can be pursued against the business’ debts.
Greater flexibility
An LLC has many options when it comes to its management structure. Members of the LLC can be individuals, partnerships, trusts, or corporations, and there is no limit on the number of members. An LLC can also decide to have its members manage day-to-day operations (member-managed), or these duties can be performed by non-members (manager-managed).
Heightened credibility
An LLC may help a new business establish credibility more so than if the business is operated as a general partnership.
Disadvantages of forming an LLC
Cost
The start-up cost is higher than for a general partnership and is more akin to that of a corporation. General partnerships do not have to pay fees for filing formation documents or annual fees.
Banking
Cashing a business check can be complicated. Some banks only permit the depositing of checks made out to an LLC. Others may allow designated signatories for the account to cash a business check with proper verification.
Separate records
To avoid the risk of personal exposure, an LLC should take the necessary steps to show that the business exists separately from the owners. This includes keeping records of major business decisions, preventing the comingling of business and personal assets, and fulfilling LLC requirements (keeping minutes, annual filings, paying filing fees, and so on).
Comparing LLCs versus partnerships: The main differences
Viewing all of these details together can help you see which business structure is best for you and your business partners. Here is an overview of the main differences in terms of liability, on-going requirements, management and taxes.
Limited liability protection/asset protection
Limited Liability Company
LLCs protect owners against personal liability for business debts and lawsuits. This safeguards the personal assets for all owners.
General Partnership
In a general partnership, owners have unlimited, personal liability for the businesses’ debts, including, but not limited to, the acts of employees. There is also unlimited personal liability for the acts of all other owners.
Limited Partnership
A limited partnership only offers personal liability protection to certain partners. The general partner is personally liable for the debts of the business and bear a great deal of the risks.
Limited Liability Partnership
General partners in an LLP have limited liability, and LLPs are often required to have insurance policies to cover personal liability. In some states, the business interests of the owners of an LLP have less protection from the claims of the owners' personal creditors, as compared to the LLC. In those states the partners are not liable for contractual debts but may still be liable for torts.
Formation and ongoing requirements
Limited Liability Company
An LLC can be less complex to form than a standard corporation. However, for multi-member LLCs, owners must enter into an operating agreement that clarifies the members’ rights and responsibilities.
LLCs must also file articles of organization with the right state office. These documents typically identify the LLC’s name, location of its principal office, whether it is managed by members or managers, the identities of those who will manage, the name and address of its registered agent, and any planned LLC term or duration, along with other statutory requirements.
While most states impose fewer compliance requirements on LLCs than on corporations, recordkeeping is a fundamental requirement for both LLCs and corporations. Various records have to be maintained, including the governing documents, shareholder and member lists, and certain tax returns. Other requirements include filing annual reports, paying annual fees, and maintaining a registered agent and office.
General Partnership
A general partnership may be formed merely by the owners beginning to do business. This means, there’s no requirement to pay a formation filing fee, ongoing state fees or franchise taxes.
A general partnership is also not required to hold annual meetings of the owners, issue partnership interest, and keep personal assets separate from business assets making formation and ongoing maintenance simple and cost effective,
Limited Partnerships/ Limited Liability Partnerships
Both business structures have formation and ongoing requirements similar to that of an LLC. This means handling initial and ongoing paperwork and fees.
Note that all businesses are still subject to certain state and local business requirements, such as fulfilling business license and permit obligations and registering d/b/a names. They apply whether you are an LLC or any form of partnership.
Pass-through taxation
Limited Liability Company
An LLC is not a separate taxable entity, which means that no federal tax is paid at the business level. Instead, all business income and deductions are passed through to the members.
If LLCs don’t choose to be taxed as a corporation, they will be taxed as if they are a partnership. As such, there is actually no such thing as LLC taxation. An LLC with more than one member is either taxed under the subchapter of the Internal Revenue Code (IRC) for corporations (Subchapter C or S) or subchapter for partnerships (Subchapter K).
General Partnership, Limited Partnership, Limited Liability Partnership
All three partnership types enjoy the benefits of pass-through taxation.
Management & flexibility
Limited Liability Company
Your LLC’s operating agreement may be used to structure management roles and decision-making authority in a way that best suits your business needs. Owners can decide whether all members will manage the LLC or if management and decision-making powers are delegated to certain members or to non-members.
General Partnership
In a general partnership, it’s important to specify roles and management. It is recommended that the partners enter into a written partnership agreement, to specify each partners’ management duties and responsibilities.
Limited Partnership
A limited partnership requires that you have one or more general partners and one or more limited partners. Limited partnerships allow for the raising of additional capital through limited partners, who remain “silent partners” while the general partners maintain control of the business. Here, the partnership agreement provides for the general partners’ management responsibilities, duties and liability.
Limited Liability Partnership
An LLP is required to have two or more partners (owners). Upon formation, the partners enter into a partnership agreement that specifies management duties, responsibilities and liabilities for each owner.
This partnership agreement can allow for partners to be added or retired, making it easy to add partners who bring existing business with them.
Which business type is right for you?
Selecting the legal structure for your company is one of the more important decisions you will make as you start your business. As you weigh your options, remember to compare the benefits and drawbacks in terms of ownership and control, along with asset protection, costs and taxation.
In some cases, you may be limited to your choice of entity depending on the type of industry you’re in and state laws.
Remember that each option brings its own set of advantages and disadvantages; no one entity is the perfect choice under all circumstances.
As always, it is best to consult with a lawyer or a tax professional before making the final decision. With the right structure chosen, you can start your business on the right foot.