Partnerships and limited liability corporations both have their advantages and disadvantages. We discuss the most important things to think about when choosing between a partnership vs LLC.
Starting your own business can be an incredibly exciting adventure. With the right decisions (and a little bit of luck), you can turn your business vision into reality. Unsurprisingly, millions of Americans will make the decision to start their own business every year.
When starting your own business, one of the first—and most important—decisions you will need to make is what type of business you want to have. There are many different types of business structures available to choose from, each with its own share of pros and cons attached to it.
Two of the most popular business structures include a partnership and a limited liability corporation (LLC). Both of these types of businesses can help reduce your exposure to risk and offer strategic tax benefits. Understanding the differences between partnerships vs LLCs will help you make a decision about which business entity is right for you.
In this article, we will discuss the most important things you need to know about partnerships and LLCs, including their key differences, advantages, and drawbacks. By taking the time to learn about the many different business structures currently available, you’ll be able to decide which one might be best for you.
What is an LLC?
A limited liability corporation (LLC) is a very common business structure. With an LLC, the owner(s) of the business is not personally responsible for their business’s debts and other financial liabilities. The primary purpose of creating an LLC, as the name might suggest, is to help provide the business owner with legal and financial protections. Separating personal and business expenses will make it much easier to safely operate and scale over time.
There are many different types of businesses that might consider creating an LLC. LLCs are often relatively small (including plenty of one-person businesses), but there is no formal limit to how large an LLC can be. A barber might consider creating an LLC, just as a large law firm might also consider doing.
The exact rules and guidelines for how to create an LLC will vary by state—some states make it much easier to create an LLC than others. To “formally” create an LLC, the business owner(s) will need to file articles of organization and choose a specific jurisdiction to be incorporated into.
To many people, an LLC represents a hybrid between a sole proprietorship and a larger corporation. Any individual can operate as a sole proprietor, but they will be personally responsible for paying all of the business’ debts, taxes, and other financial obligations. A (C or S) corporation, on the other hand, offers large amounts of legal and financial protections to stakeholders (or shareholders). However, creating an S or C corporation presents several additional responsibilities, challenges, and regulations. An LLC exists somewhere in between on the spectrum, providing basic protections for owners without being overly complicated.
As of 2015, there are about 2.5 million LLCs operating in the United States.
What is a Partnership?
In the business world, the term “partnership” is often used rather loosely. There are many different types of partnerships currently available, some with much more rigid structures than others. However, in the broadest sense, a partnership is simply a formally structured business with multiple parties in control.
When creating a partnership, it is important to clearly define each party’s responsibilities, ownerships, and rights (particularly, the right to profit-sharing). The more that can be done to clarify these details in advance, the less likely a partnership dispute will arise in the future.
There are many advantages to creating a partnership. Structurally—like an LLC—a partnership offers business owners a way to share responsibilities and risk. If something were to happen to the partnership, such as major financial losses, the consequences will be distributed across multiple parties.
Partnership vs LLC
When compared to a sole proprietorship—which is generally considered the most basic or “default” structure of a new business—both partnerships and LLCs offer greater protection from liability and risk. However, generally speaking, LLCs offer greater protection.
According to NOLO Legal Encyclopedia, “Aside from formation requirements, the main difference between a partnership and an LLC is that partners are personally liable for any business debts of the partnership—meaning that creditors of the partnership can go after the partners’ personal assets—while members (owners) of an LLC are not personally liable.”
With a partnership, your personal assets unrelated to the business (such as your home, car, etc.) could be used as a part of a debt settlement. An LLC, on the other hand, could certainly go bankrupt, but the owner’s assets are protected. Depending on the current structure and nature of your business, creating an LLC may be a wise decision.
What are the Four Different Types of Partnerships?
As indicated, business partnerships come in multiple different forms. Four of the most common (and most clearly defined) types of partnerships include:
A General Partnership is the most basic type of partnership. A general partnership does not require forming a legal entity. However, it is probably a good idea to have a written agreement that outlines each partner’s ownership and responsibilities.
A limited partnership includes at least one partner that helps run the company, along with additional partners that have a structurally limited role (such as financing or ownership). The partner(s) with a limited role might be referred to as the silent partner. These types of businesses must be incorporated within the state.
Limited Liability Partnership (LLP)
With a limited liability partnership, the partners are still at risk for all debts, but the amount they can be affected by the actions of the other partners will be structurally limited. These businesses are common among legal, medical, and financial professionals.
Limited Liability Limited Partnership (LLLP)
Currently available in 28 states, an LLLP is similar to an LLP but offers an additional layer of liability protection. The LLLP’s incorporation should clearly outline the different liabilities held by both the general partner(s) and all other partners.
These different types of partnerships, as you might expect, are structurally similar in many ways. Each of these partnerships represents a formal agreement between multiple parties and each type will also provide opportunities for reducing your ongoing exposure to risk. However, how risk and responsibilities are distributed will vary by business.
Can an LLC be a Partnership?
An LLC and a partnership are two different types of businesses. An LLC is a business entity with a defined legal structure. An LLC is distinct from the personal financial status of the owner(s), even if the owner(s) created the business entirely with their own money. A partnership is a broader term used to describe mutually exclusive types of businesses. In a partnership, owners will be exposed to personal financial risks, even if these risks and exposures have been limited in some way.
Can an LLC have two owners?
There is no limit to how many people can own an LLC. When there is more than one owner, the LLC will be considered a “multi-member” LLC—these entities, like single-member LLCs, need to be incorporated with the state. Upon incorporation, a multi-member LLC will become legally distinct from a general partnership.
Partnerships vs LLCs: Which Should You Choose?
Whether forming a partnership or LLC is right for your business will depend on several different factors. The industry you participate in, the number of people involved in the business, your personal financial situation, and your long-term goals should all be considered. Furthermore, the type of partnership you are considering creating might also affect your decision:
LLC vs General Partnership
A general partnership is very easy to create—and can even be created informally—but does not offer much financial protection. If something were to go wrong, your personal wealth might be at risk. An LLC requires incorporation and can be complicated but offers additional protections.
LLC vs Limited Partnership
A limited partnership makes it possible for people to have a stake in the company without playing as direct of a role. Like an LLC, it becomes possible for additional (potentially wealthy) parties to fund the company’s endeavors. Unlike an LLC, however, there is still structure exposure to liability.
LLC vs Limited Liability Partnership (LLP)
An LLP is a popular option for high-certification professions, such as doctors and lawyers. Multiple different partners can share and access common resources, without the need to create an additional entity. However, once again, an LLP will still present more exposure to liability than an independently established LLC.
LLC vs Limited Liability Limited Partnership (LLLP)
While an LLC can be created in every state, an LLLP can only be created in just over half of all states. There are two structural protections included in an LLLP: the “limited liability” aspect limits how much a given partner’s wealth will be at risk and the “limited partnership” aspect limits the role they will have within the company.
There is no one universally “best” way to run a business. However, when comparing an LLC vs partnership, an LLC is usually better for creating financial separation and protection, while a partnership is usually easier to establish and run. Depending on your current needs, both these business models might be advantageous.