When you start a new business, one of the first things you need to ask yourself is “What kind of business will I start?” There are a few different types of businesses — sole proprietorships, partnerships, LLCs, and corporations. Today, we’ll focus on LLPs.
Limited liability partnerships (LLPs) are a combination of general partnerships and limited liability companies. They give you the best of both worlds — the flexibility and nimbleness of partnerships with the protection that LLCs offer.
But these types of businesses aren’t for everyone. In fact, there are only a few types of businesses that are even eligible to form an LLP.
In this guide, we’re going to explain what an LLP is and how it differs from other business structures. We’ll compare and contrast with other business entities and show the pros and cons of creating and LLP.
- What Is an LLP?
- Differences Between LLPs and Other Business Entities
- Advantages of an LLP
- Disadvantages of an LLP
- Is an LLP Right for You?
What Is an LLP?
A limited liability partnership (LLP) is a business entity that personally protects members from any debts and obligations of the business. It also prevents members from being held responsible for another member’s negligence.
What makes an LLP unique is that it does not hold individual partners accountable for another partner’s actions. Each partner is liable for themselves in the event that they’re sued by another business or customer.
Therefore, if your partner is sued, you have complete limited liability protection. The same goes for if you’re sued. Your other partners won’t be held responsible for your negligence.
You’re also protected from your company’s business debts and obligations. Your personal assets are shielded from all business operations.
Let’s take a look at the differences between LLPs and other business structures to better explain what makes LLPs unique.
Differences Between LLPs and Other Business Entities
In a way, a limited liability partnership is like a combination of a standard partnership and a limited liability company. LLPs have a similar structure to general partnerships while giving you the liability protection of a limited liability company.
LLP vs. General Partnership
LLPs are the same in that each partner shares the load of the managerial responsibilities in the same manner as a general partnership. The difference is that in an LLP, you’re protected from the consequences of the negative actions of other partners.
When you start a general partnership, you become liable for the actions, debts, and obligations of the entire company. This includes not only the business but also the actions of all of your partners.
For instance, in a general partnership, if you own a food truck and one of your partners was sued for hitting another vehicle, the entire company — including yourself — would be held responsible. Your personal assets are then vulnerable to forfeiture to cover any debts and obligations of the company.
With a limited liability partnership, this isn’t the case. You’re completely shielded from any wrongdoing of your partners. The same goes for a limited liability company. You have personal liability protection in an LLC as well.
LLP vs. LLC
LLPs are similar to LLCs in that all partners’ personal assets are protected from the actions of the business as a whole. Partners can only lose the money they invested in the company. If they’re sued or the company goes under due to debt, all members’ personal assets are protected.
The difference is that with an LLC, you can choose to be taxed as a corporation or a partnership. Most LLC owners opt for pass-through taxation, but there are some benefits of choosing a corporate tax structure. With an LLP, you don’t have a choice — you can only be taxed as a partnership. You can also start an LLC with as little as one person, whereas an LLP requires at least two partners.
LLP vs. LP
There is another type of partnership that combines a general partnership and LLP. It’s called a limited partnership. In a limited partnership (LP), there are two kinds of partners — general partners and limited partners.
A general partner is a member who is responsible for all debts and obligations of the business and all other partners. A limited partner is a member who has invested in the company but isn’t responsible for debts and obligations beyond their initial investment.
Advantages of an LLP
There are several advantages of running an LLP. You protect your personal assets, get access to unique tax benefits, and have a flexible management structure.
Protection of Personal Assets
Probably the biggest benefit of forming a limited liability partnership is that your personal assets are completely protected. If your business is sued, you won’t be held personally liable besides the money you have invested in the business.
You also aren’t responsible for your partners’ personal negligence. With a general partnership, this isn’t the case.
Separate Legal Entity
Similar to our last point, an LLP is a completely separate legal entity from the partners. This allows the company to do things like enter contracts, own property, or make purchases without being legally attached to partners or their personal assets.
Limited liability partnerships are great for tax purposes. They’re pass-through business entities which means that you’ll be taxed on your personal income tax return for any income coming from the business. With an LLP you will only be taxed once. You simply fill out your personal tax return and get taxed for any income that your business has produced.
Unfortunately with corporations, you’ll face double taxation from the government. You’ll be taxed once as an owner of the corporation and then again if you have any income from dividends.
Flexible Management Structure
LLPs and partnerships have the luxury of structuring management however they feel necessary. You can decide how much responsibility each partner wants to take on and who is in charge of the different tasks and roles of business operations.
Partners can create a partnership agreement that lays out all of the details of your management structure. This can serve as a guide as to how the business will operate and how decisions will be made. You can always go back and adjust the partnership agreement as long as all partners are on the same page.
Disadvantages of an LLP
LLPs don’t come without their drawbacks. They are only available to a select few companies, there can be some operating inefficiencies, and you risk dissolving the company if you only have one partner and they decide to leave.
Not Available to All Businesses
LLPs aren’t available to all types of businesses. They are also only available in roughly 40 states across the United States.
Only certain types of businesses are eligible to form an LLP, and, unfortunately, the number of businesses that can even become an LLP are very slim. LLPs are common in professional businesses like accountants, architects, law firms, and financial consultants. For these types of professions, the structure of an LLP makes sense.
You should note that each state will have its own laws and regulations as to which businesses can form an LLP. These varying rules will lay out which types of businesses are eligible and the varying degrees of liability protection of your business.
There are even limitations and restrictions that may arise if you have formed your LLP in one state and would like to do business in another. Some states may recognize LLP business entities while others don’t. This can create plenty of headaches down the road, so make sure you’re 100% sure that an LLP is the right entity for your business.
For some, LLPs tend to have some glaring management inefficiencies that can’t be ignored. With LLPs and partnerships, the managerial responsibilities can sometimes be murky.
For example, since every partner has a managerial role, there can be redundancies that occur that waste time and money for your business. There is also the potential of someone dropping the ball because they were completely unaware that it was their responsibility to handle a certain task or business decision
Having a well thought out and organized partnership agreement can help combat some of these inefficiencies, but many of these granular details may go unnoticed when forming your partnership. You can make it a habit to routinely go back to the LLP agreement and amend anything necessary that will help your partners manage your business more efficiently.
Risk of Dissolving
If you’re operating a two-partner LLP, you may be putting yourself at risk of dissolving if one partner decides to walk away. An LLP is comprised of at least two people. If one partner decides to walk away, what happens?
While you can outline terms in a partnership agreement, this doesn’t prevent the entity from dissolving if the other partner decides to leave. You’d have to restart and restructure your entire business into a sole proprietorship or opt for an LLC if you still want liability protection.
Is an LLP Right for You?
If you’re a new business owner or are just getting started, you’ll need to decide which business structure is the right one for you. If you’re a single owner then a sole proprietorship or an LLC is most likely the right fit. It will just depend on if you want to go the extra mile in forming an LLC to receive liability protection.
But if you’re planning on creating a partnership, then you’ll have to decide between a partnership, LLP, LP, or LLC. An LLP may be a great fit for you if you want the flexibility of a partnership with the protection of an LLC.
Just remember, LLPs aren’t for all types of businesses and they’re only available in certain states. Do your research and look at the laws of the state you do business in, so you’ll be ready to hit the ground running and start growing your business.