Partnerships vs. LLCs

Many new businesses with more than one owner may consider whether to operate as a partnership or limited liability company (LLC). There are two types of partnerships; general partnerships and limited partnerships.

General partnerships involve two or more parties who voluntarily agree to own and run a for-profit business in which they equally share management duties and profits or losses. Limited partnerships are made up of at least one general partner who finances and manages a for-profit business as well as one or more limited partners who provide only capital to that partnership entity. LLCs combine positive features of both partnerships and corporations.

Many state laws have adopted all or part of uniform laws that help govern general partnerships, limited partnerships, and LLCs. This overall review of general and limited partnerships and LLCs focuses on four key aspects: formation, management, profit-sharing, and legal liability. For information on taxes, see How Partnerships Are Taxed and How LLC Members Are Taxed.

Formation

A general partnership can be formed in a variety of formal and informal ways, including orally, in writing or implied by a court from party conduct, such as pooling capital resources and sharing management duties and business profits or losses. Although not required to do so, it is always recommended that you form a general partnership in a written partnership agreement or articles of partnership. This type of agreement spells out each partner's rights and duties and helps avoid future litigation between partners. Some states require the filing of a certificate of partnership to evidence the existence of a general partnership.

Under most state laws, limited partnerships are established in a more formal way through a required filing of a certificate of partnership with the relevant department, normally the secretary of state's office. Similar to general partnerships, the general and limited partners may wish to enter into articles of limited partnership to clarify partner roles and obligations in operating the business.

Although less complex to form than a standard corporation, LLCs require more formal documentation than general partnerships. For multi-member LLCs, the owners must enter into an operating agreement to clarify members' different rights and responsibilities. LLCs must register articles of organization with a relevant state office. These articles of organization usually identify an LLC's name, the location of its principal offices, the identities of its owners, any planned LLC term or duration, along with other statutory requirements.

Management

A key characteristic of a general partnership is the equal right of each partner to manage the business enterprise. Typically each general partner possesses one vote in any key partnership decisions regardless of the amount of their individual capital contribution. Simple majorities normally determine the outcome of key business determinations. Under this business organization, general partners must be able to persuade their co-owners to agree with certain business policies or ideas.

Limited partnerships may have either one general partner or two or more general partners who operate a limited partnership on a daily basis. In a limited partnership with two or more general partners, the management framework amongst the general partners is often similar to general partnerships. Limited partners do not manage the business and supply only capital contributions.

If you are a single-member LLC, you own, manage, and operate your business. As a single-owner LLC, you can set your own business strategies and policies without having to consult or seek approval from others. If there are two or more members, 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. You may decide that all members will manage the LLC or you can delegate management and decision-making powers to certain designated members.

Profit-Sharing

The division of profits and losses are similar for both general partnerships and multi-member LLCs. Unless the partners agree otherwise, general partners and LLC members share equally in the profits of their respective business organizations.

Under a limited partnership, general and limited partners usually share profits and losses based upon the value or percentage of each partner's capital contributions to the business. Alternatively, general and limited partners as well as LLC owners possess the flexibility to enter into agreements to allocate business profits and losses in a different manner that best suits their respective business models.

Legal Liability

Like many aspects of the law, legal liability often follows party control or authority. In both general and limited partnerships, general partners have unlimited personal liability since they manage their respective businesses. When handling partnership business, general partners are liable for their own conduct as well as the acts of their fellow general partners, known as joint and several liability.

Conversely, limited partners only risk their capital contributions in limited partnerships, similar to shareholders in a corporation or members in an LLC. However, if a limited partner participates in managing the business or signs a personal guarantee for the business they may be held personally liable for these business obligations.

LLC members are entitled to manage the business while retaining the limited personal liability of shareholders in a corporation. Normally LLC members are not personally liable for LLC debts or legal liabilities, putting only their financial contributions to the LLC at risk. LLC owners may still be personally liable for their own conduct that harms others, for breaches of their duties owed to the LLC or any personally-guaranteed LLC loans.

Any business owner should consider appropriate insurance and other liability protection strategies to help shield personal assets and business resources.