Partnerships: If one or more individuals will be joining your business journey as a partner or investor, then you may want to consider forming an entity versus operating as a sole proprietor. The most common types of Partnerships are General Partnerships (GP), Limited Partnerships (LP), and Limited Liability Partnerships (LLP). It is important you know and understand the differences between each structure type before coming to a final decision. The ramifications of choosing the wrong structure could possibly lead to lawsuits against you and leave your business in shambles.
General Partnerships (GP) are easy to establish much like a Sole Proprietorship and do not need forms filed with your Secretary of State to get started. A simple agreement with your partners or investors is all it takes to get started, while the costs are rather inexpensive. Filing taxes at the end of the year are passed through directly to the each partners personal taxes, whereas corporate tax filings are double-taxed both on a business and personal level. In the event your partners are assuming too much liability on behalf of the business, then dissolving the business completely may be an option. Dissolving a partnership is quite simple and requires little paperwork such as filing a dissolution and liquidation form in the state which your business resides. In addition, alerting your creditors the intent to dissolve can prevent other partners from continuing to assume more debt on behalf of the business.
Additional advantages of a General Partnership
- Leadership Diversity: Establishing partnerships with others from different cultures and backgrounds brings with it the opportunity to mend ideas and resources under one roof.
- Equal Management: General Partners who agree to establish a business together all share in the day-to-day operational decisions on behalf of the business unless stated otherwise in the partnership agreement.
- Easy to convert: Partners who desire to protect personal assets against litigation may choose to convert over to a Limited Liability Company (L.L.C.). Conversion to a L.L.C. is easy and reduces the personal liability risks associated with the decisions other partners make on behalf of the business.
Sounds good right? Have a partner you are ready to get started with? Please consider this..
For all of the advantages a General Partnership can offer, a couple of disadvantages should be noted before forming a legal entity such as this. Although corporate structures afford you some form of legal protection against lawsuits, personal assets are not protected even if the liability was assumed by a partner. This means your personal assets can be seized by debtors to cover any unpaid debt.
Choosing a General Partnership with someone you trust also means you become personally liable for the business decisions of your partners. Debts accrued on behalf of your partners is the riskiest part of partnerships so make sure there is a standing agreement between all partners involved before making the leap together.
Additional disadvantages of a General Partnership
- Easily dissolved: In the event one partner of a three or more partnership group leaves the business or passes away, the partnership can now be terminated. If this happens, it is a best practice to terminate the old partnership agreement and establish a new agreement detailing the new roles and responsibilities.
- Self-Employment Tax Liability: General Partners in a partnership are considered self-employed working on behalf of the business. Partners who earn income or experience loss incurred on behalf of the business must pay self-employment taxes in the U.S.
- Licensing Requirements: Unlike other business structures that are allowed to actively participate in business operations without a license, partnerships are different. Partnerships are required to wait until the business receives its license to begin operations.
Limited Partnerships (LP) If you come to the conclusion that a Partnership is the best solution for your business, yet you are concerned about the potential liabilities other partners may incur, then a Limited Partnership may be your best option. Limited Partnerships, which are comprised of a General Partner(s) and/a Limited Partner(s), offers more control over day-to-day operations versus General Partnerships. Other advantages of Limited Partnerships include having unlimited shareholders and liability protection from limited partners. In other words, if your sole focus is maintaining control of day-to-day operations over your business and looking for the potential advantage investor (partners) resources bring, then a Limited Partnership is right for you.
Additional advantages of Limited Partnerships:
- Pass through entity: Unlike Sub-Chapter C Corporations which are double taxed, Limited Partnerships are considered pass-through entities. Income generated by the business is passed through to your personal income taxes.
- Less formal structure: Limited Partnerships only need a formal agreement made between the General Partner(s) and Limited Partner(s) to create an entity unlike corporate entities, which are required to file the necessary documents through the secretary of state.
- Funding from limited partners: A key advantage to Limited Partnerships is the ability to manage daily operations as a general partner while limited partners provide capital and other resources needed to keep the business up-and-running.
Despite the benefits of Limited Partnerships for the General Partner(s), several disadvantages may get you to think twice about forming a business entity under this structure. Of those disadvantages, filing the required paperwork can be extensive and an exhaustive process depending on the state the business is established. And although you are protected from the decisions and actions of limited partners in the business, as a General Partner you bear the full responsibility for debts and liabilities incurred on behalf of the business. Furthermore, if you decide to include other General Partner(s) in the future, not only do General Partners become liable for the decisions of each other, but personal assets are left unprotected against litigation.
Additional disadvantages of Limited Partnerships:
- Personal assets are not protected: As a general partner, you assume full legal responsibility of the company against litigation. This means your personal assets will be used to cover any liabilities the company accrued while under your direction.
- Termination of partnership if partner withdraws: In the event two general partners exist in a limited partnership and one withdraws or retires, the limited partnership may be dissolved if certain language is not present in the initial agreement.
- Disputes over allocation of benefits: Disputes over the allocation of benefits and overall direction of the company are common in limited partnerships with multiple general partners.
Limited Liability Partnerships (LLP) Another option to consider before deciding to form a legal entity and want other partners to share in liabilities up to the amount of their investment is a Limited Liability Partnership or L.L.P. Among the many advantages within an L.L.P. is the ability to have a group of partners under one roof, while lowering the overall costs of doing business. These cost savings could therefore be used to help bring in junior partners who help in the day-to-day operations, yet have no personal stake in the company nor would face litigation in the event the company goes belly up. L.L.P.’s also provide the flexibility to add or remove partners according to a partnership agreement, which must be agreed to by all partners beforehand. Because L.L.P.’s are considered flow-through entities, all income made through the entity is passed directly to its owners while avoiding corporate double taxation .
Additional advantages of Limited Liability Partnerships (L.L.P.)
- Separate legal entity: Much like an L.L.C, L.L.P’s are separate legal entity’s that provide claims protection against the personal assets of its partners.
- Greater role flexibility for partners: Unlike Limited Partnerships where general partners are the sole decision makers for the company, partners in a L.L.P. have more freedom in determining the direction of the company.
- No termination dates: Within the partnership agreement, L.L.P.’s are not required to include a termination date much like many other business structures.
Of course forming an entity such as an L.L.P. will have its fair share of drawbacks. One of the main disadvantages of forming an L.LP. is the disclosure of financial records to the public. Partners must declare income made during the prior calendar year and may not want those records to be released. Also, another known disadvantage of an L.L.P. is a minimum of two members are required to keep the L.L.P. intact. However, if your lone partner decides to leave the partnership, it is very possible dissolution paperwork may need to be filed with the state to dissolve the company.
Additional disadvantages of Limited Liability Partnerships (L.L.P.)
- Beneficial to only a handful of entities: Only a handful of entities benefit from the formation of an L.L.P. The most common entities that benefit from forming an L.L.P. are Architects, Accountants, and Consultants among others.
- Legal documentation can be extensive: Legal documentation of L.L.P’s are both extensive and complex compared with other business entities.
- Not available in every state: States typically differ in what entities can actually form a L.L.P. versus certain states who do not allow them. It is best to inquire with your state’s laws to make sure your entity qualifies as a L.L.P.
Made a decision yet on the type of structure you are looking for? Wait. Don’t forget about Corporate structure.
Next: Corporations
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