Last updated on: July 22, 2021
While looking for a suitable business structure, you will likely encounter a number of abbreviations like LLC, LLP, PLLC, LP, each describing an entity type with a specific set of features.
This LLCs vs LPs review looks at limited liability companies and limited partnerships in more detail as the two remain among the most popular options for new entrepreneurs.
The two business structures have their fair share of cons to counter their numerous benefits, so it’s vital to make the right choice before you launch a business.
Some of the major factors to consider before making the choice are your company’s specifications, business risk analysis, and the state’s legislation. So let’s examine in which cases starting LLC or LP would be more prudent.
What Is a Limited Partnership?
If you plan to open a new business in collaboration with one or several partners, it might be a good idea to set up a limited partnership or LP.
A limited partnership is a legal business structure headed by at least one limited partner and one general partner. LP owners are not entirely equal in terms of some of their duties or partnership interests.
Limited partners are sometimes referred to as silent partners, and unlike an LP’s general partner, their involvement does not entail any regular management of the company.
So in the event of debt collection litigation, limited partners’ liability only extends to their capital interest whereas the general partner is held fully liable. This division of responsibilities acts as a safety net of sorts, attracting potential investors to the LP structure.
Advantages of an LP
- Uniformity: the procedures for maintaining and forming a partnership are identical in all states, so you won’t be blindsided by any state-specific laws when it comes to operation, management, or legal defense action;
- Lenient taxation: limited partners are exempt from the 15,3% self-employment tax. LP’s tax deductions—such as for health insurance, 401(k) expenses, or pension plans—contribute to smoother asset allocation;
- Partially limited liability: although the general partner has unlimited liability, limited partners are only responsible for their interest, effectively separating their personal and business assets;
- Convenient LP tax treatment: LPs are classified as “pass-through” entities, meaning they do not pay federal taxes. All profits and losses are filed on the personal returns of the owners/partners;
Disadvantages of an LP
- Responsibility limitations: silent partners are limited in management, forcing them to exercise caution regarding their involvement with the company’s operations lest they lose their position;
- Management: the rights for management control of the LP all belong to the general partner. Nevertheless, limited partners are required to carry out their duties when it directly concerns their investments;
- Unforeseen dissolution: in the absence of a specific clause in the operating agreement, the LP could face involuntary dissolution if one of the partners passes away or leaves the company.
What Is a Limited Liability Company?
As a business structure, LLC combines the best features of sole proprietorships, general partnerships, and corporations.
Opening an LLC has, in a way, become a default method of starting a business thanks to the highly beneficial nature of the structure.
One of its main benefits is the LLC personal asset protection guarantee, ensuring the safety of members’ personal assets. Essentially, this limited liability status means that creditor claims are only applicable to the company’s business assets and do not infringe on member’s personal property and savings.
LLC does not limit the number of potential members, but there are a few registration provisions that must be met:
- Find a suitable LLC name;
- Designate a registered agent who meets state requirements;
- Prepare and file the Articles of Organization;
- Draft your LLC operating agreement (mandatory in some states);
- Acquire relevant licenses and permits.
Advantages of an LLC
- Limited liability: LLC owners have limited liability protection as long as the formation documents stipulate a clear divide between the personal and business assets of the members;
- Pass-through taxation: this structure is flow-through by default which exempts LLCs from federal taxes, with all profits and losses going through the members’ personal returns. That said, an LLC can elect S-corp taxation by filing an application with the IRS.
- Layered LLC management structure: an LLC can be managed by either its owners or a group of hired managers;
- Simple formation process: even though it’s still a legal business structure, setting up an LLC involves far less bureaucratic hassle than you’d get with corporations;
- Unlimited membership: an LLC is able to sustain any number of members as long as you go with a multi-member LLC rather than a single-member LLC.
Disadvantages of an LLC
- LLC start-up cost: launching and maintaining an LLC tends to be significantly more expensive than the alternative of limited partnerships;
- Full-time compliance with LLC requirements: an LLC must always remain in good standing with the state, so it’s essential to file your reports on time and follow all legal guidelines.
Comparing LLCs and LLPs
LLC vs LP: Similarities
- The LLC and LP are both formal structures the formation of which entails completing a set of requirements:
- filing formation documents like Limited Partnership Agreement (LPs) and Articles of Organization and Operating Agreement (LLCs);
- paying state fees;
- Both allow for shared ownership or membership;
- Their limited liability designation draws a clear line between the personal and business assets of the owners, protecting private securities from seizure orders. In the event of debt collection litigation, creditors are not authorized to seize personal property;
- In both cases, members can allocate their rights and responsibilities;
- Both are pass-through entities that are exempt from federal taxes.
LLC vs LP: Differences
- Their organizational differences are pretty stark, mostly due to the greater extent of legal formalities involved in LLC formation and subsequent operation. For an LP launch, you’d normally only need to draft a partnership agreement, whereas LLCs rely on the Articles of Organization, operating agreements, and more;
- Where the LP general partner holds personal liability, LLC members are not personally responsible for the company’s legal issues;
- LLC members may select the company’s operational structure as well as allocate their own duties. With LPs, regular business operations fall under the control of the entity’s general partners;
- When comparing the popularity of LP vs LLC, the latter is much more commonplace. In 2019, 73% of all new Delaware entities were registered as LLCs and only 6% as LPs.
What Is the Best Fit for You: LP or LLC?
Choosing a suitable business structure is not just a formality. It’s an absolutely fundamental step in starting official business entities as well as a major factor for determining future business procedures.
Not only will your startup capital volume depend on whether you choose to start an LLC or LP, but it will also affect the ongoing maintenance costs, taxation, and member responsibilities.
It’s impossible to say which is best between limited partnerships or LLCs since there is no uniformly compatible entity type. Each structure comes with its own set of pros and cons, all of which should be considered in the context of your business goals, including organizational specifics, taxation, and legal liability.
The simplicity of LP formation and maintenance is by far its main attraction, but then again, LLC creation is more flexible and guarantees personal asset protection.
So before you go with the easiest option and file the paperwork with the Secretary of State, think very carefully about each entity, its benefits and drawbacks, and how it relates to your situation.
This includes familiarizing yourself with the corporate law of the formation state as well as budget planning, both interim and long-term. If you still have doubts, your best course of action would be consulting an experienced business attorney or accountant to decide on the best option for you.