Limited Liability Companies (LLC) and Partnerships both offer stakeholders a structure through which they can legally and effectively govern their businesses. These two kinds of entities each have their own set of advantages and disadvantages and share some similarities. But they fundamentally differ in three main areas; ownership and governance, tax regulations and – most significantly – the matter of personal liability.
What are LLC’s and Partnerships?
LLC’s and Partnerships can both be considered as two of the many means by which “life” is legally given to a business and under which they can operate. An LLC structure was created to provide stakeholders with personal liability protection from legal and financial liabilities incurred by the business. They are able to choose how they wish to be taxed and although they require more stringent reporting, offer much more personal protection than a partnership. A partnership is an entity structure in which two or more (with a maximum of 100) individuals can hold their share of ownership in a company and manage the company with a minimal amount of mandated governmental interference. Partnerships offer flexibility in their legal structures, while LLC’s offer flexibility in their tax regulations.
What are the Key Differences Between the Two Types of Companies?
There are three main differences between an LLC and a Partnership structure;
Ownership and Governing Roles
A partnership offers stakeholders an incredible amount of flexibility in terms of governance and ownership regulations. Although all the respective share percentages of stakeholders in a company must all add up to 100%, stakeholders have complete control and autonomy over the share allocation and corporate governance of these shares and the resulting profits or losses. Partnerships are very easy to set up and have low operational costs, so along with their flexible management structure they offer entrepreneurs a large amount of freedom in terms of their internal allocation of funds and responsibilities.
A Limited Liability Company offers a more regulated business structure whereby stakeholders are required to appoint a registered agent who conducts business on behalf of the company. This agent is the only point of communication between government and the business and as well as an agent the company is required to have a valid business address in the state of business registration. The governing regulations for LLCs are more stringent than those of a partnership and they are required to meet more regulatory requirements. The exact reporting requirements for LLCs vary per state, but generally speaking, LLCs are required to submit an annual report detailing all of their financial gains and often will need to pay an accompanying fee. LLC’s on principle require a much more transparent approach to their corporate governance than Partnerships do.
When it comes to taxing these two types of entities, LLCs have a far more flexible tax offering. LLC’s are able to elect if they want to be taxed as either a partnership, c-corp, s-corp or, if you are a single member LLC, a sole proprietor. Taxes are paid through your chosen channel and the process is generally simple and effective.
Partnership tax preparation is far more inflexible and complex, there are multiple laws around partnership taxes, especially given the freedom partnerships have with their profit and investment distribution and it requires a lot more research and experience to navigate.
The most significant difference between these two types of companies is the way in which stakeholders are held liable for the actions of a business. LLC’s provide a separation between the stakeholder as an individual and the business – largely referred to as the corporate veil. This means that members of the LLC have limited personal protection from any debts and legal liability incurred by the company. In cases of gross mismanagement or fraud on behalf of the business, governments may be able to “pierce” this corporate veil and hold certain or all members of the LLC personally liable, but the exact laws around this process vary per state and it can only be done in cases of gross misconduct. Texas, for example, is an excellent place for entrepreneurs to register and operate an LLC because of their exceptionally firm laws around piercing the corporate veil. It’s worth mentioning that the mandated business address that all LLC’s are required to have should not be a personal address of the agent or any of the members of the LLC as this is a very important aspect of maintaining the integrity of the corporate veil.
A partnership on the other hand does not provide any personal liability protection to stakeholders. In the event of bankruptcy, lawsuits and outstanding payments due, all members of a partnership can be held liable in a personal capacity and will be forced to shoulder any and all financial and personally losses as a result of this. There are 3 types of partnerships; general, limited partnerships and limited liability partnerships and although limited liability partnerships can provide some protection, it is very weak and can only be evoked in very particular cases.
Ultimately, although the flexible management options offered by partnerships can be ideal for entrepreneurs who require flexibility and autonomy when running their company, they can also mean that all partners are held personally liable for any and all business decisions made by other members meaning you are extremely vulnerable in a personal capacity. LLC’s, although more tightly regulated, provide a protected and mechanism by which to operate your business and can provide more freedom to members as they will be personally protected from any mistakes made by the business. An LLC is generally the practical business decision in the long-term future both for you personally and for your business, but if you’re willing to take the risk of starting a partnership, it can provide the independence and freedom to succeed.