LLC vs Partnership | What’s The Difference?
Once you decide to launch a business venture, one main consideration would be the specific structure of the entity that would best suit the nature, interests, and needs of your endeavor.
A limited liability company or a partnership are two options ideal for small businesses starting out in the industry.
As a Mergers and Acquisitions specialist who helped several entrepreneurs with business formation, I’ll share my insights regarding LLCs and Partnership to help you make an informed decision.
Quick Summary
- An LLC and a partnership both benefit from pass-through taxation, and are easier to set up than a corporation. While an LLC features liability protection, a partnership has limitations.
- A partnership can be categorized based on the arrangement and liability protection, while an LLC is classified based on the members, management, location, and structure.
- Out of 33 million small businesses in the United States, 10% are structured as a partnership, according to the U.S. Small Business Administration.
- While a partnership is relatively simpler to form, I encourage new business owners to structure an LLC due to personal liability protection.
At a Glance: LLC vs Partnership
| Feature | LLC | Partnership |
|---|---|---|
| Liability Protection | ✓ Members protected from personal liability | ✗ Partners personally liable for debts |
| Formation Complexity | Moderate (state filing required) | Simple (can be formed with verbal agreement) |
| Management Flexibility | High flexibility in management structure | Typically managed by all partners equally |
| Taxation | Pass-through taxation by default | Pass-through taxation |
| Ongoing Compliance | Annual reports and fees | Minimal filing requirements |
| Raising Capital | Can be more challenging | Easier to add partners and capital |
| Longevity | Continues despite member changes | May dissolve with partner changes |
"Numerous entrepreneurs opt for LLC formation primarily for the protection it affords against personal liability in the event of debt or lawsuits. Conversely, in a partnership, each member is personally liable, and they are legally accountable for the actions of all other members."
- Jon Morgan, CEO, Co-Founder & Editor-in-Chief of Venture Smarter
Types of LLCs
LLCs are classified based on the number of members, form of management, base of operations, structure, and other specialized forms.
1. Single-Member LLCs
A single-member limited liability company is owned and managed by a single individual. For tax purposes, this form of LLC is classified as a "disregarded entity" by the IRS since the business is considered to be the same as its owner.
Next Steps: If you're a solopreneur, this structure offers liability protection without the complexity of partnership agreements.
2. Multi-Member LLCs
A multi-member LLC has several members. Although an operating agreement is not a requirement, I advise clients to draft one since the document will outline management, operations, profit distribution, duties, rights and responsibilities within the company.
Next Steps: When forming with partners, prioritize creating a detailed operating agreement, even if your state doesn't require it.
3. Member-Managed
A member-managed LLC is collectively ran and operated by the members of the business entity. A single, or group of members may also be appointed and tasked to make business decisions and oversee the day-to-day operations of the company.
4. Manager-Managed
The members of the LLC have the option to employ an independent professional or management service with no affiliation with the company. This qualifies the business entity as manager-managed.
5. Domestic
A domestic LLC is the most common type of limited liability company which is formed and operates in the same state.
6. Foreign
Business owners who intend to expand or grow their company can register their domestic limited liability company in another state as a foreign LLC.
7. Series LLC
A series LLC consists of a parent or "umbrella" company with several subsidiary LLCs under the management of the primary business entity. The business format allows LLC owners to operate multiple companies with separate assets and independent liability protection.
For clients who plan to operate multiple businesses in several industries, I recommend forming a series LLC.
Types of Partnerships
In a profit venture undertaken by two or more individuals, partnerships fall under three categories:
1. General Partnerships
In a general partnership, all parties share profits, losses, as well as legal and financial liability equally. All the partners will be personally liable for debts, loans and other legal obligations the partnership may incur.
2. Limited Partnerships (LPs)
In a limited partnership, one party acts as a general partner, with full personal liability for the debts of the partnership.
The second party is a silent partner who invested capital into the venture. I was once a silent partner at a law firm in California. Being one, I did not participate in the management or operations of the partnership, and my liability is limited to the amount invested.
Read More: LLC vs Limited Partnership
3. Limited Liability Partnerships (LLPs)
Limited liability partnerships are a preferred structure for professionals such as physicians, lawyers, accountants or engineers. The arrangement limits a partners' personal liability in that, if one partner faces litigation for malpractice or negligence, the assets of the other partners are not at risk.
Each partner must file a Form 1065 Schedule K, which reports his share of the company's income or loss, with the IRS. This reporting requirement applies to all partnerships in the U.S., which, according to IRS data, encompasses over 3 million businesses annually.
Next Steps: If you're in a professional service industry (medical, legal, accounting), investigate whether your state offers LLP protection specifically for your profession.
Taxation
An LLC features pass-through taxation, wherein the business entity is not taxed at the corporate level, and profits and losses are reported and paid on the individual returns of the members.
Partnerships are not taxed on the business level, all earnings and losses are passed-through to the individual partners who report and pay on their annual tax return. Essentially, partnerships are not subject to double taxation like corporate entities.
Tax Saving Example: A 3-member LLC with \$300,000 in profits would pass that income directly to members' personal returns, avoiding the 21% corporate tax rate that would cost \$63,000 before distributions.
What Are the Advantages and Disadvantages of an LLC?
Limited liability companies offer the following benefits and disadvantages:
Advantages
- An LLC offers personal liability protection among its members. Any debts, losses or legal action taken against the company may not be settled with the personal assets of the owners.
- Members are not subject to double taxation since the entity itself is not levied at the corporate level, but the owners report income and losses, and are taxed on their personal returns.
- An LLC has a more flexible management structure since the members can collectively manage the company, appoint an owner, or employ a professional.
Disadvantages
- Before an owner decides to leave the company, all member must agree to the transfer of ownership.
- An LLC may have a limited existence. Once the business has fulfilled its purpose or when members of the company decide to pursue other endeavors, the LLC may be dissolved.
What are the Advantages and Disadvantages of a Partnership?
A partnership has the following pros and cons:
Advantages
- A partnership features less legal formation and compliance requirements, making the entity easy to set up.
- The partners have the opportunity to pool capital, labor, and expertise into the business.
- The management responsibilities and day-to-day operations are shared by the partners.
- Each partner can expand their networks and business opportunities through other members of the partnership.
Disadvantages
- In certain types of partnerships, the business liabilities are the sole responsibility of the partners.
- Management conflicts may arise if the partners do not agree on business decisions and operational procedures.
FAQs
Can Two LLCs Form a Partnership?
Two LLCs can form a partnership. If the companies want to keep their identities separate, they may establish a joint agreement or simply form a new company in which each existing LLC owns a membership interest.
Do LLPs Need a Registered Agent?
LLPs need a registered agent according to state laws. Members can appoint a fellow owner to act as one or employ the services of a professional.
