Last Updated on January 18, 2022
When you launch a business, it’s not uncommon to begin as a sole proprietorship. As you grow and other people join the operation, however, the simple setup may no longer work as well.
At this point, it may become necessary to set up additional legal protection. When two business owners get involved, both LLCs and partnerships are potential options.
What is an LLC?
LLC stands for Limited Liability Company. Outside of a sole proprietorship, which doesn’t require any formal setup, it’s the simplest legal structure to establish and use.
Yet it offers some powerful benefits as well as protections. An LLC can be owned and operated by an individual or multiple partners.
Each partner is known as a “member,” rather than shareholder. An LLC can also have managers, as opposed to directors and officers.
According to TRUiC, “An LLC’s profits go directly to its owners, who then report their share of the profits on their individual tax returns. Hence, LLC’s profits are only taxed once. This is known as pass-through taxation.”
In terms of liability, each owner is allowed to limit his or her responsibility. This protects individual members from lawsuits that could put their personal assets in jeopardy.
What is a Partnership?
“A partnership is a business form that has multiple co-owners or termed partners. Partners can have any share of ownership, but the percentages must total 100 percent,” UpCounsel explains.
“The partnership agreement that is created at the time the partnership is formed determines each partner’s share. Partnerships register with a state.”
Under the partnership heading, multiple types and variations may be selected. They include:
- General partnerships, in which two or more people own and operate the business as joint owners with 50-50 interests. Each partner is personally liable for the company’s obligations.
- Limited partnerships, where two or more people own the business, but there are two levels of partners. General partners own and operate the business and have personal liability. Limited partners invest their money in the outfit, but they aren’t accorded the prerogative of making decisions. They also do not have personal liability for business debts.
- Limited liability partnerships are basically general partnerships, except there’s the option of giving all partners some limited personal liability.
Partnerships are slightly more complicated than LLCs, but they also provide more opportunities for tailoring the structure to the individual needs of multiple members.
Which One is Best?
Trying to decide which business entity is best is like trying to determine which type of car is best. Much like the way that one person will need a diesel pickup truck while another requires a hybrid hatchback, every entrepreneur and business owner will have a unique set of needs.
As you weigh your options, consider the similarities and differences. General partnerships and LLCs are similar in that they’re both started by registering/incorporating in the state where the company intends to operate.
From a tax perspective, both are labeled as “pass-through” entities. This means the taxes are passed through to the owners/partners and filed on their personal tax returns.
There are no stockholders and no stock can be offered to the owners. Furthermore, profits and losses are passed directly to the owners/partners.
The two entities also have unique differences between them. In a partnership, for example, the debts of the business are the responsibility of each partner. With an LLC, members are only liable for the debts of the business to the extent that they invested their personal assets.
In other words, LLC members aren’t usually responsible for the debts of the other members. Another difference between the two is that LLCs may choose to be taxed as a corporation or as an S corporation. Partnerships don’t enjoy this luxury.
When it comes down to it, the specific needs of the individual who build the company will dictate the best choice. LLCs have become more popular in recent years because of the limited liability factor. Most business owners start by considering LLCs.
If they don’t like what they’re seeing, they turn to a partnership option. It’s highly recommended that you do extensive due diligence, speak with advisors, and have open conversations with any and all business partners prior to making your final decision.
The ramifications of your choice will play out — good or bad — for years to come.