Two popular forms of company structures are the Limited Partnership (LP) and the Limited Liability Company (LLC). A limited partnership consists of at least one general partner and at least on limited partner. The general partner(s) assumes unlimited liability while the limited partner(s) assume liability equal only to their investment. An LLC is a hybrid of a corporation and a partnership. All members of an LLC receive limited liability and the company can be exempt from double taxation.
A growing trend in company structure is the LP/LLC hybrid company. This company can be set up with any number of participants, but in the interests of simplicity we will set this up with two people. Essentially the LP is formed with two limited partners, the aforementioned people, and the LLC as the general partner. The limited partners would control, for example, a 49% interest each in the LP. The remaining 2% would be controlled by the LLC. As the general partner, the LLC is responsible the daily operations and is responsible for all claims against the company. The two limited partners would control 50% each of the LLC, thus allowing them to manage the company through a partnership without losing the status as limited partners. Company assets are owned by the LP. Ownership interests in the LP can be assigned freely subject to the approval of the general partner, in this case the LLC.
When choosing how to structure you company, it is important to look at what kind of legal protections the structure allows you. A limited partnership and a limited liability company offer the same degree of asset protection. The owners of an LLC are not personally liable for the debts of their business or claims made against it. This legal protection is written into each state’s LLC law. Because almost every business will accumulate debts and face some risk of being sued, this is a popular and valuable feature. Without limited personal liability, all business owners are 100% legally responsible to repay these debts, even if they have to use their own money. With limited liability, their personal assets should remain untouched, even if the business fails under a heavy weight of debts and judgments. For instance, if a customer slips and is injured on company property, a law suit may still bankrupt the business, but it cannot touch the personal assets of the LLC’s members. This means that if the business owes money or faces a lawsuit; only the assets of the business itself are at risk. Creditors usually can’t reach the personal assets of the LLC owners, such as a house or car. (Both LLC owners and corporate shareholders can lose this protection by acting illegally, unethically, or irresponsibly.) This limited liability, then, is a great advantage over partnerships. In general partnerships, all members are liable for the company’s debts, and in a limited partnership, at least one member must still be liable. Combining this with the Limited Partnership model, the benefits become clear. As the general partner, the LLC is essentially the face of the company in all legal action. The limited partners, the two people from our example, receive limited liability through the LP as limited partners and through the limited reliability inherent in the LLC.
Another area of interest in considering how to structure a company is the tax and financial benefits of each. The main reason most people go on to form these LPs or LLCs, is to separate their personal assets from the assets of the company. Through an LP, the general partner remains personally liable for the company, but the limited partner is only responsible up his share of the investment. Therefore, a limited partner will never have his personal assets seized to pay for the debt of the company. It also protects you from legal suits as well. The general partner, however, can still be held personally reliable. If the company is unable to fulfill its financial obligations, the creditor can and will seize the general partner’s assets and money. The way many partnerships get around this, is to actually make their business a corporation, then naming the corporation as the general partner with the other partners becoming limited partners. This arrangement offers complete protection of personal property to all investors within the company.
As far as tax advantages/disadvantages are concerned, by remaining a partnership, you are able to avoid losses by passing them on to the individual partners. It is considered passive income, and does not actually affect the partner directly. These losses are used to offset gains made by the company to minimize your income tax. The main advantage here is that if you are a corporation, you not only pay tax on the income, but then you also have to pay taxes once you receive your stock dividends, making it being double taxed. A partnership is only taxed once in this situation. If you are an active participant in the company, however, the losses are no longer passive, but are active income, which is taxed as normal. The other major tax benefit is that many LPs are eligible for tax credits, which are used to offset tax dollars.
For obtaining financial resources, a partnership helps over a sole proprietorship in obtaining funds because it gives you an extra source of cash. It also can lend your company more credibility by giving the bank another person to evaluate for a credit basis. A bank would be more likely to lend if it knew that it had more than one option for collecting its money. This could backfire, however, if your partner had a bad credit score. Neither a partnership nor a sole proprietorship has the fund raising ability of a corporation though. A corporation can issue stock to raise capital as well as go to the banks for funding, giving it more options than an LP or a sole proprietorship. This is the main reason that companies become corporations so that they can obtain financing to expand and grow more easily.
The hybrid structure of the LP/LLC allows for a flexible company structure that can respond to difficult situations quickly. It provides many of the same benefits as tradition limited partnerships and limited liability companies, but increases the personal asset protection the owners. Financially, the hybrid structure provides single taxation of profits and for the passing of losses to individual partners as deductions, much like a traditional partnership. It also allows small businesses to utilize the fundraising power of corporations and LLCs. This hybrid of an LP/LLC is an excellent way for small businesses to overcome many of the pitfalls of sole proprietorships and partnerships, while at the same time avoiding the taxation and administrative burdens of full blown corporations.
Limited Liability Company FAQ. “The advantages of forming a limited liability company.” 29 July 2008.< http://www.4inc.com/llcfaq.htm.>
Limited Partnership. 28 July 2008.
Other information was taken from the personal documents of Don Lewis.