Starting a business is no easy feat, so many people decide to do so as a team effort. If they do, they have to pick an entity type.
Two common choices for entrepreneurs looking to form a business with at least one other person are the limited liability company (LLC) and the general partnership.
Depending on the needs of your specific business venture, the general partnership or the LLC may be a preferable business model.
With this in mind, we wrote this article as a handy guide that clearly explains the similarities and differences between these two common business types. Let’s discover which one better suits your company.
What General Partnerships and LLCs Have in Common
LLCs and general partnerships have a fair amount of shared attributes. For one thing, both types allow for a new business to have more than one owner, unlike the sole proprietorship which is strictly a one-person business entity.
LLCs and general partnerships are also subject to the same tax procedures. Both are taxed as pass-through entities, meaning that the tax is levied on the individuals who own the business, not the entity itself. Due to this taxation model, there are no taxes paid on the corporate level. Instead, the business profits and/or losses “pass through” the business to its owners, who then claim that money on their personal taxes.
Another common aspect of these business types is the fact that ownership in a general partnership or a limited liability company is viewed by the Internal Revenue Service as a form of self-employment. Due to this distinction, each owner is required to pay self-employment taxes on all income earned through the company. This rate is currently at 15.3%, which includes the employer and employee shares of both Social Security and Medicare, and this tax is paid in addition to your income taxes.
The general partnership and the LLC also both allow their ownership groups to decide how they want to distribute the business income. While most of these businesses choose to split profits evenly, you can divide the money in an uneven manner as well, if that fits the structure of your business in a more reasonable manner.
Similarly, you can split up the managerial aspects of the business any way you’d like, whether that’s an even or uneven share of the responsibilities between the owners, or assigning oversight of the day-to-day operations to a manager.
What Makes General Partnerships and LLCs Different
While these business entities certainly have their fair share of commonalities, there are also several distinct differences that set them apart, beginning with the formation process (or lack thereof).
A general partnership is formed automatically whenever the partners decide to start working together, but the LLC takes a more formal process and actually registers with the Secretary of State. This process includes filing a document known as the articles of organization with the state government, which typically includes information like the location and purpose of the business, the identity of the company’s registered agent (can be a person or professional service, and more.
As part of the LLC’s formation process, the business registers a distinct business name with the state, whereas for a partnership, the official business name is the simply the legal names of its partners (unless they register a DBA, or doing business as name). For an LLC, however, the legal name of the business is chosen by the members during the formation process.
Similarly, the costs to form these businesses differ. Because a general partnership is formed automatically, there are zero expenses whatsoever to form one. An LLC, however, has more startup and maintenance fees, including the cost of forming the business with the state, filing annual reports and franchise tax payments, etc.
By far the most important difference lies in the fact that the LLC’s owners receive personal asset protection, while the general partnership’s owners do not. This is the core of what the LLC has to offer to its owners, as the business structure limits their liability in cases of a lawsuit against the company, defaulting on a business debt, and several other financial situations.
For example, if an LLC is sued, creditors can only sue for the assets of the LLC itself, and cannot pursue the owners’ personal assets to repay business debts, unless the LLC has been improperly maintained in a way that revokes this protection, such as fraudulent acts committed by its owners. As for general partnerships, they have no such protection to begin with, so if your business accrues debts, your creditors can pursue your personal bank accounts, house, car, and any other assets you may have.
Choosing Between the General Partnership and the LLC
Which one of these business types is the right choice for your new venture? It’s difficult to give any blanket answers for this question, seeing as all businesses are unique, but we can make some generalizations that may help you figure it out.
If you’re starting an informal business venture that doesn’t have any liability issues, the general partnership may be a better option. For example, if your business idea is two teenagers starting a lawnmowing service in their own neighborhood, it’s probably acceptable to cut some corners on the business formation process and just go with a general partnership business model.
For basically all other businesses, if you’re serious about your company, you should form a limited liability company. The value of the personal asset protection provided by the LLC business structure is infinitely more valuable than the small amount of money it costs to start and maintain one, and the LLC also has much more professionalism and trustworthiness in the eyes of consumers.
Overall, while there are some noteworthy similarities between general partnerships and limited liability companies, their differences are far more important. We usually don’t recommend the general partnership to anyone, unless your business venture is extremely casual in nature.
If your child wants to operate a lemonade stand with another child from down the street, that’s an acceptable use of the general partnership. But if you want to be taken seriously, the LLC is obviously the much stronger business structure, if for no other reason than its personal asset protection and unique business name.
The general partnership and the LLC each have their own advantages and disadvantages, but if you’re serious enough about your business to bother reading this article, you’re probably serious enough about it to form an LLC as well.