Are you interested in starting a new business entity with at least one other person? There are several different business types that could suit your needs, with two of the most popular options being the limited liability company (LLC) and the limited partnership (LP).
There are some similarities and quite a few differences between these two business structures, so in this article we’ll take aim at clarifying what the LLC and LP have in common, and where they differ.
If you’re wondering whether the limited liability company or the limited partnership is the right choice for your business, read on to discover all the relevant details of these two popular business types.
Similarities of the LLC and the LP
Before we get started on the differences, let’s first briefly discuss how the limited liability company and the limited partnership are similar.
First and foremost, both of these business entities benefit from pass-through taxation. This means that taxes are not paid on the corporate level, and instead, any profits (or losses) are passed through the business itself, and are then paid on each owner’s individual taxes.
Another area of overlap between these business types is the way both LPs and LLCs are far more flexible than the comparably rigid structure of the corporation.
Whereas corporations need to stick with their strict rules for ownership and management, the LLC and the LP both allow their ownership groups to structure things in a way they’re comfortable with.
1) Management Structure
The simplest difference between an LLC and a limited partnership is the management structure. Both types are owned by multiple people (except for the single-member LLC), and more often than not, managed by those same owners.
In a limited liability company, all member/owners have equal privileges for managing the business itself. The LLC’s operating agreement might establish roles and tasks for each member, but in the end, each member has the same ability to impact the daily business decisions.
The management structure for limited partnerships is slightly different, as these businesses actually have two different classes of owners. There are limited partners, who act as investors for the business. They provide capital to help get the business going, but they do not impact the daily decisions of the business.
In contrast, a general partner acts like a manager for the business, and they do handle the day-to-day issues that arise for the company.
2) Personal Liability of the Owners
LLCs and LPs do not have the same approach to limited personal liability. For starters, in an LLC, every member has complete liability protection.
There is separation between the business and its owners, so if the business is sued or defaults on a debt, the business has to pay up. If the LLC itself doesn’t have the assets to cover the debt, there is no personal penalty to the owners, unless those owners committed fraud or otherwise failed to keep the business in good standing.
A limited partnership works a little bit differently, as not all partners have the same degree of personal liability protection. Limited partners do have some liability protection ― since they don’t make any decisions in the day-to-day business, they aren’t expected to cover the costs themselves if something goes wrong. In fact, limited partners can only be held liable for the amount of their initial investment.
By contrast, the general partners are personally liable for the company’s debts.
3) Legal Consistency
One of the drawbacks of a limited liability company is that this business type hasn’t been around for very long. In fact, it was only in 1996 that the LLC became a commonly accepted business structure in all 50 states.
Not only does each state get to write its own rules and regulations regarding the operations of LLCs, but there also isn’t much legal precedent in American court systems for issues related to LLCs.
As for the limited partnership, this is a much more established business type, and it has the same structural guidelines in every state. Therefore, there is well-established legal precedent for how the courts should rule on cases involving LPs, and there’s no state-by-state confusion either.
4) Investment Opportunities
In general, it’s extremely difficult to attract investors to pass-through business entities because you can’t sell stock. This is certainly true for the LLC, as you basically never hear of venture capitalists investing in any limited liability companies.
However, it’s a different story for limited partnerships.
While the LP is also a pass-through entity, it has a unique advantage for attracting investors thanks to the limited partner model. Many investors love contributing to limited partnerships because the role of the limited partner allows them to get involved financially without having to take on many responsibilities, or much liability for the company.
5) Tax Deductions
Finally, let’s quickly discuss how these two business types differ when it comes to deductions. Limited partnerships are allowed to deduct the cost of many different types of fringe benefits, including pension plan payments, 401(k) retirement contributions, health insurance expenses, and more.
Unfortunately, limited liability companies are not allowed to deduct any of these expenses for their employees.
As you can see, there’s a handful of commonalities between the limited liability company and the limited partnership, but there are also several crucial differences that set them apart.
In general, if you’re looking to form a real estate business or a family-owned company ― or if you want to take advantage of the LP’s superior ability to attract investments ― the limited partnership is clearly the better option.
Other than that, the LLC is the more popular entity for a reason. There are exceptions to every rule, but in most circumstances other than the ones we just mentioned, we think the limited liability company is typically the more business-friendly option.
No matter whether you choose to form an LLC or an LP, we hope this article helped you develop your understanding of the similarities and differences between these two popular entities in the American business landscape.
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