In a business partnership, each member contributes some portion of what the company needs to thrive. The type you choose impacts resource contributions, profit distribution, personal liability, and management responsibilities. When picking an entity, experts agree that it's crucial to arm yourself with knowledge.
Choosing a business structure is "an area where many business owners can get into trouble because they don't know what they don't know," advised attorney Gem McDowell. Evaluate your options and consider which best suits your immediate and long-term needs. Then reach out to your professional advisors because small mistakes can become costly.
What is a business partnership structure?
A business structure refers to a company's legal status and organizational classification. The Corporate Finance Institute suggested choosing your entity based on your investment strategy, specific industry, location, and individual attributes. There are four options for organizing a partnership: general, limited, limited liability, and limited liability limited partnership. Each gives the owners a role as a general or limited partner.
FindLaw offers these definitions:
- General partner: Manages the company's day-to-day operations. They have full authority, are responsible for the company, and assume all the risk.
- Limited partner: Serves primarily as an investor. They do not get involved in daily business decisions and assume little responsibility or risk.
[Read more: Forming a Business Partnership? 6 Things to Consider First]
General partnership (GP)
A general partnership is when two or more owners share equal responsibility and rights in an enterprise while retaining all liability for its obligations and debts. Considered one of the easiest entities to create and maintain, a GP can be created with nothing more than a handshake or verbal confirmation. But business author and attorney Garrett Sutton thinks it's a terrible idea. "Such a loose agreement leaves no paper trail for the partners to go back to when things go south," Sutton said.
Most experts agree that a GP is most effective with a formal contract that details each member's duties and responsibilities, finance requirements, dispute resolution procedures, and compensation. General partnerships have some tax advantages and require little paperwork but no liability protection. "If one partner leaves, dies, or goes bankrupt, the partnership is terminated, and the partners are liable for the company's debts and obligations," Sutton added.
All 50 states and the District of Columbia now allow some types of businesses to operate as limited liability partnerships (LLPs).
Michael D. Jenkins, tax attorney
Limited partnership (LP)
A limited partnership has a minimum of one general and one limited partner. The limited partners invest in the business but remain silent. They don't manage day-to-day business operations and only risk the amount of money they invest. In short, the limited partner puts up the capital, and the general partner does all the work and carries unlimited liability.
Like general partnerships, LPs are not taxable entities. Instead, profits and losses pass through to the owners and they, in turn, report it on their personal income tax returns. According to The Business Professor, "The notable difference between the taxation of general and limited partners is that limited partners receive their distribution of profits as passive income."
Limited liability partnership (LLP)
A limited liability limited partnership (LLP) is a hybrid structure. It's comparable to a general partnership (GP) but offers limited liability protections. Each member shares equal company obligations and privileges. All partners receive liability protection concerning the actions of other owners, employees, or any other agents of the LLP.
For example, if one physician within a medical group commits malpractice, the other doctors are protected. This safeguard allows owners to maintain control without personal vulnerability. Any business debts or financial liabilities are carried by the LLP, not the owners. Tax attorney Michael D. Jenkins reported, "All 50 states and the District of Columbia now allow some types of businesses to operate as limited liability partnerships (LLPs)."
[Read more: How to Choose a Legal Entity for Your Startup]
Limited liability limited partnership (LLLP)
The limited liability limited partnership (LLLP) takes the limited liability partnership and adds a limited partner to the alliance. It exists primarily for financial and real estate investments. Including a limited partner allows investors to invest in a business that offers personal liability protection to the controlling members.
Tax expert Mark Kohler believes it's a very good thing that only a few states allow LLLPs. "I have searched far and wide for a good reason to have an LLLP versus using another form of doing business, and frankly, I can't find one. I never recommend them," he said.
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