Entering into business with a partner or partners can require a lot of preliminary discussions.
You and your partners took half an hour to decide where to get dinner last week, and now you’re forced to come to a consensus on things like branding, location, duties, and plenty more. And that’s not even considering perhaps the most important decision of all: your business structure.
If you’re looking for a flexible arrangement with low startup costs and no rigid business guidelines, the general partnership might be a great option. But you might want protection for your personal assets and credibility as a legitimately registered business, and if so, a limited liability company (LLC) is the business type for you.
Both of these structures have their own pros and cons, and your choice will depend largely on your business goals and expectations. But in general, one usually comes out on top as a better choice for most businesses. Have we piqued your interest? Read through this guide and by the time you’re done, you’ll have a good idea of which option to choose, no long brainstorming sessions necessary.
What Is a General Partnership?
Starting a general partnership is incredibly simple. Ready? Step one: get your business partner(s) together. Step two: start working. There’s no step three because you’re already a general partnership!
This type of business entity is unincorporated, and there’s no formal startup process necessary to create one. The only thing you need to do to begin operating a general partnership is to start working with at least one other person.
The general partnership is very similar to a sole proprietorship in that neither business type is considered to be a separate legal entity by the government. Instead, your state and federal government view your general partnership as a mere extension of you and your partner(s) as individuals. You don’t even need to name your business because a general partnership can legally operate using one of its members’ personal names.
What Is an LLC?
Compared to the general partnership, a limited liability company (LLC) has a more complicated startup process.
Still, it’s a much simpler structure than the corporation. Because it’s a formal business structure, you must officially register and maintain it with your state government by filing an Articles of Organization (or equivalent form), although additional requirements vary from state to state.
One of the biggest reasons entrepreneurs decide to form LLCs is for limited liability protection. But what does “limited liability” mean? Put simply, it means if your company gets sued and the court rules against it, creditors aren’t allowed to come after personal assets like your house, car, savings, and more.
But if you’ve properly formed an LLC, your possessions are safe and creditors can only pursue business assets. In this way, the LLC truly does limit your personal liability.
What Are the Advantages of the General Partnership?
A general partnership’s main advantage is convenience. There’s no formal formation process, so it couldn’t be easier to get started. All you need to do is begin conducting business with your partner(s).
On top of that, general partnership owners save time and money because they don’t have to fulfill typical business maintenance requirements like hiring a registered agent or submitting annual reports. Business owners who don’t want to deal with the hassle of keeping up with recurring filings and fees appreciate the general partnership’s simplicity in this regard.
What Are the Advantages of the LLC?
Of course, the general partnership’s convenience and low cost come at the expense of its security and credibility, two areas where the LLC excels. The limited liability company’s most significant advantage here is the limited liability protection mentioned earlier. If your general partnership ends up on the wrong side of a lawsuit, there’s nothing preventing creditors from pursuing any and all of your personal assets. They can take your house and your car, drain your personal checking and savings accounts, claim your collection of signed movie memorabilia, and much more.
Not only that, but as an officially-registered business structure, an LLC establishes legitimacy for your company. As a general partnership, you’re simply a group of people doing business, but an LLC gives you a legitimate, separate business. But an LLC has a business name, separate finances, and a formal framework, all of which lend credibility and make it more attractive to potential customers, business partners, and investors.
An LLC is also flexible as to how many members you need. It’s possible to start a single-member LLC, no partners necessary, that’s structured for future growth. Whereas a general partnership requires at least one other member.
How Do Taxes Work for General Partnerships and LLCs?
Considering how structurally different they are, general partnerships and LLCs are actually pretty similar when it comes to taxation. Both the LLC and the general partnership are considered pass-through entities, which means that they don’t pay any separate corporate taxes. Instead, the company’s owners split up the tax responsibilities, claiming the net income of the business on their own personal tax returns.
The general partnership actually does need to file a statement of information with the Internal Revenue Service, but this is merely a document that informs the IRS how much money they should expect each partner to pay. Other than that, the business itself won’t have to file anything with the federal government, only its individual partners.
Here’s the main difference: with an LLC, you get to decide how your company is taxed. Want it taxed the same as a general partnership, great! That’s the default. But if, given your financial circumstances, a different tax structure is better, you can elect to have it taxed as a C corporation or an S corporation instead.
Corporations are taxed as separate entities, so owners don’t report business income on their personal returns, but rather on a corporate return. S corps are taxed similarly to partnerships, and C corps are subject to what’s known as double taxation, in which the same money is taxed twice ― first at the corporate level, and then at the personal level. For the most part, the only reason LLC owners choose either of these alternate tax structures is because they’re high-income individuals who could actually benefit from these options. Otherwise, most LLC owners stick with the default structure, but it’s nice to have the option.
How Do General Partnerships and LLCs Distribute Profits and Losses?
On the surface, this one is simple. But it will require some discussion and, perhaps, compromise between you and your partner(s). General partnerships and LLCs both split up profits and losses are between the company’s owners. How these profits and losses are distributed, however, is up to your discretion. You have a couple of options.
Will all owners receive equal portions of this money? Will you split it up in a way that reflects each owner’s level of involvement? These choices are entirely up to you in either business structure, so call a meeting with your partners, sit down, and hash out how the distribution split. If you don’t come to a consensus right away, it could lead to disputes over money down the line, and nobody wants that.
How Are General Partnerships and LLCs Managed?
In general partnerships, each partner shoulders an equal amount of managerial responsibility. Who will manage employees? Who will handle finances? What about sales? It’s all up to you. There’s no official document on which you need to report your managerial decisions to the government, but if you want to do anything other than equal-share management, you should draw up a partnership agreement to create an official record of your decision.
As a multi-member LLC, you have two different management options (the single-member LLC owner will obviously govern the business themselves). Your company can either be managed by its members or by outside managers, and each has its own advantages. A member-managed LLC gives the owners greater control over the day-to-day operations. On the other hand, a manager-managed LLC – which brings in managers from outside the company to handle daily minutiae – takes those responsibilities off the owners’ plates.
Hiring managers can be expensive, but it’s usually a good option for very large LLCs that have numerous departments and/or offices, while members of smaller LLCs most often opt to manage the company themselves.
Which Business Structure Is Preferable?
There’s no catch-all answer to this question. Neither type is universally the best solution for every business. Both general partnerships and limited liability companies have their advantages and disadvantages for certain types of entrepreneurs. Still, for the vast majority of our readers, we think an LLC might be a better choice.
While a general partnership can help you save money and avoid the hassles of formation and maintenance requirements, we think the benefits of the LLC far outweigh these small drawbacks. The biggest reason to form an LLC is its personal asset protection, which a general partnership cannot provide. If you’re worried about your personal assets potentially falling into creditors’ hands, go with the LLC.
Additionally, the LLC is seen by most prospective consumers and investors as a more legitimate and professional option. Plus, the ability to stake your claim to a unique business name that can’t be stolen by other businesses is another important benefit.
Whether you choose a general partnership or a limited liability company, you’re going to get an extremely popular American business structure with its own unique set of pros and cons. While each one fits different business models, we typically prefer the LLC because it does a much better job of protecting its ownership interests than the more casual nature of the general partnership.
Take stock of your business goals and consult your partner(s), then measure up each of these business structures to see which would be a better fit. And if you’re unsure, you can’t go wrong by playing it safe and forming an LLC!
Need help? No problem! Take a look at a formation service, which can take care of the entire process for you. Two of our favorites are Northwest and IncFile. Read more about them in our in-depth review guide.