Do you want to operate a business with a partner or partners? Would you rather pursue a flexible arrangement for your business, instead of having to adhere to a rigid business structure? If you answered “yes” to these questions, a general partnership might be the right option for you. However…
Are you starting a business by yourself, or perhaps with one or more partners? Are you interested in having your personal assets protected, even though you might have to follow a more strict set of rules and regulations? If this sounds like what you want from your business, you should probably form a limited liability company (LLC).
In this article, we’ll discuss the pros and cons of the general partnership and the LLC. While these business types have their own strengths and weaknesses relative to each other, in general we strongly prefer one over the other. To find out which one (and why!), read on as we break down all the relevant details.
What Is a General Partnership?
A general partnership is one of the simplest business structures to form and operate. This type of business entity is unincorporated, and there is no formal startup process necessary to create one. The only thing you need to do in order 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 the way that the business is not considered to be a separate legal entity by the government. Instead, your state and federal government view your general partnership as as mere extension of you and your partner(s) as individuals. You don’t even need to name your business, as a general partnership can legally operate using the personal names of you and your co-owners.
What Is an LLC?
A limited liability company (also commonly known as an LLC) is a more formal business structure that is officially formed with your state government. As the words “limited liability” indicate, the crown jewel of the LLC as a business entity is the personal asset protection it provides.
If your company is sued, and the entity suing you receives a judgment or settlement, the LLC business structure will protect your personal possessions from creditors. This means that your house, car, and personal bank accounts are off-limits for your creditors, and they can only pursue your personal assets in the amount of your investments into the LLC. In this way, the LLC truly does limit your personal liability.
What Are the Advantages of the General Partnership?
The biggest advantage of a general partnership over a limited liability company is the fact that there is no formal formation process for general partnerships. To create one, all you need to do is begin conducting business with your partner(s).
As a result, there are also no maintenance filings like annual reports to worry about, and there aren’t any formation fees to pay either. There’s also no need to hire someone to serve as your registered agent if you’re part of a general partnership either, so that’s another expense you can avoid with this business type.
What Are the Advantages of the LLC?
Compared to the general partnership, the limited liability company’s most significant advantage is the limited liability protection we mentioned earlier. If you operate a general partnership and you end up on the wrong side of a lawsuit, there’s nothing stopping your creditors from pursuing your personal assets as much as they want. They can take your house and your car, drain your personal checking and savings accounts, etc.
Another great aspect of the LLC is the way it can lend legitimacy to your business. Whereas a general partnership is simply an agreement between two or more people to conduct business together ― often operating just using your own personal names ― the LLC is an official business entity that is distinct from you as an owner.
Because your company is registered with the state, you have a unique business name that is exclusively yours. This means that your customers and suppliers can write checks and pay invoices to your company, rather than to your own personal name, which is obviously a far more professional and credible way to conduct business.
One other point in favor of the LLC is that you don’t need a partner to start one. The single-member LLC is a common business type, and it leaves plenty of room for growth as well. If you want to operate a general partnership though, you’ll need to find at least one person to run it with.
How Do Taxes Work for General Partnerships and LLCs?
There’s actually a major similarity between general partnerships and limited liability companies when it comes to taxation. Both the LLC and the general partnership are known as pass-through entities, which means that there are no taxes paid at the corporate level. 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 of how much money they should expect each partner to pay.
The big difference in this area is that LLC owners can actually choose how they want to be taxed. In the vast majority of situations, LLCs choose the partnership model of taxation, but there are other options as well. If it’s advantageous for the LLC owners, they can select C corporation or S corporation tax formats.
In general, the S corp is quite similar to partnership taxes, and the C corp is 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.
How Do General Partnerships and LLCs Distribute Profits and Losses?
Here’s another important area of overlap for these types of businesses. In both the general partnership and the limited liability company, profits and losses are split up between the company’s owners. With either business type, you’re also able to decide how you want this net income to be distributed.
Will all owners receive equal portions of this money? Will you split it up in a different way in order to reflect each owner’s level of involvement in the company? These choices are left entirely up to you, whether you end up forming a general partnership or an LLC.
How Are General Partnerships and LLCs Managed?
The default managerial aspect of a general partnership is that each partner shoulders an equal responsibility when it comes to the management of the company. Because this business type is unincorporated and unofficial, there is no document required by any government entity regarding the way the company will handle management. If you want to do anything other than equal-share management though, you should draw up a partnership agreement to create an official record of this decision.
For the multi-member LLC, there are some options (the single-member LLC owner will obviously govern the business themselves). The two main routes for these companies are member-managed and manager-managed. With the member-managed option, the LLC’s owners handle the managerial aspects themselves, in a format much like the one used by general partnerships.
However, the limited liability company can also choose to hire a manager from outside the company, who manages the daily operations of the business without taking an ownership share. This can help avoid some disagreements within the ownership group, although we will note that the member-managed option is much more common, probably because it can cost quite a bit of money to hire a dedicated manager.
Which Business Structure Is Preferable?
Obviously, there’s no catch-all answer to this question, as 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 it’s preferable to form an LLC.
While you can save a bit of money and hassle with the general partnership, because you avoid the LLC’s formation and maintenance requirements, we think the benefits of the LLC far outweigh these small drawbacks. The biggest reason to form an LLC is to get the personal asset protection afforded by this business structure, which a general partnership cannot provide.
Additionally, the LLC is seen by most consumers to be a more legitimate and professional option, and being able to stake your claim to a unique business name that can’t be stolen away by another business entity is a big benefit as well.
The general partnership and the limited liability company are both popular American business structures, and they each have their own set of pros and cons. While each one fits what certain businesses are trying to do, 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.
We hope this article helped clear up any misconceptions you had about general partnerships and LLCs, and we wish you luck no matter which entity you choose for your business!