There are a lot of acronyms in business, especially when you’re dealing with structures. LLC, PLLC, LP, LLP, DBA, you get the idea. When you’re preparing to start a business, it’s easy to get lost in the weeds, overwhelmed by all the little details.
So when comparing two business types like limited liability companies and limited partnerships, it’s easy to look at them and think they might be similar, or that the differences between them are inconsequential. But in reality, they’re two distinct business structures, each with its own advantages and disadvantages. There’s a considerable amount of differences between them, so it’s important to make sure that you fully understand what they share in common, as well as what sets them apart.
But you don’t have to venture deep into the web to compare LLCs and LPs. In fact, you don’t have to venture any further than this page, because we’ve compiled everything you need to know right here.
What Is a Limited Partnership?
Let’s say you’re looking to start a business selling crocheted sweaters for dogs, and you have two investors who want part of the action. You might consider forming a limited partnership (LP), a formal business structure for companies operated by at least two partners. The key here is that an LP must include a minimum of one general partner and one limited partner.
Hold up. What’s a general partner, and how is it different from a limited partner? Good question.
An LP’s general partner involved in the daily operations of the business, managing operations, employees, finances, and more. However, this partner is fully liable for the company’s debts and other financial obligations. Limited partners, on the other hand, aren’t directly involved in the company’s day-to-day minutiae, but they’re also only liable for the amount of money they invested in the LP. So, if the business is sued, creditors won’t be able to pursue their personal assets. Limited partners are often called “silent partners,” because they contribute financially without being an active part of the LP’s daily life.
Note: You may also see limited liability partnership (LLPs) which are similar but give each partner individual limited liability protection and the option for managerial roles. This means that each partner won’t be affected by debts that another partner might incur from malpractice lawsuits, making it a popular structure for professionals like lawyers, accountants, etc.
Investors like LPs because they can contribute money and have a stake in the company without taking on managerial responsibilities or being significantly liable. It’s a fairly low-stakes investment. For many LP owners, bringing in limited partners is a great way to generate financial investments into without having to give up any management control.
What Is a Limited Liability Company?
Both limited partnerships and limited liability companies can have multiple members. But unlike the LP, LLCs provide personal asset protection to all members, which means that each owner can be as involved or uninvolved in the company’s management as they want, without having to worry about whether it’s affecting their limited liability status.
There are no limitations regarding how many members an LLC can have. Two? Great. Three? That’s fine too. 30? If that’s what you want, by all means. What’s nice about an LLC is that the structure is quite flexible. The members can set forth their custom rules and regulations in an operating agreement, a brief document that lists important details like the identities of the members, the name and location of the company’s registered agent, etc.
On top of that, LLCs have some flexibility with their tax structures as well. By default, they’re taxed like sole proprietorships or general partnerships, but if you’d prefer, you can elect to have them taxed like a corporation.
Similarities of the LP and LLC
They both have “limited” in the name, they both allow for multiple members/partners, they’re basically the same, right? Actually, there’s quite a bit of nuance within each of these unique business structures, and you’ll want to examine them carefully before making a decision. Let’s start with the similarities.
Pass-Through Taxation: Both the LP and the LLC are, by default, “pass-through” entities. This means that the business itself won’t pay taxes on its income, but the owners will need to report it on their personal tax returns.
Limited Liability: The limited liability companies and limited partnerships both protect owners’ personal assets, although the LLC offers limited liability protection to all owners, whereas the LP only provides it to the limited partners. (More on this in a moment!)
Flexibility: Both of these business entities are far more flexible than the rigid structure of a corporation. You as the business owner have the freedom to interpret member roles and conduct (along with other operational aspects) during your company’s startup phase. And as your company grows and evolves, you can always amend them later on.
Advantages of the Limited Partnership
An LLC and an LP walk into a pitch competition. What happens? Well, it’s likely that the LP will leave with more investors because of its option to be a limited partner. Venture capital funds aren’t allowed to invest in any pass-through company, which is a disadvantage for both the LP and the LLC. However, because LPs allow limited partners to avoid both liability and managerial responsibilities, they’re more attractive to potential investors.
Deductions, deductions, deductions! Limited partnerships are eligible for a whole wide world of tax deductions, many more than LLCs. This includes deductions for health insurance, pension plans, 401(k) expenses, and more. On the flip side, limited liability companies allow owners to claim some tax losses, but this is a pretty limited application that doesn’t actually help many LLC members.
While we’re going on about taxes, it’s also important to note that limited partners aren’t required to pay self-employment taxes, which are currently set at a rate of 15.3% – the combined rate of the employer and employee portions of Medicare and Social Security. LP general partners and all members of limited liability companies must pay this tax rate on all business-generated income.
And then there’s the issue of consistency. Limited partnerships are legally consistent across all 50 states. But each state has its own LLC rules and regulations that can sometimes muddy the waters regarding compliance issues.
Advantages of the Limited Liability Company
Are you a one-person operation? Sorry, but a limited partnership is not for you. LPs require two or more partners. You can start an LLC, however, with any number of owners. In fact, the single-member LLC is quite common. They’re a great way to maintain the autonomy of a sole proprietorship while gaining credibility and added protection.
LLCs have a leg up on LP when it comes to personal asset protection too. Within an LP, limited partners have fantastic protection, but general partners are left high and dry. In an LLC, every member enjoys the same limited liability protections.
LPs also severely restrict the roles its limited partners can play. If you’re a limited partner and you decide that you’d like to take a more active role in the business, sorry, but you can’t. If it was an LLC, you could assume any role you’d like, as LLCs don’t have specifically rigid and defined member roles.
Now you’ve got one snapshot of the limited partnership and one of the limited liability company. Hold them up side by side. There are some similarities, plenty of differences, and one probably looks better for your unique business. In general, the LP is probably the better option if you have a limited partner lined up, but otherwise, we recommend the LLC because it’s limited liability protection is much more comprehensive.
Now, as an LP and LLC pro, you’re ready to make a confident, well-informed decision. Whichever you choose, best of luck as you kick off your new business journey.