You are going to learn nearly everything you’ll need to know about limited liability partnerships as a small business owner. Whether you’re wondering about other companies, thinking about registering your own, or just curious, this guide has something for everyone.To start with, we know that LLP stands for Limited Liability Partnership—but what do those words mean when we’re talking about different kinds of business entities? Let’s break it down one letter at a time.
Limited: Pretty self-explanatory—something is held-back or protected.
Partnership: And finally, an agreement between two or more people.
So when we put it all together, it makes sense that a Limited Liability Partnership is a business entity in which its partners are all only partially responsible for, and therefore only partially vulnerable to, the debts and obligations of the business.
We’ll explore what that actually entails in a bit, but at the most basic level, a limited liability partnership protects its partners from each other. No single partner makes more important choices than the others, so no single partner is more liable for the business’s actions. Nobody is personally liable for the debts and obligations of the partnership at large. Instead, they all share that burden—a bit.
Historically, limited liability partnerships began in the 1980s because of collapsing real estate and
energy markets in Texas. Banks failed across the state, so people turned to the lawyers and accountants who assisted them instead. Texas then passed limited liability partnership laws in order to shield those innocent individuals from having their personal assets sized, just because of their tenuous connection to an economic event—and our favorite business entity type was born.
You might sometimes see an RLLP—a Registered Limited Liability Partnership— but they’re interchangeable terms. Also, you might come across a PLLP, or Professional Limited Liability Partnership, comprised only of members from a certain profession. These generally include lawyers, accountants, architects, doctors, dentists, or engineers.
A Deeper Dive into Limited Liability Partnerships
Now that we’ve got the fundamentals out of the way, we can dig into the nitty-gritty of why a limited liability partnership is a good thing, why it’s a bad thing, and who uses them anyway.
THE GOOD
Let’s take a closer look at the biggest benefits of converting your business into a limited liability partnership.
Protection
Like we said, the main point of a limited liability partnership is to protect each partner from the potential mistakes of the others. There’s no single general owner of the business—instead, each partner owns his or her share, and they distribute responsibilities accordingly. Your assets aren’t at stake if another partner gets sued for malpractice, for example.
Of course, that protection doesn’t extend to partnership assets, only to personal assets. If there’s a lawsuit, then the partnership’s assets get targeted instead of those belonging to individual partners. More importantly, a limited liability partnership won’t protect a partner who’s actually done wrong.
Think of it this way: if Bob, Bart, and Barry form a limited liability partnership—Bob, Bart, and Barry, LLP, maybe—it’s because they can all make more profit together than each would alone… But they’re not necessarily collaborating. They’re working together, but not together.
That’s why they named their company Bob, Bart, and Barry, LLP instead of The 3 Bs LLP. They’re partners, but still distinct. And they formed a limited liability partnership so that, if Barry gets sued for malpractice or someone raises a claim of negligence against Bart, then Bob’s house and car are still in the clear. The company might lose some money, and Barry or Bart could wind up personally liable for their breaches of conduct, but Bob’s own assets remain separate
from the business’s.
Tax Breaks
If you’re an owner of a corporation, your income gets double-taxed: once through the corporation, and once as your personal income tax. Bummer.
But partners of a limited liability partnership have it better—their cash only gets taxed once, when they fill out their income taxes, since a limited liability partnership doesn’t legally qualify as an individual the same way a corporation does.
Essentially, those in limited liability partnerships simply declare their share of the company’s profits as their income and pay the appropriate amount of income taxes. It’s straightforward—and intuitive. And that leads us into…
Flexibility
A limited liability partnership is easy to financially structure—and restructure. Partners can come and go, the business can grow and shrink, and even the way a partner’s salary is decided can vary. Should a partner get a percentage of the company’s profits? Of its gross revenue? From one stream, or multiple, or from across the board?
The best way to calculate these will change from business to business, but having the option to change your company’s structure fairly drastically without altering its business entity type can be a huge help.
Management Structure
Yes, a limited liability partnership is easy to structure… But it’s flexible in more ways than just finances. As we mentioned, partners can come and go—and carry with them clients and employees.
Going back to Bob, Bart, and Barry’s limited liability partnership: these three professionals decided to pool together their resources and share employees—like junior partners, analysts, a sushi chef, or what-have-you—as well as office space and supplies. They’re each saving money by working together, and making extra by exposing themselves to each other’s profits. Their partnership also deals with a larger number and wider range of customers, which promotes growth on a bigger scale.
Finally, the management structure of a limited liability partnership is just more streamlined than that of, say, a corporation. Rather than deferring to a board of investors or to stockholders, a limited liability partnership need only hold votes among its partners. And in the case that some partners are handling more responsibility than others, simply draw up or revise the limited liability partnership agreement to properly reflect that.
THE BAD
It’s not all fun and games, though: limited liability partnerships come with disadvantages as well!
Limited Availability
Fortunately, the biggest drawback of a limited liability partnership is that not everyone can register their business as one.
Unfortunately, that’s actually a very large negative. As it turns out, the rules behind who can form limited liability partnerships are quite narrow—though if you don’t fall into the select few eligible groups, then a limited liability partnership probably wouldn’t have been best for your business, anyways.
The laws regarding limited liability change from state to state—both what kinds of businesses can form a limited liability partnership and what that limited liability actually means vary across the country.
To begin with, you need at least two partners to qualify for a limited liability partnership. This might be obvious, but we thought it could use a mention!
Limited liability partnerships are generally connected to firms of lawyers, accountants, architects, and similar profession types—and in fact, states like New York, California, Oregon, and Nevada allow only these professions to form a limited liability partnership, and no one else. This isn’t just coincidence, though: these types of professions make the most sense in limited liability partnerships, while others might not.
Some states are also stricter than others when it comes to partner liability. Most states recognize partners as protected from obligations in contracts, torts, and more, though some only allow protection against negligence claims—Tennessee and West Virginia are two examples of states where partners in a limited liability partnership are especially exposed.
Finally, all these complications pile on top of each other when a limited liability partnership wants to work across state boundaries. Some states with more restrictive laws don’t recognize limited liability partnerships from other states. Others will recognize them, but only if they conform to those states’ rules. In fact, one state might consider a company to be a general partnership instead of a limited liability partnership—which could cause a lot of legal headaches, especially if a partner’s liability is brought into question.
To sum up: not everyone can form a limited liability partnership, not all states define limited liability the same way, and not all states recognize the limited liability partnerships of other states.
Inefficiency
So, your business qualifies for a limited liability partnership. What’s a drawback to actually practicing in one?
Some say that limited liability partnerships can potentially run less efficiently than other business entity types since there isn’t necessarily a single leader who makes the big decisions. All partners can legally act in a management capacity, which could lead to redundancies, conflicting directions, and wasted resources.
The way around this is simply to communicate clearly and often, but we know that’s easier said than done. If you focus on the partnership side of limited liability partnerships, and recognize that inefficiency can and will have a tangible negative impact on your business, then this downside shouldn’t be too hard to overcome.
Fees and Taxes
Finally, limited liability partnerships often have to pay registration fees and franchise taxes. This drawback might be major or minor—it depends on your business. It also varies from state to state, as you might expect by now.
We’ll go into how exactly you register as a limited liability partnership later on, but for now, just know that you’ll need to pay a yearly registration fee to your secretary of state. This might be a flat rate or a per-partner charge.
You also may need to pay a franchise tax, which limited liability corporations also pay, depending on your state of business.
And, last but not least, some states require that limited liability partnerships maintain a sum of cash on-hand as insurance against liability claims.
WHO’S WHO?: LLP EDITION
By now, you can probably guess who’s most interested in forming limited liability partnerships—and who’s allowed to.
Besides thinking about specific states and professions, we can also consider what kinds of business owners might opt into a limited liability partnership… And whether you fit that bill.
These partnerships ideally group together partners with different experiences, histories, and client bases, in order to diversify the company’s offerings and lead to faster growth. That being said, many partnerships also have a certain field they focus on—too much diversity of work can get in the way.
Plenty of partners in a limited liability partnership could strike out on their own if they wanted—it would just take more time, money, resources, and guidance to set up shop. Looking towards the future, a limited liability partnership lets others join on and eventually make partner as well, attracted to the comfort of an already-established business.
Also, limited liability partnerships lend themselves to people—and professions—who rely on reputation to succeed. While every occupation involves word of mouth, some do business through it more than others, and those professions benefit most from limited liability partnerships.
Finally, to state the absolutely obvious: limited liability partnerships are nearly always professional service-based, so their partners must be interested in practicing among their peers. A lawyer who prefers to be head counsel for a technology company, for example, probably won’t get much out of joining a limited liability partnership with other lawyers.
What Else We Got?
We’re talking about limited liability partnerships, but let’s not lose sight of what else is out there: it’s only one type of business entity, after all. Let’s breeze through a refresher course on business entity types to see how limited liability partnerships compare.
SOLE PROPRIETORSHIPS
The simplest business entity, a sole proprietorship involves one person as owner and operator. It’s easy to start, intuitive to manage, and it offers you the opportunity to deduct your business expenses from your personal taxes.
On the other hand, you’re personally liable for your business’s debts and obligations, and you’ll have to pay income taxes on your business’s profits. Most freelancers and service professionals operate sole proprietorships, but so might any business run by a single person.
PARTNERSHIPS
If your business is run by two or more people, then you’ll have to figure out what kind of partnership best suits your needs. A limited liability partnership is naturally an option, but there are a few others to choose from.
General Partnerships
In a general partnership, all partners manage the business equally—and are equally liable. It’s
basically a sole proprietorship with two people instead of one: easy to start, intuitive, and tax deductible, but subject to income tax and open to personal liability.
Limited Partnerships
There are two kinds of partners in a limited partnership.
First, you have the general partner, who acts as any owner would. He or she makes the major decisions and takes responsibility for the business.
Second, there’s the limited partner—an investor by another name, essentially. Limited partners can’t exercise any control over the business, but in return, they’re not personally liable for any of its debts and obligations.
A limited partnership is a flexible arrangement: limited partners can along or leave without much fuss, and the entity type offers a lower risk for investors looking to gain without the potential for personal loss.
However, it’s more expensive to form a limited partnership, and general partners have to bear all the liability of the business themselves.
OTHERWISE
What if you’re not the sole proprietor and you’re not entering into a partnership? You still have a few options for arranging your business, it turns out.
Corporations
Corporations involve many more fees, taxes, and regulations, and are generally just more complicated than the previous structures.
The pay-off, though, is that corporations are considered independent from their owners in the eyes of the law. If you own a corporation, you’ve got extremely limited liability, among other advantages.
However, you’ll have to pay income taxes on your salary as well as taxes on the business’s profits, since you’re considered separately by the IRS. Corporations also require a good deal of paperwork and fees to register for.
S-Corporations
A hybrid of corporations and partnerships, an S-Corporation “passes” tax payments onto just the owner—you won’t have to double-down on tax payments, in other words. Instead of paying income tax as an individual entity, the S-Corporation passes off its profits straight to the shareholders.
You’ll get limited liability with this entity type as well, though again, an S-Corporation is relatively expensive and complicated to form.
Limited Liability Company
Finally, a limited liability company combines the tax benefits of a partnership with the limited liability that corporations offer. Owners can generally choose how their LLC gets taxed while avoiding the liability of a sole proprietorship or general partnership.
Unfortunately, limited liability companies are also more expensive than their partnership alternatives—and importantly, they’re sometimes not available to certain professions. California, for example, doesn’t allow licensed professions—like lawyers, accountants, architects, and so on—to form LLCs.
In addition, LLCs lack the structural freedom of limited liability partnerships, and are sometimes seen as confusing in their own right by potential investors and partners. They’re powerful business entities, especially for small businesses—but a bit unusual, if you’re not familiar with how they work.
(Limited Liability) Partner Up
By now, you’re an expert on all things of limited liability partnership. Now there’s only one thing left to learn: how the heck do you form one?
Continuing the trend with limited liability partnerships, the exact registration procedure changes from state to state. All states, though, will ask you to follow these 5 steps, so at least make sure you’ve read and understood them before moving on.
1. MAKE SURE YOU’RE ELIGIBLE
Check out your state’s rules and regulations on limited liability partnerships to see whether your business is eligible or not. Especially if you’re located in New York, California, Oregon, or Nevada, your state might have narrow restrictions on what sorts of professional services a limited liability partnership can offer. Be sure you can qualify before you spend time applying.
2. PICK A NAME
The fun part! Your business’s name needs to be distinct from the names of other businesses operating in your state—you can check your Secretary of State Office’s business database to make sure your ideas aren’t infringing.You’ll also need to add in “Limited Liability Partnership” or “LLP” to the end of your name, in order to indicate that you’re operating as such. For example, our old friends Bob, Bart, and Barry had no choice but to christen their company “Bob, Bart, and Barry, LLP.”
3. DRAW UP YOUR LIMITED LIABILITY PARTNERSHIP AGREEMENT
This document will define each partner’s responsibilities, their roles, and of course, their protected assets. The Limited Liability Partnership Agreement also lays out exactly what liability defenses each partner receives, and acts as insurance against personal asset seizing in case of a suit or something similar. In a sense, this is the core difference between a limited liability partnership and a general partnership.
4. BUSINESS BANK ACCOUNTS, PERMITS, LICENSES
You’ll need to apply for your Employer Identification Number through the IRS, which will then let you open a business bank account with your partners. You’ll each need proof of identification, a Social Security Number, and your address to do so.
Also, make sure you’re up to date on your required licenses and permits, depending on your type of business and the state you operate in. Some states ask for State ID Numbers in addition to Employer Identification Numbers, too, so look into your state’s Department of Revenue website.
Finally, check to see whether you need to purchase specific insurance plans, like workers’ compensation or malpractice, and whether you’ll need to publicize your limited liability partnership formation, which some states expressly require.
In short: make sure you’re ready before taking the final plunge.
5. FILE A CERTIFICATE OF LIMITED LIABILITY PARTNERSHIP
Finally! This application requires your business’s name, its address, the names and contact information for its partners, your Employer Identification Number, and other administrative details. You’ll face a minor filing fee as well, so be forewarned.
Also note that you’ll need to designate a registered agent—the person who will be receiving your legal documents. If you have an attorney, he or she might be the sensible one to nominate, but that’s up to you.