Perhaps you're an innovator who wants to bring a product to market or simply someone with a small business idea who is ready to incorporate. Because you have partners, your options for forming a business entity are a limited liability company (LLC) or a general partnership. These two entity types differ in several ways, with the main distinctions being ease of formation and asset protection. Here's a brief overview of the differences.
Relative to other corporate models, both an LLC and a general partnership are easy to form. In all jurisdictions, an LLC has formal requirements for formation, whereas a general partnership, in many jurisdictions, has no formal requirements.
Organizing an LLC
When forming an LLC, owners, called members, must draft articles of organization and file with the local Secretary of State. If there are two or more members involved in the venture, the members should also draft an operating agreement, which contains information about governance and the sharing of profits and losses. The members must also pay a filing fee.
Starting a General Partnership
Forming a general partnership is less formal. It requires at least two partners who create a joint venture, have equal duties in operating the business, and share in the profits and losses. In most jurisdictions, there are no formal requirements. A simple agreement to operate a business as partners creates a general partnership. Partners can form a general partnership in three ways:
- Orally. Partners can have an oral agreement to start a partnership that is legally binding. Note, however, that forming a partnership orally is not recommended, as one partner could deny the company's existence and there would be no proof of the agreement.
- In writing. Drafting a partnership agreement that details how the partners operate the business and share revenue legally forms a general partnership. Some states require filing the partnership agreement with the Secretary of State. Creating a written agreement provides evidence in writing.
- By implication. Even if the parties do not have an agreement, either written or oral, a court can imply a partnership based on the partners' behaviors. If two or more people jointly run a business, share in the profits and losses, and otherwise act as a partnership, a court can declare the venture a partnership by implication.
Your personal assets are an important consideration when choosing between an LLC and a general partnership. Consider the following when you make your decision.
The LLC structure is attractive because it provides members with limited liability, which separates the assets of the members from the assets of the business, thereby providing members with personal asset protection. This means that personal assets are not vulnerable to business affairs.
LLC members may be held personally liable if they breach their duties to the LLC or if a member personally guarantees liability, which most often occurs when obtaining a loan on behalf of the LLC. The LLC structure, in its basic form, shields members through limited liability protection.
Liability in General Partnerships
In contrast, a general partnership does not provide partners with limited liability. Instead, partners are personally liable for the company's debts. What's more, general partnerships impute joint and separate liability to the partners. For instance, if someone successfully files a lawsuit against a general partnership and only one partner is available to pay, the available partner is liable for the entire amount. That partner is responsible even if the other partner was entirely at fault. The innocent partner would have a right to an indemnity suit against the partner at fault, but the plaintiff would have a right to collect the entire amount from the available partner.
Weighing Your Options
When incorporating, consider the advantages and disadvantages of an LLC and a general partnership. An LLC requires a formal, though minimal, filing and provides asset protection. A general partnership, in contrast, generally does not require a formal filing and can be implied. On the other hand, a general partnership requires that all parties run the business equally and share in profits and losses, whereas an LLC provides flexibility with respect to these issues.
This portion of the site is for informational purposes only. The content is not legal advice. The statements and opinions are the expression of author, not LegalZoom, and have not been evaluated by LegalZoom for accuracy, completeness, or changes in the law.