Comparing a LP with a LLC
In our case study, Sarah and Jamie have a business idea and need to decide whether a limited partnership (LP) or limited liability company (LLC) would better suit their needs and protect them and their investors (some of whom are relatives with valuable professional experience and business advice to offer). Jamie favors forming a LP, while Sarah favors a LLC.
In both LPs and LLCs, investors and owners are known as members. LPs are formed by one or more general partners (who manage the business and accept potential liability for any business debts) and one or more limited partners (who contribute funding but have limited liability, meaning that they should be shielded from any debts the business incurs or any legal problems the business gets embroiled in). With a LP, the general partners act like co-owners and can take part in management decisions but they also take on the burden of any possible business debts; limited partners risk only their investment money (i.e., none of their personal wealth or assets can be seized to repay any of the business’ debts) but are not openly presented to the general public as partners, and they do not take part in helping make company decisions. An LP can set up a shell company; this means naming a corporation / “corporate person” as the functional general partner so members of the LP can try to avoid personal liability, but this is not without risk, as a court could decide that this “person” is a legal fiction and thus cause the LP to lose its only general partner and force it to dissolve (and LLCs can have similar problems).
A limited liability company has the limited liability of a corporation, but is taxed like a partnership; all profits are funneled through the owners, meaning that the LLC doesn’t pay federal taxes on its profits but the members report the income on their personal tax returns. (To clarify, an LLC, depending on how it is set up, can have a single member and be taxed more like a sole proprietorship, or it can have multiple members and be taxed and treated like a partnership or corporation; typically, however, members file their pro-rated share of taxes rather than the LLC filing taxes for them.) An LLC can set up a “corporate person” / corporate entity, but this is not bullet-proof protection from personal liability for individual members, as was noted in the case study in our textbook of Kaycee Land and Livestock v Flahive, 46 P3d 323 (Wyo 2002), where Kaycee sought to “pierce the corporate veil” and hold an individual, Roger Flahive, as the decision-maker and managing member of his LLC, personally responsible for environmental damage done to Kaycee property: the court decided that Kaycee could indeed pursue a suit against Flahive rather than his LLC (Twomey, 2011).
Both LPs and LLCs must cite a primary physical address for the business. LPs must file a Certificate of Limited Partnership with the appropriate state office, and an expected date of dissolution of the partnership (if known; otherwise the expected date to dissolve the partnership continues to be “guesstimated” and renewed regularly). An LLC is, technically, considered a “person” which is separate from its members. LLCs must have an operating (rather than partnership) agreement and must also formally file their Articles of Organization (which includes partnership dissolution details) paperwork with the Secretary of State and “LLC” must be included in the business’ legal name (SUO class materials, n.d.; Twomey, 2011).
If the goal is to shield everyone from future liability and if the relatives will still invest without having a voice or vote in how the business operates (thus remaining limited, not general, partners), then selecting a LP is the wiser choice. They can not, however, offer services or advice as general partners without also accepting personal liability or incorporating (Twomey, 2011). If Jamie and Sarah decide that the expertise and business acumen of the investing relatives is worth bringing them in as decision-maker managers who are willing to accept some liability for the business’ debts, then a LLC is the better choice. Jamie and Sarah have to weigh the importance of protecting themselves and their members from personal liability, the amount of power their investors will want in influencing or making business decisions, how they want to handle their taxes, and perhaps even the guidelines defining and the amount of legal paperwork required to properly set up an LP or LLC (Stone, 2012).
Another option the women can explore is a third option: a LLP, or limited liability partnership (or RLLP, a registered limited partnership), which may hit a happy medium between an LP and LLC. An (R)LLP doesn’t have limited partners but its general partners are typically not personally liable for the (R)LLP’s business debts (or malpractice of another member, or negligence of another member, and so on) as long as a partner is not a supervising or managing partner (Secretary of State Information, 2011).
When they do choose—and a LLC sounds like it would better serve their purposes—they need to clarify all business titles, the “chain of command,” member obligations, potential liabilities members are accepting and so forth in the business’ operating agreement (a cautionary tale from the textbook explains what happens when inadequately-defined roles, an overlap of decision-making capabilities with contributions to the business’—or a competitor’s—profits directly or indirectly, and accusations of intellectual property conflicts cause problems; see: Katris v Carroll, 842 NE2d 221 (Ill App 2005) (Twomey, 2011) and make sure all parties are clear on what responsibilities and risks they are agreeing to accept in exchange for having more or less control over and/or input into the business’ decisions and policies.
References
Twomey, D. P., and Jennings, M. M. (2011) Anderson’s Business Law and the Legal Environment. Retrieved from http://digitalbookshelf.southuniversity.edu
Stone, J. (2012). Difference Between LTD Partnership & LLC. Retrieved from http://info.legalzoom.com/difference-between-ltd-partnership-llc-4376.html
Secretary of State Information / South Carolina Is Open For Business. (2011, February 2). Difference between a “limited partnership,” a “limited liability partnership,” and a “limited liability company?” Retrieved from http://www.scsoscom.com/?p=911
Liberal Lore 