You probably don’t need us to tell you that founding a company is a pretty stressful ordeal.
With so much to worry about and take care of right from the get-go, it’s no wonder that many entrepreneurs and soon-to-be-business owners choose not to go it alone—instead opting to forge a business partnership with one or more like-minded individuals.
But, while forging these business partnerships can enable your business to quickly take off once things get moving, it also opens up a whole new set of concerns. For one thing, you’ll need to trust that your partners will hold up their end of the agreement—and won’t drag you down with them if things go south on their end. Secondly, you’ll also need to ensure you’re following the letter of the law as pertains to the type of partnership you forge.
While there are a number of business partnership types to choose from (that may or may not apply to your company), today we’re going to focus on one specific option:
Limited Liability Partnerships.
What Is a Limited Liability Partnership?
A limited liability partnership (LLP) is a form of general partnership in which each partner is shielded from liability in cases where another partner is at fault.
Basically, for an individual within an LLP, their liability ends exactly where their responsibilities to the company do (that is, as long as they didn’t step outside of these boundaries and, in doing so, add to the original damages in question). This is in stark contrast to traditional business partnerships, in which each partner is held liable for any damages caused in the company’s name (i.e., by any of their partners).
LLPs are often associated with business partnerships between two or more professionals within a specific niche. Attorneys, medical doctors and professional consultants will often form LLPs, as doing so allows them to band together to build a company while also maintaining autonomy at the same time (and, of course, avoiding sharing the blame for the actions of others). So, as a rather simple example, if two doctors form an LLP together, and one prescribes the wrong medicine to a patient, the innocent partner cannot be held legally liable for the error.
(As we’ll get to later on, many jurisdictions only allow professionally-certified business owners to form LLPs.)
Another key aspect of LLPs is how they’re taxed. Essentially, LLPs operate as pass-through entities, which means the business itself isn’t taxed at all. Rather, each partner simply claims their share of the company’s distributions on their own personal tax return as if they were a sole proprietor.
(As a quick side note, the partners within an LLP will, of course, have agreed on how to divide distributions at the onset of their partnership.)
Now, before we dive into how to form an LLP, let’s quickly make a couple of distinctions.
LLPs vs. LLCs and LPs
I know, I know:
That’s a lot of acronyms.
But saying “Limited Liability Partnerships vs. Limited Liability Company and Limited Partnerships” doesn’t really clarify much of anything, does it?
All kidding aside, LLPs, LLCs, and LPs are not synonyms—and those that don’t realize this will likely be in a for a rude awakening at some point down the line.
Here, we’ll provide a brief overview of how each of these entities differs from one another.
Perhaps the main difference between LLPs, LLCs and LPs concerns liability.
As we established, partners within an LLP are protected from a partner’s potential negligence or wrongdoing. For the negligent partner, this means they are 100 percent liable both professionally and personally for any damages they cause while operating in the name of the business.
On the other hand, within an LLC, personal and business assets of members are kept completely separate. Essentially, the company as an entity assumes the liability for the actions of each of its members, meaning an individual member cannot be sued for the company’s negligence—even if the individual in question was actually the one at fault.
Limited partnerships, in terms of liability, are a sort of combination of the above entities. In an LP, only the limited partners are protected from personal liability; general partners are fully liable for the company’s assets and actions.
As we’ve mentioned, LLPs are not taxed at all—the partners simply claim their share of distributions on their personal income statements.
LLCs have a choice, here: If the members of the LLC agree to be taxed as a pass-through entity, they may do so. But, the committee may also vote to be taxed as a corporation (with each member also being subject to personal income tax based on distributions, as well).
In a limited partnership, only general partners are required to pay self-employment tax based on their distributions, while limited partners are not required to do so. Limited partners also share in the company’s earnings after the general partners have claimed their distributions—which is why limited partners’ income isn’t technically seen as revenue from self-employment.
Lastly, LLPs are different from LLCs and LPs in the way they’re managed.
As we said earlier, LLPs are managed by the partners, specifically. In contrast, LLCs can either be managed by the members of the committee, or by executives and managers who are then paid by the company as the members (owners) see fit.
In limited partnerships, the limited partners have a limited amount of say in the goings-on within the company. Basically, they’re as hands-off as owners of a manager-managed LLC.
In these “hands-off” scenarios, the silent partners essentially have one interest in the business itself: Profit. The nature of these agreements is such that the silent partner doesn’t need to be involved in the actual running of the business; they simply act as initial investors of the company.
How to Form an LLP
So, you and your partners have decided to form a limited liability partnership.
Here’s how to get started:
Your first step is to ensure your potential business is eligible to be formed as an LLP.
As we said earlier, there are a number of states, such as New York and California, in which only professionally-certified individuals are allowed to form LLPs. In some cases, it might actually be compulsory for a given partnership to be registered as an LLP.
In this same vein, you’ll also want to dig deep into jurisdiction-specific laws regarding liability and taxation. Though we covered the general overview in this article, certain states do apply contingencies to specific laws and terms that you’ll need to be aware of before committing to an agreement.
Going along with that, you’ll also want to hammer out any inconsistencies that may exist between states, if your various partners operate in different jurisdictions. This, of course, needs to be handled on an individual basis (and goes well beyond the scope of this article).
Name Your Company
Once you’re sure that your business is eligible to be filed as an LLP—and that doing so is the best course of action for the company—you need to come up with a name for it.
This step is pretty straightforward, and it’s really up to you and your partners to come up with a name that truly represents what your company stands for.
There are, however, two stipulations, here:
First, you can’t use a business name that’s already been registered within your jurisdiction. Your state government’s website should provide this information within its database of registered businesses. Second, you’ll need to affix either “LLP” or “Limited Liability Partnership” to the end of your business’s name to designate it as such.
Set the Terms of Your LLP
Here’s where you’ll be setting in stone your legal agreement between all involved partners.
Essentially, this agreement will define the terms we’ve spoken about throughout this article:
- Business Responsibilities
The terms of your specific agreement are, of course, entirely up to you and your partners. That is, as long as you’re working within the law of the land, your agreement can work however you and your partners see fit.
Get Your Accounts in Order
There are three sets of documentation you’ll need before you officially apply to be registered as an LLP.
First and foremost, you and your partners need to get federal employer identification numbers, as provided by the IRS. This is a simple process, but to complete it you’ll need:
- A legal form of identification
- Your Social Security card/number
- Proof of residency
You’ll also need to open up a business bank account with your partners, through which all revenue generated by the company will flow. This is an essential part of the process, as it will legitimize the income claimed by each partner come tax time.
Finally, ensure that all partners are up-to-date on state-specific certifications, licenses and permits. Along with this, confirm whether your business will need to be insured against malpractice, workers’ comp or any other incident-related occurrences.
File Your Application and Get Ready to Get Moving
Now that you have all your ducks in a row, you can send in your application to become a limited liability partnership.
Before you do, though, keep in mind two things:
- Depending on a variety of factors, it may take time for your application to be processed. Typically, you’ll be given an anticipated waiting period as you go to apply.
- There will be a processing fee, which will also be communicated as you go to apply.
The last thing to do before you send in your application is to designate an individual to collect, maintain and store the company’s legal documentation. While this technically can be anyone (or, more specifically, any member of the partnership), it’s recommended that your team of partners designate an attorney to take on this responsibility for the duration of your business’s lifespan.
Once you know who will be receiving word of your official acceptance as an LLP, you only have one thing left to do:
Get ready for a successful launch.