Choosing the right type of legal business structure can help ease the pains of new startups and continue success for expanding companies. Before applying for a small business loan to start or continue a company, see how LLCs, LLPs and LPs differ and how to start each one.
A Note About States
Each state has its own laws for structuring a business. Generally, the state tax commission or the secretary of state will have all the forms and lists of procedures. States also require a filing fee that ranges from $30 up into the hundreds, so factor in this cost when writing a business plan or requesting a small business loan.
A limited liability company (LLC) is a business structure that offers tax flexibility and operation efficiency. The owners are called “members” and can be as few as one or two people. “Limited” liability refers to the personal protection each member receives from business decisions. For example, personal assets are legally protected, even if the company is sued or dissolves. LLCs are beneficial for single-owner businesses and small business owners.
To form an LLC, a business generally needs:
- A business name that is unique from other existing LLCs in the state, doesn’t use words restricted by the state and indicates it’s an LLC.
- Articles of confederation that include who the members are and basic contact information.
- An operating agreement that outlines percentages of ownership if there’s more than one member.
- Licenses and permits for the specific industry.
- An announcement of the LLC formation in a local publication.
- No federal business taxes because the taxes are passed on to the members of the LLC.
- Members are protected from personal liability.
- LLCs require less registration paperwork than other types of business.
- Startup costs are lower.
- LLCs offer more flexibility and fewer restrictions on profit-sharing.
- Some states dissolve an LLC when any member leaves, so a new LLC must be formed if the remaining members want to stay in business.
- Because members of the LLC are considered self-employed, they pay the higher self-employment tax on the entire net income of the LLC.
A limited liability partnership (LLP) combines the advantages of an LLC with a limited partnership. Instead of members, LLPs have partners who share in ownership of the company. All partners enjoy management rights, liability protection and tax benefits. Profit and loss are passed on to the partners, just like they are in an LLC, instead of being taxed at the corporate level. Some states restrict the types of businesses that can form an LLP. Depending on state restrictions, LLPs are beneficial for professionals who work on their own or in firms, such as lawyers, medical doctors, engineers or accountants. This type of partnership protects the individual professional even if a partner incurs obligations or debts resulting from negligence or misconduct.
To form an LLP, a business needs:
- Verification of qualification status if forming in a state that restricts the industries that may form an LLP.
- The personal name or names or a registered “doing business as” name unique from other business names in the state.
- A limited liability partnership agreement that defines each partner’s assets, liabilities and other pertinent operating agreements.
- A designated registered agent, which is a person or company authorized to conduct business in the state.
- A certificate of limited liability partnership filed with the state listing partners, location and general contact information.
- An employer identification number, a nine-digit tax number issued by the IRS.
- A state ID number, similar to the EIN but issued by the state.
- Required licenses and permits to operate legally within the industry.
- Any insurance required by the industry.
- Publication of formation in a local media source.
- No double taxation.
- Partners are protected from personal liability.
- More flexibility and fewer restrictions on profit-sharing.
- All partners share in the management of the business.
- Partners may pay more in self-employment taxes.
- Loss of a partner may result in loss of the LLP, making it necessary to go through the entire LLP formation process again.
A limited partnership (LP) is the legal structure best known as a business with “silent” partners. Unlike the partners in an LLP, an LP has one general partner responsible for all management decisions and obligations and an unlimited number of other “limited” partners who hold no voting or management responsibilities. Limited partners are only liable for the amount they invest in the company. LPs are beneficial for businesses that want to generate operating capital without giving up other rights. They are also great for time-restricted projects, such as movie productions or real estate.
LPs are formed like an LLP except for the following:
- They require a limited partnership agreement rather than a limited liability partnership agreement.
- The registered agent is usually the general partner.
- They require a certificate of limited partnership rather than a certificate of limited liability partnership.
- Workers’ compensation insurance may be required.
- Personal assets are protected up to the limit of a partner’s investment.
- Like LLCs and LLPs, taxes are passed on to partners rather than the business paying corporate taxes.
- The general partner has full oversight of the business.
- More partners can be added as needed.
- Partners pay self-employment taxes.
- Limited partners don’t have a say in business decisions.
Choosing the right legal structure can help you avoid problems down the road. Make sure to check with the state for specific laws, fees and filing requirements. No matter which one fits best, success means matching legal structure with business needs, so match wisely for a successful 2017 and beyond.
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