Clients often ask us to articulate the benefits and drawbacks of forming and operating a business as a limited liability company (abbreviated as LLC) as opposed to a limited partnership (abbreviated as LP). LLCs and limited partnerships share certain common features; however, they differ in a number of important ways. This posting describes some of the key similarities and differences.
LLCs and limited partnerships are similar in that they are, and were intended to be, flexible business forms. The terms governing an LLC or limited partnership’s operations can be tailored to the needs of a specific business. For instance, to provide only a few examples, investors in an LLC or limited partnership can provide for whatever voting or economic terms they desire, and can alter the standard of care and fiduciary duties which participants in the business owe to one another. Delaware law provides certain limited default terms that will govern in the event that the operating agreement of the entity is silent on an issue, but the LLC and limited partnership forms are each intended to give maximum effect to the participants’ freedom to contractually provide for terms they deem appropriate.
The LLC and limited partnership are also similar in a much more practical way: each provides its investors with pass-through tax treatment. Pass-through tax treatment means that the business itself is not subject to federal income tax, but each investor will be required to report separately on its income tax return for each year its distributive share of items of the business’s income, gain, loss and deduction, and will be taxed currently on that distributive share, regardless of whether the investor has received or will receive a distribution of cash or other assets from the fund.
The most important difference between the LLC and limited partnership form relate to personal liability of participants.
A limited partnership is managed by one or more general partners that control the day-to-day operations of the business. These general partners have unlimited personal liability for the debts and obligations of the limited partnership, meaning that they can be held personally liable for those debts and obligations. A limited partner does not have personal liability for partnership obligations, but is not permitted to participate extensively in the day-to-day management of the limited partnership. If a limited partner participates in a significant way in management, a court may treat that limited partner as though it were a general partner if the limited partnership is sued, and impose personal liability upon the investor. To avoid this personal liability, an entity such as a corporation (or, as described below, an LLC) may serve as the general partner of a limited partnership. However, creating a separate entity to serve as general partner adds additional cost and complexity, and could have adverse tax consequences.
The LLC was created by the Delaware legislature to provide the flexibility of a partnership while providing corporation-like protection against personal liability. An LLC can be managed by one or more of its members. Unlike in a limited partnership, however, a participant engaged in the management of the business is not personally responsible for the liabilities of the entity.
Given the personal liability applied in a limited partnership, many clients ask why a person would choose the limited partnership form. As noted above, the LLC is a relatively new type of business form (since 1992) and, as a result, the case law regarding LLCs is far less robust and settled than that applicable to limited partnerships. The predictability that a settled body of case law provides leads some to select the limited partnership form. However, the LLC has gained a lot of ground in popularity. Last year, 67% of the State of Delaware’s new formations were LLC’s while around 6 % are LP’s.
To form a Limited Partnership or Limited Liability Company please call us at 800 345 2677 opt 1, we are here and ready to assist!