What are the basics of a limited liability company (LLP)?
LLPs are a flexible legal and tax entity that allows partners to benefit from economies of scale by working together while reducing their responsibility for the actions of other partners. As with any legal person, it’s important that you check the laws of your country (and state) before you get excited. In short, check with a lawyer first. There’s a good chance they’ll have first-hand experience with an LLP.
Understand the basics of a Limited Liability Company (LLP)
Everything is better between friends
To understand an LLP, it is best to start with the general partnership. A general partnership is a for-profit entity that is created by mutual agreement between two or more parties.
It’s a very technical way to describe two or more people who work together to make money. A general partnership can be quite informal. All it takes is a shared interest, maybe a written contract (but not necessarily) and a handshake.
Key points to remember
- Limited Liability Companies (LLPs) allow for a partnership structure in which the responsibilities of each partner are limited to the amount they invest in the business.
- Having business partners means spreading risk, leveraging individual skills and expertise, and establishing a division of labor.
- Limited liability means that if the partnership fails, creditors cannot take it out on a partner’s personal property or income.
- LLPs are common in professional firms like law firms, accounting firms, and wealth managers.
Of course, with the informal nature of a general partnership, there is a downside. The most obvious risk is that of civil liability. In a general partnership, all partners share responsibility for any issues that may arise.
For example, if Joan and Ted are partners in a cupcake business and a bad batch makes people sick, they can both be personally sued for damages. For this reason, many people quickly turn partnerships into formal legal entities like a limited liability company (LLC). An LLC, like JT’s Cupcake Factory, can replace Joan and Ted as a legal entity and protect their personal property from prosecution.
Watch Now: How Does a Limited Liability Partnership Work?
A more formal partnership
In some professions, however, you need something a little more personalized than an LLC with a fixed structure. Enter the Limited Liability Company (LLP). The LLP is a formal structure that requires a written partnership agreement and usually comes with annual reporting requirements, depending on your legal jurisdiction.
As in a general partnership, all the partners of an LLP can participate in the management of the general partnership. This is an important point because there is another type of partnership, a Limited partnership– where one partner has all the power and most of the responsibility and the other partners are silent but have a financial interest. With the shared management of an LLP, the responsibility is also shared, although, as the name suggests, it is very limited.
Why an LLP?
Professionals who use LLPs tend to rely heavily on reputation. Most LLPs are created and managed by a group of professionals who have a lot of experience and clients among them. By pooling their resources, the partners reduce operating costs while increasing the LLP’s ability to grow. They can share offices, employees, etc. More importantly, reducing costs allows partners to realize more profit from their activities than they could individually.
Partners in an LLP may also have a number of junior associates in the firm working for them in the hopes of one day becoming a full partner. These junior partners receive a salary and often have no participation or responsibility in the partnership. The important point is that these are designated professionals who are qualified to do the work that the partners bring.
This is another way LLPs help partners grow their operations. Junior partners and employees do away with retail work and free up partners to focus on bringing in new business.
Another advantage of an LLP is the ability to bring in and out partners. Because a partnership agreement exists for an LLP, partners can be added or removed as indicated by the agreement. This is convenient, as the LLP can always add partners who bring existing business with them. Usually, the decision to add requires the approval of all existing partners.
Overall, it’s the flexibility of an LLP for a certain type of professional that makes it a superior option to an LLC or other legal person. Like an LLC, the LLP is a intermediary entity for tax purposes. This means that the partners receive untaxed profits and have to pay the taxes themselves. Both an LLC and an LLP are preferable to a corporation, which is taxed as an entity and its shareholders again taxed on distributions.
How limited is the limited liability?
The actual details of an LLP depend on where you create it. In general, however, your personal assets as a partner are protected from legal action.
Basically, the liability is limited in the sense that you can lose assets in the partnership, but not those outside of it (your personal assets). Partnership is the first target of any lawsuit, although a specific partner can be held responsible if they have personally done something wrong.
LLP in the world
LLPs exist in many countries, with varying degrees of divergence from the US model. In most countries, an LLP is an intermediary tax entity for professionals who all have an active role in managing the partnership.
Often there is a list of professions approved for LLPs, such as lawyers, accountants, consultants, and architects. Liability protection also varies, but LLPs in most countries protect individual partners from the negligence of any other partner.