Is An LLP the Right Business Entity For You?

This article is not intended to be financial advice.

It’s one of the most common business formation stories in America: a pairing of business minds that has magical effects. 

The Wright Brothers. Wozniak and Jobs. Hewlett and Packard. All of us know what it’s like to have a strength in one area and a weakness in another—and when two people complement each other, it makes them far more likely to succeed. For this reason, starting a partnership business with someone you trust can be a great way to get ahead.

But it’s not just the meeting of minds that makes partnerships useful. It’s also the mitigation of risk. After all, starting a business is a substantial risk for anyone. It involves putting capital down, putting your reputation on the line, and taking a leap into the unknown. Partnering with someone can spread out this risk.

Even better, your partnership company can form an LLP—a limited liability partnership—to minimize each partner’s personal exposure to risk. But is this the right business structure for you? Here’s everything you’ll need to know.

Limited Liability Partnership Definition

What is an LLP? A limited liability partnership is a business formation of multiple partners. This has the effect of spreading out both workload and risk. 

Think of an LLP as a way to get into business with the advantages of running a company at scale. If you were to open a business under your own name as a sole proprietorship, you would carry 100% of the risk. But in an LLP, you not only limit the exposure of every partner—you also spread out the risk inherent in starting a business. This is a great way to take more control over your life while keeping an ownership stake in the work you produce.

The difference between an LLP and LLC is that an LLC can be single-member, whereas LLPs will require the presence and agreement of managing partners.

This structure is not a “general partnership,” which is simply when two or more parties go into business together. The “LL” part of the equation means you limit your liabilities to only what you invest in the business. If your LLP fails and goes into debt, you won’t be on the line for that debt—the LLP is a separate entity from your personal assets.

Examples of LLPs

Businesses that form LLPs typically include firms that benefit from people partnering up together—think law firms, doctors’ offices, and accounting firms. These businesses benefit from LLPs because they can run a great deal more risk than the average business. Limiting each partner’s exposure to that risk makes a lot of financial sense for each partner.

For example, Investopedia’s “largest law firm in the world,” Kirkland & Ellis, is a Limited Liability Partnership. It shows just how flexible an LLP can be: The company has thousands of lawyers, brings in billions in revenue, and represents major clients like Nike and Boeing. And it’s a partnership structure that’s been around since 1909.

That leaves one question: If they’re so great, why doesn’t everyone register for an LLP? Well, it depends on what kind of business you run. And as you’ll see below, there are LLP advantages and disadvantages to keep in mind.

LLP Advantages

Flexibility

An LLP lets you bring in new partners or exit other partners. Because you draw up a partnership agreement at the outset, the LLP remains flexible no matter who might join, as long as they have partner approval. 

It’s also worth noting that LLPs are pass-through tax structures, which allows each partner to file their share of the profits/losses of an LLP company on their individual tax returns (rather than a corporate return). The business income quite literally gets “passed through” to their personal income. This avoids a double-taxation situation that can end up costing you.

Reduced Business Liability

Any doctor’s office will have tremendous amounts of exposure to potential liabilities. An LLP structure means that the other partners in the office aren’t liable for the risks of the other partner. However, keep in mind that the legal liability rules for LLPs can differ from state to state.

Balance of Control

An LLP works for firms like doctor’s offices and law firms for more reasons than limiting liability. It also makes a convenient way for multiple people in the same profession to go into business with each other. Depending on how the LLP agreement is drawn up, each partner can have an equal say in how to run the business, such as approving new partners. 

LLP Disadvantages

No business structure is suited for every business situation. Let’s look at some disadvantages of an LLP:

Expense

An LLP is often required to carry certain amounts of insurance—and of course, there’s always business taxes, registration fees, and more. However, creating an LLP structure can be good for a business’s long-term future, and many professions (like the medical profession) already require carrying malpractice insurance in the first place.

Limitation to Specific Professions

If you’ve read thus far and wondered why more people don’t file for LLPs, there’s a simple answer: some people can’t. According to LegalZoom, there are only 40 U.S. states that currently allow filing for LLP status. Many of these states also limit who is eligible to create an LLP structure for their business.

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How to Start an LLP

Like an LLC, an LLP’s formation is more an issue of the state government than it is the federal government. Because LLPs are pass-through tax entities, it’s your individual state that’s going to have the most say in how they’re structured.

Specific Steps for Forming an LLP

How do you form an LLP? The individual steps are simple. Here’s what you’ll need to do:

• Check with your state first: In states like California and Nevada, for example, only a few select professions are eligible for LLPs. Check with your state’s website to see the specific LLP rules.

• Come up with a name: Typically, LLPs consist of accountants, lawyers, or doctors for whom the organization makes sense. For that reason, many partnerships use the last names of the key partners. This helps build a brand based on those names and avoids overlapping with existing LLP names.

• Choose your registered agent: The registered agent is the individual responsible for collecting business papers on behalf of the company. This gives your state government a specific mailing address to use. For LLPs, a partner can be a registered agent, but many people specifically seek out business attorneys.

• Procure the necessary paperwork: You should take this time to file the certificate of limited liability partnership with your state; this is when you’ll pay filing fees to set everything in motion and make your partnership official.

• Create the partnership agreement: The U.S. has a constitution, a plan for how things will go. This partnership agreement is something like a mini-constitution for how your business will run. It will require the signatures of all relevant parties, which means you’ll have to hash out how your company will run before signing the agreement.

The Cost of Setting Up an LLP

Honestly, it depends. 

The paperwork itself is minimal—you can often get away with handling all of it for a few hundred dollars, depending on your state’s fees and rules.

Procuring a business license will often incur other fees, as will maintaining the business standards necessary to stay in business. You’ll need a mailing address, for example—and while an LLC might be an individual with a home address, an LLP is far likelier to require a dedicated office.

Procuring an EIN (Employer Identification Number) for Your Business

For federal tax purposes, pass-through tax entities like LLCs and LLPs often have minimal impact on the way you file your taxes. For example, if you have an LLC, the income you receive will be taxed in a similar way to how you might file taxes as a sole proprietor. However, there are a few key federal requirements you need to pay attention to.

The first is procuring an EIN, or employer identification number, for your business. This functions much like a social security number for the business itself. It’s how the federal government will remember your business and everything it’s required to report. 

For more information on setting up an EIN for your business, check out the IRS EIN website, where you’ll learn everything the federal government requires.

Managing Employees as an LLP

The EIN is a key point because once you have employees at your business, you’ll have to pay payroll tax. 

This will require two things on your end: reporting obligations and deposit obligations. In other words, as you pay employees, you have to both report that you’re paying and then pay regular deposits on the taxes owed. 

Filing for Your Business License

Business licensing is separate from taxation. However, it’s an obligation that you can’t do without, particularly in states they may limit your ability to file for an LLP unless you’re in a specific business, such as Nevada and California.

This is another local issue, so contact your local county or state government to get information about the standards you’ll uphold to maintain your business license. You may also need to sign up for specific types of business insurance to remain in good standing.

Making Business Partnerships Work

When it works, a business partnership can function like magic. As part-owner, you receive a portion of the profits while spreading out the liabilities, the workload, and the risk. 

But none of that happens unless you set up an LLP the right way. Stick to the steps above, pick your partners carefully, and there’s a good chance you may just find your way to the next great magical pairing.

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This article is not intended to be financial advice.