If you’re thinking about starting a business, you’ve probably heard about sole proprietorship, partnership, limited liability company (LLC), and corporation. Most people usually begin as sole proprietors, but if your plan involves multiple owners, you should know the LLC vs. partnership differences.

Both business structures have tax benefits and can reduce your risk exposure. However, they have key differences that can affect everything from your daily operations to growth opportunities.

In this post, we’ll cover everything you must know about LLC vs. partnership business structures, including their advantages and disadvantages. By the end, you should be able to figure out which business structure fits your business best.

What Is a Limited Liability Company?

A limited liability company (LLC) is a separate legal entity from its owners (also called members). This means the business can enter into contracts, own assets, and incur debts in its name.

An LLC can either be single-member or multi-member, and there’s no limit to the number of owners. Anyone can form an LLC, whether you sell cosmetics, own a floral business, or some other business.

Form an LLC

What Are the Requirements for Forming an LLC?

Most states even allow other LLCs, corporations, and foreigners to start a limited liability company. Some of the requirements for forming an LLC are:

• Business name: You must select a unique name that complies with your state’s LLC naming rules. For example, you may be required to add “LLC” or “Limited Liability Company.”

Image via GovDocFiling

• Articles of Organization: This document includes basic details about your business. You must submit it to your state’s business filing office, along with the required filing fee.
• Operating Agreement: Although this isn’t mandatory, the Operating Agreement allows you to specify your ownership structure, the role of members, and the mode of operation.
• Licenses and Permits: Depending on your industry and location, you may need specific licenses or permits to operate legally.
• Employer Identification Number: You’ll need a tax ID or EIN for filing taxes and opening a business bank account.

Image via GovDocFiling

It’s important to note that the Internal Revenue Code classifies a single-member LLC as a disregarded entity for tax purposes. This means the business itself does not pay income tax separately from its owner.

On the other hand, a multi-member LLC is treated as a partnership unless it elects to pay taxes like a corporation. Whether you’re forming a C-Corp or an S-Corp, you must file Form 8832, notifying the IRS of your preferred tax classification.

Also Read:

• Single-Member LLC vs. Multi-Member LLC: How to Choose
• LLC Member vs Manager: Which Structure Fits Your Business?

Why Should You Form an LLC?

Starting a limited liability company has various benefits, such as the ones listed below.

Protects Your Personal Assets

One of the biggest advantages of registering an LLC is that it offers limited liability protection. It shields members’ personal assets from business debts and legal claims.

So, if your business faces a lawsuit or becomes bankrupt and can’t pay its debts, your personal assets, such as your car, house, and investments, are safe. Only your business assets will be at risk.

Also, if another member goes into debt, creditors can’t come after your personal assets or the assets of the LLC to satisfy that member’s debt.

Keeps Things Simple

Starting and maintaining a limited liability company involves fewer legal requirements and paperwork compared to other types of business entities like corporations. To facilitate the process, you can also seek help from a trusted LLC formation service provider.

Some offer additional services, such as providing the website domain, bookkeeping services, and business coaching.

Additionally, forming an LLC doesn’t require having a board of directors or holding an annual meeting. You only need a registered agent who receives and processes official documents on behalf of your business.

Image via GovDocFiling

Avoids Double Taxation

For tax purposes, limited liability companies are typically treated as a pass-through entity, similar to a sole proprietorship. This means that the business’s profits and losses are passed to the LLC owners.

If you’re a single-member LLC, you report this information in your personal tax return using Schedule C (Form 1040). If your LLC has multiple owners, it’s treated as a partnership by default, and each member receives a Schedule K-1 (Form 1065) to report their share of the profits.

Also Read:

• What Is a Tax ID? Entrepreneur’s Guide to Employer’s Tax ID
• How Does an SSN Differ From a Tax ID?

Provides Management Flexibility

There are no strict rules on how to manage a limited liability company. You’ll decide whether you want to manage the business or appoint others to do so.

In a member-managed LLC, the business owners actively participate in day-to-day operations and decision-making.

For instance, salon owners can collectively decide on inventory, pricing, and store layout. If they are stylists, they can also provide services and work together to maintain the store.

In a manager-managed LLC, some LLC members may invest in the business without participating in its daily operations. Instead, a manager — who can be either a member or an outsider — is appointed to oversee business activities.

Let’s say you set up a real estate LLC. You may appoint a professional property manager or a knowledgeable member to handle key tasks like finding tenants, collecting rent, and managing the property.

This structure allows a skilled professional to handle the business while allowing investors to provide funding without giving up control over operations. This is ideal for small businesses looking for investors.

Offers Allocation Flexibility

LLCs can allocate profits and losses in ways that aren’t necessarily proportional to ownership. One member might contribute more capital, while another contributes specialized expertise.

This is where an operating agreement comes in handy, as it allows for customized allocation arrangements where:

• Members who provide specific services can receive a larger share of profits
• Members who take on greater risks can receive a higher return
• Members who contribute intellectual property are compensated accordingly

Although an LLC allows you to choose your sharing percentage, it must reflect the actual economic realities of the members. The IRS checks this strictly to ensure you’re not adjusting the allocations to avoid tax.

We recommend consulting a tax professional to ensure that your allocation methods are within the bounds of the law.

Increases Your Credibility

Let’s be honest; people are more inclined to view your business as a legitimate and established entity if there’s an “LLC” in your business name.

For instance, this can be useful for a virtual bookkeeping business. Even if you don’t have a physical address, you can register as a freelance LLC, so your clients can trust you more.

You can also obtain an EIN and open a business bank account as an LLC. This separation of business and personal expenses gives lenders the confidence to offer business loans with favorable terms and conditions.

This limited liability protection also makes it a preferred business structure for investors compared to a sole proprietorship.

Also Read:

• Freelance LLC Guide: Everything You Should Know
• When and How Should You Start Multiple LLCs? A Guide

Protects Your Business Name

When you register an LLC, the state requires you to choose a unique business name not registered with the Secretary of State. This will also prevent another LLC from registering with the same name, protecting your business. You can also add a trademark protection for federal coverage.

Disadvantages of Forming an LLC

So, we’ve discussed all the good stuff about LLCs. However, like anything, there are some downsides you should know about, such as:

• Self-Employment Tax Burden: The IRS classifies LLC members as self-employed. This means you’ll pay self-employment tax (15.3%) on your share of the profits unless you elect to pay taxes as a C-Corp or S-Corp.

• Limits of Liability Protection: A court can “pierce the corporate veil” if you personally guarantee a loan, mix personal and business finances, or engage in fraudulent activities. This means that they can come after personal assets to cover business debts.

• Transfer of Ownership: It can be difficult to transfer ownership of an LLC to another person since the company doesn’t sell shares. Adding a new member or adjusting the profit-sharing ratio typically requires approval from existing members, as outlined in the operating agreement.

What Is a Partnership?

A partnership is a business entity consisting of two or more people who agree to pool their resources together, including capital, skills, or experience. They also share profits and losses and may have unlimited liability in some cases.

The owners of a partnership are called business partners. They may have a written partnership agreement or an informal, verbal understanding.

In a formal partnership agreement, you’ll outline each partner’s roles and responsibilities, profit and loss sharing, and procedures for dissolving the partnership.

It’s important to note that different types of partners exist. Some prefer active participation and control over the business, while others are silent partners, contributing only capital.

Apply with Partnership EIN Service

What Are the Requirements for Forming a Partnership?

You can easily form a partnership so long as you have the following requirements:

• Partnership Agreement: You must draft a comprehensive document outlining the roles and expectations of each partner.

• Partnership Name: You can file a doing business as (DBA) or trade name, but search the state’s database to ensure it doesn’t already exist.

• Tax Registration: You need to apply for a state tax ID and federal employer identification number (FEIN).

• Obtain Licenses and Permits: In some states, you need a license, certification, or permit to conduct business as a partnership.

Image via QuickBooks

Also Read:

• Partnership vs S Corp: Everything You Need to Know
• Sole Proprietorship vs Partnership: How Are They Different?

Types of Partnerships

There are three common types of partnerships for businesses that plan to generate profit. They include general partnership, limited partnership, and limited liability partnership.

By law, partners share equal responsibilities, but the type of partnership can limit liability for some partners. Let’s break down what each type of partnership involves.

General Partnership

In a general partnership, two or more people agree to do business without forming a separate entity like an LLC. Similar to a sole proprietorship, it’s an unincorporated business entity that doesn’t require formal registration to get started.

You can become a general partner without a written partnership agreement. However, to avoid disputes later, ensure there’s a written contract that outlines the rights and obligations of each general partner.

Here are the risks of forming a general partnership:

• Unlimited Liability: General partners are personally responsible for the partnership’s debts and obligations. This puts your personal assets at risk.
• Shared Responsibility: Each partner is liable for the actions and debts of the other partners, even if they were unaware or uninvolved.
• High Risk in Service-Based Businesses: In industries where partner actions can have significant financial consequences, liability concerns are even greater.

Therefore, you should thoroughly know and trust anyone you choose to partner with.

For tax purposes, a general partnership is usually treated as a pass-through entity. The partners report their share of the profits in their personal income tax returns.

Limited Liability Partnership

This is an upgrade to a general partnership. It’s a separate legal entity from its partners and protects them from being personally responsible for business debts.

Since a limited liability partnership is an incorporated business structure, it’s ideal for professionals like accountants, attorneys, and doctors. If one partner is sued for negligence or other unprofessional conduct, it won’t affect the other partners’ personal assets.

It’s important to know that while a limited liability partnership is common for professional services, it isn’t exclusive to them.

Also, state laws will determine the specific requirements for forming a limited liability partnership and the protections it offers. Generally, you’ll need:

• A detailed partnership agreement
• The business’s registered address
• An updated register of partners

Limited Partnership

A limited partnership combines a general partnership and a limited liability partnership. The general partner runs the business and bears personal liability for the business’s debts.

On the other hand, the limited liability partnership allows silent partners to invest in the business. As a result, their personal liability is restricted to only their invested amount.

If you decide to become a silent partner in a limited partnership, you’re not allowed to participate in the day-to-day operations of the business, as this can nullify your personal liability protection.

A limited partnership is a great way to incorporate a real estate business, such as apartments or shopping malls. This is where the project manager is the general partner and the investor is the limited liability partner.

The latter provides funds for the project and gets an income when the completed project starts generating profit.

This business structure also allows pass-through taxation for all partners. However, the limited liability partners are exempted from paying self-employment tax because they’re not actively involved in the business.

Image via Universal CPA Review

Also Read:

• 27 Low-Cost Online Business Ideas for Beginners
• How to Start Your Freelance Business: A Quick Guide

Advantages of Forming a Partnership

Partnership business structures offer distinct advantages that make them ideal for certain business ideas. Let’s discuss some of the benefits.

Shared Resources and Expertise

Remember the saying, “Two heads are better than one?” This is what a partnership business structure entails. However, you can have more than two partners.

For example, if you’re a software developer, you can team up with a marketing expert to promote your products effectively. Another example is a small cleaning company, where one partner may have the skills while the other may have access to leads.

Your partner can also give you a fresh perspective on doing business, such as which markets to target or effective pricing strategies. In a partnership, what one lacks in terms of skills and experience, the other complements.

A partnership allows you to share the financial costs and managerial responsibilities with people you trust.

Ease of Formation

Just like how you start a sole proprietorship, you can form a partnership without formalities, especially in a general partnership.

Although some states require you to register a partnership, the requirements aren’t expensive. You also don’t have to do a lot of paperwork, and submitting a written partnership agreement isn’t mandatory (but we highly recommend it).

This flexibility allows you to start your business without worrying about legal documents for new business formation. Also, partnership business structures provide options based on your business needs.

You can have partners who manage the business and make decisions with you. Meanwhile, others can bring in capital while staying in the background and receiving a share of the profits.

Potential for Growth and Expansion

Having business partners makes you more productive because you can focus on your areas of expertise while they handle the rest. This teamwork frees up your time, allowing you to develop ways to grow your business.

For example, you can have more time to launch a new line of products, upgrade your services, or even open a second location. You can expand your offerings and reach more customers because you’re not trying to do everything yourself.

Emotional Support and Shared Burden

Starting and running a business can be stressful and isolating, but having a partner means you won’t be alone. They understand the ups and downs, late nights, and tough decisions you need to make.

They provide the necessary emotional support — someone you can bounce ideas off, vent frustrations, and celebrate successes with. This built-in support system can help you stay motivated and resilient, especially during difficult times.

Your partners are just as invested in the business as you are. So, they provide a sense of camaraderie and shared purpose that can be invaluable for your mental and emotional well-being and the overall success of your business.

Incentive for Talent Retention

Some partnership business structures offer a clear pathway for employees to become partners. This can be a big reason for top talent to remain in the company.

This incentive drives them to contribute their best work, aligning their personal success with the company’s growth. When employees feel motivated, they’re more productive, which is critical for thriving in competitive markets.

Also Read:

• How to Start a Retail Business: Everything You Need to Know
• Important Legal Requirements for Starting a Small Business

Disadvantages of a Partnership

While partnerships offer flexibility and shared responsibilities, they also come with some risks. Before starting one, it’s important to understand the potential downsides to avoid costly mistakes. Below are some disadvantages of forming a partnership.

• Unlimited Personal Liability: In most partnerships, each partner has a personal liability. This means creditors can pursue your personal assets, such as your home or savings account, to satisfy business debts. You’re also liable for your partner’s mistakes.

• Potential for Disagreements and Disputes: If you and your partner disagree on something, these disputes can escalate, leading to costly legal battles or even the dissolution of the business. With the help of a legal advisor, a well-written partnership agreement can help to mitigate potential disputes.

• Complicated Exit Strategy: You or your partner may plan to sell or exit the company due to relocation, lack of interest, or financial difficulties. This can be challenging if one party isn’t willing to sell.

Also, it can be very difficult to continue the business when a partner leaves, especially if their skills or investments were crucial to operations.

Image via Insight Law Firm

LLC vs. Partnership: Key Differences

We’ve explained how LLC vs. partnership works. Each business structure can determine how you’ll run the business and the challenges you’ll likely face. If you’re not sure about which one to choose, here’s a detailed LLC vs. partnership comparison:

LLC vs. Partnership: Formation and Legal Requirements

The process of forming an LLC vs. a partnership differs in terms of the level of difficulty and legal requirements. You must file formal paperwork with your state when forming an LLC.

This involves preparing Articles of Organization and an operating agreement. You also need to maintain a registered agent, pay annual state fees, and comply with the state’s record-keeping and reporting requirements.

On the other hand, you can easily form a partnership after a friendly discussion and seal it with a handshake. The state doesn’t strictly require a written partnership agreement, but having one can help clarify roles and responsibilities.

Also, there are usually no state filings, annual fees, and strict record-keeping rules. However, a limited partnership and limited liability partnership may have some state regulations regarding business formation and tax filing.

In this section of the LLC vs. partnership comparison, we’d lean toward the LLC for a more structured approach. However, a partnership might be your best choice if you prioritize simplicity and fast business formation.

LLC vs. Partnership: Management Structure and Decision-Making

Another key difference between an LLC vs. partnership lies in how you want to manage the business and who can make decisions.

Limited liability companies have a flexible management structure that allows members to choose between an LLC member or a manager to handle daily operations.

In a partnership, you share equal decision-making authority with your partners unless the partnership agreement states otherwise. Also, the type of partnership you choose will determine who will manage the business.

For instance, you can have silent partners in a limited partnership. They provide the capital while you manage the business alone or alongside other skilled professionals.

If your business has multiple owners, the LLC vs. partnership decision may hinge on how much control each owner wants to retain.

Also Read:

• Sole Proprietorship vs. LLC: Everything You Need to Know
• Guide to Starting a Real Estate LLC: How To Do It

LLC vs. Partnership: Profit Distribution and Ownership

Managing business finances is another critical factor when comparing LLC vs. partnership. An LLC allows you to decide how you want to share profits or losses among members.

This sharing formula isn’t tied to the amount you invested in the business. For instance, in an LLC, you can distribute more profits to a member who contributed more in terms of skills and experience.

In a partnership, the state laws expect you to divide everything equally among partners. This simplicity may appeal to some partners, but those who invest more time or resources into the business may feel short-changed.

In this LLC vs. partnership contrast, think about how you want to reward the contributions of your co-owners.

LLC vs. Partnership: Transfer of Ownership

In an LLC, you can transfer ownership based on the terms stipulated in the operating agreement. Typically, LLC members have a “right of refusal,” which allows them to become the first buyers if they don’t want you to sell to an outsider.

However, if they allow you to sell your ownership interests, you refer to the “buy-sell agreement” clause in the operating agreement. This will value your share of the company and determine the selling price.

If the operating agreement doesn’t cover transfers, you can verify the default rules with your state. Transferring ownership in an LLC may have tax implications; it’s advisable to involve a tax professional for proper guidance.

In a partnership, it can be more complicated to transfer ownership. Unless the partnership agreement specifies otherwise, adding or removing partners typically requires the consent of all existing partners.

Due to the personal nature of partnerships, existing partners may be reluctant to accept someone they don’t know. You’ll need to find a new member that all partners are familiar with.

So, if you plan to transition ownership over time, the LLC vs. partnership decision may favor the LLC due to its more structured approach to changes.

Also Read:

• What Happens if One Partner Wants to Leave the Partnership?
• What Do I Do If My Business Changes Location?

LLC vs. Partnership: Credibility and Professional Image

In the LLC vs. partnership debacle, consider how your business structure affects the credibility of your business. When dealing with vendors, investors, and customers, an LLC is usually perceived to be more professional.

This is particularly important if you’re pursuing contracts with larger organizations or looking to secure credit to expand your business.

Partnerships, on the other hand, can sometimes be viewed as not as professional as an LLC. For example, a general partnership is usually associated with smaller, informal businesses.

However, a limited partnership or limited liability partnership can be more professional due to the formal registration requirements and the added layer of liability protection.

If you plan to pursue contracts with larger organizations or attract investors, your LLC vs. partnership decision may lean toward LLCs due to their enhanced credibility.

LLC vs. Partnership: Fundraising and Investment Opportunities

There are key differences in the LLC vs. partnership comparison when it comes to raising capital and attracting investors. This distinction is crucial for entrepreneurs in industries where scaling quickly often requires external funding.

While an LLC can’t issue traditional stock like corporations, it can create membership units that represent ownership interests. You can sell these units to investors in exchange for capital, allowing the LLC to raise funds without taking on debt.

This structure may attract investors because it provides them with a stake in the business and a share of its profits. But remember that the benefits of an LLC ownership are subject to the provisions of the operating agreement and state laws.

Additionally, an LLC is better suited for scaling businesses because you can easily add new members without disrupting the existing ownership structure. This makes it easier to bring in additional funding as the company grows.

Partnerships, on the other hand, may face more challenges when it comes to fundraising and attracting investors. Partners typically rely on each other’s contributions or loans to raise capital.

Bringing outside investors in a general partnership is more complicated because it requires adding new partners. Also, investors may be hesitant to invest due to the lack of limited liability protection in a general partnership. However, forming a limited partnership or limited liability partnership can resolve this issue.

Looking at the LLC vs. partnership comparison for fundraising and investment, an LLC may be able to attract investors and raise capital quickly. Partnerships, while simpler to establish, are better suited for small, self-funded businesses that may not require significant external investment.

Also Read:

• Business Startup Checklist: What New Businesses Need
• Starting a Consulting Business Checklist: Everything You Need to Know

Factors to Consider When Choosing Between an LLC vs. a Partnership

Deciding between an LLC vs. a partnership is a critical step in setting up your business. While both structures have their merits, the right choice depends on your circumstances, business goals, and preferences.

Here are several key factors to consider when considering an LLC vs. a partnership:

Cost and Your Availability

When choosing between LLC vs. partnership, the financial and time commitments required to set up and maintain the business structure are important factors, especially since there are legal requirements to comply with.

An LLC can have higher upfront costs that include state filing fees, annual reporting fees, and franchise taxes.

If you’re starting a business with a few people who have a limited budget, a general partnership might be cheaper to establish and maintain. However, the potential for disputes and the lack of liability protection could lead to higher costs in the long run if issues arise.

Additionally, if you have the time and skills to run the business, you may prefer a general partnership. Otherwise, an LLC might be more suitable as it allows you to hire a manager and other employees, and you’ll only need to supervise.

However, you can still be a silent partner if you choose a limited partnership or limited liability partnership, but you won’t have a say in the business.

Relationship with Co-Owners

The relationship between you and your potential business partners is another critical factor to consider in your LLC vs. partnership decision.

If you’re partnering with people you don’t know too well, an LLC can help you set clear boundaries and expectations.

Also, the limited personal liability of an LLC acts as a safety net, so you don’t lose your personal assets overnight because of a co-owner’s debts or mistakes.

On the other hand, if you’re starting a business with people you know well, such as close friends, family members, or long-time colleagues, a partnership can work well. That said, you must make sure everyone is on the same page about responsibilities, decision-making, and profit sharing to avoid any disputes in the future.

Business Goals and Growth Plans

Another factor to consider in the LLC vs. partnership decision is your long-term vision for the business. Where do you want the business to be?

If you have plans to expand into multiple product lines or markets, an LLC business structure can support that growth more effectively. Its formal structure and flexibility make it easier to access business credit, add new members, and adapt to changing business needs.

However, if you don’t have plans for significant growth or external investment, a partnership might be sufficient. Partnerships are often ideal for businesses that rely on the combined skills and resources of a small group of individuals.

Also Read:

• 13 Best Online Incorporation Services for Small Businesses
• How to Start an Entertainment Company: A Beginner’s Guide

Research the Industry and Potential Risks

The nature of your industry and the level of risk involved in your business can also influence your LLC vs. partnership choice. If your business operates in a high-risk industry, such as construction, manufacturing, or retail, an LLC’s limited liability protection can be invaluable.

For low-risk businesses with minimal exposure to legal or financial liabilities, a partnership may be sufficient. For example, a small floral business with few physical assets and low overhead costs might not need the added protection that an LLC provides.

FAQ

1. Which is better, LLC vs. partnership?

The choice between LLC vs. partnership depends on your business needs. A limited liability company offers liability protection and a flexible ownership structure, making it ideal for growth and external investment. A partnership is simpler and cost-effective, making it better for collaborative businesses.

2. What is the downside of a limited liability company?

A limited liability company involves a higher setup cost and ongoing compliance requirements compared to partnerships. Also, you’ll have to pay federal and state taxes, which can be expensive for small businesses or those with limited resources.

3. Is a limited liability company with two owners the same as a partnership?

No, a limited liability company with two owners is not the same as a partnership. However, the Internal Revenue Code allows it to pay federal income tax like a partnership. A striking difference in the LLC vs. partnership comparison lies in limited liability, where a general partnership lacks personal liability protection and a formal structure.

4. Which one is better for taxes, LLC vs. partnership?

Whether you choose LLC vs. partnership, both business structures offer pass-through taxation. However, a limited liability company allows you to choose whether you want to pay taxes like a C-Corporation or an S-Corporation.

5. What is the difference between LLC vs. partnership in Texas?

The differences between LLC vs. partnership in Texas are:

• An LLC offers limited liability, while a general partnership exposes partners to unlimited personal liability.
• An LLC requires state filing, while a general partnership can be informal but must file a DBA.

Overall, the key difference between an LLC vs. partnership in Texas is the level of liability protection and state requirements. If you plan to form a partnership or an LLC in Texas, ensure you consider these factors carefully before proceeding.

Also Read:

• Low-Risk Business Ideas to Start Your Own Venture
• How to Start a Floral Business in 13 Simple Steps

Conclusion

Deciding between LLC vs. partnership depends on your business goals, personal situation, and how much risk you’re willing to take. Whichever option you choose, LLC vs. partnership, setting up your business the right way is essential.

GovDocFiling simplifies this process, ensuring you can form your business quickly and correctly without missing any step. You can contact us today to take your next step in building your business with confidence.