Two of the most popular business structures are general partnerships and limited liability companies. When it comes to protecting your business interests, creating a limited liability company will have significant advantages over a general partnership.
Protection of your business interests should be part of your estate planning considerations. Perhaps you established a business from the ground up or are continuing a family business that has gone on for generations. Either way, an important part of creating an estate plan involves finding the best business structure.
There are numerous different forms a business can take, and for good reason. They all have their unique characteristics that make them advantageous in some situations, but not others. Some of the most common business forms include:
- Sole proprietorship
- General partnership
- Limited liability company
- Limited liability partnership
- Limited partnership
- Limited liability limited partnership
- Professional corporation
- Professional limited liability corporation
Keep in mind that not all of these business structures will be available in all states. Most states have their own unique set of corporate and business laws. However, the majority of states will have most of the above-listed types of business entities, or a very close variation. Two of the most common business entity types are general partnerships and limited liability companies and we'll discuss these two types.
A general partnership is a business with two or more people who own a business together and have equal rights to the management, liabilities and profits (or losses) of the for-profit entity. For the most part, creating a general partnership is extremely easy and can be done very informally. Registration or other formal procedures are not usually required. Simply orally agreeing to start a business with a friend or family member can create a general partnership. But it's usually best to have a formal partnership agreement that sets out everyone's responsibilities and rights.
A limited liability company, or LLC, is a type of company that allows its members to limit their potential liability, yet retain many of the features of a general partnership. Creating an LLC is a bit more complicated than creating a general partnership and will typically involve registering with a state's business registration entity, such as the secretary of state.
The exact answer will depend on your specific business objectives and personal needs. However, when it comes to protecting your business and personal interests, an LLC will be a better business form to take the vast majority of the time. This is for several reasons.
First, there is the limited liability of the LLC. In a general partnership, the partners have unlimited liability. If the business fails and has debts that the business assets cannot pay for, the partners are personally liable. If the business gets sued and is found liable, the partners will be personally liable as well.
All of this means that the partners may not only lose their business, but could lose their car, family heirlooms, house and anything else they own. In an LLC, this will not happen, unless special circumstances arise. This limitation of liability is usually the single most important reason for creating an LLC.
|Major Characteristics of Common Business Forms|
|Business Structure Type||Liability||Ownership Requirements|
|Sole proprietorship||Personal liability||Only one owner|
|General partnership||Personal liability||Two or more owners|
|Limited liability company||No personal liability||One or more owners|
Source: U.S. Small Business Administration
Second, LLCs make it easier to ensure continuing operations in the event of the death or incapacitation of an owner or member. Third, the LLC is more likely to have a special resolution procedure in place to resolve certain situations. Both these advantages will be provided by the LLC's operating agreement.
Most LLCs will be created with the help of an operating agreement. The operating agreement allows for the flexibility of a partnership, without the formal structures of a corporation (like having a board of directors).
Specifically, an operating agreement is a special document that outlines how the company will operate. This can include who does what in the company, as well as provide for contingency plans for situations when someone leaves, dies or becoming incapacitated. The operation may agreement may also dictate things such as how profits will be shared, how debts will be allocated, how to add new members and tax issues.
Every state will have its own set of rules and requirements. For instance, in some states, the operating agreement is required to create an LLC. But most states do not require an operating agreement. Even in states where they are required, they don't usually need to be filed with the secretary of state.
Regardless of your state's requirements, not having an operating agreement will negate some of the advantages of having an LLC. Remember, the operating agreement allows you to decide how your business will be run and managed. Imagine what happens where there is a disagreement on how to handle a certain situation.
In the best-case scenario, failing to have an operating agreement will result in looking at state laws to decide how the business will be run. In the worst-case scenario, it could lead to lengthy and bitter litigation among members of the LLC.