Whether you notice them or not, limited liability partnerships are quite common. Often your lawyer or your accountant will have the acronym LLP after a list of names as in “Howser, Hunter & Smith, LLP.” In this article, we’ll look at what an LLP is, what it does for its members and the reasons for forming one.

Everything is Better with Friends

To understand a limited liability partnership, it is best to start with the general partnership. A general partnership is a for-profit entity that is created by a mutual understanding between two or more parties. This is a very technical way of saying two or more people working together to make money. A general partnership can be quite informal. All it takes is a shared interest, perhaps a written contract (though not necessarily), and a handshake.

Of course, with the informal nature of a general partnership, there is a downside. The most obvious risk is that of legal liability. In a general partnership, all partners share liability for any issue that may arise. For example, if Joan and Ted are partners in a cupcake venture and a bad batch results in people getting sick, they can both be personally sued for damages. For this reason, many people quickly turn general partnerships into formal legal entities like a limited liability company (LLC). An LLC, like JT’s Cupcake Factory, can stand in for Joan and Ted as a legal entity and protect their personal assets from being part of any lawsuit.

A More Formal Partnership

In some professions, however, you need something a little more customized than a limited liability company with a set structure. Enter the limited liability partnership. 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 partners in an LLP can participate in the management of the partnership. This is an important point because there is another type of partnership - a limited partnership - in which one partner has all the power and most of the liability and the other partners are silent but have a financial stake. With the shared management of an LLP, the liability is also shared - although, as the name suggests, it is greatly 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 between them. By pooling resources, the partners lower the costs of doing business while increasing the LLP’s capacity for growth. They can share office space, employees and so on. Most important, reducing costs allows the partners to realize more profits from their activities than they could individually.

The partners in an LLP may also have a number of junior partners in the firm who work for them in the hopes of someday making full partner. These junior partners are paid a salary and often have no stake or liability in the partnership. The important point is that they are designated professionals qualified to do the work that the partners bring in. This is another way that LLPs help the partners scale their operations. Junior partners and employees take away the detail work and free up the partners to focus on bringing in new business.

Another advantage of an LLP is the ability to bring partners in and let partners out. Because a partnership agreement exists for an LLP, partners can be added or retired as outlined by the agreement. This comes in handy as the LLP can always add partners who bring existing business with them. Usually the decision to add requires approval from all the existing partners.

Overall, it is the flexibility of an LLP for a certain type of professional that makes it a superior option to an LLC or other corporate entity. Like an LLC, the LLP itself is a flow-through entity for tax purposes. This means that the partners receive untaxed profits and must pay the taxes themselves. Both an LLC and LLP are preferable to a corporation, which is taxed as an entity and then its shareholders are taxed again on distributions.

How Limited is Limited Liability?

The actual details of a limited liability partnership depend on where you create it. In general, however, your personal assets as a partner will be protected from legal action. Basically, the liability is limited in the sense that you will lose assets in the partnership, but not those outside of it (your personal assets). The partnership is the first target for any suit, although a specific partner could be liable if he or she personally did something wrong.

LLPs Around the World

Limited liability partnerships exist in many countries with varying degrees of divergence from the U.S. model. In most countries, an LLP is a tax flow-through entity intended for professionals who will all have an active role in managing the partnership. There is often a list of approved professions for LLPs, such as lawyers, accountants, consultants and architects. The liability protection also varies, but most countries’ LLPs protect the partner from the negligence of any other partner.

Bottom Line

LLPs are a flexible legal and tax entity that allows partners to benefit from economies of scale by working together while also reducing their liability for the actions of other partners. As with any legal entity, it is important that you check the laws in your nation (and your state) before getting too excited. In short, check with your lawyer first. The chances are good that he or she has firsthand experience with an LLP.

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