This section will explain various types of business organizations and help you decide if a partnership is the right form for your business.
Types of Business Organizations
A partnership is only one type of business organization. There are basically five types of business organizations:
- sole proprietorship
- general partnership
- limited partnership
- limited liability partnership
- limited liability company
Each of these has advantages and disadvantages and are discussed in the following pages.
A sole proprietorship is simply a business owned by one person, as an individual. The main advantages to a sole proprietorship are that you are your own boss with no one to account to and it is the most simple form of business with respect to taxes and other government intervention. You pay taxes on your profit and file a Schedule C form with your regular personal income tax return.
A general partnership is a business owned by two or more people, who share in the profits or losses. A legal definition of a partnership is: a voluntary association of two or more persons to carry on, as co-owners, a business for profit.
A limited partnership is a special kind of partnership, in which there are two classes of partners. One class is that of general partners. The general partners run the business and share in any profits or losses the same as in a regular partnership. The other class is that of limited partners. Limited partners contribute money, but are not allowed a say in how the business is operated. They might also be called silent partners. Usually, limited partners are only liable for losses up to the amount of money they contributed to the partnership.
Example: Suppose there are two general partners and three limited partners. Each of the five people put in $2,000, for a total of $10,000. If the partnership loses $20,000, only the two general partners are responsible to pay that loss over the amount of the contributions from the limited partners.
However, some limited partnership agreements also require limited partners to contribute additional money under certain circumstances.
Limited Liability Partnership
A limited liability partnership, or LLP, is a relatively new creation. It operates much like a limited partnership, but gives each member of the LLP protection from personal liability, except to the extent of their investment in the LLP.
Generally, partners in a limited liability partnership aren't responsible for another partner's debts, obligations, or liabilities resulting from negligence, malpractice or misconduct.
Professional organizations (such as accounting and law firms) often form as limited liability partnerships because an LLP is specifically designed to limit malpractice claims against uninvolved partners. Each partner is liable for debts and obligations created as a result of his or her own negligence, malpractice or misconduct, as well as negligence, malpractice or misconduct by any person under that partner's direct supervision.
A corporation is a business entity where one or more persons are owners of the business, by being owners of stock in the corporation. Legally speaking, the corporation is an entity of its own and is considered as a separate person. The corporation is separate from its individual stockholders. If the corporation loses money, only the corporation is responsible for paying the losses. The stockholders are not liable for losses.
More differences between these types of business organizations are discussed in following sections.
Limited Liability Company
The limited liability company is designed to give the owners (called members) the limited liability of a corporation, while retaining at least some of the tax benefits of a partnership. None of the members have personal liability and all have some control of the business.