When an individual does business, the law considers he or she a “sole proprietor.” Sometimes a business or organization grows beyond one individual, and there might be cause to consider forming an entity. Entities can provide for the division of ownership, division of profits, formalization of governance, insulation from liability, and some preparation for continuation of business, all depending on entity type and certain choices and conduct as an entity.
Common entity types include general partnership, limited partnership, limited liability partnership, limited liability limited partnership, corporation, and limited liability company. Each is briefly introduced below.
A general partnership (GP) is often referred to merely as a “partnership,” though it is helpful – and more precise – to call it a general partnership. General partnerships are the oldest form of business organizations. To form a general partnership, nothing more is required than that two or more persons agree to carry on business together; however, there are potential advantages to formalization of the partnership agreement and registration of the partnership. Typically, in a general partnership, management, profits, and rights to partnership assets are split equally among the partners, and there is no insulation of partners from the partnership’s liability. A limited partnership (LP) can involve partners that are “limited” as distinguished from “general,” though there must always be at least one of each, a general partner and a limited partner. Formal documentation and registration in the appropriate office are necessary to formalize the formation of a limited partnership. In a limited partnership, there can be distinctions between the management participation, division of profits, and rights in partnership assets as between general partners and limited partners. Typically, though general partners are exposed to liability for partnership obligations, limited partners are not.
A limited liability partnership (LLP) is a general partnership that has completed a formal election to insulate partners from liability for partnership obligations. Likewise, a limited liability limited partnership (LLLP) is a limited partnership that has completed a similar formal election. The formal election involves preparing, signing, and filing specific documents, and there can be consequences – including that the election is ineffective – even for relatively minor errors; consider consulting an attorney for more information on this point.
A corporation (Corp. or Inc.) is formed by the filing of articles of incorporation. A corporation is significantly different than a partnership insofar as its existence is entirely separate from anyone else; a partnership requires partners, but not so for a corporation. For a corporation, the division of ownership, division of profits, and formalization of governance all depend on the formative document (usually articles of incorporation) and other governing documents (usually including bylaws). There are standard rules provided in state statutes, but there are myriad combinations and permutations possible by agreement. Typically, shareholders are insulated from liability – beyond risking whatever amount they invested to purchase shares.
A limited liability company (LLC) is a formed by the filing of articles of organization. A limited liability company is somewhat like a hybrid, having some similarities to a corporation and some similarities to a partnership. For a limited liability, the division of ownership, division of profits, and formalization of governance all depend on the formative document (usually articles of organization) and other governing documents (usually including a member control agreement and an operating agreement). As with corporations, there are standard rules provided in state statutes, but there are myriad combinations and permutations possible by agreement. Typically, members are insulated from liability – beyond risking whatever amount they invested to purchase membership interests.
Note that, while the formation and structure of an entity has some effect on issues like insulation from liability, conduct also has some effect. The behavior of owners and management can affect whether the structure has a “typical” effect; forming an entity is an event, but behaving as an entity is a process.
Also note that there are important considerations and requirements regarding taxation of entities and the tax consequences of particular structures, choices, and conduct that are beyond the scope of this article. Consider seeking advice from a qualified professional regarding the tax-related aspects of entities.
NOT INTENDED TO PROVIDE LEGAL, ACCOUNTING OR OTHER PROFESSIONAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH.