The short answer to the question in the title is, about 1,000 years of legal technology! We’ll get into the longer answer below.
The legal definition of a partnership is when two or more people enter into any commercial agreement (literally, anything where money exchanges hands). Partnership law goes back to the very beginning of the legal world, as far back as we have historical records. As you can imagine, there are a lot of outdated laws for “partnerships.” Here are some examples:
A multimember LLC is any LLC that has two or more owners. These are probably the most common type of new companies being formed. LLC stands for “Limited Liability Company.” We talked about limited liability above, and how partnerships do not have it. Thankfully, LLCs do have limited liability, hence the name.
These days, if a person refers to their business as a “partnership,” I think it’s just as likely to be an LLC with two business partners as the type of outdated partnership we listed, above.
With an LLC, you write a special partnership agreement, called the “Operating Agreement.” This is a more streamlined version of the old “Corporate Binder” that we had for corporations. It’s typically more of a “one-and-done” contract that specifies who gets to make managerial decisions for the LLC, what each member (partner) owns, and what happens to their ownership if/when they pass away (the buy/sell agreement).
We laid out some of the differences between these two entity types, but have a more thorough explanation for you, here:
For better or for worse, partnerships are created, from a legal standpoint, the second that two or more people decide to sell something. Given all the risk we laid out above, from the archaic general partnership laws left on the books, this “partnership creation by mistake” is a real risk for people starting businesses!
In contrast, the creation of an LLC is a highly formalized task that requires a great deal of intentionality and organization. We recommend hiring a professional (lawyer) to set it up for you, so that all of the documentation fits your unique business’s needs. The short list of things to do are:
Note that this list is not comprehensive, just something to get you started.
General Partnerships, the “oops, I made a company” entities, are very open-ended. The managerial structure and even who owns it is left vague and up in the air, unless a partnership contract is written and signed. Whether it’s a general partnership or an LLC, it’s always best to negotiate these terms before the company is set up.
For LLCs, you still want a professional’s help with the Corporate Governing Documents (your Operating Agreement). If you don’t have one professionally written, some states offer a sort of “de facto” partnership or operating agreement that would apply to your company, but that’s a feeble attempt at a “one-size-fits-all” agreement, and of course, most business partnerships have some nuance that require their own specialization.
We talked about “Limited Liability” above, but I think it’s important to list out. General Partnerships have no limited liability, meaning that anything that goes wrong with the partnership (a liability) allows the people bringing the lawsuit to dig into the partner’s personal assets and savings.
For an LLC, you do get Limited Liability, so that, even if the company gets sued and loses the lawsuit, the business owner’s personal accounts and savings/assets are not at risk (absent something criminal).
Limited Liability Companies have a great deal of formalities and need regular legal “maintenance” in order to comply with the regulatory laws out there (it’s common to hire a business lawyer to do this work). Given all of the formalities, most LLCs work in the way they were intended to, giving the owners limited liability and all of the other perks of owning a business.
In contrast, however, general partnerships can be “set up” accidentally, and don’t technically require much (if any) formality. This is more of a curse than a blessing. Most people that enter into partnerships have done so without a lawyer’s help (it’s probably malpractice for a lawyer to advise two people to enter into a partnership). That partnership comes with all of the risk that we outlined above. That all said, it’s tied to your social security number, and there’s not much you need to do to keep the partnership going.
By default, both LLCs and General Partnerships are taxed the same. However, LLCs give you a plethora of additional options for how you can be taxed. For example, many LLC owners choose to tax the LLC (and its owners) as if the LLC is an S Corp. This usually yields the owners a significant reduction in money they have to pay in taxes each year. With a partnership, however, you’re just taxed on the money the partnership receives. I believe that some states still hold that tax liability as “jointly and severally liable,” meaning that one partner may have to pay the other partner’s taxes. If that seems totally unfair to you, that’s because it is! Don’t set up a partnership!
At Sparks Law, we’ve worked with business owners for well over a decade. We love breaking down the pros and cons with their entrepreneurial decisions, and have good predictable flat rates for all of your legal needs. We’re easy to talk to, and easy to get ahold of. We don’t use AI or an answering service; when you call us during business hours, we have a real human being answering your call and are happy to schedule consults. Reach out to us today to learn more!
