When you are starting a business, if you have a business partner (or two or more), you can choose a partnership as your business entity. After reviewing the options, you have decided a limited partnership (LP) or limited liability partnership (LLP) is the best choice for you. Making the choice to create a partnership is a big decision, but there are still quite a few decisions to make. This article will discuss the various decisions you will have to make as you set up your partnership, either LP or LLP.
An LP is a business relationship whether there are general partners and limited partners. The general partner(s) bear unlimited liability for the partnership, and the limited partner(s)’ liability is limited to the total amount of their investment in the company. This is similar to a general partnership, but the liability is taken away from the limited partners.
An LLP is a business relationship in which one partner is not responsible for the negligent acts committed by another partner or by the employees not under that partner’s supervision. This is similar to a general partnership, except that the partners are not responsible for the actions of other partners.
There are also general partnerships and limited liability limited partnerships (LLLP). General partnerships are business arrangements where two or more individuals agree to share in all assets, profits, and financial and legal liabilities of a jointly owned business. There is unlimited liability for each individual partner. Limited liability limited partnerships are similar to limited partnerships, but the general partners have limited liability, and LLLPs are not recognized in all states. They are recognized in Utah, but may not be recognized in other states.
This article will discuss LPs and LLPs, but many of the same decisions will need to be made for each type of partnership. If you have questions regarding the different types of partnerships, I offer free consultations.
Decisions to Make When Filing with the State
The first thing you have to decide is the name for your partnership. There are certain rules for naming LPs and LLPs in Utah. The name of an LP must contain the following words: “Limited Partnership,” “Limited,” “Ltd.,” “L.P.,” or “LP”. The name of an LLP must contain the following words: “Limited Liability Partnership,” “L.L.P.,” or “LLP”. If you choose a limited liability partnership and want to name your LLP “New Business Idea,” then you have to put one of those partnership labels after the name. This could be “New Business Idea Limited Liability Partnership”, or more commonly, “New Business Idea, LLP”, but either of those will work.
The next thing you have to decide is where your partnership will be located with regards to the state filing. If you have an office space, great! If you do not, you can put your or your partner’s home mailing address. This is primarily so you will continue to get notice and mail concerning your partnership, but if you ever do get an office space or a physical address where your business will be located, you will have to amend that with the state.
To file with the state, you will need to have a registered agent. This is a business or individual that is designated to receive service of process when a business entity is a party in a legal action. The registered agent must have a Utah street address. You can be your own registered agent.
One of the biggest decisions you have to make is who is involved in the partnership. A partnership, by definition, must have at least two partners. In both LPs and LLPs there must be at least one general partner and at least one limited partner. Working with others can create many unknowns in a business venture, but a partnership agreement (discussed below) can lay out how partners interact with each other and their roles withing the partnership itself.
You then have to decide if the partnership will have a perpetual duration or have a date of expiration. Putting an end date on your partnership is completely optional. Typically, a partnership will have a perpetual duration unless the partnership is only set up for a specific purpose, like the purchase and sale of a property.
You also have the option to state the purpose of your partnership. This is not necessary but can be useful for future situations. Most entities state that their purpose as “any lawful purpose for which a limited liability partnership may be organized.” This covers a partnership if it decides to pivot and do something other than continue in its original purpose.
Decisions to Make When Drafting Your Partnership Agreement
LPs and LLPs inherently will have a general partner (or more) that will manage the partnership, and a limited partner (or more) that will participate in the partnership. The general partner will make most of the business decisions, while the limited partners will only participate to help the partnership make major decisions.
Distributions and Profit Sharing
Distributions in a partnership are a transfer of cash from a partnership to a partner. The distributions are made in proportion to the partner’s interest in partnership capital. A partnership’s distributions can get complicated. It is best to have an accountant and a tax attorney help you navigate your income, basis, and distributions to ensure that you are doing it correctly. Put simply, when income is paid out to partners in cash, they are not taxed on the cash if they have sufficient basis. Instead, partners will reduce their basis by the amount of the distribution. If the cash distribution exceeds a partner’s basis, then the excess is taxed to the partner as a gain, which often is considered a capital gain.
What Happens if a Partner Leaves the Partnership?
The terms for a partnership exit agreement can be written into a partnership agreement for the possibility that a member wants to sell their partnership interest, dies, or becomes disabled. There can be other events that can trigger an exit as well. You will have to decide when a partnership exit agreement is necessary and what terms you want in place when the exit occurs.
A partnership exit agreement will handle the situations listed in the partnership agreement. Because partners often work together in close proximity, it is important to ensure that there are standards for how a partner can sell or pass on their interest. A well-written agreement can include rules to prevent a partner from selling or passing on their interest to someone you do not want or is incompatible with the goals of the business.
There are many decisions that need to be made about how a partnership will dissolve and finish business. The partnership agreement will layout the process for the partnership dissolution. Typically, when a partnership decides to cease business, moving forward, the individuals are no longer partners, but the partnership is still an entity. In Utah, the partnership will have to file a Letter of Cancellation to cancel the partnership officially with the state.
Decisions will have to be made as to how the partnership will notify employees, customers, and other entities about the cancellation of the partnership. The partnership will also have to notify creditors of the dissolution and pay all debts. After the debts are paid, the partnership should close their bank accounts and distribute the assets of the partnership to the partners.
Both general and limited partners in LPs and LLPs have voting rights. The partners in LPs and LLPs get to determine in their partnership agreement how each class of partner will vote. General partners take the management role in LPs and LLPs. The general partner, or general partners, will also take on the liability of the partnership’s business.
Limited partners usually take a passive role in LPs and LLPs. Usually, in LLPs specifically, if a limited partner acts, they could be considered a general partner for liability purposes under the law. In an LP, occasionally, the partners can determine that the limited partners can take a more active role, since they already have liability in the partnership. The partners can restrict limited partners’ voting to certain issues, or they could allow the limited partners to vote on all business matters.
There are many important decisions throughout the life of the partnership that will need to be made. This is related to the previous section regarding voting. If the partnership is a limited partnership, the decisions will most likely be made by general partners, and occasionally limited partners may participate. If the partnership is a limited liability partnership, the limited partners are not involved in management and it is likely they will not make many operational decisions for the partnership. Limited partners in both LPs and LLPs will often only vote on big picture issues such as changing the partnership agreement or dissolving the partnership.
The partnership’s fiscal year will usually be the same as the majority of the partners. Each person or entity in the partnership will have their own fiscal year, usually the calendar year. If there are multiple entities that have an alternate fiscal year, such as the end of October, and these entities make up the majority of the partners then the fiscal year of the partnership will end in October. To determine what your fiscal year will look like and how your partnership will disburse its profits. It is best to talk with an attorney and an accountant to determine what your situation needs.
Setting Up Your Partnership
If you need help with the state filings or with making the various decisions required as you draft your partnership agreement, an attorney can help. If you have any questions about setting up a business entity, drafting a partnership agreement, or navigating the decisions necessary for running your partnership legally, we can help. I offer a free consultation. My direct dial is 801-365-1020, and you can email me at [email protected].