Both LLPs and private limited companies are business structures that allow the owners to protect themselves from debts incurred by the business. However, the extent of the limitation on liability varies between the two vehicles, as do the management and ownership structures.
The ownership interests in most companies are called shares, although in a few specific scenarios, companies are limited by guarantee. More shares mean more votes on the company’s decisions. Owning more shares therefore means having greater control over a company unless voting power is altered by share classes or a shareholder agreement. Typically, one share grants one vote.
By contrast, ownership of partnerships is nominally equal, giving each partner an equal say in the standard model. As partnership numbers swell as the business grows, however, such a model may become difficult to manage. To counter this, law firms, accounting firms and consultancies, who together are the most common users of LLPs, establish management committees through their partnership agreements. These management committees handle the partnership’s day-to-day decisions and strategic direction, leaving the rest of the partners to focus on the core business. All of the partners still need to vote on certain issues like adding partners or approving a merger or acquisition.
The profits of the business are usually distributed along the lines of the voting and ownership interests. The same caveats therefore apply for rights to profit distributions as to voting. In the case of LLPs, partnership agreements are often used to better suit the needs of a business. Typical models for weighting the share of profits to which a partner is entitled include:
- “Lockstep”, with profit shares determined by tenure;
- “Eat-what-you-kill”, with profit shares determined by a partner’s financial contribution to the firm; and
- “Modified lockstep”, which combines the two models above.
Company shares are transferable by sale, inheritance or otherwise, but the same cannot be said for partnership interests. Consequently, businesses whose success depends on the partners’ knowledge and expertise are the most common use for partnerships and LLPs. Companies, on the other hand, are more useful when the business accrues assets and has a significant “book value”. This means that one’s status as a partner is usually tied to a job, so death, retirement or movement between firms will trigger an exit from the partnership.
A departing partner will receive his or her initial equity contribution from the firm, possibly with some interest (contingent on the partnership agreement and the terms of the partner’s exit). Since the partnership interest is not sold, there is no windfall for a departing partner; the benefits of ownership accrue during membership of the firm in the form of profit draws.
Limitations on liability
The owners of a company limited by shares are only liable for the company’s debts to the extent that they continue to owe any money for their shares. If the shareholders have paid for their ownership interest in full, then the only loss they will make is what they have already paid for the shares; the company’s creditors will have no further recourse to the shareholders’ personal assets.
This is broadly the situation for limited liability partnerships as well. However, LLP status differs in that the limitation applies only to liabilities incurred by the partnership as a whole; individual partners of an LLP can still be liable if their own acts and omissions caused the loss in question.