Key Takeaways

  • LLPs offer liability protection but come with significant drawbacks depending on jurisdiction and industry.
  • Tax complexity and compliance costs are major LLP disadvantages compared to other structures.
  • Some states restrict which professionals can form LLPs, limiting accessibility.
  • LLPs may be perceived as less credible than corporations or LLCs, impacting funding and contracts.
  • Disclosure rules often require LLPs to publish financial records, reducing privacy.
  • Partners in LLPs still face risks like disputes, unequal workloads, and difficulty attracting investors.

There are several disadvantages of limited liability partnership. According to the U.S. Small Business Administration, when two or more people agree to operate the same business, this is known as a partnership. The managerial responsibilities are shared among partners along with the profits and losses.

When partners want to protect themselves from the negligence of the other partners, they must form a limited liability partnership, also commonly referred to as an LLP. An LLP is often confused with a private limited company because it is very similar — both have a separate legal identity that is kept separate from the legal identities of the partners.

How to Form an LLP?

If you are wanting to start a business, there are many ways it can be formed. One of the more popular types is an LLP. In fact, LLPs have been extremely popular for more than 20 years, especially among licensed professionals.

When forming an LLP, there are several steps you will need to take. First, you will need to start by filing the proper paperwork. This typically involves completing an application to receive a certificate to be an LLP. You will also have to pay a filing fee.

What Types of Professionals Benefit from LLPs?

Common types of professionals that especially benefit from LLPs include:

  • Accountants
  • Solicitors
  • Architects
  • Consultants
  • Surveyors
  • Lawyers

LLPs also tend to be suitable when a business has individual earnings that are not added to a single account and then distributed according to dividends. When an LLP is formed, the earnings that are distributed to the members are deemed as personal income.

How Do LLPs Differ From Traditional Partnerships?

In most ways, an LLP will operate almost identically to a traditional partnership. However, one of the key differences lies in the fact that LLPs have to register with the Companies House. Traditional partnerships do not.

How Many Designated Members Does an LLP Have to Have?

To create an LLP, there must be at least two individuals who are assigned as designated members. The designated members will be responsible for carrying out a variety of administrative tasks, like handling payroll information and tending to tax matters. Although an LLP must have at least two designated members, there is no maximum number it can have in ordinary members.

Since the legal identity of an LLP is not directly tied to the legal identity of its members, legal claims cannot be made against the members. If a person wants to make a legal claim against a member, it has to be made directly toward the company.

Any liability that falls back onto the members is limited to the capital investment that they make into the LLP. This means their personal assets are not at risk of being seized if any of the partnership's debt has to be settled.

What Is an LLP Agreement?

The management of a partnership is outlined in an LLP agreement. It states which duties are to be managed by which specific partners. This agreement will also outline the rights of the members. More so, it gives an extensively detailed description as to how the partnership is to be run. The LLP agreement should be constructed before any of the company's stocks or shares are traded.

Restrictions on Forming an LLP

One significant limitation of LLPs is that not all businesses or professionals are permitted to form one. While LLPs are widely used by accountants, lawyers, and consultants, some states prohibit certain professions, such as doctors, from operating as an LLP. In addition, several states do not recognize LLPs at all, or impose specific filing requirements and extra taxes, making them less flexible than corporations or LLCs.

Disadvantages of a Limited Liability Partnership

One of the main disadvantages of an LLP is that they aren't allowed everywhere. The tax filings of this type of entity are extremely complex, which is why some states don't allow them to be formed. There's also the issue that some states don't recognize them as a legal entity. In some states, LLPs can with the fact created but not by certain professionals, like doctors. Just like some states don't allow them, some states enforce heavy tax limits on them. These taxes are often endured both when creating the LLPs and throughout their operations.

LLPs are often associated with having less credibility than other businesses. This is why many businesses choose to incorporate themselves as actual corporations rather than LLPs. Another major con of LLPs is that individual partners do not have to consult with one another when they are conducting certain activities. And lastly, as mentioned before, financial records must be submitted for public record.

Loss of Privacy and Credibility Concerns

LLPs must typically disclose their financial records to public registries. This lack of privacy may deter partners who prefer to keep earnings and business details confidential. Moreover, LLPs are sometimes perceived as less credible than incorporated businesses. Potential clients, lenders, or suppliers may prefer dealing with corporations, viewing them as more stable and professionally managed.

Partner Accountability Issues

Although LLPs shield individual partners from liabilities created by other partners, conflicts can still arise. Partners may contribute unevenly to the workload or decision-making, which creates tension within the firm. Additionally, while one partner’s personal assets are generally protected, each partner remains fully liable for their own negligence or malpractice. This means professional risk is not eliminated but merely limited.

Limited Access to Capital and Credit

Another drawback is that LLPs may struggle to raise funds compared to corporations. Banks and investors often prefer dealing with corporations or LLCs because these entities provide clearer structures for issuing shares or ownership interests. As a result, LLPs can appear less attractive when seeking venture capital or large loans, which can restrict growth opportunities.

Tax Complexity and Compliance Burden

LLPs are often criticized for their complex tax structures. Depending on the state, LLPs may face franchise taxes, annual filing fees, or restrictions on pass-through taxation. Unlike an LLC, which typically has more predictable tax treatment, LLPs can encounter additional administrative filings. This increases compliance costs, especially for small partnerships that lack robust accounting support.

Frequently Asked Questions

  1. What is the biggest disadvantage of an LLP?
    The biggest disadvantage is the complexity of tax rules and compliance costs, which vary by state and can be burdensome for small businesses.
  2. Can all professionals form an LLP?
    No. Some states limit LLP formation to specific professions like lawyers or accountants, and others do not permit LLPs at all.
  3. Do LLPs pay more taxes than LLCs?
    Often yes. LLPs may face additional franchise taxes and fees that LLCs avoid, depending on state law.
  4. Why are LLPs considered less credible than corporations?
    Because corporations have established governance structures and clearer investor protections, they are often seen as more reliable for financing and contracts.
  5. Do partners in an LLP have complete liability protection?
    No. Partners are protected from liabilities caused by other partners but remain personally liable for their own negligence or malpractice.

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