Finance glossary

What is an LLP?

Bristol James
5 Min

A limited liability partnership (LLP) is a type of business structure where some or all partners have limited personal liability for the financial obligations of the business.

In general, it is a structure that combines elements of general partnerships and corporations.

Understanding LLPs

To better understand LLPs, it may be helpful to first describe general partnerships.

General partnerships describe any entity established as the result of an agreement between two or more parties. The agreement may be formal or informal, but regardless, each partner in the business has unlimited liability for its financial obligations as well as the actions of other partners.

Liability in an LLP is “apportioned” differently, such that each partner can work on the business without fear of being liable for another partner’s actions.

Not all Australian states recognise LLPs under the relevant Acts, but NSW (which calls them limited partnerships) and QLD dictate that such structures must have:

  • At least one general partner with unlimited liability who manages the business, and
  • At least one limited partner with limited liability who cannot manage the business (or enter into contracts on its behalf) and is only liable for the amount of money they contribute to the partnership, and
  • A registered office address in the state where the LLP intends to do business.

It should also be noted that a partner can be an individual or a legal entity such as a company.

How are LLPs administered?

LLPs are administered based on a partnership agreement which, ideally, should be created before the business is registered.

These agreements serve as a contract between each partner that clarifies the purpose and scope of their working arrangement. In some cases, it may be wise to seek legal advice when drafting the agreement.

In any case, partners will need to discuss and incorporate:

  • The rights and responsibilities of each partner.
  • How decisions are made.
  • How conflict is resolved.
  • Exit clauses.
  • Financial responsibilities.
  • What management of the business will look like, and
  • Details of each partner as well as certain details about the business.

Advantages and disadvantages of an LLP

Advantages

LLPs come with many advantages, such as:

  • Lower risk – when liability can be spread across multiple business partners, the risk is lowered for each.
  • Limited liability – if the partnership fails, the limited liability aspect of an LLP ensures creditors cannot chase after the personal assets or income of the partners.
  • Flexibility – with no official structure or framework to follow, partners in an LLP have the flexibility to dictate how the business is run. Partners can choose which aspects of the business they want to be involved in and also the extent of their involvement.
  • Increased economies of scale – LLPs enable partners to pool their assets, knowledge and connections to lower the cost of doing business and increase company revenue.
  • Raising funds – while LLPs do not have the same capacity as publicly listed companies to raise funds, they can be attractive to investors who want to share in the company’s profits.

Disadvantages

There are also some disadvantages to establishing a limited liability partnership:

  • Potential instability – if one partner in a two-partner company passes away or decides to leave the company, the company must necessarily be dissolved.
  • Public disclosure – in NSW, for example, LLPs must declare the income of each partner for the public record. Some may be uncomfortable with such details being made freely available.
  • Decreased performance – since each partner in an LLP is not liable for the actions of others, individuals may act in their own best interests or without proper communication of their intentions. This can create instability in management and potentially detract from business performance.

LLPs in the United States

LLPs in the United States emerged in response to a crash in energy and real estate prices in the 1980s.

The collapse caused a wave of bank failures, but since the amounts recovered from the banks were minuscule, lawyers and accountants who advised the banks were targeted by debt collectors.

With the potential for such action to bankrupt these individuals, the first LLP-related laws were passed in Texas in 1991.

The laws were enacted to protect innocent partners in professional service firms from liability, but today, LLPs are also favoured by consulting firms, medical practices and finance businesses to name a few.

Similarities between the U.S. and Australian model

In many ways, limited liability partnerships serve much the same purpose as they do in Australia. They are formal structures that require a partnership agreement and, depending on the state, annual reporting.

LLPs also protect each partner from another partner’s misconduct, which can be beneficial in some professional services industries.

What’s more, LLP formation is dictated by state legislation. In many states, there is no law that dictates who can start an LLP. But in states like New York and California, for example, only professional services firms may do so.

However, there are two key differences to keep in mind.

How LLPs in Australia and the United States differ

The most obvious difference lies in the way the business is managed.

In Australian states where they are recognised, LLPs must have a general partner and a limited partner with duties and responsibilities distributed as each sees fit.

In the United States, management duties are equally divided between the partners by default. This means that LLPs more closely resemble general partnerships (but without the unlimited liability).

If partners in a U.S. LLP do not want to share equal management responsibility, their specific roles and duties can be delineated in a partnership agreement.

Taxation

Limited liability partnerships in the United States are also taxed by the IRS as pass-through entities. In other words, partners pay personal income tax on their share of the profits instead of the LLP itself paying tax.

This is similar to how tax is treated for limited liability companies (LLCs).

In Australia, taxation is similar but not the same. LLPs are not taxable entities, but in most cases, the partner with the most interest in a business has to submit a partnership tax return with the ATO at the end of the financial year.

Partners are taxed on their respective shares of the profits, and each is likewise entitled to claim deductions on their personal tax returns if the partnership makes a loss.

Summary:

  • In Australia, limited liability partnerships (LLPs) are a type of business structure that combines aspects of general partnerships and corporations.
  • LLPs are only recognised in Queensland and New South Wales (which calls them limited partnerships). In both states, LLPs must contain one general partner who assumes full liability and one limited partner with limited liability.
  • LLPs in the United States emerged after a crash in energy and real estate prices in the 1980s. The manner in which LLPs are administered and structured is similar to Australia, though slight differences exist in terms of division of management and taxation.
  • The limited liability of an LLP reduces risk and lowers it further by spreading it out amongst each partner. Partners also have the flexibility to determine how much of the business they want to be involved in
  • However, LLPs are inherently unstable if a partner passes away or wants to leave the company, and the limited liability aspect means some partners may act in their own best interests and not toward a common objective.

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