Limited company vs partnership: the four key differences and the problem that affects both

The business structure you choose affects your personal risk, your income and even your relationship with your business partners. The two structures most people weigh up are the limited company and the partnership, and the differences between them come down to four things: whether the business is a separate legal person, whether your liability is limited, how the business is created and how the profits are shared. There is also one problem that affects both structures equally, and it is the one I see cause the most damage.

Types of partnership in the UK

One caveat before we start. This article focuses on general partnerships. There are three main kinds of partnership in the UK, the general partnership, the limited partnership and the limited liability partnership, and they differ mainly in how much liability the partners carry. If you want to understand the other two, see what is a partnership. Everything below compares the general partnership with the private limited company.

Separate legal person vs partners

The first difference is what each structure actually is.

A general partnership is where two or more people come together with a view to making a profit. It is a relationship between people. The partnership is not something separate from the partners.

A limited company, instead, is recognised as a separate legal person. You and I are human beings and, under the law, are recognised as natural persons. A limited company is recognised as a legal person. It is not a human being, but it is a person nonetheless, and as a person it can enter into contracts, take out loans and so on, in its own name rather than in the name of its owners. When a customer signs a contract with your company, they are contracting with the company, not with you personally. In a general partnership, there is no such separate person to contract with, so the partners themselves are the other side of every deal.

Limited vs unlimited liability

The second main difference is whether or not your liability is limited.

A limited company has limited liability for its members. If you are a shareholder of a limited company and the company runs into trouble, you should not be forced to sell your home to cover its debts. The company's liabilities belong to the company.

In a general partnership you have unlimited liability. If, for example, a customer sues the general partnership, then your home is at risk, because there is no separate person standing between the business and you. For many people this single point is what decides the question, and it is the main reason owners who start out as partners later move the business into a limited company.

How is a company or partnership created?

The third difference is when each structure comes into existence.

A limited company is created when a certificate of incorporation is issued by Companies House. To get that certificate you go on the Companies House website, complete a questionnaire and, within 24 to 48 hours, you receive the certificate. Until that happens, there is no company. For more on the process, see what is Companies House.

A general partnership is different. You might have already created one without even knowing it. The law says that when two or more people come together with a view to making a profit, they are recognised as a partnership. There is no form, no fee and no certificate. If you and a friend have been running a side business together and sharing the takings, you are very probably partners already.

How are profits shared?

The last main difference is how the profits are divided between the owners.

In a general partnership, unless there is a partnership agreement that states otherwise, the partners split the profits equally among themselves. It does not matter who put in more money or more hours; the default is an equal share.

In a limited company, the profits are split according to shareholding. So if you own 90% of the shares and your business partner owns 10%, you will receive 90% of the profits and your business partner will receive 10%. The ownership structure and the profit share are the same thing.

The #1 issue: disputes between owners

Having set out the differences, here is the issue that is faced by both partnerships and limited companies alike: issues between the partners. Disagreements and arguments between the people who own the business.

When starting a business, everyone thinks it will be great. Your business partners and you are on board, you have a shared vision, you believe in it, you are optimistic and you cannot wait to get started. But inevitably there will be issues. Someone wants to leave. Someone is not pulling their weight. Someone wants to take the business in a direction the others do not.

For this, having a partnership agreement for a partnership, or a shareholders' agreement for a private company, is essential. The agreement is where you decide, while you are still on good terms, how those situations will be handled. If you take one thing from this article, it is to get one of these documents professionally drafted to avoid issues down the line. What goes into each is covered in partnership agreement explained and how to structure a shareholders' agreement.

Limited company vs partnership: summary

• What it is. A general partnership is a relationship between two or more people; a limited company is a separate legal person.
• Liability. Shareholders of a limited company have limited liability; general partners have unlimited liability, so personal assets such as your home are at risk.
• Creation. A company exists once Companies House issues a certificate of incorporation; a partnership can exist automatically without you realising.
• Profits. Partners share profits equally unless a partnership agreement says otherwise; shareholders receive profits according to their shareholding.
• The common risk. Disputes between owners affect both, so put a partnership agreement or shareholders' agreement in place.

Next steps

Decide how much personal risk you are prepared to take and whether you want the business to be a separate person from you. Then, whichever structure you choose, have a partnership agreement or shareholders' agreement professionally drafted before you start trading with your partners. Before you launch, also check what other legal documents you need to be compliant, which is covered in legal documents you need to start a business.