If you’re starting a new business, one of the most important first steps is deciding what legal entity it takes. Most businesses choose to organize as a corporation, limited liability company, or partnership. Individuals can also decide to operate as sole proprietors. Which one of these business structures is right for your company? The Oracle Legal Group takes a look.
Call our Houston business lawyers today at 832-291-2798 and let us help you start your company.
The Benefits and Drawbacks of Corporations
To incorporate a business, the owners (shareholders) must submit a Certificate of Formation to the Texas Secretary of State. This document contains details such as the corporation’s official name and its registered agent.
Pros of This Business Structure
These are some of the pros of incorporating:
- Liability protection: Because a corporation is a separate “person,” its owners’ personal assets are shielded from the company’s debts and liabilities.
- Pass-through taxation: The profits and losses of S-corporations (also known as S-corps) pass through to the individual shareholders. The owners report these on their tax returns and avoid the double taxation of the traditional C-corporation.
- Raising capital: Corporations are legally permitted to issue shares and raise a large amount of capital quickly.
Cons of This Business Structure
Some of the cons of the corporate structure are:
- Double taxation for C-corps: As mentioned above, if the corporation is formed as a C-corp it will be subject to double taxation. The corporation pays income tax on profits while any shareholder distributions (dividends) are also taxed.
- Higher operating costs: Corporations usually require more money to form and are typically more expensive to operate versus other business structures.
- Formalities: Corporations require incorporation documents, bylaws, annual filings, annual meetings, meeting minutes, and other formalities.
The Facts About Limited Liability Companies (LLCs)
A limited liability company, or LLC, is designed to shield its owners from the debts and liabilities of the business. As with a corporation, an LLC is also formed by filing a Certificate of Formation.
Pros of This Business Entity
Benefits include:
- Limited liability: LLC owners, or members, enjoy similar liability shields as corporate shareholders do.
- Less formality: There is far less formality with an LLC versus a corporation. For instance, Texas law does not require LLCs to hold annual meetings.
- Flexible tax structure: A one-member LLC can be taxed as a sole proprietorship or as an S- or C-corp. Multi-member LLCs are taxed as partnerships unless they choose to be taxed as an S- or C-corp.
Cons of This Business Entity
Some disadvantages are:
- Costs and fees: There is an initial LLC filing fee of $300. Like a corporation, an LLC must have a registered agent which could cost substantial sums of money.
- Harder to raise capital: LLCs cannot issue company shares to raise capital. Investors also generally consider LLCs to be riskier investments than corporations.
- Harder to obtain loans: Lenders are more reluctant to loan money to an LLC. Its members may be required to personally guarantee the loan, which partially defeats the limited liability protection.
Is a General or Limited Partnership Right for You?
There are two types of partnerships: general and limited. In a general partnership, partners share liability and responsibility for running the company.
Under a limited partnership, at least one partner is the general partner while at least one other is a limited partner. The limited partner usually has less liability exposure but also less say in business operations.
Pros of This Business Structure
These are the reasons you might want to form a partnership:
- Combined expertise and resources: Partnerships pool resources like experience and skills. This leads to greater efficiency and management.
- Easy to set up and operate: Partnerships have fewer formalities and paperwork than corporations and LLCs. A partnership agreement is not required but is strongly recommended.
- Tax benefits: Tax liability passes through to partners (similar to S-corps) thereby avoiding double taxation.
Cons of This Business Structure
Reasons to avoid a partnership include:
- Liability: Partners face unlimited liability for business debts and judgments. However, the partnership agreement can apportion debt and liabilities unequally between the partners.
- Conflict: Partners may disagree over how to run the business and share resources. A partnership agreement can potentially, but not absolutely, limit this problem.
- Lack of continuity: If a partner retires, dies, or leaves the partnership, the entire business might need to be dissolved.
Should You Operate as a Sole Proprietor?
A sole proprietorship makes no distinction between the business owner and the business. The individual running it simply works for him- or herself. There is no paperwork to file and no business documents to record.
Pros of This Business Entity
The advantages include:
- No filing fees or related costs: With a sole proprietorship, there are no business filing fees, licenses, or the like.
- No paperwork or formalities: Unlike the other types of business structures, sole proprietors have no papers to file with the state. Such formalities as meetings, minutes, annual reports, and the like aren’t mandatory.
- Easy to begin and end: Becoming a sole proprietor is the best way to move quickly into a new line of work. Ending a sole proprietorship is as easy as stopping your business operations.
Cons of This Business Entity
These are the drawbacks of becoming a sole proprietor:
- Liability: Since the owner and the business are identical, the sole proprietor is personally liable for business debts and liabilities. This includes court judgments against the business.
- Taxes: The sole proprietor must pay all income and other business taxes. Many sole proprietors are independent contractors who have to pay self-employment taxes.
- Lending and capital: Banks are far less likely to lend money to a sole proprietor. Raising capital is also difficult for similar reasons.
Ready to Advise Your Texas Business
Are you ready to begin your new business? You will need trusted legal representation to protect your rights and minimize risks. Count on the Oracle Legal Group. We can counsel you as to all aspects of Texas business law, from formation to termination. We can also defend your business in litigation.
Give us a call today at 832-291-2798 for a free consultation.
