Business Entity Choices in Texas
While the word Corporation or Company often conjures images of huge multi-national empires that employ hundreds or thousands of people, a vast majority of businesses in Texas and the United States are small “Mom & Pop” or “Family” businesses. Even for these small businesses, however, choosing the appropriate entity type can have far-reaching consequences for the liability of the business owners as to business contracts, tort liability, and taxes. Accordingly, when starting your own small business, one of the most important questions you can ask is, “What entity choice is best for me?”.
Owning a business as a Sole Proprietorship is the default in Texas and is the same as simply carrying on a business endeavor by yourself without any sort of filing with the State. All business debts and liabilities are the same as if they were your own. Similarly, if someone sued your business while you were operating as a Sole Proprietorship, they would be suing you individually; that means almost all of your personal money and assets are at risk when operating a Sole Proprietorship. This type of business entity is rarely favorable and can result in undue liability for business owners.
General Partnerships, sometimes referred to as simply Partnerships, are the same as Sole Proprietorships in all aspects except that where a Sole Proprietorship has one owner, a Partnership has two or more owners, referred to as Partners. By default, all partners share equally in the benefits (profits) and burdens (expenses and liabilities) of the group. These arrangements can be changed by written or oral agreement, however, allowing flexibility in both ownership and management structure. General Partnerships share the same drawbacks as Sole Proprietorships in that all Partners are responsible for the debts and liabilities of the business, including actions taken by other partners, and they are similarly disfavored by experienced practitioners.
Limited Partnership (“LP”)
A Limited Partnership is a variation of a General Partnership where there is at least one general partner, who remains personally liable for the debts and obligations of the business, and at least one limited partner, who enjoys limited liability protections from the debts and obligations of the business and is liable only to the extent of the contributions made to the partnership. Limited partners in LPs are not permitted to manage the business, that job being reserved to the general partner in exchange for its assumption of the business’s liabilities. Limited Partnerships, like all partnerships, are governed by a written or oral partnership agreement that designates the responsibilities and benefits allocated to each limited or general partner. Depending on the specifics of the business plan, Limited Partnerships can enjoy more favorable tax treatments than some Corporations while retaining some of their owners’ limited liability protections. As a general rule, general partners for modern Limited Partnerships should always be some form of limited liability entity themselves to avoid any individual from becoming individually responsible for the business’s debts and obligations. Usually, LLCs or Corporations are formed for the sole purpose of managing LPs as General Partners and assuming this risk. To form a limited partnership, special filings and fees are required by the State of Texas.
Limited Liability Partnership (“LLP”)
Limited Liability Partnerships are variations of General Partnerships wherein all partners, including general partners, enjoy limited liability for debts and liabilities of the partnership. Partners in LLPs may still hold individual liability for partnership debts and liabilities that are the fault of that partner or the fault of another partner who was or should have been supervising the offending partner or partnership agent. As is typical for all Texas business entities, partners in LLPs retain individual liability for torts committed while acting on behalf of the partnership and contracts that the partner enters or guarantees in their personal capacity. Limited Liability Partnerships can have multiple classes of partners (general, limited or otherwise named) as designated in the controlling partnership agreement (written or oral). Also similar to LPs, LLPs can hold preferential partnership tax treatment for its partners and are required to file formation and maintenance documents and fees with the State of Texas.
Corporation (S or C)
Corporations are business entities in which the owners, known as shareholders, enjoy limited liability for the debts and liabilities of the business in exchange for delegating management authority to a board of directors or other centralized management group. Corporations allow for flexible ownership structures, which can encourage different levels or types of investors and boast a relatively well-understood body of law supporting their features. They have rather rigid governance rules that require regular meetings, and sometimes cumbersome formalities are followed to maintain corporate status. Because of this rigidity, Corporations are often better suited for experienced entrepreneurs and established business ventures seeking to expand to offer large numbers of investors ownership stakes (known as stock). Depending on their size and other factors, Corporations can either qualify as “S-Corporations” or “C-Corporations”—which impacts the way corporate profits are taxed. Generally, the larger “C-Corporations” have their profits taxed twice: once at the corporate level and again once they are distributed to the shareholders. “S-Corporations,” however, can avoid this double taxation but must meet more restrictive criteria regarding size and management. With the advent of LLCs, many practitioners have disfavored these restrictions, and consequently, the use of the Corporation for small businesses has declined. Corporations, like all limited liability entities, require special filings with the State of Texas for formation and thereafter to legally transact business.
Limited Liability Company (LLC)
Limited Liability Companies (“LLCs”) are one of the newest forms of limited liability business entity but have quickly become one of the most popular as well. LLCs grant the owners, referred to as Members, limited liability from the debts and obligations of the business without many of the restrictions placed on Corporations. Unlike Corporations, LLCs allow their Members to decide on almost every facet of the business’s governance: LLCs can be governed directly by the Members, by appointed managers, by some Members, with rigid or flexible governance rules, or with simple or complex ownership structures. Moreover, LLCs qualify for a wide range of favorable tax treatments, further broadening appeal to money-conscious investors. Caution should be taken by savvy entrepreneurs, however, because of the tremendous amount of flexibility afforded to LLCs. A written Operating Agreement, drafted by your business’s attorney and signed by all Members and the Company, is essential to avoiding potential costly litigation or disputes down the road. Operating Agreements of this sort are normally offered by Attorneys as part of a package that includes the State-mandated filing fees.
Overall, the State of Texas provides a framework for numerous entity structures, each of which contains benefits and drawbacks for the small business owner or entrepreneur. These variations should encourage anyone considering setting up a new venture to seek both legal and tax advice from appropriate professionals regarding both the choice of business structure and the process of properly setting up and organizing the business.
This blog is made available by Mazurek, Belden & Burke, P.C. for educational purposes only, and not to provide specific legal advice. This blog does not create an attorney-client relationship between you and Mazurek, Belden & Burke, P.C. This blog should not be used or considered as a substitute for competent legal advice from a licensed attorney in your state. If you have any questions about this topic, please contact us.