Choice of Business Entity
When starting a business of your own, it is important to choose a business entity, or type of organization, for you to conduct your business through.
SOLE PROPRIETORSHIP/ GENERAL PARTNERSHIP
A sole proprietorship is the simplest form of business entity, as all responsibility is held by the owner of the company. Forming a sole proprietorship does not require the business owner to file any formal documentation aside from registering a “doing business as” name (if applicable) with the local county clerk’s office or the Secretary of State.
While administratively this is the easiest entity to establish, it is risky in terms of personal liability. Because there is no distinction between the owner and the business (or owners, in the circumstance of a general partnership), it exposes the owner to substantial liability and puts the owner’s personal assets at risk. Funding poses another challenge for a sole proprietor, as there is no opportunity for people to buy shares in the company. For a sole proprietorship, obtaining outside investment is virtually impossible without accruing debt.
LIMITED LIABILITY COMPANY
The most popular choice among small businesses, a Limited Liability Company (LLC), offers owners greater legal protection than a sole proprietorship. With an LLC, the business owner or owners cannot be held personally liable for the company’s debts or legal liabilities. This entity allows the owners to enjoy the protections of a corporation without the tax implications of incorporating. For federal tax purposes, a single member LLC is taxed as a sole proprietorship, while a multi member LLC is taxed by default as a partnership, unless the entity files an election to be treated as a corporation. Most LLCs opt for the default partnership federal tax classification to avoid double taxation of corporate income. To establish an LLC in Texas, an entity must draft and file a certificate of formation with the state. The operating agreement is a separate document that defines the company’s management structure and other details like compensation and responsibilities.
LIMITED LIABILITY PARTNERSHIP
Like an LLC, a limited liability partnership enjoys the tax benefits of a partnership and some of the legal protections of a corporation. In a partnership, there is a general partner (which can be an entity such as a limited liability company), who is responsible for the operation of the business, and limited partners, who are investors in the business, much like shareholders in a corporation. Limited partners are sometimes called silent partners, as they have no control over the operation of the business.
Though it’s the most complex type of legal entity, a C Corporation has virtually unlimited potential for growth and profit. Governed by certificate of formation and bylaws, a corporation must have a board of directors, elected by the shareholders, who are responsible overseeing the company’s management. A corporation may sell shares of its stock to outside investors to grow the business, allowing ample opportunity for raising funds.
One drawback to this entity type is double taxation. The income of the corporation is first taxed at the entity level, and then again at the shareholder level, based on each shareholder’s distribution of the corporation’s profits and losses. Additionally, C Corporations can be costly to set up, as there are fees that must be paid for registration, but once a corporation is formed, it continues in existence even if the entity’s management changes. Legal liabilities for a C Corporation belong to the corporation itself, so investors, employees, and the board of directors are not personally responsible for the debts and liabilities of the corporation.
Organized and governed in the same manner as a C Corporation, an S Corporation is an elected federal tax status. For a C Corporation to make this tax election, there are several requirements to which it must adhere, including limiting the number of shares sold and restrictions on the distribution of profits. The major benefit of S Corporation status is no double taxation. As with a partnership, profits and losses are passed on to the shareholders to file on their individual tax returns. Legal liability is also limited in an S Corporation, so members are not responsible for the debts and responsibilities, which fall to the business itself.
Regardless of what business you are trying to start, it is often beneficially to consult with an attorney so that you can make a well-informed decision about your business future.
Joseph Centrich has experience dealing with complicated business relationships and can provide counsel on a range of business structures. If you are in the Woodlands, Conroe or the Houston area and are contemplating starting a business, contact HCWD, PLLC to speak personally with a business law attorney.