Opening your own business is an exciting and courageous move. But before you launch the website or start printing business cards, let’s think about how the business is built. After all, you wouldn’t build a house without a frame!
Here in Texas, entrepreneurs have several options. Each of them comes with its own pros, cons, and legal implications, so the best fit will depend on your personal goals. Let’s go through a quick overview to help start the conversation.
Sole Proprietorship
This is the simplest and most common structure for newly hatched businesses. A sole proprietorship means that you and your business are one and the same, legally speaking. This used to be reasonably common, but there are some significant downsides that we’ll discuss in a moment.
How simple is it? You don’t even need to file formation documents with the state for a sole proprietorship. It just happens by default! However, you’ll need to register the name of your business (DBA = “Doing Business As”) with your county clerk if it differs from your own.
Pros:
- Simplest possible setup.
- The business is you, which means you control it.
- Fewer reporting requirements.
Cons:
- Absolutely no liability protection — what happens to your personal assets if you get sued?
- Harder to raise capital.
- The business is likely to die with you.
Partnerships
If you’re starting a business with one or more people whom you trust, a partnership can be a good way to go. Texas recognizes general partnerships and limited partnerships. Here’s a (really) quick overview of each:
General Partnership
All partners share responsibility for the business’s operations and debts. Think of this a bit like a bigger version of the sole proprietorship.
Limited Partnership (LP)
Includes both general partners (who manage the business) and limited partners (who invest but have no day-to-day involvement or liability beyond their investment). These are relatively rare in the modern era due to some notable downsides:
Pros:
- Shared responsibilities and resources.
- Straightforward tax treatment (pass-through taxation).
Cons:
- General partners are still “on the hook” for personal liability.
- Potential for disputes without a solid partnership agreement.
- Limited partners have virtually no say in business operations.
Limited Liability Partnership (LLP)
Think of these like a board of chairmen who are insulated from liability issues caused by the other partners. That “board” aspect is important here: in a traditional LLP, your partners are all technically equals, and each of them have an equal say in your operations. Typically, they can also execute contracts and conduct business on the entity’s behalf. Because of this structure, LLPs are most commonly used by groups of skilled professionals: dentists, CPAs, doctors, and the like.
Pros:
- Equal recognition of each full partner.
- Simple taxation.
- Liability protection.
Cons:
- Equal authority for each partner – what if someone loses their mind?
- Potential for disputes unless a solid partnership agreement is in place.
Limited Liability Company (LLC)
Now let’s move on to a more typical company. LLCs are a popular choice here in Texas because they offer liability protection, are generally easier to manage than a traditional corporation, and are often a great fit for small businesses. Their flexibility allows for an LLC to be adapted to a variety of situations.
LLCs do require some filings and formalities; they aren’t as simple as a sole proprietorship. However, most small businesses report that this is a small tradeoff for their excellent liability protection.
Pros:
- Personal assets are shielded from the company’s liabilities.
- Flexible management and taxation options.
- Standard LLCs are usually easier to manage than a traditional corporation.
- Can have separate management (Managers) and financial interests (Members, which are like shareholders).
- Can choose (structure themselves) to be taxed as a disregarded entity (extreme simplicity), partnership, or corporation.*
Cons:
- More upfront costs and paperwork than a sole proprietorship.
- Needs a solid operating agreement or it defaults to the Texas Business Organizations Code.
*IMPORTANT NOTE: LLCs can make a corporate “IRS election” after they are formed. These can be used to accomplish goals such as tax savings or raising capital, but it would be wise to discuss this with an advisor who can ensure that this is appropriate for your individual business. Many entrepreneurs make these elections in situations where they don’t provide any real benefits in exchange for the significant downsides. See below for more information on the benefits and potential drawbacks of common corporations for small businesses.
Corporations
Now we’re operating more like a “big corporation!” Unfortunately, this has some significant potential drawbacks. Corporations (C corps and S corps) are more complex legal entities which can offer significant advantages for larger, more speculative, or fast-growing businesses. However, these also have negative factors that may make them less attractive for small, local businesses.
C Corporations
This is what most people think of when they have a “corporation” in mind. C corporations (“C corps”) have a traditional corporate structure that offers strong liability protection and allows for unlimited shareholders, including foreign investors and other entities.
This structure can issue multiple classes of stock and is often used by businesses seeking outside investment or planning to go public. C corps are subject to double taxation since profits are taxed at both the corporate and individual levels when distributed as dividends.
Accepting money from investors/shareholders can also create managerial issues, as it will impose notable (and potentially significant) required duties from leadership to your investors as a whole. Mismanagement and/or misconduct can even result in financial liability to your shareholders!
S Corporations
An S corp provides liability protection like a C corp, but it is taxed more like a partnership: profits and losses pass through to the shareholders. This is designed to avoid the dreaded “double taxation” issue.
However, these structures are limited to 100 U.S. citizen or resident shareholders and can only issue one class of stock. Smaller, closely held businesses are often S corps.
Keep in mind that S Corp stock often has restrictions on transferability due to the inherently limited number of shareholders, and that conflict between shareholders and leadership can even result in the involuntary dissolution of the entity.
All Texas corporations must file a Certificate of Formation and maintain bylaws, meeting minutes, and annual reports. Basically, run it like a corporation, no matter how small!
Pros:
- Strong liability protection.
- Easier to attract investors.
- Can offer stock and issue shares.
Cons:
- More regulatory requirements and formalities than LLCs or LLPs.
- Separate tax filings, no opportunity for disregarded entity status.
- Potential double taxation for C Corps.
Which Business Structure Is Right for You?
If you’re just testing an idea,a limited liability partnership or single-member LLC is often a great starting point. LLCs also offer fantastic potential to grow and scale with your needs due to their inherent flexibility.
Regardless, we always recommend consulting with a business attorney or CPA familiar with Texas law to make sure you choose the structure that best fits your situation. Picking the right structure now can save you a lot of headaches (and money!) down the road. Want to sit down to go over your particular needs before deciding on a structure? Reach out now to set up a consultation.