Business Formation: Texas Corporations, Partnerships and LLCs

If you operate your business as a sole proprietorship (e.g., just a DBA), you are exposed to a number of risks that can threaten both your business and your personal finances.  Because your business is not recognized as a separate legal entity, you can be held personally responsible for any debts of your business.  If someone sues your business over an accident, for example, and wins, they can come after your personal assets if those of the business are not enough to satisfy the judgment.  This unlimited personal liability is the greatest disadvantage for the owner of a sole proprietorship.

There are also other potential problems with operating a sole proprietorship, such as difficulty raising capital with just your personal credit, and providing health insurance to employees.  Also, because the business is tied to a single person, there is also the issue of how to keep the business running in the event of the illness, disability or death of the owner.  There may be no one else who has the authority to step in and make the decisions needed to keep the business operating, resulting in its collapse.

Forming a Business Entity in Texas

In order to minimize the risks involved in operating a business, and to avoid unlimited personal liability, you can make your business a separate legal entity under Texas law.  This enables your business to exist separately from you, its owner.  As a legal entity, the business is able to hold assets, incur debts, sue and be sued, all in its own name.

Texas Corporation

A corporation is an independent legal entity, separate from the persons who own, control and manage it.  The owners of a corporation are called “shareholders”, and it is managed by a board of directors.  (Only one director is required, and it must be a natural person.)   In order to create a corporation in Texas, a Certificate of Formation must be filed with the Secretary of State.  This document also identifies the company’s registered office and agent for service of process in the state.

The corporation provides the maximum protection from individual liability, but only when strict corporate formalities are observed.  For example, a corporation must have by-laws, hold annual meetings (and keep minutes), and elect directors and officers.  If you fail to do all of these things, you take the risk that your corporate entity could be disregarded in court, and you could still be held personally liable for the debts of the business.

A corporation can choose to be taxed directly (as a “C” corporation), or it can pass its profits or losses on to its shareholders (as an “S” corporation) to report on their individual tax returns.  This election can be changed each year, depending on which is more advantageous.

Advantages: Limited liability, flexible ownership/management structure, easy to transfer ownership, flexible taxation, business continuity

Disadvantages:  Required formalities, record-keeping burden

My Texas Incorporation Package includes all of the documents and legal advice you need to set up a legal Texas corporation.

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Texas Partnership

A partnership is similar to a sole proprietorship, but it allows two or more people to share ownership of a business, as well as its profits and losses.  A general partnership can be formal (governed by a partnership agreement) or informal.  No documents need to filed with the Secretary of State, and no formalities need to be observed.  (If you do business under an assumed name, you have to file an Assumed Name Certificate (“DBA”) in your county, and obtain an Employer Identification Number from the IRS.)   You are free to run your partnership any way you like, and divide the profits as you see fit.  Any partner has the ability to make binding agreements that obligate the partnership.  Normally, it is best to have a written partnership agreement clearly spelling out how the partnership will be run, and the rights and obligations of the partners, in case disputes arise in the future.

Because the partnership is not really a separate legal entity, all of its profits and losses are passed through to the individual partners for income tax purposes.

There is one major disadvantage to operating your business as a partnership – it offers no protection from personal liability.  Each of the partners can be held personally liable for the debts of the business (and the actions of the other partners in connection with the business).

Advantages: No formalities, flexible ownership/management/division of profits

Disadvantages: Unlimited liability, difficulty transferring ownership (may require forming new partnership), less stable

The Texas Partnership Agreement I offer can be used to formalize your general partnership arrangement, in order to avoid misunderstandings and disputes between partners.  It can be also be used to plan for future transfers of ownership, to minimize disruptions to the business.

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Texas Limited Liability Company (LLC)

A Texas LLC combines some of the best features of a corporation and a partnership.  As a separate legal entity, it offers the liability shield of a corporation, but can be managed like a partnership.  The owners of a corporation are called “members” (many LLCs are single-member LLCs).  In order to form an LLC in Texas, a Certificate of Formation must be filed with the Secretary of State.  A member can be an individual, partnership, corporation, trust, or any other legal or commercial entity.  An LLC requires fewer formalities than a corporation, and provides a more flexible structure for a small business.  At the same time, its clearly-defined structure makes it more attractive to lenders and potential investors than a partnership.

The LLC can be managed directly by its members, like a partnership – or it can hire managers to run the business.  For tax purposes, an LLC can elect to be taxed as a C corporation or an S corporation; a single-member LLC can also be taxed as if it were a sole proprietorship (“disregarded entity”).  The tax election does not affect the liability shield that the LLC provides – the members’ liability is limited to the amount invested in the LLC.

Advantages: Limited liability, flexible ownership/management structure, easy to transfer ownership, flexible taxation, business continuity

Disadvantages:  Shares cannot be publicly traded (e.g., on a stock market)

My Texas LLC Package includes all of the documents and legal advice you need to create your Texas LLC.

Start for Free Click here to start your LLC questionnaire for free

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