This summer, our firm is presenting a free, four-part webinar series on hardening your small- to medium-sized business against litigation. Following is a recap of the first webinar in our summer series:
On June 22, litigation attorney Ray Panneton kicked off our four-part summer webinar series with a discussion on the right way to set up your Texas business.
Ray covered all the elements of setting up a business that online, do-it-yourself solutions may fail to cover – from entity selection and filing with the Secretary of State to putting sound corporate governance documents in place (without them, state law will likely govern the way you run your business!).
Selecting the Right Entity for You and Your Business
Which entity is best for your business? Broadly speaking, there are four types of entities in Texas:
This is the most basic type of business structure: This is a one-person operation conducting business for a profit.
Under Texas law, the sole legal requirement is that if you’re conducting business under any name but your surname, you must file a “Doing Business As” (“DBA”) form with the county clerk’s office in the counties where you are conducting business.
The great drawback of the sole proprietorship is that you’re personally liable for debts and obligations of the business, and if you cannot pay your bills, creditors may go after your bank account and personal possessions to satisfy the debt.
Texas law views corporations as an entity separate from the owners, which means that when you organize a corporation you create a legal “person” that has the capacity to own property, sue and be sued, and also has to pay taxes.
Under most circumstances, a board of directors – chosen by the shareholders – governs the major operations of the corporation, including the appointment of executive officers who will conduct the day-to-day business affairs.
You can organize your corporation as a C-Corp or an S-Corp:
- C-Corps are required to pay taxes on their profits before distributing dividends to its stockholders. Additionally, shareholders pay income taxes on the dividends received, and this double taxation is one of the major drawbacks of a corporation.
- The advantage of the S-Corp is its tax structure. An S-Corp has what is called “pass-through” tax status, meaning the S-Corp does not directly pay taxes on its income, which allows S-Corps to avoid the double taxation found in C-Corps.
Limited Liability Corporation (LLC)
An LLC is owned by one or more members and can be either member-managed or manager-managed. And like a corporation, executive officers can be chosen by the members or the managers, depending on whether it is member-managed or manager-managed.
Unlike corporations, there is no requirement for either an initial meeting of the owners or managers or an annual meeting.
One of the great advantages of an LLC over a corporation is the pass-through tax benefit. LLC owners do not have to file a corporate tax return. Owners simply report their share of profits and losses on their tax returns, avoiding the double taxation paid by the traditional C-Corp’s shareholders.
There are generally two types of partnerships:
- General Partnerships – This business structure is a slight step above the sole proprietorship and is essentially any association carried on by two or more people for a profit. Each person involved is a general partner, and they split profits and losses. One problem, however, is that if your partner loses a lot of money at their end of the business, they might sue you for half those losses.
- Limited Partnership (LP) – The LP is the next step above a general partnership and offers advantages over the latter. There are two types of partners in an LP: general partners and limited partners. General partners act much like the partners in a non-filing general partnership. They conduct business operations and are also responsible for the partnership’s debts and obligations under Texas law. Limited partners enjoy liability protection under Texas law; however, they are not allowed to participate in the management or operation of the limited partnership. They are essentially “silent partners.”
Making It Official – How to Create your Business Entity in Texas
After making the decision as to which entity is best for your needs, you may need to file certain documents with the Texas Secretary of State.
Some entities do not require you to file paperwork with the State of Texas; these are called non-filing entities and include Sole Proprietorship and General Partnerships.
Filing entities, by contrast, must be registered with the Secretary of State in Texas. These include LLCs, Corporations, LLPs, and non-profits.
When completing the necessary documents for the Secretary of State, you will typically need:
- The name of the entity
- Name and address of your registered agent
- Purpose of the entity
- Management or leadership structure
- Names and addresses of key people
- Address of the principal place of business
- Name and address of organizer
What Is a Registered Agent?
Often overlooked, governance documents, such as bylaws and operating agreements, govern the relationship between the shareholders and/or members.
This is important if disputes ever arise! Without appropriate governance documents, the entity will be governed by statute, which may not accurately reflect the intent of the parties.
Document Requirements for Corporations
The governing documents of a domestic corporation consist of its certificate of formation and the other documents or agreements adopted by the corporation to govern the internal affairs of the corporation.
These agreements set up the ground rules for governing and running the corporation. The certificate and by-laws are binding on all shareholders and can make a great difference in the rights of shareholders and the responsibilities of officers and directors.
Documents Recommended for LLCs
LLC documents should contain asset protection clauses and provisions from the very beginning of the formation process.
At minimum, such documents include:
- The certificate of formation (“COF”);
- A comprehensive company agreement (also called an operating agreement);
- The minutes of the first meeting of members (organizational meeting);
- Signed and issued membership certificates;
- Signed consent by the registered agent;
- If the LLC is a series company and there are to be registered series, a certificate of registered series.
Having governance documents in place is critical because these agreements will dictate how the entity is run, who has what authority, and what’s going to happen in the event of a dispute.