I am in the process of starting a small business. How do I know what corporate entity (sole proprietorship, general partnership, corporation, LLP, LLC, etc.) is right for the business?
If you’ve got the entrepreneurial spirit and don’t want to lose your shirt if things don’t go as well as expected, there are several considerations to keep in mind when deciding what business entity is best for your business. The main considerations are limiting personal liability, minimizing taxes, management structure, and transferability of the entity. There is no right choice of entity in absolute terms, so the decision turns on your goals for the business.
That said, the least attractive alternative is usually a sole proprietorship or a general partnership. These forms do not offer limited liability, meaning you are on the hook for the debts and obligations of the business.
If you ultimately plan to seek investor financing, the choice is easier. Entrepreneurs seeking venture-capital financing should structure their business to be attractive to investors. Most investors require a Delaware C corporation. The investors (and their lawyers) are familiar with Delaware’s business-friendly laws. But don’t despair if you’ve already chosen some other entity. You could merge that entity into a Delaware corporation when required by investors.
If your plan is to self-fund, one option is to incorporate in Texas as a limited-liability company or a limited-liability partnership. These entities are attractive because they offer tax savings to profitable businesses by allowing for pass through taxation. This means that the company’s tax benefits or liabilities are passed to its partners or members. LLCs and LLPs also offer limited liability and flexible management structures.
A limited partnership also enjoys pass through taxation, but it is a less popular choice because Texas law provides that the general partner of an LP is jointly and severally liable for the obligations of the business. Therefore, many LPs create a corporate general partner to limit liability to the general partner. A corporation has the advantage of limited liability, but its drawback is dual taxation. A corporation is taxed on its income, while the shareholders are also taxed on their distributions.
Corporations, LLCs, LLPs, and LPs are required to file with the Office of the Texas Secretary of State. The secretary of state’s Web site (www.sos.state.tx.us) lists the fees for each entity and provides additional information on the advantages and disadvantages of each business form. You should contact an accountant for more details on the tax implications of your entity choice.
This article appears in April 20 • 2007.