The Benefits of Forming a Limited Liability Company

By Rachel Luna, Attorney and Owner of Luna Law, PLLC

At some point, most small business owners consider creating a separate entity to run their business. Since its inception, the limited liability company (LLC) [1] has increasingly become the entity of choice for most small businesses in Texas. If you are considering whether to create an LLC for your business, you may be wondering what benefits you really get from creating a separate entity and whether it’s worth the additional paperwork and cost involved.

Read on for some guidance to these questions.

The process and costs to form and operate an LLC are relatively minimal

To form an LLC in Texas, you must file a Certificate of Formation with the Texas Secretary of State and pay a filing fee of $300. Critical decisions that must be made as part of this process include:

  1. Determining the name of the LLC, which generally cannot be the same as or similar to the name of any existing company doing business in Texas;
  2. Deciding whether the LLC will be governed by its owner(s); and
  3. Identifying the LLC’s registered agent.

One of the most appealing features of an LLC is the flexibility allowed in its governance. To maximize and tailor this flexibility, it is a good idea to create a company agreement (often called an operating agreement in other jurisdictions). A company agreement governs the internal affairs of the LLC, including the duties and obligations among the company, the owner(s), any managers, and any officers of the LLC. A final recommended step in an LLC’s formation is the documentation of the initial decisions of the organization, either through resolution or written consent. Such decisions include issues such as approval of the formation of the company and confirmation of the organization’s banking authority.

Ongoing formality requirements are fairly minimal, however, to help ensure personal liability protection the business should operate under and through the LLC and not its owner(s). For example, bank accounts, contracts, insurance, and similar matters of the business should be transitioned to the name of the LLC.

The benefits and flexibility of an LLC are substantial

Owners and managers generally are not responsible for the debts, obligations, and liabilities of the company, except as provided in the company agreement. Additionally, through the company agreement, owners can establish charging order protection against the creditors of any other owners. Through charging order protection, any creditor that has seized ownership interests in the company could be limited to allocations and distributions of the company and would have no rights to make operational decisions on behalf of the company.

By default, an LLC with only one owner is taxed as a sole proprietorship, and an LLC with more than one owner is taxed as a partnership. However, in either case, the LLC has the option of electing C-Corp or S-Corp status. [2] Likewise LLC owners have great flexibility in determining how and when allocations and distributions are made, ownership interest transfers are allowed, and additional ownership interests are created.

Forming (or converting to) an LLC is often the best small business entity choice

Each entity structure has pros and cons when compared with the other options; however, for most small businesses, the advantages of an LLC will likely outweigh the negatives and make it the best choice. Below are some highlights of this comparison based on Texas law.

Sole Proprietorships

Sole proprietorships are how many small businesses with a single owner get started. There is no need to take any formal action to start a sole proprietorship. If you are running a business on your own and you have not taken any steps to formalize its structure, you are likely a sole proprietor.

  • Advantages over an LLC. No need to file any documentation with the Secretary of State; no formal governance requirements.
  • Disadvantages when compared with an LLC. No personal liability protection; no taxing flexibility (i.e. can only be taxed as a sole proprietorship); no ability to co-own the business with anyone else.

General Partnerships

Like sole proprietorships, many small businesses get started as a general partnership, because there is no need to take any formal action to start a general partnership. If you are running a business with anyone else and you have not taken any steps to formalize its structure, you are likely operating as a general partnership.

  • Advantages over an LLC. No need to file any documentation with the Secretary of State; no formal governance requirements.
  • Disadvantages when compared with an LLC. No personal liability protection unless additional documentation is filed with the Secretary of State; no ability for the business to have only one owner.

Limited Partnerships

Limited partnerships are businesses with two classes of partners: (1) partners that own and operate the company (general partners); and (2) partners who invest money into the business but are not involved with the operations of the company (limited partners).

  • Advantages over an LLC. May be more attractive to investors who do not want to be involved in the operations of the business or be exposed to the liabilities of the company.
  • Disadvantages when compared with an LLC. No personal liability protection for general partners unless additional documentation is filed with the Secretary of State; no ability for the business to have only one owner.

Corporations

With a long and rich history, corporations are a readily recognized form of business structure that are attractive to investors for a myriad of reasons, including strong personal liability protection for owners.

  • Advantages over an LLC. May be more attractive to investors.
  • Disadvantages when compared with an LLC. Has more extensive and structured governance and record-keeping requirements; no charging order protection.

Moving forward

Deciding whether to form an LLC should be an individualized decision based on the totality of your circumstances. However, the rich benefits afforded by operating through an LLC balanced against the minimal upkeep requirements likely justifies discussion and consideration of the issue by most business owners with their tax professional and attorney.

[1] In addition to general LLCs, Texas law allows for the formation of professional limited liability companies (PLLCs) as well as series limited liability companies (SLLCs). Stay tuned for additional information on these entity forms in a future installment of The General Counsel Blog.

[2] You should work with your accountant to review any additional tax filings, payment obligations, or other tax consequences that might arise through the formation of an LLC as part of the process of determining whether creating an LLC makes sense for you.

This update is for informational purposes only and does not provide legal advice. Every legal situation is different and must be independently analyzed by an attorney. Please consult with an attorney for specific guidance.

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