After those great guest posts by our law intern, we are returning this week to Part IV our series about the various Texas legal structures available for use by startup companies. This post is focused on the advantages of forming a new business as a Texas limited liability company.
If you enjoy this article, check out last week’s post about forming a new business as a limited partnership.
Introduction to Texas Limited Liability Companies
Limited liability companies (LLC’s) are a relatively new form of business entity, but have caught on quickly and are heavily favored by Texas attorneys for use by small businesses. Combining the flexibility in management and taxation options of a general partnership with the liability shield of a corporation, LLC’s pack a potent punch for business owners of all types. This hybrid business model has few disadvantages and gives Members broad leeway to contractually agree on management structure, ownership rights, and profit allocation.
Here are our top 5 reasons to structure a startup business as a limited liability company:
1. Liability Limit for Members
As the name suggests, and except as provided in the Company Agreement, a Member or Manager of an LLC is not liable to third parties for the debts, obligations or liabilities of that LLC. In other words, if you are a Member of an LLC and that company is successfully sued under a standard breach of contract action, you are generally liable for that judgment only up to the amount of contributions you made or promised in writing to make to the LLC. Your personally assets are ordinarily out of the reach of your business’s creditors. This is in contrast to the sole proprietor or partner in a general partnership, who are both personally liable in Texas for the debts of their respective companies.
2. Options Regarding Tax Status
LLC’s that have two or more members will normally be classified as partnerships for federal income tax purposes unless the LLC voluntarily elects to be taxed as a corporation. An LLC that elects to be taxed as a corporation is a C corporation taxed under Subchapter C unless it is eligible for, and makes an election to be taxed as, an S corporation under Subchapter S. A detailed explanation of the specific advantages and disadvantages of each type of tax structure is beyond the scope of this article, but it is important to note that LLC’s are the only entity type in Texas that provide both liability protection for all of their Members and the option to be taxed as either a partnership, S corporation, or C corporation.
3. Flexible Business Management
Owners of an LLC are called “Members” and an LLC can be either Member-managed or Manager-managed. If no Managers are appointed, the Members are generally required to vote, by majority, on most company decisions and each Member is considered an agent of the LLC, with the power to bind it contractually. Members of an LLC may, and often do, appoint Managers, acting similarly to corporate directors, to oversee the managerial duties of the LLC and enter into contracts on its behalf. This structure is particularly attractive for LLC Members with an investor willing to contribute to the LLC but not interested in participating in its day-to-day operations.
4. Minimal Statutory Formalities
As mentioned above, an LLC’s rules regarding operations and governance are largely defined by its Company Agreement. Unlike corporations, LLC’s are not statutorily required in Texas to conduct time-consuming formalities such as annual meetings and minutes. Non-compliance with these formalities is one of the leading causes of successful piercing of the corporate veil. Avoiding the required conventions of corporations allows LLC owners to both save time and decrease potential liabilities.
5. LLC’s Are Favored By Investors
LLC’s offer investors several advantages over other types of business entities, including a liability shield, an opportunity to save on taxes, and the ability to sell their Member interests. The first two features have already been discussed above, so we will focus here on the third.
By default, Membership interests in a Texas LLC are freely transferable, except that the ability to participate in the management of the LLC’s business generally must be approved by the existing Members. This attribute provides some peace of mind to potential investors who may wish to cash in on their investment down the road by selling their interest to a third party. Of course, Members can contractually restrict the transferability of Membership interests in the LLC’s Company Agreement, so investors are encouraged to examine those documents carefully when conducting due diligence.
Limited liability companies provide clear advantages to potential business owners – too many, in fact, to list in this article. With proper counsel, Texas startup entrepreneurs can form a business that protects their personal property, provides favorable tax treatment, and enables them to seamlessly bring investors into the fold as the need arises.
Feel free to email me directly if you live in Texas and would like more information about forming a limited liability company. A link to my firm’s website can be found under the “About” page. Just submit the form at the bottom of our firm webpage and it will be sent to me.
As always, comments are welcome and will be published if on topic and of value.