There are many business structures an entrepreneur may employ in forming his business. Each structure is somewhat different and choosing a specific business model depends on each entrepreneur’s specific needs. Below are 6 important business vehicles that any entrepreneur should explore before making their final decision to start their business.
- The Sole Proprietorship: This business structure is the most simple. The business is comprised of a single individual. There is no legal separation from the entrepreneur and his business. The proprietorship and the entrepreneur are taxed as one entity. The entrepreneur reports all income and deductible expenses for the proprietorship on his personal income tax. There is no personal protection from liability for the owner with this business structure. The entrepreneur is personally liable for anything that happens with his business and receives no protection.
- The Corporation: This business structure is more complex and offers more protection. The corporation is a separate legal entity that is created and must be recognized by the state. The corporation, unlike the sole proprietorship, gives the entrepreneur significant liability protection. The corporation itself can be sued, but the shareholder is protected. Usually small beginning entrepreneurs will create a “closely held” corporation in which all shares are owned by the entrepreneur and no stock is publicly sold. The price or this liability protection is that the corporation must pay a tax. A tax is paid on the earnings of the corporation and there is a second tax on the dividends paid to the shareholders. This is commonly referred to as the “double tax measure.” If the entrepreneur wants the benefit of liability protection, he may have to address double taxes if deciding upon a corporation, or assume all income is disposed of as salary.
- The General Partnership: This business structure is similar to the sole proprietorship, but consisting of multiple people or entities. No formal agreement is necessary, but is strongly recommended. The partnership agreement will control and describe the powers and limits of each partner. Just like the sole proprietorship, there is no personal liability protection. All partners are jointly and severally liable. This means that if the partnership acts negligently, one or all of the partners will be vulnerable to being sued. The partnership does not pay a tax. Each partner will be taxed on a personal level equal to the share that the partner owns unless the partnership agreement states otherwise. However, Texas does subject general partnerships to a franchise tax.
- The Limited Partnership: This business structure is a combination of both a general partnership and a corporation. There must be at least one general partner. The general partner will assume personal liability for the partnership, but is the only partner with most management and control of the partnership. The limited partners have no personal liability to the partnership, but are prohibited from participating in management of the partnership. The partners will be taxed on a personal level equal to the share that the partner owns as well as a franchise tax. A certificate of formation must be filed with the Secretary of State in Texas.
- The Limited Liability Partnership (LLP): This is similar to the limited partnership, but the limited partners may participate in management. At least one general partner must still be personally liable for the partnership. This is a common business structure for law firms and accounting firms. The LLP is still subject to the Texas franchise tax and the proper paperwork must be filled with the Secretary of State.
- Limited Liability Company (LLC): This business structure is another combination between a corporation and a partnership. This business structure is the most common for starting entrepreneurs because an individual may guard against personal liability as well as double taxation. The individuals that comprise the LLC pay taxes individually, similar to a partnership. All members of the LLC are allowed to participate in management and decision making. An operation agreement must be formed similar to a partnership agreement that structures how the LLC will be run. An entrepreneur must fill out the necessary paperwork and submit it to the Secretary of State in Texas to properly form an LLC. The LLC is also subject to a franchise tax in Texas.
All of these business structures have both vulnerabilities and merits. It is important to sit down with an experienced attorney and discuss your options before choosing a specific type of business formation. This is the most basic and important decision an original entrepreneur must address and he/she should be aided by a lawyer with experience in the matters and decision making.