Business Planning
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Sometimes it’s easy for me to forget that not everybody is as passionate about business law as I am. As I sat down to write this, I had to convince myself that there’s just too many technicalities and too much legalese to give you a complete picture of business planning in a single page. (Unless you want to know what it’s like to study for a law school exam.)
If you’re just starting as a real estate investor or small business, you probably hold title to property and do business in your own name, but that’s usually not to your advantage.
There are several reasons business owners choose to create limited liability companies (LLCs) or S-Corporations (S-Corps) to run their businesses, including:
- Liability protection.
- Tax flexibility.
- Privacy concerns.
- Strategic ownership structures.
Business entities allow you to separate your personal assets from your business assets, which gives you protection from business debts and protects the business from your debts. This separation means that if real estate owned by your business is at risk from litigation or creditors’ claims, your personal assets will not be at risk (with a few exceptions). By taking careful steps toward separating your personal property from business holdings, you can utilize the business entity for greater protection against personal liability.
The (Multi) Million Dollar Question: LLC or S-Corp?
The number one question I get when planning a new business is whether to create an LLC or an S-Corp. Choosing between these two types of entities can be difficult for business owners who are not familiar with the unique features of each type. To choose the right one for your business, you should be aware of their similarities and differences.
Liability Protection:
LLCs and S-Corps are entities legally allowed to organize as a business under Texas law. Both legal structures provide limited liability – a “corporate veil” that means owners are not personally responsible for the business’s liabilities or debts, although there are some exceptions.
The goal of each entity is to protect business owners’ personal assets from being reached in lawsuits against the business or by the business’s creditors.
The LLC is a newer entity structure that generally provides more flexibility than the S-Corp.
Naming Requirements:
In Texas (and most states), the law requires the name of an LLC end with the words “Limited,” “Limited Liability Company,” or an abbreviated form of those terms.
In contrast, the name of a corporation must end with “Incorporated” or “Corporation”.
This distinction is important because your application may be rejected if you fail to comply with these naming requirements.
Ownership Structure:
The owner of an LLC is typically called a member, and ownership interests can be defined by units (similar to shares of corporate stock) or by percentage.
On the other hand, the owner of a S-Corp is called a shareholder or stockholder, and the units of ownership are called shares or stocks. The structure of the S-Corp transfers easily by dividing ownership into these units.
LLCs with ownership interests consisting of units borrow this structure from the S-Corp, reflecting the LLC’s flexible nature.
Management:
LLCs typically take one of two basic structures: member-managed or manager-managed.
In member-managed LLCs, the members conduct the day-to-day management of the LLC.
In manager-managed LLCs, one or more managers make decisions for the entity. An LLC’s operating agreement may even require that managers of the LLC be members.
In S-Corps, by default, a board of directors has management authority. The board is answerable to the shareholders and is charged with the day-to-day management functions.
The members of an LLC also have the flexibility to choose to create a board of managers like an S-Corp’s board of directors.
Tax Flexibility:
LLCs, unless they choose to be taxed differently, enjoy pass-through taxation. This means that the LLC entity itself is not taxed; rather, the taxes flow through to the LLC’s members.
On the other hand, some corporations are subject to double taxation. This means some corporations must pay taxes on corporate income, and the corporation’s shareholders must also pay taxes on the dividends they receive.
Other Business Entities
Partnerships:
Partnerships are “business marriages” that simply must be planned correctly from the beginning. When you don’t need a business entity as formal as an LLC or corporation, a partnership may be exactly what you’re looking for.
Most partnerships aren’t required to file papers with the Secretary of State to become a legal entity, but that doesn’t mean the partnership should operate on a “handshake agreement”.
Nonprofit Organizations:
Having a charitable soul might not translate into skillfully running a nonprofit organization. How do you protect your tax-exempt status, file tax forms, get insurance, select board members, and protect from personal liability?
Nonprofits are usually formed with the goal of receiving 501(c)(3) tax-exempt status. However, the 501(c)(3) designation isn’t necessary to do good in the world.
Nonprofit organizations often fail to pay for legal services because they’re operating on a limited budget. But it’s often cheaper to pay a lawyer to help your nonprofit avoid problems than to fix them.
Professional Practices:
If you need a license from the State of Texas to do business, you need a professional practice. Professionals deal with unique challenges when it comes to ownership, retirement, and asset protection.
Not only will your business rely on the design of your corporate structure, but your license will too.
For nearly every business entity, there’s also a “professional” version, such as a Professional Limited Liability Company (PLLC), Professional Corporation (PC), etc.
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The best time to plan your legacy was 10 years ago. The next best time is today. Everyone needs estate planning – the good news is it’s never too early and if you’re reading this, it’s not too late.
