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Choosing the Right Entity Structure for Your Business

So, you’ve got a great idea and you’re ready to make your business dreams a reality. You’ve made a frantic run to the local office supply store and you’re scouting the right color combination for your business cards, but suddenly you realize that in your zeal you’ve forgotten a very crucial step: You haven’t actually, legally formed your company.

Choosing the right entity structure can seem like a daunting task. It requires knowing what you’re working with upon starting your company and what goals you have for your company in the future. Are you a single-member LLC just looking to formalize a one-time business venture? Or, are you a corporation looking to establish a board of directors, shareholders, and, hopefully, investors? Here's some helpful starter links we send to clients at this phase of their venture:

Either way, knowing some basic differences in the most common corporate entity types will help you start out on the right foot. Some helpful questions in deciding whether it’s time to start your business are offered by the U.S. Small Business Administration. In Texas, the Texas Business Organizations Code, or TBOC, governs the requirements of each entity structure, and the Texas Secretary of State provides helpful information regarding those requirements.

One of the most common entity structures is an LLC, or limited liability company. LLCs usually have a small amount of Members, or owners, of the company. Upon organizing a LLC, you must decide the number of your members and what percentage ownership each member will maintain in the company. You must also decide whether your LLC is going to be managed by the members, or whether management of the LLC will be reserved to one or more Managers, who will be responsible for the daily affairs of the LLC. Some things to take into consideration, as Manager-managed LLCs leave the operational responsibilities to the managers, who may or may not be equity holders or owners, while the members of the LLC take a more passive role within the Company, although not totally devoid of some authority regarding the LLC’s structure and operation. Member-managed LLCs, as you may have guessed, reserve the operational and managerial authority to the ownership or members. There are many situations where one is preferred over another, as decision making powers and ownership rights do not always, and should not always, be one and the same.

Another common type of entity structure, in fairly stark contrast to LLCs, are corporations, which are comprised of shareholders who own certain amounts of stock, of potentially varying types, and usually either a Board of Directors, various Officers, or both. A corporation can issue different types of stock, usually common and preferred stock, and the amount of stock owned by any one shareholder equals that shareholder’s ownership interest within the corporation. The different classes of stock carry different voting rights, so knowing the difference between the various classes is important. Management of the corporation is delegated to various officers established by the governing documents of the corporation, and those officers usually report to a Board of Directors and, ultimately, the shareholders. The U.S. Small Business Administration also offers more information regarding corporations.

If you’re looking to grow your company or you’re in need of investor capital, a corporation can often be the most advantageous option, as the opportunity to obtain preferred stock may entice investors to infuse capital within your corporation. If capital isn’t your problem, and you don’t anticipate the need to bring in outside personnel, then an LLC may be a suitable choice as membership interests are usually heavily restricted in their transferability and ownership.

Besides understanding the basic differences between the various entity types available to the budding business owner, it’s a good idea to familiarize yourself with the different tax implications that correspond to different entity types. The Internal Revenue Service provides useful information regarding these implications, and understanding these tax implications will undoubtedly play a major role in your choice of entity structure.

Although you have several decisions to make before forming your company, even a basic understanding of the requirements and characteristics of corporate entity structure will place you on the path to success. Please contact us for any questions you may have or assistance in bringing your business goals to fruition.