First Steps: Exploring Business Types
You’ve got a great idea you think will catch on in the market. So now what? You begin materializing things. Among the basics of setting up your new business in Texas is getting the business type down. This may seem simple – and in some ways, it is – but that doesn’t take away from its importance. Understanding each of the several options you have is critical to making the decision that best suits your needs and positions you for success.
By far, the most common entity type is the tried-and-true LLC. Whether you’re concerned with filing taxes or creating the actual entity, they’re just really easy to maintain overall. You don’t need to file many documents for it, for starters.
Typically, I find that my clients start as LLCs but eventually switch to C-Corp status once they get investors. Why? A corporation is likely a better fit for entities that are a little more robust or mature. This allows for a more complex and formal governance structure, as well as the ability to issue stock. A common benchmark wherein companies will make this switch if they haven’t already is securing venture capital funding.
Most small businesses don’t ever need to do this — and that’s completely fine. They are born and die as an LLC. One reason for this is that you can elect to be taxed as an S-Corp even if you continue to grow as an LLC. Contrary to what you might first assume, an S-Corp is not an entity type but is more of a tax election. This trips up a lot of people, and understandably so. You don’t file as an S-Corp; your accountant or CPA helps you elect to tax your entity as such.
There are some limitations to S-Corps, namely that the number of shareholders is usually capped at around 75. Despite this restriction, S-Corp status can be advantageous, depending on your exact circumstances and specific needs. Companies tend to only begin considering electing S-Corp status once they generate $100,000 in net profit a year. It’s at this point that the benefits outweigh the cost, and maintaining S-Corp status can be pretty expensive.
Likewise, you’ll likely only really consider filing as a C-Corp once you meet a specific threshold where the benefits outweigh the costs. A difference here is that there isn’t a threshold of shareholders, restrictions on the type of shareholder, or a limit on stock class that you can make use of. Furthermore, unlike S-Corps, which are limited to American citizens and legal residents, C-Corps can accommodate international and foreign shareholders, offering a broader scope for investment and expansion.
Finally, I want to make an important note: Most people tend to think they can do business as a sole proprietor, but I rarely recommend taking this approach. This is because, when you’re a sole proprietor, you’re exposed to a lot of personal liability – and a DBA filing doesn’t offer any further coverage. Sole proprietorships simply don’t offer the umbrella of protection available to you with other entity types, and as a result, your assets are left totally at risk. So, I highly recommend spending the less than $500 it would cost to get an LLC filing set up.
Changing Business Entity Types
I constantly get notices of changes to business entity types. This is the first step in the process — letting your lawyers know that you want to make this change or that you have already initiated the process. Several factors typically prompt the carrying out of these sorts of changes, but the two most common and pressing ones are getting investors and experiencing increases in revenue since choosing your tax election is typically the driving force of the entity type and tax status.
Addressing trademark issues when moving forward with these changes is also important. You will likely have fillings that need to be updated, as well as an assignment, so make sure that the old entity assigns the new one. What’s more, changing your entity type means you will need to transfer all other IP rights you have as well. This translates to your registration being up to date with the U.S. Patent and Trademark Office and searchable by others, putting the public on notice that the new entity now owns the trademark, not the old LLC.
The same is true of any contracts you have. For example, let’s say you have a handful of independent contractor or employment agreements – these will need to be renewed. Typically, an assignment clause will exist in the original agreement that states how the terms of the agreement should survive any new assignments. Put more simply, this just means that you need to have a valid assignment in place so that all of the rights of the original entity, the LLC, are transferred over to the corporation so that you don’t have to have them re-signed. And remember: If you sign your original agreements as an LLC, make sure that those agreements have the proper language for situations like this.
Selecting The Right Business Entity For A New Venture
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