Starting an LLC in
Texas: The 5 Biggest
Mistakes To Avoid
Mistake #1
Doing business Before the LLC is Formed
Starting an LLC in Texas always
requires properly forming the Texas limited liability company before
conducting in any business activity. Liability protection
under Texas LLC laws do not kick in until the Texas LLC is formed.
You are personally liable for
any business activities or transactions that take place before your
LLC is formed. If your Texas LLC business becomes successful
even if years later, those early
acts could cause you to be subject to a personal lawsuit.
Many new business owners work on the other
business details before focusing on the Texas LLC laws and
requirements for starting an LLC in Texas. Once you have decided to start a business, it
is a much smarter move to form your Texas limited liability company at once and then have the
LLC engage in the other start up activities as opposed to you
personally. This is the best way to ensure your liability
protection.
Mistake #2
Failing to Actually Issue Ownership Interests after starting an LLC
in Texas
After starting an LLC in Texas
by forming one under the Texas LLC laws, many never actually issue ownership interests (known as
Membership Units) to the persons that are going to be owners of the
Texas limited liability company (known as Members). It can be easy for you mistakenly think
that because you created the Texas LLC, your are automatically the owner
of the Texas limited liability company.
The fundamental premise of an
LLC under Texas LLC laws is that it is its own separate entity. When
a person completes the formation process when starting an LLC in
Texas and the Texas limited liability company is formed by the
state agency, it does not automatically have owners and designated
ownership interests. Membership Units in the Texas limited
liability company
must be issued to the persons who will be the owners. This issuance
transaction needs to be in writing as best evidence under Texas LLC
laws.
The LLC Operating Agreement is
the typical place where a Texas limited liability company issues shares to Members and usually
the Members agree to contribute a certain amount of money to the
Texas LLC
for those Membership Units (this money obligation is known as a
Capital Contribution).
Make sure that after starting an
LLC in Texas, you complete this next step. It is vital to your
Texas limited liability company
business because an LLC once formed is a shell entity without any
ownership attributes until Membership Units are issued to Members.
Mistake #3
Failing to Create a Management Structure and Appoint Officers after
Starting an LLC in Texas
A Texas limited liability
company needs to have a
management structure. A management structure determines who has the
authority to make decisions on behalf of the Texas LLC. There are two
management structures discussed under Texas LLC laws. A member-managed LLC is when the members
automatically have the rights to operate and manage the Texas LLC
business. The second is a manager-managed LLC which creates a
corporate type structure. A Board of Managers is created and
persons who are appointed to that Board have the authority to run
the business. Every Texas limited liability company should appoint the officers (President,
Secretary, Treasurer) of the LLC.
The best place to create a
management structure and appoint initial officers is in the
Operating Agreement of the Texas limited liability company.
Even a single member LLC in Texas should have this document because
a single member LLC in Texas runs a higher risk of losing liability protection if
the Texas single member ignores the Texas limited liability company as a separate entity by not having a separate set of official
rules for the Texas LLC.
Remember, your Texas limited
liability company is a separate
and distinct entity and this is important to preserve the layer of
limited liability protection afforded by the LLC.
Now, the Texas LLC laws do have default management provisions that apply if
your LLC does not have an Operating Agreement, but those laws are
always changing, may not be ones you want for your business and they
can be difficult to apply. Plus, if you have other Members,
then disputes can arise as to what voting requirements, profit
allocations and other rules apply. Another great benefit of a
Texas limited liability company afforded under the Texas LLC laws is that the Members can decide
amongst themselves how they operate their LLC. Use a well drafted
Operating Agreement for your LLC and get all of your Members to sign
the Operating Agreement.
Mistake #4
Failure to Get Investment Obligations in Writing when Starting an
LLC in Texas
The Texas LLC Laws require that all agreements by a Member of a
Texas limited liability company to
contribute money to the LLC must be in writing. An oral agreement
is not enforceable under the law.
If you are planning on starting
a new Texas LLC business with other persons, you will likely get together and
decide on how much of the business each of you will own and on what
obligations each of you are agreeing to with respect to that
business. Obligations usually include how much money you are each
going to contribute to the Texas limited liability company business and what kind of services and
time commitment each of you will devote to the business.
At the beginning of a business,
these conversations take place and everyone agrees. An important
discussion is how much will the business require in money before it
can generate its own cash to operate the business. This amount is
known as start-up capital.
A typical conversation goes like
this:
Anne: “John, we are going to need $20,000 over the next
year to start this business. If we are going to each work equally
and you agree to put in $ 5,000 of the capital, I agree to issue to
you 25% of the ownership of the business.”
John: “Anne, that sounds fair. We will each work
equally in the business but because you will be contributing $15,000
and I will contribute only $5,000, the 75%-25% allocation makes
sense. Now, I am looking at our budget and most of the money will
not be required until 5 months from now when we will move into
office space and need to pay our vendors for products purchased- I
will contribute my $5,000 then- is that okay?”
Anne: “Sure, as long as we are in agreement as to
amount, I can front the initial expenses until the 5th
month and then the LLC will need your $5,000.”
Then John and Anne move forward
with starting their LLC in Texas and move on to running the business. . . forgetting to ever document the
agreement among LLC owners (known as Members) in any written
agreement. Five months later, Anne asks John to contribute $5,000
and he says he does not feel like he should contribute this money
because he has worked more on the business than Anne or. . . perhaps
he decided to invest the money elsewhere at that point.
This is a common situation that
a multi-member Texas LLC can find itself in. In this situation
the Texas limited liability company business and Anne lose out. Meanwhile John has received all of his
ownership interests in the Texas LLC and does not have to contribute the
rest of the money he orally promised. Any monetary or
services obligations need to be in writing to be enforceable under
Texas LLC laws.
Mistake #5
Thinking that an LLC is a Foolproof Layer of Liability Protection
Yes, once starting an LLC in
Texas with proper Texas LLC formation, it is established under the
Texas LLC laws that a
Member of a properly formed and maintained LLC is not liable for the
debts, obligations and lawsuits of the LLC merely by being a Member
of the LLC. But, in a realistic business context, persons who are
Members are usually not passive owners of the LLC. They are
also active managers and operators of the LLC business.
In today's litigious world, all
businesses should be run through a limited liability entity such as
a Texas limited liability company. The LLC liability protection is a significant
protection vehicle. However, the LLC layer of protection does
not extend to all potential liabilities that can arise in the midst
of running an LLC.
For example, you may be in a
company car driving to see a client when you are in an accident.
You will be personally liable for that accident regardless of the
fact that, at the time, you were working on behalf of your Texas
limited liability company
business. The Texas LLC laws do not cover personal negligence. You LLC
should always have insurance to cover these types of business
related accidents. Do not ever think that starting an LLC in
Texas and running the business through the LLC is enough to
protect you in these circumstances.
Similarly, there are some laws
outside of the Texas LLC laws that hold you personally liable regardless of whether you are operating through
a Texas limited liability company. The most obvious one that might apply is if you are a
licensed professional. Doctors, lawyers, accountants, real estate
brokers and dentists, for example, are always personally liable for
acts of malpractice. If you are a licensed professional, make sure
you get the proper insurance.
Also, there are certain tax,
environmental and securities laws that you can be held personally
liable for if your Texas limited liability company is in violation of those laws and you were
the responsible manager. Immediately after starting an LLC in
Texas, do your homework in performing the
administrative and other tasks of your LLC and retain the proper
professionals to advise you when appropriate.
Finally, you cannot use your
Texas limited liability company
to engage in fraud or hide behind the LLC to protect yourself when
you engage in fraudulent or unlawful acts. If you break the law or
try to defraud others, the law will hold you personally accountable.
* * *
In summary, the Texas limited
liability company is a
wonderful vehicle for providing Members with limited liability
protection. And, the most important first step to do is
starting an LLC in Texas with proper Texas LLC formation. But, in order to preserve that protection, you cannot
just form an LLC and then forget it exists. Make sure you do the
necessary things to honor your Texas limited liability company as a separate entity and also
know that the LLC should not be your sole means of protection- get
insurance when it makes sense and always invest in the required
knowledge for operating your business which includes getting the
right help when needed in your business!
