Five reasons not to incorporate in Texas
Everything is bigger in Texas, including the hurdles entrepreneurs face when incorporating.
Today, we'll take a deep dive into why incorporating in Texas might not be the best move for you and offer two fantastic alternatives: the Wyoming LLC and the Delaware C-corp.
Choosing the right state to incorporate in is key. Here's why:
Business is a bit like real estate—it's all about location, location, location. When choosing to incorporate, you need to be intentional about where you establish your business.
This is because different states have different tax laws, regulations, and incentives that can greatly impact your business. For example, Washington has no personal or corporate income tax.
When you choose the right state, you can save money, protect your assets, and set yourself up for long-term prosperity.
Why you shouldn't incorporate in Texas
While Texas may offer cowboy boots, big hats, cheap land, and football, it might not be the best choice when it comes to incorporating your business. Here are a few reasons why:
Restrictive franchise tax laws: Texas imposes a distinctive franchise tax that can affect your profits. Rather than being calculated directly from your total revenue. It's based on your margin. This can be determined by a couple of different methods:
- Total revenue times 70 percent;
- Total revenue minus cost of goods sold (COGS);
- Total revenue minus compensation; or
- Total revenue minus $1 million
Option 2 is a much simpler calculation, and it may also lead to a lower tax bill—especially if your business has high margins. At the same time, Texas is still less favorable compared to states that don't have a franchise tax at all.
Investors, mainly VCs, prefer Delaware corporations: Venture Capitalists (VCs) and other investors tend to lean heavily toward Delaware corporations. A few key reasons contribute to this preference:
Delaware's business-friendly statutory laws and precedents: Delaware has robust, business-friendly statutory laws and precedents. Its extensive corporate law history minimizes legal ambiguities and offers high predictability in corporate governance practice and contractual interpretations.
Proficiency in Delaware corporate law: Almost every corporate lawyer is well-versed in Delaware law due to its dominance in corporate America. This proficiency can expedite responses to legal queries, saving both time and money.
Potential ambiguities in Texas law: In contrast, incorporating a company in Texas could lead to potential ambiguities in the state's business governance and contract interpretation. Legal professionals might need to conduct extensive research to answer certain questions, which could lead to additional fees.
Delaware's pro-business laws: Delaware's pro-business laws usually enable courts to defer to the business judgments made by a corporation's officers and directors, barring gross negligence or self-dealing.
Increased investor confidence: Delaware's strong pro-business legal environment contributes significantly to investor confidence. Investors, particularly VCs, often highly value predictability in their investments. Delaware's corporate law, known for its stability and predictability, provides a clear legal framework within which businesses operate.
Limited flexibility in corporate governance: When it comes to corporate governance in Texas, strict rules and regulations like the Texas Business Organizations Code (TBOC) exist. This code provides the basic regulations for governance structures for Texas businesses.
High costs for incorporating and maintaining a business: Operating a business comes with its fair share of expenses, and in Texas, those costs can add up rather quickly. From filing fees to annual fees and taxes, it's important to be aware of the financial implications when incorporating and running a business in the Lone Star State.
Filing fees: Texas charges a filing fee for the required paperwork to establish a corporation, limited liability company (LLC), or limited partnership (LP). For example, filing a Certificate of Formation for an LLC has a filing fee of $300.
Annual report fees: Nonprofit corporations in Texas must file a periodic report (Form 802) with a filing fee of $5 plus late fees, if applicable.
State and local taxes: Besides the franchise tax, Texas businesses are responsible for a 6.25% sales tax on top of other state and local taxes.
Weak asset protection laws: Asset protection laws are a key consideration in choosing where to incorporate a business. While Texas has implemented the Uniform Fraudulent Transfer Act (UFTA), similar to other states, Texas' UFTA, found in Title 3, Chapter 24 of the Texas Business and Commerce Code, provides particular protection to creditors, which can potentially expose businesses to certain risks.
Texas' version of the UFTA works by preventing a debtor from moving assets to avoid a debt obligation, thereby ensuring that the creditors' ability to recoup their investment or loan is protected. It prohibits any transfers done with an intent to hinder, delay, or defraud any creditor of the debtor. This law essentially protects a creditor's claims against a debtor, possibly putting business assets at risk.
While the law is designed to prevent fraudulent asset transfers, its enforcement could potentially make your business assets more vulnerable than they might be under the asset protection laws in states like Delaware.
When it makes sense to incorporate in Texas
While Texas has some clear drawbacks with respect to incorporation, that doesn't necessarily mean it's a bad idea. Many business owners are happy with their Texas entities and find that it's the best option for them for one reason or another.
The most obvious situation in which we would recommend incorporating in Texas is if you live and/or operate your business there.
For example, if you're a landlord running properties in Texas, it may be ideal to set up a Texas LLC and minimize complications. In this case, we also recommend acquiring landlord insurance in Texas.
Better alternatives: Wyoming LLCs and Delaware C-corps
Wyoming and Delaware are two US states known for their business-friendly laws. If you're an entrepreneur looking to incorporate, these are two options worth considering. Here's why:
Wyoming LLCs
Stronger asset protection laws: Wyoming prioritizes protecting your assets with solid laws, ensuring your personal finances stay as safe as a well-trained cowboy on horseback. For example, Wyoming's strong asset protection laws offer comprehensive exemptions covering personal properties, business tools, and homestead exemptions for up to $10,000 of the homeowner's equity.
Greater anonymity: If you prefer to refrain from broadcasting your business ownership, Wyoming has your back. Unlike Texas, Wyoming doesn't require LLCs to disclose their members' names or addresses.
Lower costs and no state income tax: Wyoming offers low startup and maintenance costs. Plus, the cherry on top? No state income tax!
Delaware C-corps
Flexibility and funding opportunities: Not only is Delaware an investor favorite, but incorporating in Delaware provides businesses with more flexibility in structure than Texas.
Delaware understands the need for flexibility in structuring your company. Its corporate laws accommodate various business models, allowing you to make important decisions without leaping through hoops.
For instance, in Delaware, the directors are allowed to have different classes with different voting rights, which can help to customize the power balance within the corporation. Plus, Delaware corporations may take action without the need for a meeting as long as written consent from a majority of shareholders is secured.
Texas corporate law, on the other hand, maintains a more rigid structure; it requires an annual shareholders meeting and doesn't allow for the same breadth of action by written consent.
These differences lend Delaware corporations a level of flexibility and adaptability that Texas corporations may not experience.
Plus, as a hub for venture capital and other funding opportunities, Delaware can propel your business growth.
Legal and liability protection: Delaware's well-established corporate laws provide top-notch legal and liability protection for your business. Think of it as a bulletproof vest, ensuring you're well-guarded.
Tax savings and incentives: Say goodbye to those excessive tax bills! Delaware offers enticing tax savings and incentives, especially for businesses operating outside the state. Who doesn't love a little extra cash in their pockets?
For example, businesses incorporated in Delaware but operating elsewhere can enjoy no state corporate income tax on goods and services provided in Delaware, and no business license is required for most corporations. In addition, there is no state sales tax in Delaware.
Privacy protection: Want to keep your personal information private? Delaware has your back. Rest easy knowing your information is safe.
For example, a tech startup registered in Delaware doesn't need to reveal personal owner information like names, addresses, or social security numbers on the public incorporation documents in Delaware, offering more privacy than companies incorporated in, say, Texas, where this information might be more accessible.
While Texas isn't always the right choice, Firstbase can help you find the right state for your business.
No matter where you are in the world, Firstbase makes incorporating in the USA easy. We'll help you find the perfect corporate structure and state for your startup, support you through paperwork headaches, and connect you with a network of professionals dedicated to helping you succeed.