When starting a new business, it’s important to make sure the venture is complying with all the legal obligations of running a business in the area in which it’s located. There are a range of legal requirements for new businesses and start-ups, including financial regulations, tax obligations and employment laws. It’s important to make sure the new company complies with all its legal responsibilities so the focus can be on growing the business.
The first legal requirement is to choose the structure of the company. The different types are explained below.
A sole proprietorship is the is the easiest and quickest to form. This form gives complete control of the company to the entrepreneur. It’s also the most dangerous because it does not separate business assets and liabilities from your personal assets and liabilities. This means the entrepreneur can be held personally liable for debts and obligations of the business. The temptation to use business funds on personal expenses is also present which is not good business practice for growing companies.
However, it’s a good choice for low-risk businesses that just want to test out their ideas before forming a more formal business.
An LLC protects the owner from personal liability under most circumstances. This means that if your business is sued or if it declares bankruptcy, your personal assets including your home and vehicle will not be at risk. With an LLC you’ll be able to file your business income as part of your personal income taxes, but you will likely need to pay self-employment tax.
A corporation, or C corp, is a company that is legally a separate entity from its owner or owners. Corporations offer the greatest level of personal protection from liability out of all business structures. However, they’re more expensive and complicated to form. Corporations file separate income tax on their profits.
An S corporation, sometimes called an S corp, is a special type of corporation that’s designed to avoid the double taxation drawback of regular C corps. S corps allow profits, and some losses, to be passed through directly to owners’ personal income without ever being subject to corporate tax rates. However, all areas tax S corps differently. Some countries tax S corps on profits above a specified limit and others do not recognize the S corp election at all, simply treating the business as a C corp. Just like C corps, if a shareholder leaves the company or sells his or her shares, the S corp can continue doing business relatively undisturbed.
A benefit corporation, sometimes called a B corp, is a for-profit corporation. B corps are different from C corps in purpose, accountability, and transparency, but they are taxed the same. Shareholders hold the company accountable to produce some sort of public benefit in addition to a financial profit. Some states require B corps to submit annual benefit reports that demonstrate their contribution to the public good.
Close corporations resemble B corps but have a less traditional corporate structure. These shed many formalities that typically govern corporations and apply to smaller companies. They vary, but shares are usually barred from public trading. Close corporations can be run by a small group of shareholders without a board of directors.
Non-profit corporations are organized to do charity, education, religious, literary, or scientific work. Because their work benefits the public, non-profits can receive tax-exempt status, meaning they do not pay state or federal income taxes on any profits it makes. However, they must file with the IRS to get tax exemption. Non-profit corporations need to follow organizational rules very similar to a regular C corp. They also need to follow special rules about what they do with any profits they earn. For example, they cannot distribute profits to members or political campaigns.
Partnerships are the simplest structure for two or more people to own a business together. There are two common kinds of partnerships: limited partnerships (LP) and limited liability partnerships (LLP).
Limited partnerships have only one general partner with unlimited liability, and all other partners have limited liability. The partners with limited liability also tend to have limited control over the company, which is documented in a partnership agreement. Profits are passed through to personal tax returns, and the general partner — the partner without limited liability — must also pay self-employment taxes.
Limited liability partnerships are similar to limited partnerships, but give limited liability to every owner. An LLP protects each partner from debts against the partnership, they will not be responsible for the actions of other partners.
A cooperative is a business or organization owned by and operated for the benefit of those using its services. Profits and earnings generated by the cooperative are distributed among the members, also known as user-owners. Typically, an elected board of directors and officers run the cooperative while regular members have voting power to control the direction of the cooperative. Members can become part of the cooperative by purchasing shares, though the amount of shares they hold does not affect the weight of their vote.
Practical steps in getting your Company legal
The various types are explained above.
An entity name: legally protects your business.
A trademark: legally protects your business.
A DBA (Doing Business As): doesn’t offer legal protection, but may be required, depending on your location and business structure
A domain name: claims your business’s web address
You will need to apply for business licenses and permits at the state government level, but the specific licenses you need depend on the industry and business location.
Business insurance can protect you in cases where the personal liability protections offered by your specific business structure are not enough. Business insurance can protect not just your personal assets, but your business assets as well. Some types of insurance are required by law, such as unemployment and disability insurance. It’s also a good idea to purchase business insurance to protect your start up from other potential risks. Some common business insurance options include:
General liability insurance: Protects your business from various forms of financial loss, including property damage, injury, medical issues, lawsuit settlements or judgements
Product liability insurance: If your business sells products, this insurance protects you in the case that one of your products is defective and injures a customer
Commercial property insurance: Protects your business from loss or damage to company property, as a result of natural disaster, accidents or vandalism
From a legal perspective, it’s important that you separate your personal and business finances before you start collecting payments from clients.
Make sure the area you are looking at is properly zoned for the type of business you plan to operate. Ask local government bodies to be certain that you can open your business in that area. Looking at other business in the location cannot be the basis because those businesses may have exemptions.
If the business will be working with a bank or other partners for business financing or entering into contracts with suppliers, make sure you have the right confidentiality and non-disclosure agreements.
These parties will have access to business information that you may want to keep private and, as such, you should consider preparing these contracts. Make sure your partners and suppliers sign them as well.
Invest plenty of time, energy and money in finding the right legal experts to help protect your business, and your new company will be up and running in no time.
Starting a new business and growing it to a successful entity may seem daunting. However, if others have done it so can you. All you need is the right information to set you up for success. Some businesses may be small and the vision is to keep it small. Some of you may have a big dream, either way staying on the right side of the law is necessary. Look out for our videos and podcasts with further information regarding the various processes and stages.