There are over 30.2 million small businesses running in the USA, and every year, a new set of ambitious, driven entrepreneurs set out to join them on their own promising ventures.
But navigating the business of starting a business can be tricky, particularly from a legal perspective. So, if you haven’t done this before, or just want to brush up on the process, we’ve outlined a few things you need to know, as an aspiring small business owner.
Here are the major legal requirements for starting a small business.
Entity Formation and Protection of Personal Assets
Legal entities offer several benefits for their owners. Among the most important is limited liability. The best way to protect your personal assets from your business debts & liabilities is by forming a legal entity.
A legal entity, if used properly, can offer the following:
- Limited Liability protection from business debts & liabilities
- Tax Advantages (write-offs and business deductions)
- Longevity (an entity can last in perpetuity)
We outline a few types of legal entities below. They each have advantages and disadvantages, and you should speak with your tax advisors in conjunction with a corporate attorney to help you decide which entity is best for your situation.
Types of Legal Entities
Depending on the kind of business you run, you can choose to register as different types of entities. Here are a few of your choices.
A corporation is a business entity owned by shareholders. Shareholders typically elect a board of directors to oversee the organization’s activities.
C Corps are the traditional “corporation” and have a long history of use in business. C Corps are typically used for larger organizations or corporations that are publicly traded. C-Corps pay tax on the corporate level and on the distribution to the shareholders (i.e. double taxation).
Subchapter S corporations (S Corps) are typically closely held businesses. S Corps receive pass-through taxation and thus avoid double taxation. However, S Corps are subject to more restrictions such as shareholder limits and corporate formalities.
A Limited Liability Company
A limited liability company (or LLC) is run by its members (or managers). LLCs are the easiest to set up and maintain, especially for single-members, and also receive pass-through taxation. However, it’s very easy to break the corporate form as a single-member LLC, and thus requires discipline to operate properly.
If your business is classified as a sole proprietorship or a partnership is not considered a separate entity.
Now, while a legal entity will offer limited liability, you need to keep proper records and corporate formalities. This includes maintaining the proper financial records and using your company name on all legal documents. If certain corporate formalities are not maintained or abused, court can “pierce the corporate veil” and strip you of your limited liability.
Getting the Right Kind of Insurance
Depending on what state you operate in, you may be legally required to carry certain kinds of insurance such as commercial general liability or worker’s compensation. A failure to get proper insurance can have both legal and financial repercussions that may be insurmountable for a new or young business.
For example, the average worker’s compensation claim is around $40,000, while the average data breach in the U.S. costs $8.19M. It’s easy to see why investing in the proper insurance is advisable from a legal standpoint.
Evaluate the Brand Name and Protect IP
It’s important to do your due diligence before registering your business. This includes making sure that your brand name and/or logos aren’t already in use by someone else. You can file trademark applications for your designs, logos, and names with the U.S Patent and Trademark Office.
Small businesses are particularly vulnerable to having their inventions and intellectual property stolen. That’s why, in addition to getting a registered trademark, be sure to get applicable copyright and/or patent protection for other types of IP including books, software code, inventions, or other original creative material.
Before you can do any of that, you should ensure you’re the true owner of the IP. If you work with an artist, designer, or creator, you should make sure they sign a work made for hire agreement (or something similar) to assign their rights in the IP to either you or your business.
Applying for an EIN
EIN refers to “Employer Identification Number”. In a nutshell, it’s your business’s social security number. You can get an EIN online through the IRS website, or with the help of a business attorney. You especially need an EIN if you run a business with employees, or if your business is registered as a corporation or LLC.
An EIN enables you to open business bank accounts, file your tax returns, and apply for business licenses you may need.
Business Contracts and Agreements
Before you start a business or during the early stages, make sure all your paperwork is in check. This includes having proper business contracts and agreements in place.
Some important business contracts include:
- Non-Disclosure agreements which protect confidential information.
- Employee agreements outlining the scope of employment, payment terms, benefits, and other items.
- Master Service Agreements (MSAs) for service providers
- Distribution Agreements to for your distributors
- Software Licenses or SaaS Agreements
Remember, ambiguity in a contract will typically be interpreted to favor the party that did not draft it. It is beneficial to hire a legal team to draft or at least proof-read your proposed business contracts and other third-party agreements.
Doing your due diligence at the start will save you a lot of unnecessary complications in the future.
State Licensing and Industry-Specific Needs
Depending on the kind of business you’re running, you may have industry-specific requirements to take care of. This includes getting the necessary health permits, land use permits, state business operating licenses, and more. Some examples include liquor licenses, home improvement contractor licenses, barber licenses, and distribution licenses.
Are There Other Legal Requirements for Starting a Small Business?
This list of legal requirements for starting a small business is not exhaustive. That’s because different businesses come with their own needs. Be sure to read up on your state laws to get a more holistic view of what applies to your business and niche.
Schedule a consultation with our business attorneys for personalized advice on your industry and state-specific requirements.