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Starting a business is exciting but also risky. A business owner must account for many legal and practical concerns en route to realizing their vision. The Small Business Legal Center at Justia points out some issues to keep in mind.
This month marks the 25th anniversary of a spectacularly shrewd (or perhaps spectacularly lucky) investment. In August 1998, two Stanford University graduate students met with Sun Microsystems co-founder Andy Bechtolsheim at the home of a Stanford professor. After hearing about the company that the students planned to form, Bechtolsheim made out a $100,000 check on the spot. The professor, David Cheriton, wrote a $100,000 check of his own. The students were Larry Page and Sergey Brin, and the company was “Google, Inc.”
Technically, “Google, Inc.” did not yet exist. Page and Brin celebrated their infusion of capital with a meal at Burger King and a trip to the Burning Man festival in Nevada. (The trip inspired the first Google doodle, a design based on the festival’s logo.) When they returned, they officially founded Google, and the rest is Silicon Valley history. Those $100,000 investments have turned into billions, making Cheriton probably the wealthiest academic in the world.
No matter how talented and dedicated they are, business owners will not get far without financing. This takes two main forms: debt financing or equity financing. Debt financing generally involves getting a loan from a person or an entity like a bank, while equity financing involves an investment like those that Bechtolsheim and Cheriton made in Google. Although business owners or their family and friends can make these investments, large-scale equity financing usually comes from venture capitalists. These investors funnel funds into startups when they are convinced that there will be a strong return on the investment. Sometimes a venture capitalist will demand some input on the management of the business in exchange.
Getting financing for a business is just one of the issues covered by the Small Business Legal Center in the Justia Legal Guides. This free resource also describes the potential structure that a business might take, further considerations in starting a business, and the process of managing and growing a business, among other topics.
Choosing a Business Structure
The business structure that you choose can have a huge impact on how your business runs and your potential liabilities. According to the IRS, the most common business forms are sole proprietorships, partnerships, corporations, and S corporations. In a sole proprietorship, one person is the sole owner of the business. These businesses tend to be easy to form, and paying taxes is simple because profits are considered the income of the owner. However, a key drawback is that a sole proprietor is personally on the hook for the debts of their business.
A partnership can arise when two or more people own a business together. The main type of partnership is a general partnership, in which each partner has the authority to act on behalf of the business and an equal right to its profits and losses. Each partner also is personally liable for all the debts of the business. Taxes on partnership income are passed through to partners and paid through their personal returns. Some partnerships are limited partnerships, though, which means that some of the partners are “limited partners” who do not have full decision-making authority and are not liable for business debts.
A corporation is a more formal type of business structure. The classic type of corporation is known as a C corporation. This entity is separate from its owners, who are not personally liable for its debts in most situations. Creating a C corporation requires going through certain formalities, such as setting up articles of incorporation and bylaws. The Small Business Legal Center provides a step-by-step guide for aspiring business owners in California, Florida, New York, Texas, Delaware, and Nevada, explaining the process of incorporating in each state.
C corporations are subject to “double taxation,” which means that they are taxed on their profits, and those profits are taxed again when they are passed to shareholders as dividends. Forming an S corporation avoids this problem because the profits of these corporations pass through the business without being taxed at that stage. Profits are taxed only when they are passed to shareholders or owners. However, S corporations must meet strict requirements. If a business or its owners cannot meet these requirements, they might consider a limited liability company (LLC), which may offer some of the same benefits while imposing fewer requirements. The rules for LLCs vary by state.
Further Considerations in Starting a Business
In addition to choosing the structure of their business, its owners will need to look into issues such as any licenses or permits that they may need to acquire. For example, a state may require people in certain trades or professions to hold a specific type of license to operate a business. (A well-known example is the cannabis industry in states where these products are legal.) Local zoning rules also might require a business to get a permit from the city where they are located.
Another important step in starting a business involves getting tax IDs, which are essential for any business that hires employees. Federal and state tax IDs are separate. The federal tax ID is a nine-digit number assigned by the IRS, which is often called an employer identification number. A business may need to get a federal tax ID before getting a state tax ID. While a state tax ID number is used only for state taxes, the federal tax ID number serves functions beyond paying taxes, such as opening a bank account for the business.
Business owners will want to consider which types of insurance they should get for the business. Typically, they will get property insurance to cover the physical facilities of the business. They also should get general liability insurance, even if they choose a business structure that largely shields their personal assets. Businesses with employees must get workers’ compensation insurance and unemployment insurance. If they are operating their business from home, a business owner should be aware that their homeowners’ insurance will not cover their business. They will need separate coverage for business-related risks.
Ongoing Legal Concerns
After setting up a business, its owners still will need to keep certain legal concerns in mind. If they hire employees, for example, they should understand how employee benefits work and decide whether they want to provide benefits beyond those that are legally required. They also must comply with federal, state, and local anti-discrimination laws and other provisions protecting employee rights. A business must understand the differences between employees and independent contractors so that they do not accidentally misclassify a worker as an independent contractor instead of an employee.
Most businesses will need to enter into contracts with other entities, such as suppliers or customers. They should know what makes a contract enforceable and how to use these instruments to protect their interests as fully as possible. Justia provides a detailed guide to making a business contract, describing the standard structure and commonly included provisions. Contracts involving the sale of goods are usually governed by the Uniform Commercial Code (UCC), which provides a distinctive set of rules.
Any type of business may encounter disputes with employees, consumers, or business partners. A former employee might bring a wrongful termination claim against the business, a consumer might argue that a product was defective, or a business partner might feel that a contract was breached. To reduce the risk of these disputes, a business may want to put the terms of its relationships with other parties in writing to the extent possible. If a dispute does arise, a business might try to negotiate a resolution rather than going through the expensive and time-consuming process of litigation.
Final Thoughts
Many people dream of being the next Larry Page or Sergey Brin, and starting a new business can be exhilarating. However, entrepreneurs cannot overlook the less exciting legal, financial, and practical concerns that could keep their business from getting off the ground. Someone who wants to start a business, especially if they have never done it before, should consider talking to a business lawyer about their needs and goals. Meanwhile, the Small Business Legal Center at Justia provides a general overview of key issues that can arise during this process. Like the other Justia Legal Guides, it aims to make the law transparent and accessible to all.
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