Small businesses in the US are thriving. The total number reached over 30.2 million in 2018. While there is no shortage of advice for those looking to start a business, startup founders often are still in the dark when it comes to common legal issues. Here is a curated list of legal tips for startups to help you succeed in 2019.
“Lawyers are sometimes asked by those intending to start a business when to hire a lawyer. I like to compare the situation to when you should see a doctor. Many people dread the idea and want to put it off (particularly as they get older). But the conventional wisdom in both cases is that going early may be a bit painful, but going too late can be deadly.”
Edwin L. Miller Jr. “Lifecycle of a Technological Company”
Choose the best business structure for your startup
Here are the most common forms of structure for startups and what you should know about them:
- Sole proprietorship: The fastest and cheapest way of starting a business. Caution: this is also the only structure where you will be personally liable for all business debts.
- Partnership: You can either create a general partnership (where you will still be personally liable for business debts) or a limited liability partnership (where the burden of debt cannot be more than your share in the business). You should also know that one partner can act on behalf of all partners.
- LLC: An LLC is a hybrid between partnerships and corporations. LLCs provide the best of both worlds. You’ll pay lower taxes than corporations while still being protected from liability.
- C Corp: (Or a regular corporation) will protect you with its limited liability status. This comes at the cost of increased difficulty in securing loans (without a personal guarantee), administrative and legal burden, and less privacy. You’ll also pay taxes on the profits of the company (corporate tax) and then taxes on your share of profits as well (income tax). Johnathan Rees calls this a “double whammy” in his book, Do Protect: Legal Advice for Startups.
- S Corp: S Corps enjoy the benefits of limited liability while being free from federal income tax. Shareholders are taxed upon their allocated share of the income.
- Nonprofit Corporation: Nonprofit corporations can get tax-exempt status by filing with the IRS. However, they still have to comply with most of the rules of corporations as well as special rules regarding how the profit is used/distributed.
For help choosing the right business structure, you can visit www.sba.gov to review the various business structures available to you.
Name and protect your business and products
Each business structure has its own set of rules and regulations. For instance, most states prohibit and limit the use of certain words in corporate names. Words like banking, cooperative, trust, United States, insurance, pharmacy, national, medical, Olympic, etc. are restricted.
You should be able to find the complete list of these words on most of the secretary of state websites or by contacting the office where you will file for incorporation.
Another thing to note is that your state filing office may accept your business name even when it’s trademarked, as filing offices do not check state or federal trademark registers.
Here are some helpful tools for this stage of your startup:
- TrademarkNow: Get a list of names already trademarked as well as any risk factors associated with your name.
- Binded: A simple blockchain based software that will copyright your image for free.
Get necessary licenses and permits
Depending on your business, you may need to obtain one or more licenses and permits from different levels of government.
Let’s start with two tax registrations at the federal level. First is the Employer Identification Number (EIN). It’s highly recommended that you apply for EIN, though sole proprietors and single-member LLCs may use their SSN in place of EIN. The other tax registration is Form 2553, only for those who want to elect status as an S corporation.
You must research and find out the details of each permit or license that you need. A good place to find out about your state requirements is www.sba.gov where you can find a list of small business assistance agencies in your area.
You will most likely need to get permits/licenses if you’re dealing with food, liquor, or firearms or hazardous materials.
Prepare documents and evidence by calling state agencies related to your field and finding out what they require.
Get your taxes in order
No matter whether your business is organized as a sole proprietorship, partnership, corporation, or limited liability company, you’ve automatically got a silent partner: Uncle Sam.
– Attorney Fred S. Steingold, author of Legal Guide for Starting & Running a Small Business
There are three main business taxes that can apply to your business:
- Income tax: You’ll have to report your business income in your annual federal tax return. Different businesses will have to use different forms. Note that manufacturing businesses can be eligible for a significant tax deduction.
- Employment tax: There are quite a few employment taxes, also known as federal payroll taxes. Most of these involve withholding a part of the employees’ paychecks and paying them to IRS periodically.
- Self-employment tax: If you receive a salary or bonus for playing a significant part in the operations of your business, you will be considered an employee and will have to pay self-employment tax. This is separate from employment taxes but quite similar. Here’s a more in-depth explanation.
There are quite a few services and software that can help you with calculating and paying your employment taxes on time. Here’s a list.
Prepare to be audited
Small business owners are three times more likely to be audited by the IRS and in 80% of those audits, the business ends paying more. Keep Uncle Sam happy by recording everything.
A great resource to start your research about the taxes you’ll have to pay as a small business owner is the Small Businesses Self-Employed section found on the IRS website.
Here are some tools you can use to keep things organized and safe:
- Clerky: One of the best online software to file paperwork and be on top of important documents.
- Mint: A budget tracker and planner software for bills and business expenses.
- QuickBooks: One of the most popular accounting software among small business owners.
Finance your business and raise capital
Whichever way you choose to raise capital, be sure to document everything. Even gifts from family members and supporters as you can save on taxes.
If you have a business plan (which you should), you can start raising capital. The 12 most common methods of raising capital for startups are:
- Personal Salary
- Personal Savings
- Equity in Your Home
- Retirement Savings
- Credit Cards
- Buying on Credit
- Friends, Relatives, and Business Associates
- Banks loans
- Other Commercial Lenders
- Venture Capitalists
You can also look into SBA’s loan prequalification program if you belong to a demographic that has traditionally been underserved by the banking sector. Contact an SBA expert to improve your loan application.
Get business insurance
It’s recommended that you look for a single insurance agent (aka insurance broker) who isn’t tied to any one insurance company. You want them to look at different vendors for quotes. When choosing an insurance policy:
- Look for multiple agents and don’t be afraid to ask for quotes.
- Make sure the insurance company is in good financial condition.
- The policy should cover all current and expected assets. In certain cases you may have to pay additional premiums.
If you’re manufacturing or selling a product that can injure the user, consider product liability insurance to protect yourself from litigation and damages.
If you’ve hired employees, you will have to buy workers’ compensation insurance (or some form of it) to cover injuries in the workplace.
If you need to make a claim, start gathering evidence (pictures of the damage and receipts of assets you’ve lost). Time is of the essence so take action quickly. You can also create a comprehensive list of your property beforehand to aid you in the unfortunate event of losses.
Know the zoning laws
50 percent of all small businesses in the US are home-based. Before you set up your business in your home, you need to research the zoning laws of your area. They will decide the extent of business activities you can carry out inside your house.
Some laws may allow light or even heavy manufacturing while some may restrict or outright prohibit home-based businesses. This can be the case in more affluent neighborhoods with tighter regulations.
If you’re only planning to use a small room of your house as an office that doesn’t look out of place, you’ll be fine. Be sure to see if you can write off your home office when tax season comes around. But if you’re going completely rework your house to accommodate new business needs, you may attract an inquiry into your business from your local zoning officials
Try talking to other local businesses to see what they’ve found while setting up their own businesses.
Use business contracts
You WILL enter contracts, either oral or written. Here’s what you should know:
- If it’s important, get it in writing. Oral contracts are much harder to enforce in court.
- Contracts can be unfair but not illegal, so think carefully before entering into a contract.
- Misrepresentation or mistakes can be grounds for cancellation of the contracts.
- Contracts that you “can’t say no to” or those that you are forced into are not legally enforceable.
- If both parties have lost a signed contract, it can still be enforceable. In this case, you’ll need to “prove to the satisfaction of” a judge or arbitrator that the contract was signed contained the specific terms you’re trying to enforce.
- If you’re about to enter a large transaction, hire a lawyer from your field. Have them read through the contract first.
Here are some tools you can use to write, send, and review contracts:
- Shake: Easily sign and send legally-binding agreements for free.
- LegalSifter: Use a powerful artificial intelligence system to review your contract and find what’s missing.
Understand how to deal with legal disputes
Fighting legal disputes is often the most expensive method of resolving a dispute. You may or may not achieve the results you want. Litigation isn’t your only option. Non-courtroom approaches like negotiation, mediation, and arbitration can save you thousands of dollars, headaches, and lost business.
Before saying “I’ll see you in court!”, try to settle the dispute by negotiating or mediating. Mediations are negotiations where an unbiased third-party facilitates the negotiation by giving advice. Some lawyers call them “turbocharged negotiations”.
Your final non-courtroom option is arbitration. With arbitration, an arbitrator or a panel will hear the case and make a final, legally binding decision but the process is much quicker while being less expensive than an actual court hearing. Fred Steingold advises considering arbitration when dealing with employment disputes.
If you’re looking for an arbitrator or a mediator, you may contact the American Arbitration Association or JAMS, or U.S. Arbitration & Mediation. You (or your opponent) can also hire your own arbitrator.
BONUS: Find the right lawyer
During the course of your business, you will require a lawyer’s services time and time again. However, only a small minority of these lawyers have sufficient experience working with small businesses. Fred Steingold advises against using lawyer directories, websites, and advertisements as your only source of information. Instead, go out and talk to your community of small business owners and look for referrals to create a list.
Find a lawyer who knows your business and is interested in it. Someone practical enough to understand how a business works and can help you capitalize on opportunities.
The other most important thing to note is the fees. Lawyers can charge hundreds of dollars an hour which can compound quickly into some hefty bills. Here are some tips on saving money on lawyer fees:
- Group your legal issues together and consult your lawyer in one go.
- Use nonprofessional help when you can. For instance, you or your employees can gather evidence, review receipts, write drafts, etc.
- Brush up your legal knowledge of your trade and ask your lawyer to be a coach.
- Maintain a good client-lawyer relationship and know your rights.
Here are some services focused on the legal needs of startups:
- RocketLawyer: Get access to millions of free legal documents, advice, and information.
- Upcounsel: UpWork but for lawyers. There are more than 5,000 experienced lawyers on this platform ready to give you advice and look over legal documents.
- StartupLawyer: Another service like RocketLawyer that provides information on a wide of legal topics related to startups.
The services we’ve mentioned are all great and plenty of businesses vouch for them. But nothing beats traditional face-to-face counsel. If you’re about to start talking to investors and potential business partners, you may want to look at a trusted firm like Walker Corporate Law.
Here are some links to the books that we used during research. We recommend reading them to get discover additional legal tips for startups.