Important Legal Considerations for Starting a Business
Starting a business can be an exciting and challenging pursuit. Taking the time to address important legal considerations will help prevent costly mistakes and ensure compliance with applicable laws.
Forming a legal entity is essential for many businesses. This step creates a legal separation between the business and its owners, protecting them from personal liability. Other important requirements include obtaining necessary licenses and permits.
Legal Issues for Startups
When a company is in its early stages, it needs to take several legal issues into account. These include choosing a business entity, complying with government regulations, protecting intellectual property rights and drafting agreements with founders or employees.
Startups need to carefully consider the various legal entity structures available, including LLCs, C corporations and limited partnerships. Each offers different benefits, including liability protection from business creditors and tax savings through deductions and other treatment available only to corporations.
Companies need to be in compliance with securities laws when offering shares and reorganizing business capital funds. Failure to do so can result in substantial financial penalties, including the requirement to repurchase shares sold to investors in violation of the law.
Businesses should create a written founders’ agreement and a vesting schedule upon incorporation that will stipulate that equity will be vested in increments over time, preventing the founders or early employees from selling their shares to third parties at will. This can prevent disputes between founding members and save valuable time and resources.
Business Entities
In order to start a business, entrepreneurs must first determine the company’s legal structure. This decision has significant implications. Choosing the correct entity allows startups to establish a legal distinction between their company and its owners, protect them from personal liability for business debts and obligations and allow them to take advantage of certain tax benefits.
Generally, there are four different types of business entities: corporations, limited liability companies (LLCs), partnerships and sole proprietorships. The decision on which one to choose is based on several factors, including the level of liability protection, tax treatment and registration paperwork requirements.
Corporations have the greatest level of liability protection. They also offer flexibility in terms of the number of shareholders and transferring ownership. Lawyers, accounting firms and doctor’s offices often organize as C corporations. Limited liability companies are similar to C corporations but are more flexible and less expensive to set up. Partnerships are typically used by businesses with two or more owners and require an agreement by all partners.
Licensing Requirements
When starting a new business, entrepreneurs often have a long list of tasks to complete before opening the doors. These include selecting a name for the company, registering with the IRS and getting all of the proper licenses. Failing to meet these legal requirements can result in fines and even the shutdown of the company.
In addition to creating a legal entity, startups need to make sure they comply with federal, state and local licensing requirements. These vary based on industry and location, but can include sales tax laws, employment regulations, environmental laws and zoning rules.
At the federal level, companies must obtain a tax identification number, known as an Employer Identification Number (EIN), to pay taxes and apply for certain types of licenses and permits. In most cases, the EIN is also required when opening a bank account or hiring employees. This is one area where the assistance of a skilled business attorney can be beneficial.
Taxes
In addition to legal considerations, startups must comply with tax regulations and employment laws. This requires careful planning so that the company can operate without violating any applicable laws.
The structure of a business has a major impact on taxes, personal liability and control. Entrepreneurs should consult a lawyer for expert advice when choosing a legal entity.
Various forms must be filed for each type of business. Sole proprietorships file schedule C with their personal taxes, while S corporations and LLC’s file separate business tax returns. Depending on the business type, there may be a requirement to withhold and report employee income taxes.
Recording business expenses accurately is crucial to reducing the amount of taxes owed. Founders should also be aware of differences between personal and business expenses, including when to claim them. The American government offers many tax deductions to stimulate startup costs and operating expenses. These can save entrepreneurs thousands of dollars in taxes on their full-time wages.