The value of setting up your business correctly, and preemptively covering your legal bases, cannot be overstated. As a small business owner, you may not want to spend the money on legal fees on the front end — but on the back end, it can save you a lot of heartache, time and significant costs.
For startups, the most critical legal issues revolve around the following:
- Selecting the best legal business structure
- Creating contracts that serve you
- Signing an appropriate lease agreement
- Protecting intellectual property (IP)
- Handling independent contractors
First, you need to make sure that your personal assets — which you work so hard to amass — will survive a business mistake. In case of a dispute or lawsuit, the legal structure of your business can protect your personal assets from attachment. Therefore, it’s critical that you incorporate or organize your company, instead of operating as a sole proprietor or partnership DBA (doing business as). Individuals and firms use DBA when the name they operate under differs from their legal name, for example Henry Smith DBA Smith Construction.
In case of a dispute or lawsuit, the legal structure of your business can protect your personal assets from attachment.
Additional risks that an attorney can help you with:
- Personal liability arising from a customer, vendor or landlord lawsuit
- Lowballing the value of your assets
- Ineligibility for government contracts or funding
Corporation or LLC?
When your business is operating as a sole proprietor DBA, you’re personally liable for business debts. As a general partnership DBA, if your partner is sued, you could be held personally liable for their obligations. Furthermore, some organizations will only enter into contracts with legally separate entities, leading to opportunity exclusion.
Given the importance of operating under a formal legal structure, which structure is the best? All legal structures require filing the proper documentation and paying the applicable filing fee. Establishing a corporation requires articles of incorporation, while a limited liability company (LLC) requires articles of organization.
Some organizations will only enter into contracts with legally separate entities, leading to opportunity exclusion.
- LLCs are generally easier to establish, with more flexibility and fewer rules than corporations.
- Corporations have formal structural and maintenance requirements. All corporations must hold at least one annual meeting of the board of directors and at least one annual shareholders meeting; the secretary must record and disseminate the minutes of both. The board must document any changes in ownership in the bylaws and the stock certificate log.
- LLC: Although not required by law, creating an LLC operating agreement is crucial. An LLC must clearly file timely state registrations and document the following in an operating agreement: member withdrawal or death, or acquisition of another firm. If these aren’t filed, the LLC can be administratively dissolved, invalidating the liability shield. Furthermore, many LLCs have a defined end date that, if passed, automatically dissolves the LLC.
- Corporation: Corporate bylaws are mandatory. These work in tandem with the articles of incorporation. Bylaws provide the board management structure and information on elections and meetings, as well as any amendments. Although optional, shareholder and buy-sell agreements are strongly recommended. The shareholder agreement addresses shareholder rights and responsibilities, valuation and new share issuance and repurchasing. A buy-sell agreement stipulates what happens in the event of death, disability or shareholder desire to exit the business.
Which is best:
- If you intend to scale rapidly, hire employees across multiple regions or have multiple owners or investors, form a corporation. It’s easier to transfer and sell corporate stock, and corporations have a defined structure, including perpetual existence, that supports these activities. Also, significant precedents in case law govern the what-ifs.
- Use LLCs to hold assets such as real estate, equipment and machinery. LLCs can limit or even stop distribution payouts for a defined period. Courts generally cannot override these payout restrictions when clearly delineated in an operating agreement. However, this feature typically applies only to multimember LLCs.
- If you intend to create a lifestyle business or limit ownership to a few individuals, an LLC offers advantageous flexibility and simplicity.
Other structures include:
- Private corporations (PCs): Some states require licensed professional firms, such as law, medicine, accounting, architecture and engineering, to register under this designation.
- Limited liability partnerships (LLPs) or limited partnerships (LPs): High-risk real estate or commodity-based investment firms often use these structures.
A good contract lays out the rights and responsibilities of both parties and the consequences of not performing. Before creating or signing any contract, consider the contract’s purpose, intent and what you want. Written supersedes verbal; make sure the terms of the actual, final contract reflect your intent and goals.
Before creating or signing any contract, consider the contract’s purpose, intent and what you want.
The basic requirements of a good contract include:
- Clearly defined subject matter, and a clear description of what’s being exchanged or changed
- All relevant timelines and specific quantities
- Description of the expected quality
- Payment and timing of such
- Consequences (clearly delineated) for non-performance such as late delivery or poor quality
- Jurisdiction (use your state, or another state with favorable laws)
- How to handle disputes:
- For example, if a customer does not pay, can you repossess the goods or file a lien?
- If you prefer mediation or arbitration, include this and the associated parameters.
Finally, because attorney fee reimbursement by the losing party isn’t automatic, clearly specify whether the prevailing party can recoup attorney fees.
Many new business owners are just happy to convince a landlord to lease to them, so they don’t review their lease as carefully as they should — or they can even outright ignore red flags in the excitement of securing their first office space. But of course, your landlord will hold you to the lease terms, so it’s important that you review the terms and negotiate as needed. An attorney or commercial leasing agent can assist you.
Many new business owners are just happy to convince a landlord to lease to them, so they don’t review their lease as carefully as they should.
Key lease components include:
- Landlord, tenant and premises: Ensure the lease clearly designates your business’s name as the tenant and provides a detailed description of the premises and what that includes. Are there common area usage fees? Who is responsible for interior fit-out?
- Term, extensions or holdovers and renewal options: How long is the lease for? Does it automatically extend, or is advance notice required? If you must break the lease for any reason, what are the consequences?
- Rent, escalation and security deposit: What are the specific occupancy dates? What’s the starting rent and required deposit? How often does rent escalate and by how much? What must occur for a full return of your deposit?
- Utilities and more: Are the utilities included? What insurance level is required? Who is responsible for maintenance and repairs?
If you don’t properly recognize and protect the value that your IP provides, you could unintentionally execute agreements that result in significant costs or hamper your business growth. For example, while your business name may work in your state, another firm may own the same name in other states. Then when you expand your business, you may need to change the name, which will come with a costly rebranding effort and potential loss of customers who don’t recognize your new name.
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Consider using trademarks, copyrights and patents to protect your IP as follows:
- Trademark your name or business motto early. The process will ensure no one else in the country has your business name, and it will protect your brand.
- Copyright your content, and enforce the copyright by periodically conducting searches and notifying others of their infringement. This will defend against others stealing content you produce and reclassifying it as their own. Registering a copyright also allows you to sue for statutory damages, instead of only actual damages.
- Patent new methodology or code, as well as new product inventions. You can generally enforce patents for 20 years, and filing a patent allows you to license the innovation.
Also ensure that you’re not infringing on anyone else’s IP. A number of small companies have failed, or nearly failed, to defend themselves against an IP infringement lawsuit filed by a much larger company.
Many new businesses utilize independent contractors and freelancers when they’re starting out. This enables owners to tap necessary resources at a much lower price point, and only when needed. However, problems may arise when an independent contractor begins working for you almost exclusively.
- To circumvent this, create an independent contractor agreement that all sign. Incorporate the independent contractor terms outlined on the Department of Labor website.
- You can also require that all independent contractors you use operate as a legally organized entity. To confirm compliance, obtain W-9s, available via the IRS, from all of them in advance of any work or payment.
Taking these actions will protect you in the case that an independent contractor claims to be an employee, and will help you set work delivery standards that support your needs.
You can reduce the cost of this process by utilizing online vendors’ templates, guidance and an attorney review to craft the necessary documentation.
All businesses with growth aspirations have to address liability, legal structure and registration, contracts, independent contractors, lease agreements and intellectual property. You can reduce the cost of this process by utilizing online vendors’ templates, guidance and — for an additional fee — an attorney review to craft the necessary documentation. And to delve deeper, you can use the information herein to brainstorm with an attorney and craft precise documentation.
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