What to Ask: Incorporation and Legal Expenses | Curtis Roberts, Esq.
Starting a new business? UpCounsel attorney Curtis Roberts explains what every startup should be asking their legal team about incorporation and legal expenses6 min read
Do I need to form a corporate entity (and if so which is the right one for me)?
This is a critical, if not the most critical question you should be asking your legal team. The reason is because the entity you ultimately choose will greatly affect your liability, taxation and record-keeping burden. See below for short summary of the most common forms of business entities available to entrepreneurs. Sole proprietorship – This is very common entity and very easy to form. It requires almost not legal input before starting. And it lets you run and change your business on a whim. However, there is one huge downside, the owner is personally liable for EVERYTHING. Partnership – If you have a cofounder or are starting a business as husband and wife this might be the structure for you. Two or more people must agree regarding sharing profits or losses of a business. The primary advantage is 'pass through' taxation. Meaning that each of partner will report any income or losses on their individual income tax returns. One disadvantage is that like sole proprietorships, each partner is personally liable for the financial obligations. Unless it has been formed as a limited partnership. Then the entity will enjoy limited liability. Corporation – You may have heard some debate in the news about corporations being treated as people and having similar rights. This is true. When a company is established a separate entity is created. This entity is distinct from the owners. This means that unless the corporate form is abused, the business entity must be sued separately from the owners. There are a couple of disadvantages. First corporations can be expensive to form. Second corporations are taxed and the owners are taxed in what is known as double taxation. Note: This is not applicable if it is an S corporation, because there it allows for the pass-through taxation mentioned above. Third corporations require extensive record-keeping. Limited Liability Companies – If you want a lower cost, easier to manage entity that still has the advantages of limited liability the LLC might be the structure for you. The two main advantages of the LLC are that it allows profits and losses to pass through to the owners like in a partnership or S corporation. And it allows for limited liability. Meaning its owners are protected from lawsuits like corporations.
Do I have all my business licenses?
Every business needs some form of license or permit to operate legally. But, licensing and permit requirements vary depending on what type of business entity it is. Other factors are the type of business and location. Make sure these are in place BEFORE you open your doors to customers and clients. Use the resources below to make sure you are compliant. Federal – You can visit the U.S. Small Business Administration (SBA) website to make sure that you are complying with all federal guidelines. https://www.sba.gov/starting-business/business-licenses-permits/federal-licenses-permits State – You will have to visit each state's website to check the requirements in each state in which you operate. The SBA has provided a helpful link to each state. https://www.sba.gov/starting-business/business-licenses-permits/state-licenses-permits Local – You may need separate city or county permits. The local Chamber of Commerce is the best place to start. Give them a call and ask about local licenses and permits or check out their website Additionally, there are many professional services that you can reach out to handle your business licensing needs or you can call a professional startup attorney.
How should I fund my business?
Most small business need money to operate. See below for some common sources of capital for startups. Friends and Family – There is a saying that the first people to fund a new company are friends, family, and fools. This should be your first stop when looking to find funding. SBA Loans and Grants – The SBA has a number of loan programs designed for business owners. The Basic 7(a) Loan Program is the most common type of loan. The first step is to visit a local bank that participates in SBA programs. If you meet the application guidelines the loan will be eligible for an SBA guarantee. Meaning that the SBA will repay to the lender up to the guarantee if you default on your loan payments. Crowd Sourced Funding – With the Crowd small businesses have an exciting new investment partner. You have undoubtedly heard of Kickstarter or similar crowdfunding sites. These sites allow anyone from anywhere in the world to invest a small amount of money in exchange for a product or service. As of May 16, 2016, the Crowd can invest in a percentage ownership of your company. The change was made by the Jumpstart Our Businesses (JOBs) Act and required the SEC promulgate the rules. WeFunder is one of the major names in the equity crowdfunding space that is marketing solely to the Crowd and not operating under a Regulation D (accredited investor) exemption. There are many funding options available to today’s small business owner. They can get confusing very quickly. So before taking any money make sure you understand any terms that come along with it.
Is it better to hire employees or independent contractors and what is the difference?
This is a crucial question to ask your team and has major implications First what is the difference. Employee – An employee is anyone who performs services IF you can control, 1. what will be done and 2. how it will be done. Independent Contractor – An independent contractor is someone who has the right to control or direct their work and how it will be done. The earnings of an independent contractor are subject to Self-Employment Tax. The IRS provides some guidance on how to determine if someone working for you is an employee or independent contractor. They state that all businesses must weigh the factors to determine if a worker is an employee. Behavioral – Does the company or the worker control what the worker does and how the worker does his or her job? Financial – Questions like how worker is paid and are his expenses reimbursed. And who provides tools or supplies to get the job done are helpful in figuring out this factor. Type of Relationship – Does the employee receive any types of benefits (i.e. pension plan, insurance, vacation pay, etc.)? Why does this matter? If you wrongly classify an employee as an independent contractor the IRS can hold you liable for employment taxes and penalties.
Do I have what it takes to do this?
This isn't a question for your legal team, but it is critical that you answer. Make sure to ask yourself and the 'board of directors' in your life. The life of a small businessperson can be tough, especially initially. It is usually fraught with more worry than your average 9 to 5. But, if you have determined that this is the type of life for you, there is none that is more rewarding.
What is the best way a small business owner can protect personal wealth and assets from business risks?
Limit your liability – Use a corporate entity (LLC, corp., Limited Partnership, etc.) or insurance (liability, owners, etc.). Ideally some combination of both. As a small business owner make sure this is at the top of your list of priorities.
What specifically are small business owners most confused about when you first meet with them?
What is a Limited Liability Company and it is going to be a pain to file and to keep up with the requirements.
How can quality legal services help a small business grow?
They usually don't. But, they will only save you numerous headaches and a lot of money as you do grow. Without the right types of employment contracts, NDAs, and insurance in place you could face lawsuits that stifle and stunt your growth.
How can quality legal services help small businesses save money?
Quality legal services, while they can be potentially expensive up front, can save you from legal fees, taxes, penalties, and many other headaches down the road.
How can small businesses maximize the value of their legal team’s services?
Look for an attorney that will charge capped or flat fees. Negotiate those fees up front. Use an online legal service if you need a basic document or an uncomplicated legal entity formed.
Should business partners have the same amount of equity in a company? Why or why not?
This is a tough question and one that has kept many partners up at night. There are many online resources to help you determine how much equity you should give to your cofounder or business partner. They take into account factors like amount of hours spent, level of skill, amount of money invested, earning potential, etc. But at the end of the day it is up to the partners to decide how much equity should be allocated to each. It is an art rather than a science so trust your instincts.
What are the top three things a small business owner should be aware of when purchasing an existing business?
Accurately determine the value, Review the business's tax returns to determine profitability and if there is outstanding tax liability, Find out if there are any human resources issues or outstanding lawsuits pending against the company.
Do you have any other essential legal guidance for startups that you haven't already included in this survey?
Please see my blog for helpful articles and my free resources that small business owners can use today.