What to Ask: Incorporation and Startup Tips | James D. Cormier, Esq.
Starting a new business? UpCounsel attorney James D. Cormier explains what every startup should be asking their legal team about Incorporation and Startup Tips6 min read
How should we organize our company?
Should we incorporate, form an LLC, or do you recommend something else? This question (or some version of it) is by far the most common inquiry new founders have for me when I start working with them. It's also perhaps the most important. I invariably reply, in what I hope is not a frustratingly lawyerly way, that it depends. And then I answer their question with a question. The first question I ask founders is very simple: do you plan on seeking outside funding from venture capital firms, angel investors, or other seed funding sources at any point? If you're just a traditional small business or even a tech startup looking to bootstrap your way to success, you've got a lot of options. I often recommend the LLC model to clients, due to its flexibility and pass-through taxation benefits. But the sky's really the limit, and it all comes down to the details of your business. For some, the S corporation is an option; for others, a partnership of some kind will suffice. But if you're a startup looking to woo VCs or angel investors, and maybe someday go public, incorporating as a Delaware C corporation is usually the only way to go. There are a variety of reasons for this that go beyond the scope of this question, but what it comes down to is that the corporation model offers the best combination of opportunities and protections for potential investors. The very same legal and administrative requirements that make running a C corporation burdensome on mom-and-pop businesses provide the safeguards and, most importantly, the financial structure that make third-party investment feasible and appealing. As you can see, the type of entity you choose for your company is innately related to your goals for that company; one informs the other, and vice versa.
Should I trademark my company name?
Yes, you probably should. It's relatively cheap and easy to do so, and it can provide a lot of value in the long run. But more important than the question of whether you should, is what that trademark should be. Trademarks vary from strong to weak. Especially if your dream for your company is market disruption and, eventually, an IPO, then your intellectual property plan should be every bit as well thought out as your corporate organization and your business model. Too often, I speak to founders who have decided on company names that make weak trademarks –marks that may not actually qualify for registration with the USPTO, usually because they are too generic. If your business name is descriptive – Oklahoma Business Services, Inc. – or even merely suggestive – Express Logistics, Inc., or Rabbit Delivery, Inc. – it probably won't make a good trademark, for two reasons. First, someone else has probably already thought of it and trademarked it, and second, because from a legal perspective it is inherently prone to dilution. The best trademarks are either "fanciful" (made-up words like Google, Microsoft, or Comcast) or "arbitrary" (Apple, for a computer company; Radish, for a subscription fiction website; Starbucks, for a coffee chain). Like choosing the right type of legal entity for your startup, choosing the right name – or the wrong one – early on can have legal repercussions years down the road.
What is the best way a small business owner can protect personal wealth and assets from business risks?
By forming a separate legal entity (whether it's an LLC, a corporation, or something else) to hold and control the assets of the business.
What is the best way a small business can maximize its tax deductions?
Not to be clever, but the best way to optimize tax deductions is to secure the services of an experienced CPA. More than that, however, it's important to implement commercially reasonable accounting practices, choose the right elections, and to ensure that business assets are not commingled with personal assets.
What specifically are small business owners most confused about when you first meet with them?
How can quality legal services help a small business grow?
I often encourage prospective clients to seek quality legal advice sooner rather than later. Companies, like individuals, often approach legal services from the perspective of damages mitigation rather than prevention. A good lawyer can set a business up to grow by ensuring that the business is organized in the most effective manner for its industry and needs, by drafting the operational documents and agreements that allow it to do business and contract with other service providers, and by providing ongoing guidance before, during, and after funding milestones and capital transactions.
How can quality legal services help small businesses save money?
Spending some money to have your corporate documents prepared correctly and your contracts drafted effectively and comprehensively can potentially save you thousands, if not millions, of dollars in the long run. The resources available to business owners online mean it's possible to do many things yourself, without the assistance of an attorney, but there is no substitute for having qualified, experienced counsel on your side. Not only can your lawyer save you money by preventing problems before they happen, he or she can point out trouble areas and opportunities that you may never have thought of, no matter how well prepared you are.
How can small businesses maximize the value of their legal team’s services?
Be upfront with your legal team about what your budget is, which services are most important to you, and whether you're interested in working with them again in the future. Good attorneys prioritize long-term relationships over short-term financial gain, and many will work with you on pricing if it means the establishing a relationship that will be profitable for both parties over the long term.
Should business partners have the same amount of equity in a company? Why or why not?
It depends. There's that answer again! Every company is different. There's no one answer that fits every business. Each company is its own unique venture that has different needs, values, assets, and opportunities. The traditional answer would be that your equity should proportionally represent your capital investment in the company, but in many situations, there are exceptions to this rule. Some founders split equity equally despite unequal initial investments, either because one partner intends to provide services in return for "sweat equity" or because they simply want to have equal investment and control over the business.
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, Due diligence reviewing customer lists, sale records, advertising materials, and employee contracts
Do you have any other essential legal guidance for startups that you haven't already included in this survey?
An accountant once gave me some great advice when I first went into private practice: do what you do; don't try to be everything to your own business. He was referring to outsourcing payroll services, rather than attempting to do it all myself. From both a legal and a business perspective, it's best for startups to focus on creating value for their products or services, not obsessing over the details of running their business or even providing support services for their products. Outsource all of that. And get a good lawyer to help you draw up the contracts that make it happen. The second piece of advice is more strictly legal in nature: build your worst fears into the legal fabric of the company. I don't mean that you should think negatively, but rather that you should hope for the best while preparing for the worst. Worried your co-founders won't stick around through the lean times? Create restricted stock purchase agreements that have vesting schedules that motivate them to stay the course and allow the company to buy back their stock in the case of a departure. Concerned employees will leave the company, taking vital proprietary information with them? Have your attorney draw up an ironclad, narrowly tailored noncompete and nondisclosure agreement that will protect your intellectual property and limit your employees' ability to jump ship for a competitor. As I said before, the best legal work is preventative: prevent the worst from happening, by imagining it first