Business Formation: Legal Considerations for Entrepreneurs

You may have the talent, skill, and vision to establish your new company. However, there are a range of legal considerations in business formation. As an entrepreneur, you must be as conscientious about legal matters as you are about marketing, operations, hiring, and raising capital. To ensure that you meet all your legal obligations, you should retain the services of a law firm that specializes in working with startup companies.

Here are some of the legal considerations for entrepreneurs.

1. Choosing the Right Business Structure and Understanding Its Implications

First, you must select a legal structure for the business. Your choice will depend on factors like the kind of services you offer, the people you intend to work with, and the company’s long-term goals. You can operate as a sole proprietor, or you can form an LLC or a corporation. These are the main features of each one:

Sole Proprietor: This is the simplest kind of company to start. A Sole Proprietorship is an unincorporated business owned and run by one individual, with no distinction between the business and the owner. This means that the liabilities of the business are also the liabilities of the owner. You can operate the business under your Social Security Number or apply for a Taxpayer Identification Number (TIN). A Sole Proprietorship’s business income and expenses are reported on the owner’s personal Schedule C, there is no separate tax return filed on behalf of the entity. A Sole Proprietorship can be suitable for an individual looking to start a small business with minimal startup costs. The process involves very little paperwork.
Limited Liability Company (LLC): In an LLC, the business is treated as a separate entity from its owners. As a result, the owners, referred to as “members,” are offered protection from personal liability for the business debts and claims. An LLC can also be advantageous for tax purposes, granting the members discretion in selecting to be taxed as an S-Corp (utilizing pass-through taxation), as a C-Corp (taxing income at the corporate level then distributions at the individual level), or remaining by default under the taxation of a Sole Proprietorship (for Single-Member LLCs) or a Partnership (for Multi-Member LLCs). LLCs also allow for profit distribution in manners other than a proportionality to ownership percentage but may require members to pay self-employment taxes on their share of profits. LLC’s are best suited for small to medium-size businesses valuing flexibility and simplicity in regards to both management and compliance.
S Corporation: Similarly to an LLC, S-Corporations, commonly referred to as “S-Corps,” offer their owners, known as “shareholders,” protection from personal liability. Unlike an LLC however, S-Corp shareholders are taxed in a “pass-through” manner, meaning income is passed to the shareholders and taxed at their individual rates. Another key advantage of an S-Corp is the ability to raise capital through issuance of stock. Like an LLC, S-Corps are also suitable for small to medium-sized businesses looking to take advantage of pass-through taxation and appealing to outside investors but must adhere to more compliance requirements and restrictions. As you can see, most of the legal work involved in startups concerns tax, ownership, and liability. Working with a lawyer will ensure that you structure your business in a way that most benefits you.

2. Drafting Partnership Agreements and Shareholder Agreements

If you intend to work with partners or give others a stake in your business, you will need to draft the appropriate agreements. First, we will deal with partnership and shareholder agreements, which are different legal structures.

A partnership consists of a group of persons who have agreed to form a business for their mutual material benefit. Most partnership agreements articulate how the business will be managed and funded and the responsibilities and obligations of each partner. In partnerships, the partners are jointly liable for the company’s debts.

A shareholder is someone who invests money in the company and, in return, receives an ownership stake in it. Most shareholder agreements establish the right of shareholders to vote at shareholder meetings, receive dividends, and receive company reports and updates. Shareholders usually have limited liability for a company’s debts.

If you form an LLC, you will need to draft operating agreements. These documents establish the terms on which the company will function, such as outlining the ownership structure, management roles, and operational procedures of the business. Operating agreements are meant to meet the specific needs of each LLC member, including their ownership percentage, voting rights, and distribution of profits and losses. They enable the internal operations of the company to be governed according to clear and specific rules by setting out provisions for regular meetings, record-keeping, and dispute resolutions. Members are bound to these documents once they are signed.

You will need help drafting any of the above agreements, as the legal language must be precise. This is for your protection and the people you want to do business with.

3. Complying With Local, State, and Federal Regulations

It is essential that your company complies with all local, state, and federal laws and regulations. In most instances, you will need a permit or license to begin operations. Startups, like well-established corporations, are subject to laws and regulations concerned with finance, privacy, advertising, intellectual property, and other matters. When starting your company, it is best to create a compliance plan so that you do not unwittingly run afoul of the law.

4. Protecting Intellectual Property Rights During Business Formation

As you take the first steps in starting your business, you have a right to protect your intellectual property—that is, your company’s name, logo, patents, and inventions. Doing so will prevent others from profiting from them.

A trademark refers to the name of your company, the name of a product, or a company logo. A patent gives you the rights to a unique invention. Securing rights in each type of intellectual property requires different levels of legal work and effort. You should not wait until you start business operations to seek legal counsel on these matters.

5. Resolving Contract Disputes and Handling Litigation as Needed

It is necessary for entrepreneurs to deal with all the legal issues described above. To do so effectively, you will need to hire lawyers experienced in working with entrepreneurs. A lawyer’s drafting skills are essential for entrepreneurs in creating client, vendor, and distribution contracts that are clear, comprehensive, and legally enforceable, offering the highest degree of protection for the entrepreneur. Expertly drafted contracts mitigate both potential legal and financial risks that an entrepreneur may encounter down the road, by ensuring legal compliance, streamlining operations, and promoting sustainability of the business. Lawyers for entrepreneurs can also ensure that you are in compliance with state and federal law regarding the hiring and treatment of employees.

But these are not the only reasons to hire lawyers for entrepreneurs. As a business owner, you will be subject to contract disputes and vulnerable to litigation. In many instances, such conflicts can be resolved out of court. To minimize the cost of dispute resolution, you need an experienced business lawyer.

Final Takeaway

Working with an attorney from the very beginning will ensure your business gets started on a solid legal footing. The Campbell Law Group offers a range of services in business, commercial, and employment law.