Ask A Lawyer: What You Need to Know When Starting a Business
Starting a business is exciting. You've got an idea, you're ready to make it happen, and you can already picture your success. But before you dive in headfirst, there are legal considerations that can make or break your venture. Getting these things right from the start saves you headaches, money, and potentially your entire business down the road.
Too many entrepreneurs skip the legal groundwork because it seems boring or expensive compared to actually building their product or finding customers. Then, a year or two later, they're dealing with a lawsuit, a tax nightmare, or a dispute with a co-founder that could have been easily prevented. Don't let that be you.
Let's walk through the essential legal issues every new entrepreneur needs to understand to start their business the right way.
Choosing Your Business Structure
One of the first and most important decisions you'll make is what type of business entity to form. This isn't just paperwork. Your business structure affects how much you pay in taxes, how much personal liability you face, and how easy it is to raise money or bring on partners.
Here are the main options:
Sole Proprietorship is the simplest structure. You and your business are legally the same entity. No registration required in most cases, and you just report business income on your personal tax return. Sounds easy, right? The problem is you have unlimited personal liability. If your business gets sued or can't pay its debts, your personal assets like your house and savings are on the line. For most businesses, this isn't worth the risk.
Partnership is similar to a sole proprietorship, but with two or more people. You share profits, losses, and liability. General partnerships have the same unlimited liability problem as sole proprietorships. Limited partnerships offer some protection to limited partners, but at least one general partner still has unlimited liability. Unless you have a specific reason to choose this structure, there are usually better options.
Limited Liability Company (LLC) is the most popular choice for small businesses. It protects your personal assets from business liabilities (hence the "limited liability" part), while offering flexibility in how you're taxed and how you run the company. You can be taxed as a sole proprietorship, partnership, S corporation, or C corporation. LLCs are relatively easy to set up and maintain, and they tend to work well for various businesses, from solo consultants to small teams.
C Corporation is a separate legal entity from its owners. It offers the strongest liability protection and makes it easier to raise money from investors and issue stock to employees. The downside: Double taxation. The corporation pays taxes on its profits, and then shareholders pay taxes again on dividends. C corps also have more regulatory requirements and paperwork. If you're planning to raise venture capital or go public someday, a C corp is probably your path. If not, it might be overkill.
S Corporation is a special tax designation that lets you avoid double taxation while still getting liability protection. Profits and losses pass through to shareholders' personal tax returns. Sounds great, but there are restrictions. You can't have more than 100 shareholders, they must be U.S. citizens or residents, and you can only have one class of stock. However, for many small businesses, an S corp or an LLC taxed as an S corp tends to be the preferred choice.
So which one should you choose? That depends on your business model and risk tolerance. Whatever you choose, make sure to research and speak with professionals (tax pros, attorneys, etc.) to make sure it's done right.
Formation, Incorporation, and Registration
Once you've chosen your business structure, you need to actually create the entity. This is where formation and registration come in.
For an LLC or corporation, you'll file formation documents with your state. For an LLC, this is usually called the Articles of Organization. For a corporation, it's the Articles of Incorporation (or Certificate of Incorporation in some states). These documents include basic information like your business name, address, registered agent, and the names of founders or initial directors.
You'll also need to appoint a registered agent. This is a person or company with a physical address in your state who receives legal documents on behalf of your business. You can be your own registered agent, but many businesses use a registered agent service to maintain privacy and ensure they don't miss important legal notices.
Delaware as a place for business formation. You'll hear people talk about Delaware corporations all the time, especially in the startup world. Why Delaware? It has well-established corporate law, a specialized court system (the Court of Chancery) that handles business disputes efficiently, and business-friendly laws that give management flexibility. If you're planning to raise venture capital, investors will often expect you to be a Delaware corporation. For most other businesses, forming in your home state tends to be simpler and cheaper.
After you form your business, you need an Employer Identification Number (EIN) from the IRS. Think of this as a Social Security number for your business. You'll need it to open a business bank account, hire employees, and file taxes.
Depending on where you're located, you might need city or county business licenses, permits, or other local registrations. A restaurant needs health permits. A contractor needs a contractor's license. Check with your local government to make sure you're not missing anything.
One more critical document: your operating agreement (for an LLC) or bylaws (for a corporation). Even if your state doesn't require it, it's usually a good idea to create one. This document spells out how your business will operate, how decisions get made, what happens if a founder leaves, and how profits are distributed. If you have co-founders, then this document is recommended. Too many businesses implode because founders didn't agree on basic issues that could have been documented from day one.
Remember, a business is like a house; a cracked foundation is difficult to build on and it can lead to trouble down the road.
Understanding Your Tax Obligations
Taxes might not be exciting, but getting them wrong can sink your business. Here's what you need to know.
Your business structure determines how you're taxed. Sole proprietorships and partnerships are pass-through entities. Income passes through to your personal tax return. LLCs can choose how they're taxed. Corporations are taxed as separate entities (C corps) or as pass-through entities (S corps). Choose wisely, because this affects how much tax you pay.
You'll deal with several types of taxes. Income tax is the big one. You pay tax on your business profits. Self-employment tax is another. If you're self-employed, you pay both the employee and employer portions of Social Security and Medicare taxes. That's 15.3% on top of income tax. If you have employees, you pay payroll taxes and withhold taxes from their paychecks. Depending on what you sell and where you sell it, you might also collect and remit sales tax.
Sales tax has gotten complicated. The old rule was that you only had to collect sales tax in states where you had a physical presence. But a 2018 Supreme Court case (South Dakota v. Wayfair) changed that. Now, if you sell enough to customers in a state, you might have to collect sales tax there even if you have no physical presence. Each state sets its own threshold. If you're selling products online, you need to understand these rules.
Quarterly estimated taxes are required if you expect to owe more than $1,000 in taxes for the year. As a business owner, no one is withholding taxes from your income, so you need to pay estimated taxes four times a year. Missing these payments can result in penalties.
Keep immaculate records. Track every business expense, every bit of income, and keep receipts for everything. Use accounting software from day one. It makes tax time infinitely easier and helps you actually understand your business finances. Consider hiring a CPA, at least for your first year. They can help you set up your books correctly, identify deductions you might miss, and ensure you're complying with tax laws.
Business expenses are generally deductible, but only if they're ordinary and necessary for your business. Your laptop? Deductible. Your home office? Potentially deductible. A fancy dinner with your spouse? Probably not deductible unless there's a clear business purpose. Keep detailed records and be honest. Overly aggressive deductions are a red flag for audits.
Insurance: Protecting Your Business
Insurance is one of those things that seems unnecessary until you desperately need it. Don't learn this lesson the hard way.
General liability insurance protects you if someone is injured on your property or if you accidentally damage someone else's property. If you have customers visiting your office or if you work on client sites, you need this. It's relatively inexpensive and absolutely essential.
Professional liability insurance (also called errors and omissions insurance) protects you if a client claims your work caused them financial harm. If you're a consultant, designer, accountant, or any kind of professional service provider, you need this. Even if you do great work, you can still get sued. This insurance covers your legal defense and potential damages.
Product liability insurance is crucial if you manufacture or sell physical products. If your product injures someone or damages property, you could face a massive lawsuit. This insurance protects you from that risk.
Workers' compensation insurance is required in almost every state if you have employees. It covers medical expenses and lost wages if an employee gets injured on the job. Don't skip this. The penalties for not having workers' comp when you're required to are severe.
Commercial property insurance protects your business property like equipment, inventory, and furniture. If you're working from home, your homeowners insurance probably doesn't cover business property. If you're leasing an office, your landlord's insurance doesn't cover your stuff.
Business interruption insurance covers lost income if you have to close temporarily due to a covered event like a fire or natural disaster. This can be the difference between surviving a setback and going out of business.
Cyber liability insurance is increasingly important, especially if you handle customer data. If you experience a data breach, this insurance can cover notification costs, legal fees, and damages. Given how common cyberattacks are, this is worth considering for almost any business.
Talk to an insurance broker who works with businesses like yours. They can help you understand what coverage you actually need and find policies that fit your budget. Don't just grab the cheapest policy you find. Understand what's covered and what's not.
Compliance and Regulations
Depending on your industry and location, you might face specific regulatory requirements. Ignoring these can result in fines, shutdowns, or even criminal liability.
Licenses and permits vary widely by industry and location. Restaurants need health permits. Contractors need licenses. Some professions like lawyers, doctors, and accountants require state licenses. Home-based businesses might need home occupation permits. Research what's required for your specific business in your specific location.
Industry-specific regulations can be extensive. If you're in healthcare, you need to comply with HIPAA. If you're in financial services, you have a whole alphabet soup of regulations. If you handle credit card information, you need to comply with PCI DSS standards. If you collect personal information from customers, especially from EU residents, you need to understand GDPR. Don't assume you can figure these out as you go. Talk to a lawyer or consultant who specializes in your industry.
Employment regulations go beyond basic employment law. Depending on your size and location, you might need to post certain notices in your workplace, maintain specific records, provide certain benefits, or comply with specific safety regulations. OSHA regulations apply to most businesses and require you to provide a safe workplace.
Environmental regulations might apply if your business produces waste, emissions, or uses certain materials. Even seemingly low-impact businesses can face environmental regulations. Check with your state's environmental agency.
Zoning laws determine what kind of businesses can operate in different areas. If you're running a business from home, your residential zoning might not allow it, or might allow it with restrictions. If you're renting commercial space, make sure it's zoned for your type of business.
Privacy laws are becoming increasingly important. If you collect customer information, you need a privacy policy that explains what you collect, how you use it, and how you protect it. Some states like California have strict privacy laws that apply even to small businesses. If you have a website, you probably need a privacy policy and a terms of service agreement.
Accessibility requirements might apply to your business. The Americans with Disabilities Act (ADA) requires businesses to be accessible to people with disabilities. This includes physical accessibility if you have a location customers visit, and increasingly, digital accessibility for your website and apps.
Staying compliant is an ongoing job, not a one-time task. Laws change. Your business changes. Set up systems to stay informed about regulatory changes in your industry. Consider joining an industry association that keeps members updated on regulatory issues.
Final Thoughts
Starting a business is complex, and the legal side can feel overwhelming. But here's the thing: every successful business you admire dealt with these same issues. They figured it out, and so can you.
After reading all of this, you might be thinking that you need a lawyer on speed dial. It's not a bad idea, but you also don't need to spend a fortune on legal fees to start your business properly. Though, don't try to save money by skipping legal help on important issues. The cheapest option upfront is often the most expensive option in the long run if it leads to legal problems.
You don't need to be a legal expert. You just need to know enough to ask the right questions and get the right help when you need it. This article is a starting point, not a comprehensive guide to every legal issue you might face. Every business is different, and your specific situation might require specialized advice.
The legal work isn't the fun part of starting a business. But it's the foundation that lets you build something lasting. Take it seriously, get it right, and then get back to the exciting work of building your business.
The key is to not ignore these issues or put them off until later. Deal with the legal fundamentals from the start. Form the right business structure. Protect your IP. Get things in writing. Understand your tax obligations. Have proper insurance. Stay compliant with regulations.
And remember, when in doubt, talk to a lawyer.
Want to learn more? Our team of dedicated attorneys and consultants are here to work with you to make sure your business starts off on the right foot. Contact us to learn more and to see if we can help you with your business needs!
*Disclaimer: This article is intended solely for educational purposes and is not intended as legal advice resulting from legal representation, broker-dealer advice, tax professional advice, or other professional advice resulting in an implied or actual agreement with a professional acting in a representative capacity. This article does not directly or indirectly establish a relationship of representative capacity. All copyright and rights belong to Fox & Chester and are reserved. Consult with a professional where applicable.