Deciding whether to start your own business (instead of working for someone else) may be one of the most daunting decisions you will ever make. In our work with entrepreneurs and new business owners, the biggest difference we see between successful and struggling businesses is not the founders’ skills or even the strength of their business idea. The biggest difference is in execution and proper planning at the start of the venture - that is, whether the business has the legal, financial and business structures in place to support not only its growth and development, but also whatever inevitable bumps and hurdles come its way.
For entrepreneurs who are getting ready to start a new business and for those who are just thinking about it, we provide an overview of some of the practical and legal considerations that new businesses will encounter. This is a general overview only, and is not intended to constitute legal advice.
Create a Business Plan
While not a legal requirement, at the outset of a new business venture, owners should clearly define the business’s objectives in a concise, dynamic business plan. Business plans typically include the following information:
a summary of the business history, management and goals;
a description of the products or services to be offered;
a profile of the target customer;
an analysis of the general industry, market trends and competition;
a list of assets, liabilities, budgets and timelines;
a forecast of sales growth and profits.
The business plan is something every new business owner knows they should have, but very few – especially small business owners – have actually put together. However, creating a business plan has real practical benefits:
Investors. Most investors won’t even consider a business seriously without a written business plan. A well-crafted business plan shows potential investors that you have thought through your idea and have a plan for execution.
Third Parties. It is not uncommon for suppliers and vendors to ask for your business plan, particularly if you are placing a large order or buying on credit. If you plan to apply for a business loan, most commercial loan applications will require a business plan.
Management Tool. The business plan can be an effective management tool to help you establish a roadmap for your business. In the business plan, you can identify goals, establish critical benchmarks and articulate strategies and other actions that need to be taken to reach your goals, including assigning tasks or responsibilities needed for the day-to-day operations of your business.
Prepare for Failure. Business plans can also be used to identify any potential issues that may affect the business. If your plan was to pursue one kind of client but you end up with a completely different kind of client, how would you pivot your business to better serve your new target clients or redesign your business strategy to better reach your original target audience? If you set out on your new venture with a co-founder but later decide to part ways, how will you ensure a smooth transition? If you think about potential failures up front and put in place all the legal and structural safeguards to help you and your business deal with them, when difficulties arise, they will be neither surprising nor overwhelming and you will be equipped to take them head on, both emotionally and organizationally.
Select a Business Structure
One of the most important decisions in forming a new business is selecting the appropriate business structure, which in turn will have an impact on many key aspects of your business, including management, protection from liability, taxation and financing.
As a preliminary matter, you will have to decide whether to form a legal entity. Sole proprietorships are common because they are the least costly and easiest to form. You do not file formation documents with the secretary of state and your business is not taxed separately; you simply report business income or losses on your personal income tax return. However, a sole proprietorship is not a legal entity, so there is no distinction between you and your business. What this means is that as the business owner, you are personally liable for all the losses and liabilities of the business – your personal assets and, if you are married, the community property are at risk in a sole proprietorship.
Therefore, limited liability is the primary reason why business owners form a legal entity. Limited liability means that only the assets of the business and not your personal assets, are exposed to liability. There are a number of legal entities to choose from, depending on the state you are in, and the relative advantages and disadvantages of each legal entity will depend on your specific business situation.
Limited Liability Companies (LLCs) are often attractive to small business owners because they are flexible and relatively easy to set up. LLCs are not bound by the same formalities as corporations and are flexible with respect to taxes, allowing owners to choose from a few different options.
Corporations may be appropriate for entrepreneurs who intend to secure financing from serial or institutional investors. Most investors are unwilling to consider any other kind of business entity besides a corporation. However, the incorporation process can be costly and time-consuming. Corporations themselves are more complex to operate, as shareholders are required to observe a number of corporate formalities, including holding regular meetings of the board of directors and keeping records of corporate activity.
Limited Liability Partnerships (LLPs) are usually formed by licensed professionals such as attorneys, accountants, architects, land surveyors, and engineers. All partners in a LLP receive limited liability protection.
Choose and Protect Your Business Name
Before settling on a business name, make sure the name isn’t being used by someone else. You can make sure your business name is legally cleared by:
checking name availability with the secretary of state;
performing a trademark search for the name at the state and federal levels;
conducting internet searches to disclose common law uses of the same or similar names; and
verifying name availability with domain name registrars.
Once the business name is cleared for use, you should protect the name by:
filing the name with the secretary of state;
registering the name as an internet domain name; and
filing an application for federal or state registration of the name, if it will be used as a trademark or service mark.
Obtain Business Licenses and Permits
The nature and location of your business will determine the kinds of licenses and permits required under federal law (for businesses that are federally regulated) or state and local laws and regulations, which vary by jurisdiction. Additional licenses and permits may be necessary to comply with federal, state, and local environmental regulations.
These websites will assist you in finding license and permit information for your business:
Evaluate Insurance Needs
All new businesses need insurance. An insurance agent or broker can help you decide what insurance to buy and how much is necessary, based on factors such as:
the nature of your business;
exposure to suppliers and customers;
activities of employees and independent contractors; and
corporate activity, including inherently dangerous activities.
At a minimum, new businesses should consider obtaining the following types of insurance coverage:
commercial general liability, including property damage, personal injury, and advertising injury;
professional liability (or errors and omissions);
workers’ compensation (required in California and Washington for businesses with employees);
unemployment insurance (required in California and Washington for businesses with employees); and
disability insurance (required in California for businesses with employees).
As a new business, you may not be thinking about hiring employees just yet. However, keep in mind that hiring employees is an important step that creates many legal obligations for the business. Some issues to consider before hiring employees are:
Obtain an employer identification number from the IRS if you have not already done so for other reasons. (See here for situations in which you are required to obtain an employee identification number: https://www.irs.gov/businesses/small-businesses-self-employed/do-you-need-an-ein.)
Determine whether the worker is an employee or an independent contractor, a decision that has serious tax and legal implications.
Determine whether the employee is exempt or non-exempt from federal and state minimum wage and overtime requirements.
Make sure you have the appropriate agreements in place, including offer letters, employment or independent contractor agreements, and confidentiality and invention assignment agreements;
Set up payroll to withhold taxes.
Report your new hire to the California Employment Development Department's New Employee Registry or the Washington State Department of Social and Health Services.
In starting a new business, your enthusiasm and energy will naturally be focused on possibility, your product or services, the growth of your business, and your target customers. However, taking the time, at the start of your venture, to think through the logistics of your business, including its management, legal structure, agreements, and potential liabilities, can pay dividends, saving you time, money and headaches down the road.