Millennials get a bad rap, often pegged as lazy, entitled and non-committal. However, millennials are an entrepreneurial generation, creating their own jobs when there were no jobs to be had. If your dream is to open a cupcake shop, start a dog walking business or commercialize the “next big thing,” know that there is more to starting a business than creating a Facebook page. In fact, before marketing too heavily, there are many legal considerations to keep in mind:
What Kind of Entity Do You Want?
When it comes to starting a business, there is no one-size-fits-all formula. One of the first big decisions is determining what type of legal entity to create. The type of entity will affect, among other things, how you are taxed and your personal liability.
Sole Proprietorship: A sole proprietorship is the easiest, least expensive business to establish, but it carries serious risks. There is no legal distinction between the business entity and its owner, so the business is not taxed separately from the owner. This means the owner has unlimited personal liability for the acts, errors and negligence of the business. In NH if you are doing business under any name other than your own name, you must register with the Secretary of State or local jurisdiction (often referred to as filing a d/b/a certificate).
Partnership: There are many different types of partnerships, but in each instance there are two or more people or entities sharing ownership. Partnerships must be registered with the state. A partnership agreement should cover operations, rights and obligations of partners and some common long-term issues such as the death or disability of a partner and transfer of partnership interests. The partnership’s income or loss is “passed through” to the partners in accordance with their share. As with sole proprietorships, partners may be liable for their own actions, those of other partners and the liabilities of the business.
Corporation: Corporations are the most common form of “limited liability” entity. The corporation is a legally distinct, independent entity owned by shareholders, who have no legal responsibility for corporate liabilities beyond their stake. The corporation has its own tax identity, so unless they qualify for and elect to adopt a “flow through” tax status as an S-corporation, corporate income is taxed twice. First it is taxed as profits at the company level and then, if company profits are distributed to shareholders, again as income at the shareholder level. Formation of a corporation, referred to as incorporation, requires preparation of articles of incorporation filed with the state for a filing fee. Initial documents should also include by-laws, action of incorporator (appointing initial directors, among other actions) and initial directors’ meeting (appointing officers, setting up bank accounts, etc.) and a shareholder agreement if there are multiple shareholders.
Limited Liability Company (LLC): Limited liability companies are a hybrid of the partnership and the corporation. They offer the limited liability feature of the corporation, but the tax benefits of the partnership or S-corporation. Limited liability companies can either be member- or manager-managed. Like corporations, an LLC certificate and filing fee must be paid. The key document is the operating agreement, which sets forth the rights and responsibilities of the members and the internal management of the company (like corporate by-laws) and allows for flexible arrangements and provisions (like shareholder agreements). This is a relatively new entity so its legal parameters are not always certain.
Where Will You Be Located?
The new business entity will need a place to set up shop:
Home Office: A home office may be the most economical way to get your new business up and running, especially if you have no employees. Check your local zoning laws and any applicable homeowners’ association documents for any restrictions, or you may be subject to significant penalties.
Rental: Renting is the most common way to get needed space. You will want a written lease and will have to negotiate the terms with the landlord. Before signing that agreement, have legal counsel review it to ensure the lease embodies your intended agreement and has no unfair terms. Be prepared to provide a security deposit.
Acquisition: If sufficient funds are available for a mortgage, the new business may acquire property or you may acquire property to rent to the new business through another entity. An attorney can help you structure the acquisition, perform due diligence and prepare documents for closing. Be sure to get title insurance and certification.
How Will You Get Paid?
Something important, but which may go overlooked, is the question of how you are going to get paid. The answer depends on the type of business entity you chose:
Sole Proprietorship: As there is no distinction between the individual and the business, all income and all losses will be attributed to you. There are no taxes withheld from your income and you are responsible for estimated tax payments quarterly.
Partnership: The partnership agreement will set forth the method of distributions or guaranteed payments from the partnership to the partners, which is one of many reasons the partnership agreement is such an important document. As with the sole proprietorship, there are no taxes withheld from your income and you are responsible for estimated tax payments quarterly.
Corporation: If you created a corporation, you are likely considered an employee and entitled to reasonable compensation. The corporation is responsible for withholding taxes from each paycheck (income tax, part of the Social Security tax and part of the Medicare tax). The corporation must also make payments monthly or quarterly for the taxes withheld and the employer’s tax obligations (Social Security and Medicare). In addition to payroll, you may be able to make year-end bonuses based on company profitability, which helps avoid double taxation.
Limited Liability Company: If you created a limited liability company and elected to be taxed as a partnership, compensation is received as year-end profit distributions based on each member’s percentage interest in the company. However, if the LLC elected S-corporation treatment, members who work for the company may receive wages as employees, similarly to a corporation, and also have the ability to take distributions.
Will You Have Employees?
You may be a one-man show at first, but important legal issues arise when you hire employees.
Complete State Filing Requirements: Most states require businesses to register as new employers for the purpose of unemployment insurance and worker’s compensation insurance.
Employment Contracts: As a general rule, employees are presumed to be “at-will” employees, which means the employer or employee may terminate the employment relationship at any time without cause or advanced notice. Employment agreements are not required, but such agreements, even in letter form, can be helpful to outline duties, scope of authority, compensation, benefits and additional requirements such as non-disclosure of confidential information or a provision to prevent ex-employees from later becoming competitors for a limited period of time after leaving the business. Any written agreement should be reviewed by a qualified attorney and clearly state that the presumption of at-will employment is not affected.
Policies and Notices: As your business grows, consider compiling an employee handbook with all applicable employee policies. Such policies may include benefits, acceptable conduct, non-discrimination, alcohol/drug policies, dress code, confidentiality, discipline and leaves of absence.
Know the Law: Gain familiarity with the applicable federal and state labor laws. Employment is a broad and complex area of the law, with significant penalties for non-compliance.
Commonly, labor law offenses pertain to wage and hour laws, record retention, discrimination, privacy, illegal employment of minors, and failure to secure and maintain worker’s compensation insurance. Consider attending a seminar geared to human resources professionals for a more in-depth overview.
Contracts You Will Need
Even though deals are sealed with handshakes in the movies, proper documentation is used in the real world. Having vendor and client contracts in place from the beginning will avoid pressure to enter into agreements quickly without getting them in writing or considering all relevant factors.
Vendor Contract: Vendor contracts should be in place for things as simple as cleaning services and office equipment supplies or as large as Internet and telephone services or equipment leases. Contracts should always be in writing and should lay out all terms of the agreement. Beware of clauses dictating limitations on liability, choice of law/jurisdiction and mandatory arbitration, among others.
Client Contract: The contents of a client contract will vary depending on the nature of your business and the client’s needs. On top of offering legal protection, presenting a contract to the client will not only come across as professional, but it will also give you the upper hand in negotiations. Consider having your attorney develop and occasionally revisit a basic Standard Form of Terms and Conditions, or something similar, to make sure all issues are covered.
Intellectual Property?
Your new business probably will have intellectual property. Protect it. Intellectual property may include a trade name, logo, customer list or special recipe. Taking these measures will protect your ideas from being stolen, misused or misrepresented. Common forms of intellectual property are:
Copyrights: Commonly protect literary works and computer software.
Trademarks: Words, phrases, logos and images associated with a certain service or product.
Trade Names: Identify goods and services of an organization as a whole.
Trade Secrets: Information not generally known, such as formulas and business lists.
Patents: Applies to inventions and processes.
Establish Business Relationships
Establishing outside relationships is important to the success of any startup business. If your trusted advisors work together with you as a team, you will be well served. There are at least a couple people you should have on speed dial as you get your new business up and running.
Bank: A bank account and capital is necessary in order to get any business on its feet. Lines of Credit may be needed for working capital or capital expenditures such as finishing space or buying computers.
Accountant: There are many tax considerations that go into choosing your business’s legal structure. Accountants can provide advice not only at start up but also at various stages of business growth. State taxes should also be carefully considered. Each state has its own tax code. Common state tax issues to consider are income taxes, sales and use tax, nexus, and apportionment. Having an accountant on board from the start will help you set up your business in a way that best suits your needs and help you with planning and preparation as your business grows.
Lawyer: There are all sorts of legal considerations that must go into the creation of a business, from choice of entity and basic documents to employment contracts and client contracts. The attorney’s fees to keep you out of trouble are fractional to the fees due if you run afoul of the law or have a dispute with your co-owners down the road.
An added benefit to establishing a relationship with a bank, accountant and lawyer is that, generally, people in these professions know a lot of people and are more than willing to make referrals. Working with a younger lawyer or accountant under the supervision of a more experienced attorney within their firm may help keep costs down and allow these relationships to grow as your business grows.
To get off on the right foot and protect your long-term interests, take the time to become familiar with the law. Attend seminars and learning opportunities geared towards startups and get help from the organizations that are out there to help entrepreneurs get up and running.
Attorney Jocelyn R. Wiese is an associate at Sheehan Phinney Bass + Green in Manchester. Her practice focuses on real estate and finance. She can be reached at 603-627-8272 or jwiese@sheehan.com.
Current Issue - April 2024