Business Law Basics for Entrepreneurs and Startups
Understanding business law basics is at the heart of any successful startup. Googling for answers or generic advice, it’s easy to get discouraged by the mountains of information available. How do you know which advice applies to you and your business?
While this service is less common than personal injury or workers' compensation, in our family-owned law practice, we do offer it. In fact, we had to do some business law work for ourselves recently when the practice added Jim’s nephew, Steven, as a partner.
So, as a public service, we offer this overview, breaking down the pieces of business law you need to understand to protect your dream.
Business Law 101: Choosing the Right Business Structure
The first part of business law you’ll deal with is how to set up your new business. Which structure you choose impacts your personal exposure to liability, how and when you pay taxes, and your day-to-day operations. Here are the most common choices for small to medium-sized businesses.
Sole Proprietorship
This is the simplest form of business ownership, where you, the entrepreneur, are the sole owner. While it's easy to set up and operate, it doesn’t provide any separation between your personal and business liabilities. Sole pros means your assets (house, cars, savings) could be at risk if your company gets in legal trouble.
Partnerships
When two or more people share a business, it's a partnership. Partnerships can be general (where all partners share equal responsibility) or limited (where some partners have limited liability based on their investment). All business partnerships must be set up with an explicit legal agreement that outlines each person’s responsibilities and profit-sharing.
Limited Liability Companies (LLC)
An LLC combines the benefits of a corporation with those of a sole proprietorship or partnership. It provides limited liability protection—that means your personal assets are generally protected from business debts and liabilities—while offering flexible tax options. There are many flavors of LLCs to choose from. Make sure you know which one is right for your new business.
Corporations
Corporate structures are complex and best if you’re consistently grossing more than $10,000.00 per month. Corporations can be classified as C-corporations or S-corporations, and each has different tax implications. Many entrepreneurs start with simpler structures and evolve into corporations as they grow. If you choose this route, just know that you’ll have protection from personal liability, and you’ll also have to deal with more regulations and tax filing requirements.
Get legal advice from a business attorney and certified public accountant before you pull the trigger on your setup. It might seem like a big investment for something that’s just getting started. However, this is not the place to bootstrap your business.
Legal Advice for Startups: Registering Your Business and Obtaining Licenses
Once you’ve decided how to structure your business, it’s time to “get legit” and register with the appropriate government agencies. Don’t skip this step. Some clients and networking groups require this to work with you.
Federal, State, and Local Licenses
Federal Licenses: You’ll need this if your business involves alcohol, firearms, and broadcasting. All businesses need an Employer Identification Number (EIN) from the IRS if they have employees or operate as an LLC, corporation, or partnership. Sole proprietors can get those too, or they can use the owner's social security number as their EIN.
State Licenses: All states require a health department permit to operate a food business and professional licenses to offer legal, financial, beauty, or real estate services. Some states require all businesses to have a license to operate. If your business sells something, you need a state sales tax permit or seller’s permit to collect and remit sales tax legally.
Local Licenses: Local requirements can include general city business licenses, zoning permits, and specific permits related to health, fire, signage, safety, or environmental standards.
If you decide you don’t need these licenses, your business can be fined or subject to legal action that forces it to close.
Business Law and Employment: What Startups Need to Know
Every entrepreneur needs to know a little bit about employment law. At the very least, you need to know who the state considers an employee and who is an independent contractor. Whether you're hiring your first employee or expanding your team, staying in compliance with employment law is non-negotiable.
Yes, You Need Employment Contracts
If you’re going to hire someone, have clear employment contracts that outline the terms of employment, like job duties, what they’ll be paid, any benefits, and grounds for termination. Handshake deals like the one chronicled in the musical Jersey Boys rarely have happy endings. Employment contracts can also include non-disclosure agreements (NDAs) to protect intellectual property and confidential information. You need a contract for all employees and any 1099 contractors if they don’t provide you with one of their own.
What About Wage and Anti-Discrimination Laws?
Your business must comply with wage and hour laws, such as paying the correct minimum wage, paying overtime, and correctly classifying employees (exempt vs. non-exempt). Getting this wrong can lead to hefty fines and back-pay issues. It’s your responsibility as the owner to ensure the workplace is free from harassment and discrimination. You’ll need policies in place to handle complaints and take quick action when something comes up.
Business Law Essentials: Contracts and Agreements
OK. You’ve set up your business, registered it with the proper authorities, and learned how to handle the people who will work in your business. Now you’re ready to start offering your products or services, so you’ll need a contract. Whether you’re dealing with clients, suppliers, or partners, knowing how to draft, review, and enforce agreements is part of being an owner.
Some standard contracts you may need in a startup include:
Service Agreements: Defines the terms of the services you’re providing, including scope, duration, and payment.
Non-Disclosure Agreements (NDAs): Protects confidential information from being shared without permission.
Partnership Agreements: Describe how your partnership will work, including roles, responsibilities, and profit-sharing.
Sales Contracts: Explains the way you’ll sell and deliver goods or services, including deliverables, timelines, payment terms, refund policies, and warranties.
Legal Advice for Startups: Plan for Legal Disputes
When you decide to open your own business, you must plan for occasional disputes. Just like “good fences make good neighbors,” “good contracts make good customers/vendors/employees.” Your contracts should contain a conflict resolution roadmap all parties can follow to save time, money, and unnecessary stress.
A word of caution. Never use someone else’s agreement as a template for your business. That’s a “shortcut” that could cost you everything. Invest in a custom contract with a qualified business lawyer or buy a template customized for your field from a legal service that offers service contracts for sale.
When You Ignore Business Law Basics: A Worst Case Scenario
We get it. The number of steps we’re telling you to take before you open your business sounds like a lot. You can probably think of someone you know who didn’t do all this, and everything turned out fine.
Well, we can share a personal anecdote about a time when things didn’t go so well. A young person has a bright idea for a new business. They get a few things together, like a business bank account, an EIN number, and a contract they found by Googling “business contracts.”
The business takes off. It’s so successful in its first 2 years that members of their family invest their life savings to help it keep growing. All is well, right? Wrong. In year 3, an unscrupulous customer noticed a loophole in the contract and sued the business.
Our budding entrepreneurs lost their businesses and everything their parents and siblings invested. The next time we saw them in public, they were bagging groceries at Whole Foods.
It’s a tragedy that could have been avoided. If that agreement had been reviewed by a business law attorney who customized it for their specific business, they would have had protection.
Wrapping it Up: Embracing Business Law Basics
Starting and running a successful business requires more than just a great idea—it requires a solid understanding of business law. Doing it right might take a little more time and money than you’d hoped when you had your big idea to start a business.
Approximately 45% to 50% of new small businesses fail within the first three years. The specific percentage can vary slightly depending on the industry, location, and economic conditions, but it's generally accepted that around half of new small businesses don't make it past this three-year mark. From choosing the proper business structure to protecting your intellectual property and writing contracts, being informed about the legal aspects of your business can make all the difference between success and costly mistakes.
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Disclaimer: This blog article is for informational purposes only and should not be considered a substitute for formal legal advice from Attorneys Jim and Steve Brady and Associates P.C. Please consult a qualified professional for personalized advice tailored to your needs.