Launching a Start-up: The Excitement Inspires Immediate Action, But Braking for These Top 5 Legal Considerations Makes for a Wiser Approach

It’s exciting when a great business idea hits you…something that will change the lives of your target market and help them solve their problems and fulfill their dreams. You want to plunge full speed ahead and get your new product or service to market immediately. A word of extreme caution: Hold on. Pump the brakes. Slowing down may be wiser than you think.

Taking your idea from vision to reality requires some serious prep before you open your doors. Covering all your legal bases is one of them. There are several legal issues you must address before setting up shop. When you hire a business attorney to help you navigate legal considerations, you’re being proactive in circumventing pitfalls. You’re also giving yourself the time to focus on other business considerations. Common sense dictates that you leave the legal work to the experts.

Make the following five items a priority on your start-up to-do list. Launch your business with a strong foundation and kick off on the right foot.  

Choosing the right structure is important. Failure to do so could potentially make you a target for business losses and cause you to end up with a high tax bill from Uncle Sam. There are multiple types of business structures including sole proprietorship, C-corp, S-corp, partnerships and more. One size does not fit all. The tax implications for each entity vary, and it’s important to study the individual tax structures to determine which tax method will work best for you. For example, the C-corp is one of the most well-known entity types. It’s also a draw for many entrepreneurs because the structure shields them from personal liability for losses. A C-corp also makes you more attractive to investors and venture capitalists than sole proprietorships, limited liability companies or various partnerships.

But does it make sense for your business? Taxes in C-corps are generally higher than other entity structures because of the double-taxation applied to corporations. With a C-corp, a company’s profits are taxed at the lower corporate rate, and after-tax income pays shareholder dividends. But shareholders, who inevitably include the company’s founders, pay personal income taxes on dividends, thus, the term double-taxation.

The operations of C-corps are also more complex than other business structures. C-corps are required to observe formalities such as electing officers, holding meetings, and keeping meeting minutes. On the other hand, there are no restrictions on who can hold C-corp shares. Plus, the shares are readily transferrable. This means that shares can be transferred to other owners or back to the company for reinvestment. These two factors make the C-corps an attractive option for entrepreneurs starting a business.

There are five different written agreements necessary for the establishment of your business. These include:

1. Governing Documents: First and foremost, you need the proper governing documents for your business.  Are you a single-member LLC?  You’ll need an LLC Operating Agreement.  Aside from providing you and others guidance about how your business is run, you won’t be able to obtain a bank account and other types of financing without one. If you’re a partnership, Limited Liability Partnership, or multi-member LLC, you’ll need an agreement to clearly outline your company’s governance, voting rights, termination and dissolution procedures, tax distribution and allocation provisions required by the Internal Revenue Code. 

2. Confidentiality/NDA Agreements (Non-disclosure Agreements): These are crucial to protect your intellectual property (trademarks, copyrights and patents), and other confidential information such as customer/client lists, business processes, ideas, business strategies, inventions, trade secrets and any other sensitive information.

3. Equity/Stock Agreements: Many start-ups and emerging businesses need to raise capital to fund their enterprise. They do this by selling ownership (stock) in their company. These types of agreements can be complex and lengthy, typically running at 50 or more pages depending on the complexity of the transaction and the investors involved.  Having an experienced corporate lawyer well-versed in securities laws is critical to help you prepare these documents.

4. Employment Agreements: These are crucial to outline the terms and conditions of employment for all employees. Among other considerations, these agreements make sure your employees are bound by confidentiality and non-compete provisions to ensure an employee won’t leave and go to a competitor with sensitive information. The release of that information could hurt your business.

5. Service Contracts: When your company provides services rather than only a product, service contracts are important. Service contracts explain the terms and conditions under which your company affords their clients services and makes clear what your responsibilities and liabilities are. Having a solid service contract avoids misunderstandings and undue liability.

If you plan to hire employees, use independent contractors, or a mix of both, it’s imperative that you stay abreast of employment laws. Labor laws are protections and safeguards to help ensure employees are safe and protected in the workplace. As an employer being compliant with them means that you are protected, too.

On the one hand, many labor laws and regulations are mandated by the Occupational Safety and Health Administration, which enforces safe and healthy working conditions.

It’s also crucial to know the law that governs whether a person is considered an employee or an independent contractor. Key considerations include whether the company or worker has control of how workers do their jobs, how workers are paid, and whether workers are eligible for employee benefits such as pension plans, insurance, or vacation pay. But the employee versus contractor issue is just the tip of the iceberg. There are myriad federal, state, and local laws and it is imperative to get expert help to make sure your company is in compliance with laws regarding discrimination, disabilities, harassment, and wage and hour laws.

Many small businesses think they may fly under the radar when it comes to the bigger federal labor laws — not so. Get any of this wrong, and you could be looking at stiff penalties from the IRS (up to $10,000 or more depending on number of violations)—even jail time. You’ll also have higher exposure to lawsuits from your workers! 

We’ve all heard the saying, “You have to spend money to make money.” You can’t argue against this thinking. Whether your business is strictly online or whether you’re a brick-and-mortar operation, you will need money to form your business and keep it running.  Founders typically provide seed financing with their own money and sometimes solicit funding from family and friends, dubbed “F & F” financing.  It has also become common practice over recent years for start-ups to use crowdfunding to raise money.

As funding needs increase, you may give thought to loans and also, potentially, outside investors. In situations in which you may be looking to keep as much equity as possible in the business, loans may be a preferable objective—especially because there are more favorable tax implications in repayment of interest on the loans. Business loans are typically paid off in equal monthly payments. Sometimes, too, loan repayments are structured to make lower monthly payments or monthly interest payments with large balloon payments of remaining principal and interest at the end of the loan term or on a predetermined date.

For whatever reason, however, a company may be unable to obtain loans or may be looking for more than just money. For example, start-ups, especially those who have formed as corporations, may choose to pursue venture capital. Start-ups that go this route are looking not only for funding, but for access to professional and industry guidance from the venture capitalists. The benefit in getting venture capitalists’ attention is that you may also create connections to potential future management and board members for your company. That access, however, doesn’t come without tradeoffs; even though you won’t have to make monthly repayments or repay the investment at any particular date, as an owner, you’re giving up equity in your company. This means you’ll have to share company profits with your investors, generally in proportion to the percentage of the business they own.

Inevitably, decisions of this magnitude require you to surround yourself with a  top-notch team of trusted advisors. Lawyers, accountants and financial business managers are among this group. These professionals can help you evaluate the tradeoffs and explore the various avenues available for financing—and the most appropriate course for your particular business.