It’s easy to fall into legal pitfalls when a startup isn’t properly established, and its owner is treading dangerous grounds in the industry, as well as with regulations. Here’s a quick guide to navigating some different potential legal structures for the small business, and a few things to avoid on the legal front.
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Among the initial crucial decisions that need to be made is the legal structure for the business, which will be partly dictated by the tax structure and consequences. Sole proprietorship is the simplest of them, where solo business owners include their expenses and income from the business in their personal income tax return. It’s very simple, but lacks any legal protection for your personal assets.
A partnership can be general or limited. In the former, a creditor may go after any of the partners or all of them, while in the latter a general partner has unlimited personal liability and limited partners have limited liability. Again, it can only offer limited protections against your personal assets, so it may only be a good structure under specific conditions, commonly in real estate.
A corporation is an independent legal entity that stays separate from its owners, so there’s increased protection against personal liability in case the company faces bankruptcy or a lawsuit. It’s ideal for ventures requiring liability protection and looking ahead to grow. Depending on the type of corporation (C or S), owners could face double taxation – tax on the company’s profits and then a second tax on distributions taken by owners. A limited liability company (LLC) also provides liability protection enjoyed by corporations but without double taxation. In LLCs, earnings and losses go through owners and are incorporated in their personal tax returns.
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Startups have to be particularly careful around several issues, such as not making the deal and legal details clear with every co-founder, not complying with securities laws when issuing stock, neglecting intellectual property protection, and not taking important tax issues into account. A skilled, experienced commercial or business attorney can assist in dealing with these legal issues.
Attorney David Baer has core competencies in strategic business planning, execution, direction, business and culture transformation, business law, corporate governance, and tactical negotiations. More articles like this on this page.
