Starting a small business is an exciting time, your head filled with ideas of what to sell, how to sell it and the successes you anticipate.
During the planning time leading up to the launch of a small business, owners need to consider many things, from the company’s name to whether to sell online, in-person or both.
When starting a business, it’s important to consider many important legal matters that are essential to running your company. Addressing these issues from the beginning helps you have your business structured correctly, in compliance with state laws and protecting your hard work.
Here is a close look at 7 of the best legal practices to consider when starting a small business.
1. Choose the Right Business Structure
Businesses are legal entities and require a formal business structure. There are several types of business structures to choose from, each with distinct features, especially around taxes, liability and operations.
Consider the following questions before choosing a business structure for your company:
- What are my long-term goals?
- How much risk am I willing to accept?
- What kinds of products and services will I offer?
- Will I hire employees or be a solo business owner?
- What are my future financial requirements?
With those questions answered, you can more clearly choose the right business structure for your company. Here are four main structures to consider:
Sole Proprietor
This is the simplest and easiest business structure to choose. There is no paperwork required to become a sole proprietor.
Under a sole proprietorship, you are the only employee. Any profits or losses from the business are passed through onto your personal income tax filings. As such, you are personally liable for any taxes owed and any legal judgements against the company.
Many first-time business owners start out as sole proprietors, especially if the business is a part-time endeavor.
Partnership
A general partnership operates like a sole proprietorship, but with additional owners, each responsible for business debts and reporting profits and losses on personal tax returns.
A limited partnership gives partners limited personal liability as long as they are not managing the business. Limited partners earn a return on their investment, like a dividend, as defined by a partnership agreement.
Read trusted tips for creating a strong partnership here.
Limited Liability Company (LLC)
The LLC structure is very popular among small businesses. It provides some of the best options and flexibility for business owners. The profits and losses pass through to the owner’s tax returns much like in a partnership. However, there is liability protection not offered by other structures. In addition, the IRS allows LLCs to choose the way they are taxed, either as a partnership or a corporation.
An LLC structure is relatively simple to organize, offers owners strong legal protections and tax flexibility. The LLC requires more paperwork to get started than some other structures, which is why many owners use a trusted professional to help with the filing and documentation. You can use an online service to create an LLC, to save you time and hassle.
Corporation
There are multiple corporate structures to choose from. With a c-corporation, the business is a separate entity, paying corporate taxes. S-corporation owners must report their share of profits or losses on personal returns.
Understanding the nuances of the different business structures allows you to make the right decision for how to legally structure your business.
2. Identify Required Licenses, Permits and Registrations
Each business is unique and the area where you operate will have its own requirements at the state and local levels.
Depending on the type of business you operate, you will be required to obtain various licenses and permits to run your business. If your business offers food or drinks, for example, there will be local health department requirements that need to be fulfilled. If you’re offering skilled services such as plumbing or electrical work, you may need to obtain professional licenses before setting up your shop.
The licenses, permits and registrations you need will vary by state, county, city and town. You may need state or local business licenses, for example, or register your business at the state or local level. Building permits and other code-related local laws must be followed and inspections may need to be scheduled to ensure compliance. Even home-based businesses may require a license.
With so many potential requirements, it’s important to reach out to your local and state licensing offices, or use a professional, to be sure you have all your bases covered.
3. Get an Employer Identification Number
Opening a corporate bank account, paying employees or filing your business tax returns all require having an employer identification number (EIN). The EIN works in much the same way as a Social Security number. It’s a unique identifier that allows you to conduct business.
If you are a sole proprietor or run a single-member LLC, you are exempt from this requirement. Otherwise, you can obtain an EIN for free from the IRS over the phone or via an online form.
The person completing this process will need to provide their Social Security number and have information about the business entity and date of incorporation available.
4. Pay Business Taxes
No matter what business entity you choose, your business will have tax forms it needs to complete, either as a corporate entity or for you as an owner on your individual forms.
You may be subject to multiple taxes at the federal, state, and occasionally, local levels. In addition to income taxes, you may be liable for self-employment taxes and sales taxes.
Businesses do not use the same April 15 tax calendar exclusively. The IRS requires many businesses to pay estimated taxes on a quarterly basis. Check with the IRS to ensure your business type is paying taxes at the right time to avoid fines and penalties for late payments.
Having the right records makes filing your taxes that much easier. Investing in a bookkeeping service or using software helps ensure that you are tracking inventory, sales, taxes and other terms accurately. Being able to document and find transactions, sales and other business information is important not just for tax filing but also in case of an audit.
5. Secure Your Name and Trademark Your Name, Logos and Slogans
What’s in a name? For your small business, it’s everything. In many states, you need to register your legal name, finding one that is not already in use within the jurisdiction. In some states, there are two names to consider. One is the legal name of your business. The other is your doing-business-as or DBA name, which is what is used to promote your business and is on signs, business cards and advertising.
Most states have online databases where you can search for both legal and DBA business names and file yours.
If you are going to operate nationally or online, you may want to consider trademarking your DBA name. A business or DBA name filing in your home state will not be enough to protect your brand in the 49 other states. Trademarking provides additional brand protections, though is not required.
In addition, consider trademarking any logos, slogans and other branding materials you use. The U.S. Patent and Trademark Office is where trademarks are filed and can help with searching to see if your chosen symbols and brand items are already trademarked.
6. Obtain a Bank Account and Insurance
Having a separate bank account for your business transactions is a smart move. It allows you to separate your personal and business assets, which can be important if you are ever sued or audited. Set up a business bank account as soon as you start to accept payments. Find a bank that caters to small businesses and establish a good banking relationship, which can help in the future when seeking business loans.
To establish a bank account, you’ll need your EIN, business formation documents, any applicable ownership or partnership agreements and business license, if applicable.
Similarly, insurance is an important safeguard to protect you from claims by employees, customers, clients and business partners. There are many different types of business insurance available. Among the most common are
- General liability insurance, which covers a range of issues, from property damage, libel or slander claims or legal costs defending lawsuits
- Workers’ compensation insurance, which is required in all states but Texas and protects you and your employees in the case of work-related injuries, illnesses or accidents. It’s important to have this coverage in place before an employee begins working
- Home-based business insurance, which will cover losses not covered under your homeowner’s policy
- Errors and omissions insurance, also known as professional liability insurance, which protects you if a client incurs financial losses due to an error or omission on your part and chooses to sue you to recoup the losses
7. Draft Founders and Partners Agreements
If your business has multiple owners, you need to set forth the terms – financial and operational – for your business. If your business is a corporation, you’ll need articles of incorporation and shareholder agreements.
These agreements are critical in defining how the business operations, how profits are shared and how disputes are resolved. Without these agreements in place, your business could be in for costly legal disputes later.
Having sound legal decisions made is an essential responsibility of running a small business. From the business structure you choose to the financial infrastructure you establish, having a firm legal grasp on your business operations is critical.
When you’re ready to launch your company , knowing the legal steps necessary to protect it, and yourself, is smart business sense.
