Starting a business can be difficult for anyone, there are so many unknowns that you may come across. Particularly navigating decisions regarding business structure, obtaining the right permits or having the right insurance. Luckily, at Mitchell- Firm we offer many consulting services to place your business on the right track. Continue reading to learn about the basic legal requirements for starting a business.
With a fledgling business, passion for a product or service usually comes easily. Less exciting are the legal requirements for operating legitimately. Requirements vary dramatically depending on the industry, the type of business and its location, so specific research will be required. While there’s no substitute for advice from experienced legal counsel, this guide outlines some of the most important legal requirements that small business owners should consider before getting too far into operations.
Business Structure and Designation Requirements
Once the mission and strategy of a business become clear, an important next step is to decide on the business’s legal structure. The choice you make can affect everything from the way you operate the business to the liabilities you’ll face to the way you pay taxes. Here are the most common options for small business owners:
The simplest structure for a one-owner business is a sole proprietorship. As a sole proprietor, a business owner has relatively few regulatory burdens and a high degree of control and flexibility. There’s no paperwork required to establish a sole proprietorship–it’s automatically created as soon as you start doing business. However, if you’ll be using a business name other than your own name, you’ll probably need to register your business name as a DBA with your state or locality.
A sole proprietorship does not form a distinct business entity, which means that there’s no legal difference between the business’s assets, debts and other liabilities and those of the owner. This creates a risky situation for owners, as they’re on the hook for any legal or financial failures of the business. You can’t take on partners and remain a sole proprietorship, and your ability to get a loan for your business will hinge on your personal credit. Sole proprietors report business income and expenses on their personal tax returns, and they pay income and self-employment taxes on their profits. Some business founders use sole proprietorships to test a business idea before committing to a more formal structure and paying the higher fees associated with those structures.
There are several kinds of partnerships. If you go into business with other people and don’t set up a formal business entity, your business is automatically considered a general partnership. Like sole proprietors, partners in a general partnership are fully liable for all business debts and obligations. They’re also liable for actions taken by their partners–a major reason why most lawyers encourage businesses to form an LLC or corporation rather than remain a general partnership. General partnerships are taxed similarly to sole proprietorships, with partners reporting their share of income, expenses, credits, profits and losses on their personal tax returns.
Other kinds of partnerships include:
- A Limited Partnership or LP, which stipulates that at least one “general partner” assumes personal liability for the business’s affairs, while other partners are passive investors with limited liability. Limited partnerships are common in certain industries such as real estate development.
- A Limited Liability Partnership or LLP, also provides limited liability for partners, but the specifics vary by state. In some states the liability protection is the same as for an LLC, but in other states the protection only extends to liability for other partners’ negligence. Some states require one general partner to remain fully liable. And some states restrict LLPs to certain licensed professionals like doctors, lawyers and architects.
Related: Limited Liability Partnership vs Limited Liability Company
Limited Liability Company
A Limited Liability Company or LLC balances the relative ease and flexibility of a partnership structure with the increased risk protection and potential tax advantages of a corporate structure. LLC owners (known as “members”) aren’t personally liable for business obligations. By default, LLC members are considered self-employed, and they file and pay taxes in the same way as owners of a general partnership or sole proprietorship. But an LLC can also elect to be taxed as a corporation. To set up an LLC, you must file articles of organization with your state.
An LLC should also have an operating agreement that details how the LLC will be run and the rights and responsibilities of the members.. Many small business owners choose LLCs for their simplicity and flexibility.
With a corporation, the owners’ liability for business obligations is limited to the amount they have invested in the company–business creditors can’t go after their personal assets. Corporations have a well-defined organizational structure that includes a board of directors, officers, and owners, who are known as shareholders. A corporation may pay corporate income tax as a C-corp, or it may be eligible for pass-through taxation as an S-corp. Corporations tend to have more rigorous recordkeeping and reporting requirements than LLCs.
A corporation is formed by filing articles of incorporation with the state. Corporations should also have bylaws. Because corporations have a predictable structure and their shares are easy to transfer, corporations are well-suited to businesses hoping to attract outside investment.
Business Name Registration Requirements
Business owners should explore several different ways to register and protect a business name:
If you form an LLC, corporation or other type of business entity, your business name will be registered with the state. The state won’t allow another business to be formed with the same name as yours.
A federal trademark helps protect a business name nationwide. You can apply for a trademark through the US Patent and Trademark Office. Though trademarks are not required to operate a business, registering a name may be a good idea to protect the exclusivity rights that come with a registered trademark.
A “doing business as” (DBA) is often also known as a “trade name” or an “assumed name.” You usually must register a DBA if your business is using a name other than its official legal name. Sole proprietorships and partnerships don’t need a DBA if they’re doing business under the owners’ names. LLCs and corporations don’t need a DBA if they’re using the business’s official name. It’s possible for multiple businesses in the same state to share the same DBA name. Depending on your state and the type of business you have, you may need to file your DBA with the state or with your locality.
A domain or web address is unique to the buyer and can be essential to a business’s online presence. Though there is no legal requirement to have a domain, obtaining a domain name that matches your business name can help you brand your business and minimize the chance your business will be confused with another business online. Having a domain name does not establish a business entity or fulfill any other legal requirements, nor does it give you the exclusive right to use your business name.
Tax Identification Numbers
A federal tax identification number, also known as an Employer Identification Number (EIN) is a nine-digit number for businesses. Almost all businesses must get an EIN, though sole proprietors and single-member LLCs with no employees may be able to use the owner’s Social Security number instead. You can get an EIN for free at the IRS website, which offers specific, detailed information about requirements on its EIN application page.
Licenses and Permits
Business owners should anticipate potential requirements from all levels of government:
A federally-issued license or permit is required for many businesses whose activities fall within a federally-regulated field, such as transportation, agriculture, alcoholic beverage production and sales, broadcasting and use of natural resources.
A state or local license or permit may be required in a variety of business categories as well, all depending on state and local law. For example, if you sell goods in a state that collects sales tax, you’ll need a seller’s permit. Most localities require businesses to obtain a general business license or permit. And you may have additional state or local licensing requirements that apply to your specific industry. City or county business licensing agencies can be good places to learn what special permits or licenses might be necessary.
No matter how well a business is run, liability risks can never be eliminated. Risk is part of the cost of doing business, and it pays to be prepared. Depending on the circumstance, certain insurance policies may actually be legally required as a safeguard, much like personal auto insurance is.
Many businesses rely on an insurance broker to help determine the appropriate “coverages” (and amounts of coverage) for their situation, such as these common types:
General liability insurance is recommended as the bare minimum of coverage for any business. It insures against near-universal liabilities like damage to company property or personal injuries that occur as a result of doing business.
Product liability insurance covers alleged harm from defective products and might be important for businesses that produce and distribute goods of any kind.
Professional liability insurance, also known as “errors and omissions insurance,” covers claims of professional negligence on the part of any business employee.
Commercial property insurance offers additional coverage for land and facilities that could suffer damage from issues like fire, flood and vandalism.
Workers’ compensation insurance covers employees who get hurt on the job and is required for any businesses with employees in all states but Texas.
Auto liability insurance covers accidents involving company-owned vehicles and employees driving on company time.
The Bottom Line
Depending on the location and type of business, getting a new small business properly registered, named, licensed and insured can be a daunting process. Doing this work right can prove worthwhile as legal troubles can pile up quickly—from regulatory agencies, other businesses, customers and even a company’s own employees. Business founders take on significant risks when starting a small business venture, but much of this risk can be mitigated by ensuring legal requirements to starting the business are taken care of as early as possible.