Legal Issues to Consider When Starting a Business
Starting a business can be exciting but failing to consider and address early legal issues can expose a new business to unanticipated costs. Below are some important legal issues to consider when starting a business.
1. Choosing a Business Structure
Choosing a business structure is a fundamental decision that can have several implications for a business. The business structure determines how a business is organized, how it will be taxed, and the level of personal liability its owners may face. Common structures include sole proprietorships, partnerships, limited liability companies (LLCs), and corporations. Each structure has distinct legal and tax obligations.
By default, if you have not formed an entity for your business and you sell a good or service by yourself then you are a sole proprietor, and if you sell a good or service with a partner then your business is a general partnership. These business structures are the easiest to set up because there are no required government filings. But neither of these structures provides any limited liability protection for the business owners. Conversely, the owners of an LLC or corporation are generally not personally liable for the business’s debts, obligations, or other liabilities.
If you choose to structure your business as an LLC or corporation, you will need to form that entity. In California, this requires that you file the articles of organization (for an LLC) or articles of incorporation (for a corporation) with the California Secretary of State and file an annual or biennial report (depending on entity type) called a statement of information. And to help ensure that the entity is governed and managed correctly, you will likely need to draft additional governing documents for it such as an operating agreement for an LLC, bylaws for a corporation, and possibly other documents.
2. Considering Whether a DBA is Necessary
If you operate your business under a name other than its legal name, you will likely need to file for a DBA (doing business as), which is also called a “fictitious business name” or “trade name.” In California, if you are a sole proprietor, your business’s legal name is your personal name; if your business is an LLC or corporation, its legal name is the name on file with the California Secretary of State. Failure to obtain a DBA when required can result in several issues such as the inability to enforce the business’s contracts or open a business bank account.
3. Obtaining an Employer Identification Number
An Employer Identification Number (EIN) is a unique nine-digit number assigned by the IRS to businesses operating in the United States. It serves as a business's federal tax identification number similar to a Social Security number for individuals.
The primary purpose of an EIN is to identify a business for tax purposes. A business needs an EIN to file tax returns, open business bank accounts, hire employees, and apply for business licenses.
4. Opening a Business Bank Account
Opening a business bank account is a critical step for establishing a business. One of the primary reasons for opening a business bank account is to maintain a clear distinction between personal and business finances. This separation is important not only for accurate financial reporting and tax compliance but also for protecting personal assets from business liabilities. Commingling personal and business funds can undermine the legal protections afforded by limited liability structures like corporations or LLCs, which could potentially expose your personal assets to business creditors.
5. Ensuring Zoning Compliance
Zoning laws are established by local governments to control what types of structures can be developed on a property, how they may be modified over time, and the permissible uses for those structures. Compliance with these regulations is essential to avoid issues like fines, a requirement to cease operating the business at the location, and other penalties. For example, if you are operating an auto repair business in a zone that is designated for commercial offices, and auto repair is not a permitted use there, then you may be required to stop operating your business at the property.
6. Obtaining Required Permits and Licenses
Obtaining required permits and licenses is a fundamental legal obligation when starting a business. These permits can include health permits, building permits, occupational licenses, and more depending on the nature of the business and its location. Permits and licenses may be required by federal, state, and local authorities. Like a zoning violation, failure to secure required permits and licenses can result in various consequences such as fines, forced cessation of business operations, and other penalties.
7. Drafting Contracts
Drafting contracts is a critical legal task for any business, as contracts establish the terms and conditions of business relationships and transactions. A well-drafted contract clearly outlines the rights and obligations of each party, which helps to prevent misunderstandings and disputes. Contracts can cover a wide range of business activities, including sales, employment, partnerships, leases, and more.
Ensuring that contracts are comprehensive and legally sound is essential to protect the business’s interests and minimize the risk of litigation. Poorly drafted contracts can lead to legal disputes, financial loss, and damage to business relationships.
8. Protecting Your Intellectual Property
Protecting your intellectual property (IP) is vital for maintaining a competitive edge and safeguarding the unique aspects of your business. Intellectual property includes trademarks, copyrights, patents, and trade secrets, which are essential assets that contribute to a business's identity and value.
Failing to protect IP can lead to unauthorized use by competitors, which can result in financial loss and damage a business’s brand reputation. Legal protection of IP through registration helps ensure that your business retains exclusive rights to its innovations and creative works.
9. Complying with Employment Law
Employment laws encompass a wide range of topics such as wage and hour laws, anti-discrimination, workplace safety standards, and employee benefits requirements. Adhering to these laws helps protect the rights of employees and ensure that the business operates within legal boundaries. Implementing policies and procedures that align with employment laws minimizes the risk of lawsuits and penalties.
10. Getting Insurance
Getting insurance is an important step for protecting a business. Insurance can provide financial coverage against unforeseen events such as property damage, legal claims, and employee injuries. Common types of insurance include general liability, property, workers' compensation, and professional liability insurance. Having the right insurance policies in place helps ensure that a business can recover from losses and continue operations without significant financial strain.
11. Managing Online Presence
Creating a legally compliant website is essential for businesses operating online. This requires compliance with data privacy and protection laws and consumer protection laws. To comply with these laws, a business should implement a privacy policy, establish procedures to secure user data, and ensure its website does not contain any unfair or deceptive acts or practices. Non-compliance can lead to fines and other penalties.
12. Complying with Sales and Use Tax Laws
Depending on a business’s activities, it may need to register with its state’s tax authority (such as the California Department of Tax and Fee Administration) and collect sales and use tax. Compliance with tax laws, including sales and use tax, is essential for businesses to operate legally and avoid penalties. Businesses must accurately collect, report, and remit sales and use taxes to the appropriate tax authorities. Failure to comply can result in audits, fines, and interest charges.
The text above is intended for informational purposes only and is not legal advice. For advice tailored to your situation, please consult with an attorney.