Starting a new business is an exciting venture, but it comes with important legal, financial, and operational decisions. Entrepreneurs should take time to understand their options and work with professionals to set up their business for success. Below are key considerations for aspiring business owners.
Choosing the Right Business Entity
One of the first decisions an entrepreneur must make is choosing the type of business entity. The structure of the business impacts taxation, liability, and administrative requirements.
- Sole Proprietorship: The simplest form of business, a sole proprietorship requires no formal setup beyond necessary licenses or permits. However, the owner is personally liable for all business debts and obligations.
- General Partnership: If two or more people start a business together without forming a separate entity, they automatically create a general partnership. Each partner is personally liable for the debts of the business. A partnership agreement is strongly recommended to define roles, contributions, and dispute resolution methods.
- Limited Liability Partnership (LLP): An LLP provides liability protection to some extent while maintaining the flexibility of a partnership. Commonly used by professionals like attorneys and accountants, this structure offers liability protection for individual partners regarding malpractice claims.
- Limited Liability Company (LLC): An LLC provides liability protection similar to a corporation but with fewer formalities. LLCs offer flexible taxation options—either as a disregarded entity, partnership, or corporation. An operating agreement is essential, especially when there are multiple owners, to outline governance and profit distribution. The lack of required corporate formalities that an LLC must follow is great, especially if it is a sole-member LLC. When there is more than one owner, it is more likely that formalities like formal meetings with minutes become invaluable to avoid misunderstandings.
- Corporation (C-Corp or S-Corp): A corporation is a separate legal entity that provides strong liability protection. C-Corporations face double taxation (corporate and individual levels), while S-Corporations pass profits and losses through to shareholders, avoiding corporate tax. S-Corporations have restrictions, such as a limit on the number of shareholders and requirements for U.S. residency.
Keep in mind that these different business structures come with specific legal terms that may not be appropriate to be used for the other business structures. For example, many individuals refer to the other stakeholders in a business, corporation or LLC as a “partner”. That can confuse the roles, rights and responsibilities that individuals have in a business endeavor. Disputes have arisen when an owner uses the word “partner” more to build camaraderie with their employees. However, calling someone a “partner” might unintentionally cause someone to believe or actually create a partnership relationship.
Tax Considerations
Each entity type has different tax implications. Entrepreneurs should consult with a CPA or tax professional to determine the best structure for their business. Key considerations include:
- Pass-through taxation vs. corporate taxation
- Self-employment tax obligations
- The benefits of electing S-Corporation status for tax efficiency
- State-specific tax obligations and franchise taxes
The Role of Insurance in Risk Management
Insurance is a critical component of risk management. A new business should work with an insurance broker to determine appropriate coverage, which may include:
- General liability insurance
- Professional liability insurance
- Workers’ compensation insurance (mandatory for businesses with employees)
- Employer Practices Liability Insurance (EPLI) to protect against employment-related claims
Many landlords and lenders require personal guarantees from business owners, making it even more crucial to have sufficient insurance coverage to mitigate risks.
Governing Documents for Multi-Owner Businesses
When a business has multiple stakeholders, clear governance documents are crucial. Depending on the entity type, these documents may include:
- Partnership Agreement (for partnerships)
- Operating Agreement (for LLCs)
- Bylaws and Organizational Minutes (for corporations)
These documents set out how the business is managed, decision-making procedures, profit distribution, dispute resolution mechanisms, and what happens if an owner exits or the business dissolves. Establishing these agreements early can prevent costly legal disputes down the road.
The Importance of Well-Drafted Contracts
Contracts are the backbone of any business, particularly for service-based companies. While free templates are available online, they often only include basic terms (boilerplate provisions) and may not adequately address the unique aspects of a business’s operations. Entrepreneurs should consider working with a small business attorney to ensure their contracts:
- Clearly define the scope of work
- Address payment terms, late fees, and remedies for non-payment
- Include provisions for terminating the relationship, including dispute resolution mechanisms
- Protect confidential information and intellectual property
Some businesses use boilerplate forms that actually have terms that hurt their business! For example, some businesses are so focused on getting paid (as a they should) that they include illegal terms that may violate laws, like usury, or terms that are so aggressively or poorly written that the term is not actually enforceable. This is frequently seen with poorly drafted liquidated damages provisions- they are buried in the document, in an inadequate font size or type of font, not reasonably tied to any potential loss, etc. Business owners frequently fail to recognize the possibility that they may want to terminate the relationship. This is especially true for new businesses who are excited when they actually start getting clients. Business owners who fail to consider that they may want to terminate the relationship oftentimes unintentionally lock themselves into a relationship that they no longer want to be in or that is losing money.
Building a Professional Support Team
Starting a business requires guidance from multiple professionals. Entrepreneurs should connect with:
- A Small Business Attorney: To ensure proper entity formation, draft contracts that are actually useful and not a source of liability, and navigate legal risks
- A CPA or Tax Professional: To optimize tax strategy and compliance
- An Insurance Broker: To identify necessary insurance policies for risk management
By working with these professionals, entrepreneurs can start their businesses with a strong foundation, avoid costly mistakes, and focus on growth.
Starting a business is more than just having a great idea—it requires careful planning and the right professional support. By considering these key factors, entrepreneurs can set themselves up for long-term success.