My nine-year-old daughter recently informed me that she and her best friend were about to start a dog-walking business. I’d previously rebuffed her requests for our family to get a dog by noting my aversion to picking up dog poop. However, I thought this seemed a reasonable way for her to get some dog time, and some familiarity with the work involved with having a dog. I wasn’t deterred by her statement that the services would be free for dog owners, pre-IPO profitability not being particularly in vogue these days. But, as a lawyer and typical dad, I did have some questions – for example, what type of agreement had she reached with her best friend? Had she thought through liability waivers with the clients? What would the branding be and how would she protect it?
I assured her that while it might seem daunting, the legal aspect of starting a new business doesn’t need to be.
If you’re thinking about making the move to start a new business, whether working with my firm, another firm, or handling the process yourself, the list below should point you in the right direction.
- Don’t Be Surprised by a Previous Employer’s Restrictions
- The Benefits of Forming an Entity
- Sole Proprietor, LLC, or Corporation?
- You Probably Don’t Need to Form In Delaware
- Protect Your IP Right from the Start
- You Should Have A Standard Agreement
- You Should Have A Standard Agreement
- The Starting a Business Checklist
Don’t Be Surprised by a Previous Employer’s Restrictions
One key thing to consider is whether your agreements with a current or previous employer might continue to impose any restrictions on you. When starting a new venture, it’s essential that you make sure that you’re in compliance with any prior employment or consulting agreements that you have signed. You’ll want to give a close read to any prior agreements in which you may have agreed not to work in a particular field for a certain amount of time, or not to solicit your previous employer’s employees, customers, or vendors, as these obligations may extend into your post-employment activities. These provisions are typically contained in a confidentiality agreement, an employment offer letter, or an exit agreement. While these restrictions are not always fully enforceable, they are something to take stock of at the very outset. Ideally, you should consider these issues before you sign any type of exit agreement.
The Benefits of Forming an Entity
While there is no requirement to form an entity, there are many benefits to having an entity that is separate and distinct from the owner personally. For example, generally, an owner is not personally liable for the debts and liabilities of the entity. And, having a company with its own name and existence provides a sheen of legitimacy; it gives counterparts some comfort that you expect to be in business for the foreseeable future. It can also be a mechanism to bring on partners and divvy up profits.
If you’re expecting it to be a long-term plan, then you should consider setting up a proper entity, usually either a limited liability company, or a corporation. If the intention is that it is going to be a short term plan to do consulting work between employment opportunities, it’s likely fine to be set up as a sole proprietor, doing business in your personal name. If you go this way, then you definitely should have a carefully drafted agreement with your clients – you want to make sure that you don’t put your personal assets at risk if an engagement goes south.
Sole Proprietor, LLC, or Corporation?
This is where the type of business might affect the decision. Most consultants that I work with form a limited liability company. It’s the most flexible form, has little in the way of formalities, and has pass-through taxation so there is not “double taxation,” where the entity has to pay its own tax in addition to the tax imposed on you as the owner.
However, if you expect to raise investment capital in the near term from venture capital funds, or expect to issue options to employees, then a corporation becomes a much more likely choice.
You Probably Don’t Need to Form In Delaware
I’m often asked whether the company should be formed in Delaware. It’s commonly thought that Delaware has the “gold standard” of company formations and that it provides some additional corporate benefits. However, for most small businesses, there is little benefit to being formed in Delaware as opposed to another state. And for companies where the employees would not otherwise be in Delaware, it subjects the company to the jurisdiction of another sovereign – the State of Delaware. So the company would need to maintain its formalities in Delaware and could be sued in Delaware, in addition to the state in which the company’s employees are located. For most small businesses, it makes most sense for the company to be formed in the state where the owners and employees are going to be. And, remember, if you’re incorporating in one state, but your employees are located in another state or the business has an address in another state, you want to register to do business in all of these states.
Protect Your IP Right from the Start
If you are going to be branding your company or your services, or you are going to be creating any inventions, images, text, software, videos, music, or other creative works, then you’ll want to think about protecting your intellectual property. If you’re branding your company or services, you’ll want to clear your branding through a trademark search, and then register your trademark to prevent third parties from using any confusingly similar brand. If you’re creating videos, text, code, or other fixed intellectual property that you expect to keep ownership of, then you may want to register your copyrights in that work product. And if you think you may have some novel inventions, you should consider filing for a patent.
You Should Have A Standard Agreement
I’m often surprised how many extremely smart and otherwise very savvy small business owners don’t have a standard form of agreement to use with their clients. This usually comes across my desk when a person reaches out to say that they are in a dispute with a client over how much they should be paid or that they’re worried about being sued, or they’ve already been sued.
For example, I heard from a web developer who thought agreements were a waste of money until he lost months of sleep over an easily-avoidable lawsuit. I had someone contact me when there was a dispute over an image; although the person believed the illustrator had transferred image ownership, it was never formally documented so the company’s rights were greatly at risk.
At the outset of a relationship it’s easy to mistakenly think everyone is in agreement as to the terms. Even if you’ve agreed on the services and pricing, what about the warranties, ownership of intellectual property, ownership of rejected work, or limits of liability? Having a set of standard terms is a way to not only show that a business is well managed, but it also level-sets what the terms of the engagement will be.
Similarly, if you’re going to be using third-party contractors as part of your services, it’s important to have those agreements in place and carefully drawn to reflect the relationship, including confidentiality and ownership of the resulting work product.
If you’ve taken care of all of the issues noted above, you should be headed in the right direction. Below I’ve listed a basic checklist to use to get yourself up and running.
The Starting a Business Checklist
- Check your existing agreements for any restrictions and make sure you’re clear to start your venture.
- Form the entity. Corporations and LLCs are both formed by state-level filings. Most of the documents are fairly standard and can be handled by an attorney or document services company at minimal cost. New York requires that a newly formed LLC “publish” its existence, which can add around $800 to $1000 to the cost of the formation.
- Get an EIN from the federal government. While the government is slow at so many things, they’re usually fast about providing an EIN (because you use it to pay them).
- Open a bank account in the name of the entity. Keeping your cash flow and books and records for your entity separate from those of your personal accounts is essential to maintain the protections afforded by the entity.
- Register to do business in states where you are going to be located, if that’s not where the entity is formed.
- Protect your branding and other IP, including registering trademarks and copyrights.
- Draft your agreements, including a standard client agreement and the agreements you’ll have with any contractors. And if you are going to have a business with multiple owners, you definitely want agreements to document your rights and relationship, and what happens if one person wants to leave the business.
- Get a good financial advisor on board. You’ll want someone to help you with tax guidance right from the start.
- And, of course, get your clients.