Starting a Small Business? Don’t Forget the Legal Stuff
When a small business is being conceived, it can be tempting for owners and investors to race past entity formation, legal, and liability issues.
Those issues can be a drag. They don’t inspire anyone, and no one starts a new business expecting ideas, business models, or relationships to run into snags, much less fall apart.
Snags can happen, however, and things routinely do fall apart. Even better mousetraps make yours the MySpace of mousetraps, and day-to-day routines can make running a small business feel something like “Marriage Tango” in I Love You, You’re Perfect, Now Change (where the husband sings about getting the kids in bed, cleaning up, and the “joys of being wed” and then it’s “Mom! Dad! The lizard’s eating the guppies!” and “Tyler threw up in the bed!”).
Whatever promise a new venture may hold, disputes and “business divorce” are routine.
Those involved in a start-up venture should consult with a lawyer about basic formation issues, along with liability, compliance, and taxes, and all the “What Ifs.” Small businesses face enough ups and downs in the business and financial world. Lack of planning can create otherwise avoidable problems.
A start-up attorney is something like Wilford Brimley’s character in The Firm: there to “worry when there’s nothing to worry about.” That’s not precisely true, but any good lawyer will prioritize basic issues that can be overlooked–how the business should be organized; the handling of routine, day-to-day functions; and anticipating hiccups and disputes.
The law applicable to start-up business issues is primarily a function of state law. Along with other states, Connecticut recognizes business forms and ideas can take many shapes and allows for a range of ways for owners and investors to do business.
For instance, a “sole proprietorship” generally means all risks and benefits associated with the business (e.g., profits, losses and risk exposure) flow to the owner(s). Some small businesses have a “doing business as” (d/b/a) designation. But a d/b/a has no legal significance. I could open an organic donut shop named the “Wilton Mostly Donutoruim” but if my “Donatrium” was sued for serving a non-organic donut, the exposure would be mine personally. In other words, the profits, losses, risks and liabilities would generally all be mine.
Any new venture should consider risk protection and more formal governance. Connecticut law provides for entities of varying complexity including limited liability partnerships (LLPs), limited liability companies (LLCs), and either “S” or “C” corporations. (Although insurance can lessen risk, creating the right business entity is often the most cost-effective means of limiting risk and liability.)
The most common entity for small businesses is an LLC. The key advantages of LLCs as compared with other entities are limited personal liability, simplicity, and flexibility. Generally, LLCs enable owners to protect personal assets and limit personal exposure without complicating day-to-day operations or raising significant tax or compliance issues.
Starting an LLC in Connecticut requires only a few basic filings with the state. Connecticut does not require LLCs to have an Operating Agreement, but these agreements can be exceptionally important, since they memorialize a basic understanding among owners about the business–how the company will be run, who will manage the LLC and make decisions, voting protocols, how profits and losses are distributed, how risks are shared, and other issues. An LLC Operating Agreement should also set forth how ownership and voting rights can be modified.
Of course, LLCs are not the right answer for all businesses. Connecticut is one of several states that authorizes entities with various levels of complexity, including S- or C-corporations. More complex business entities can outlast the original owner(s) and help attract business and capital but are difficult to form and raise complexities associated with ownership, governance, tax, and compliance.
In tandem with entity and formation issues, new business owners should plan for day-to-day operations. These range from routine (e.g., lease agreements, supplier and vendor contracts, and insurance coverage) to more complex (e.g., employment and independent contractor agreements, licenses, and intellectual property issues). As with business formation and governance issues, new businesses should consult with counsel about what formality and agreements may be needed.
It is understandable that addressing issues like the ones discussed here can be a drag on time, resources and money for new businesses. It’s not why anyone starts a small business. But “business divorces” are common; things do go haywire, and ideas, business models, and relationships all do fail. When they do, a lack of due diligence and planning will compound problems, and any eventual resolution undoubtedly will be more far expensive and time-consuming. Business owners should view good planning as a form of insurance–spending some time and money now to avoid spending a lot of time and money later.
Bill Lalor is an attorney in Wilton. He can be reached via email.
This content is provided as background and does not constitute legal advice.