12 Steps to Starting a Business

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Startup Overview

Incorporation

Contracts

Co-Ownership

Intellectual Property

Branding & Naming
 

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Individual circumstances will dictate the order in which these steps should occur.  Nonetheless, the order appearing below is a common path followed for many businesses.
 

The primary legal issues raised by selecting products and services for your new business are:

• Contracts. These can provide protection against liability as well as grant you significant advantages such as exclusive opportunities.  Contracts can shift liability to your advantage, ensure you have leverage to negotiate if a vendor doesn't perform or a client/customer doesn't pay, give you the edge if lawsuits arise, and help you avoid unintended warranties.  Unlike contracts in our personal lives, there is often great room to negotiate contracts in the business world.  As such, only your imagination limits what can be done with a contract to help your business.
   
• Intellectual Property. The primary issue here is to be certain that you are not selling or using a product that is protected by someone else's patents, copyrights or trade secrets.  You also want to consider obtaining your own protection for any valuable intellectual property you might have created by your new product offering.  NOTE:  if you have a patentable invention, you have a very brief time after selling or showing it to people before you must apply for patent protection.  

The word "incorporation," literally interpreted, refers to the process of becoming a corporation.  However, in popular usage, "incorporation" refers to the formation of any legal entity that shields the company's owners from personal liability.  Thus, you could, for example, "incorporate" as a limited liability company (LLC) or as a limited liability partnership (LLP).

At a minimum, incorporating requires filing "Articles" with the MN Secretary of State's office.  By so doing, you may receive legal and tax benefits that you would not otherwise receive.  However, if done properly, incorporation goes way beyond merely signing on the dotted line of the Secretary of State's Articles of Incorporation or Articles of Organization. 

On the legal front, what you get from incorporating is protection against personal liability from debts and lawsuits directed at the business. For example, if your incorporated business goes bankrupt due to excessive debt or lawsuits, then in theory, you should be able to avoid having your personal name associated with any bad credit, or any judgments associated with that bankruptcy.  Instead, while the business undergoes bankruptcy, you could be starting all over in a new business.

However, there are specific limitations to this liability protection, some of which exist only if the owners fail to operate the business according to the appropriate formalities required by law.  However, the exceptions are generally easy to avoid once you know what you're doing.  More about incorporating...
 

Laws governing business activity exist at every level of government - federal, state, county and city.  Further, the laws for any given level of government are not found in any single place.  For example, federal laws are made by Congress in the form of statutes, made by judges in the form of case law, and by made by administrative departments in the form of agency rules and regulations.  

The Minnesota Department of Trade and Economic Development provides a list of agencies that can help you through the maze of permits and licenses for each industry. 

Another source for determining which regulations may apply to you are journals in your particular trade or industry.  Trade journals often keep their readers apprised of new regulations, and usually revisit the most important regulations by publishing ongoing articles on those regulations. 

LawMoose and the James J. Hill Library are two outstanding sources for researching the multitude of laws and regulations that exist for business in Minnesota.

Finally, an attorney can also help you determine which laws regulate your business, and whether or not you're in compliance.  However, because this research is time-consuming, you may wish to do as much of the research on your end as possible before seeing an attorney.  And, when finding an attorney for this purpose, it is especially important to ask if they have familiarity within your particular industry.
 

The single legal issue that directly applies to writing a business plan is an unlikely one:  avoid copying other people's plans or you may infringe their copyrights.  The best business plans are those customized to the specific business at hand, so it would be unwise to copy anyway. 

Of more relevance are the number of legal matters that you may want to address as topics in your business plan.  These include:

• Intellectual Property.  If you have valuable intellectual property, you probably want to mention that in your plan as a business asset.  By registering valuable intellectual property, you show bankers and lenders your business savvy, so any registrations you own should certainly be mentioned. Also, you need to consider whether the intellectual property is owned by the company, retained by you, or owned by a separate holding company you might own.  In any case, you probably need an assignment or license of that intellectual property, so that it is legally on the books of the company. 
   
• Contracts.  You will want to mention all your legally binding deals and obligations.  Obligations, such as leases, are an important part of the liability your company holds, but may also be viewed as a competitive edge, if the contract or lease has favorable terms.  If negotiated well, favorable contract and lease terms can be viewed as a competitive edge for your company.  If such is the case, you'll want to show them off in your business plan. Typically you would only mention terms summarily. However, at times it may make sense to provide the entire contract or lease with the business plan as an attachment.
   
• Incorporation.  In the "Description of Business" or "Operations" sections of your business plan, you will want to mention whether or not you are incorporated, and if so, what entity you have selected.  Lenders like to see that you have shielded liability from yourself as an individual, because doing so will ensure a greater chance that you will have money and assets left over to pay them if the business bankrupts (lenders almost always require a personal guarantee, so you won't bankrupt the business and leave them out in the cold).

"Clearance" refers to the process of determining whether any pre-existing intellectual property rights are owned by other companies or individuals.    If there is a prior rights-holder, they can stop you completely from using their intellectual property, period. 

"Protection" refers to the steps you can take to maximize the value and security of your own intellectual property.  These steps include registering, monitoring and enforcing your rights in intellectual property.  It is generally best to clear intellectual properties before taking steps to protect them.   

• more about what intellectual property is...
• more on clearing and protecting intellectual property...

You will need enough money to keep the business running until it becomes self-sustaining.  There are two basic sources for obtaining startup money beyond your own savings; namely, lenders and investors.   Money given by investors is referred to as "equity financing."  Money given by lenders is called "debt financing." 

Lenders are typically banks, but can be anyone who loans money with an understanding that it will be paid back even if the business fails.  Investors, on the other hand, will give money only in exchange for an ownership interest in the business.  If your business is a corporation, you can raise money from investors by selling shares of stock in the company.  If your business is a limited liability company, you can raise money from investors by selling a percentage interest in the company.  Investors will be paid back only if the business is profitable.  But, if it is not profitable, they may loose their entire investment without recourse.

For this reason, there are both state and federal restrictions on the sale of business interests, better known as securities laws.  In most instances, small businesses can fit within the exceptions to the burdensome securities laws.  However, even the smallest of business operators won't escape liability if they misrepresent a business investment opportunity to an investor.  For this reason, at a minimum, it is wise to provide written disclosures to the investors -- disclosures that explain they may loose all of their money if the business fails.  Because of the sensitive issues involved, you should certainly seek legal help if you are considering offering an interest in your business to anyone, even if it's merely an exchange of bartered services for an interest in the business.

If your business is successful in the long run, then debt financing tends to be less costly than equity financing, assuming you qualify for a reasonable loan (as opposed to financing through credit cards, for example.)  The main reason investors get a higher return is that investors are generally taking a much higher risk.  If a bank won't give you money, it's usually because you don't have good credit, the business doesn't look worthy, or you have insufficient personal dollars at stake -- or all of these..  This makes you high risk, by definition.  As with mortgage lending, the worse you look on paper, the higher interest rate you will pay.  However, the risk factors alone don't always answer the disparity on returns.  It may also be the case that an investor provides advice and other forms of assistance in addition to money.  Lenders may help, but typically don't get as involved as investors.  This extra assistance may warrant a higher return on the investor's monetary investment.

Another advantage to using debt financing is that you avoid the complications of having a co-owner.  These complications usually revolve around control over decision-making, management and overall direction of the company.  If you sell shares or interests in the company to an investor, you should try selling non-voting shares or interests to avoid this problem.  This is difficult to do, however, because most investors don't want to turn over large sums of money without the assurance of having a certain voice in the direction and oversight of the company.  To offset the unattractiveness of non-voting shares, you might offer payment preferences to investors.  For instance, you could sell shares of "preferred stock" that allow the investors to be paid first when there are profits to distribute.  In fact, most investors require this arrangement.

People often misunderstand the role and value of investors in small startup businesses.  For example, people may think that investors only look at ambitious startups seeking millions of dollars.  However, you may find a friend of a friend who has less than $20,000 to invest in a small business.  These individuals are called angel investors, and are often hard to find (but nonetheless can be found).   The beauty of a non-professional investor is that they often are more willing to let you run things the way you want to.  They typically have another career, and don't feel qualified to tell you what to do in a way that a professional investor would, such as when dealing with a venture capital firm.

Investors provide an invaluable service to startup businesses, and are often the only avenue available for launching a business.  However, you should seek legal advise before entering into any investor agreements, so that you don't give away more than what is fair, and so that you don't violate securities laws.

You should buy enough insurance to adequately handle the anticipated risks in your particular business.  For instance, if you own a child care center you need to be covered for personal injury of the children, and if you're a computer programmer you will probably want coverage for errors or omissions that harm your client. 

The amount of coverage you should buy depends on the level of risk you are likely to incur.  There are two aspects of risk that must be considered: (1) How likely it is that something bad will happen; and (2) if that something bad does happen, how damaging or costly will it be?

Your particular line of business dictates how much risk there is, and therefore, how much insurance is needed.  For example, if you provide in-home health care services, a lawsuit is much more likely than if you provide wardrobe advice;  people are more likely to sue when they are in pain or are grieving the loss of a loved one.  Your business activity also informs the amount of coverage that is needed.  For instance, even if the wardrobe consultant provides ghastly advice, it's difficult to imagine significant economic harm resulting.  By contrast, personal injury lawsuits have already defined the exact value of body parts and human lives-- and they're not cheap.

Ideally, you should read and understand your entire insurance contract, and make sure it covers everything you think it covers.  Oftentimes the standard insurance contract doesn't cover everything you need, and you will want to purchase additional coverage.  However, unless you have an outstanding agent who understands your business needs, your insurance agent may not ensure that the coverage you need is actually in the policy.  Consider hiring someone an attorney to help you understand whether you are adequately covered, particularly if you don't understand the policy terms.

• More insurance help

Unless your business can be run from your home, you'll have to determine whether leasing or purchasing commercial real estate is right for your business. In either case, you will need an attorney to help you structure the deal, and to draft or review the lease or purchase agreement.  Commercial real estate leases and purchases are not nearly as standardized as residential transactions. Experienced legal counsel can help you get the best deal possible with the least amount of risk.   

When starting a business, it is far more common to lease than to buy real estate.  This is because commercial real estate is simply too expensive, and the risk of defaulting on financing too great, given that the viability of a new business is always uncertain. 

Commercial Leases
Because commercial property owners tend to use attorneys more frequently than residential property owners, the size and complexity of a commercial lease compared to a residential lease may boggle the minds of the uninitiated.  For one, the calculation of rent is far more complex in most commercial leases than any residential lease.  That is because owners of commercial properties try and recoup all their economic risks, and charge tenants for everything from utilities to building management, taxes and assessments.  They typically require tenants pay a pro-rated amount for all such building expenses.  And, the landlord may want partial profits from the business in lieu of a flat monthly rate of rent.

In addition to more complex payment calculations, a commercial lease typically holds host of other legal issues that never get negotiated in a residential lease, such as responsibility for maintaining the property, build-out expenses, or what to do in the event of an eminent domain action, foreclosure or sale of the building. 

One advantage that commercial leases have over residential leases for the small business owner is that there is room to negotiate.  Unlike residential leases, which are typically a take-it-or-leave-it proposition, commercial leases can flexibility structured to provide room to grow and shrink.  You can often get a very long lease followed by one or more options to renew the lease.  You can sometimes negotiate a reduction in base monthly rent as a trade-out for paying a percentage of monthly income.   That way you can mitigate the unfortunate effect of having money stop flowing into the business while rent keeps going out the door.

Purchasing Real Estate
When purchasing real estate, you will find that in addition to all the typical  concerns about title and general condition of the property that you must investigate when buying residential real estate, you will often need to contend with additional legal issues that may be associated with the property itself.  For example, one of the biggest risks in buying commercial real estate is the possibility of environmental contamination.  You should plan on conducting a Phase I Environmental study (or have the seller certify results of such a study.)  Depending on the results of that study, you may also need a Phase II study done. 

In addition to the increase in legal risk with commercial purchases, you'll find that commercial transactions are more complex because of the sometimes complicated financing arrangements they require.  For instance, since commercial buildings tend to be larger, they are more expensive, and thus more creative financing of deals may be necessary to close.

Purchasing or leasing of equipment may be done with or without the help of an attorney, depending on your risk tolerance and the money and risk involved in the deal.  Some deals are worth less money than the attorneys fees to review them.  However, it's important to pay attention to the liability risk, not just the amount of money chancing hands.  That is because large lawsuits sometimes arise from very small deals; as when the sale of a defective child's toy causes a personal injury lawsuit worth millions.

Click here for an outline of legal issues you may want to think about and possibly discuss with your attorney before entering into any lease or other contract.

Finally, you might be able to do simple contracts without a lawyer under some circumstances.  Indeed, if money is a barrier to hiring an attorney, it is better to write your own contracts rather than have no contract at all, in most instances.  There are many new sources for legal forms than there has ever been.  The one caution in using those forms, and it is a big one, is that you need to be careful that the form fits your particular situation.  All too often people try to adapt a contract from one they have for a completely different situation, only to find out that the contract hurt them more than helped them.  In fact, it may be better to start from scratch in most cases where a person cannot afford to hire an attorney, than it is to adapt someone else's form contract.  Even outfits that claim their forms cover all states have either been found all too often to be wrong in their assertion, or they are so basic and simplistic that you are better off writing one on your own.
 

Increased Liability.  Hiring help will inevitably subject your business to increased legal risk and responsibilities, especially if the hired help is an employee rather than an independent contractor.   For example, when hiring employees, you must consider regulations governing:

• Child labor
• Environmental contamination
• Worker safety
• Unlawful discrimination 
• Hours, rest periods and wages
• Payroll taxes & record keeping
• Unemployment insurance & workers compensation 
• Vacation, holiday, medical and family leave
• Employee benefits

Even hiring independent contractors creates new liability for your business because you have additional people who can act on the company's behalf as agents of the company.  That is a problem because a company can sometimes be held responsible for actions of its employees and independent contractors, even when nobody in the company had knowledge of the wrongful acts.  For this reason, it is becoming increasingly common to hire only contractors who are adequately insured or bonded, and hire only those employees who pass criminal background checks and/or drug tests. 

Finding your way through all the regulations governing employees is nearly impossible without the help of a detailed and up-to-date book devoted to these issues, or the assistance of an attorney or human resources consultant experienced in employment regulations.

Pros and Cons of using Employees versus Contractors

The heightened regulations that exist when hiring employees provides sufficient basis to generally recommend hiring independent contractors over employees, if the job is one which can be done by an independent contractor.  Yet, one need only look at the number of employees that exist in this country, and it becomes obvious that there must be a significant benefit to hiring employees over independent contractors.

The primary benefit to hiring someone as an employee is that you are allowed to exert  a greater amount of control over them than independent contractors.  In fact, if you exert control over an independent contractor, the law may deem that individual is in fact an employee, even if you both agree he/she is merely a contractor.   

In most instances it's in the company's best interest to assert that an independent contractor relationship existed.  However, when it comes to copyrights, the employer often claims the opposite, namely that the hired person was their employee.  That is because copyrights created by employees are owned by the company, but those created by independent contractors are owned by the individual contractors themselves. 
 

Distinguishing Employees from Independent Contractors

Knowing the difference between an employee and an independent contractor can be quite important.  That is because there are a number of rights and responsibilities at stake for both the company and the person hired.  For instance, when a company hires someone as an employee, they must withhold employment taxes from that individual's paycheck.  If the company fails to do so, they must pay all the back-taxes for that individual, plus penalties.  Or, in the case of unpaid benefits, the company may end up paying out compensation for benefits that were never given to those deemed to be independent contractors by the company.

It is important to note that even if the business and the person for hire both agree that the work being done is under an independent contractor arrangement, the courts or IRS may not agree.  A statement by the parties that their status is independent is only influential, but not determinative of, the actual status that may be imposed on the relationship.  In reality, courts and the IRS, as may be the case, will look for a variety of factors to be present or not present in that working relationship.  If those factors are found, then they may declare the status of the relationship is employment, even if both parties disagree, or visa versa.  

The factors that the law states as differentiating employees and contractors varies not only state by state, but also varies with respect to the specific legal issue being settled.  For instance, courts deciding copyright ownership have a slightly different focus on these factors than does the IRS.  A vague rule of thumb is that independent contractors control the manner and means of their work.  In other words, you don't typically tell contractors when they have to be at the office or which tools they can and cannot use, or whether or not they can hire others to assist them at the work they're doing for you. 

One of the most important factors distinguishing employees from contractors is whether the person working is at risk of loosing income if they are sick, have holiday time off, go on vacation, or if they fail to perform up to standards set.  If they loose income in these situations, then they are likely to be deemed an independent contractor.  If they continue to receive money from the company in these situations, then the person is likely to be an employee. 

Because of the complexity in determining whether someone is an independent contractor, and because of what is at stake, you are well advised to seek legal help in making this determination.
 

(Coming Soon)

Topics will include:

• Preventing collection problems before then happen
   
• What to do when nothing else works
   
• When is someone truly "judgment proof" ?

(Coming Soon)

Topics will include:

• Annual business registrations
   
• Maintaining limited liability protection