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Have a Big Business Idea? | Legal Strategies for Startups

Originally Published by Cole Publishing

Woman holding an open sign. Legal documents for new businesses

Got a big idea for a new business? Well then, you need the Big 4 – an accountant, insurance agent, attorney, and banker. A successful business launch involves a jillion details, and many of these details require professional expertise. The Big 4 enables entrepreneurs to turn their business ideas into reality. Before opening their doors, new companies need to lay a foundation for operations. This foundation includes the legal documents to establish a business identity, organizational structure, and taxation.

“Anytime we’re creating a business entity, we’re always thinking through how an entity is going to be formed and also the tax designation you want,” says attorney Jim Ledvina, of the Law Firm of Conway, Olejniczak & Jerry, S.C. The structure of an organization depends on its activity, number of owners, and the goals the owners want to achieve. “There’s lots of ways to structure the entity, depending upon what folks are trying to accomplish,” Jim says.

Legal Structure of a New Business

New businesses typically fall into two categories, a limited liability company (LLC) or domestic corporation. For Jim’s clients, LLCs are the most popular business classification by far.
“The reason is, the LLC is significantly more flexible in terms of the management and control. The administrative requirements are not nearly as demanding as a corporation,” he says. Corporations are required to appoint officers and hold annual shareholder meetings and annual board of director meetings.
“That’s all very rigid in corporate law, versus an LLC, in which you can create any type of management structure you want,” he says.

Tax Classification of a Start-up

The second aspect to consider when launching a business is its tax classification. An LLC with a single owner falls under the disregarded entity status. Basically, the LLC is not taxed as a separate entity by the Internal Revenue Service, so the business owner doesn’t file a separate business tax return. All income and expenses flow to Schedule C of the owner’s 1040.
“It’s all very simple,” Jim says, and he means it. An LLC with a single owner is one of the simplest business structures that exists. When a business has two or more owners, it defaults to partnership tax status. However, the members of the LLC can elect to have their LLC treated as an S Corporation or C Corporation for tax purposes.

LLC vs. S Corp or C Corp

An S Corp has a “flow-through” tax designation. Thus, the business entity files an informational return, and income and loss “flow through” to a business owner’s 1040 via a K-1 IRS form. The percentage of ownership determines the share of the income or loss attributed to each owner. For an S Corp, business owners pay tax at the individual level and not the entity level. From a tax standpoint, it’s rare to have a C Corp because of what’s known as the “double tax.” With a C Corp, the entity pays tax. However, if the owners want to make distributions as a dividend, the owners would be taxed on the dividend. Hence, the double tax. Although tax legislation enacted in 2017 addressed the double tax, Jim says there’s still more benefits being an S Corp than C Corp.
S Corp owners can avoid some payroll taxes when making distributions. In addition, S Corps offer other tax benefits, depending on the activities of the entity. It’s best to consult an attorney and an accountant for advice.

Legal Documents for LLCs and Corporations

Both LLCs and corporations require a set of legal documents before the businesses open. A corporation files Articles of Incorporation, whereas an LLC files Articles of Organization. A corporation drafts bylaws and a shareholder agreement, whereas an LLC drafts an operating agreement. While the articles and bylaws are fairly standard and straightforward, the shareholder agreements and operating agreements differ significantly based on the entity. These agreements cover the management and control of the business. For example, an operating agreement outlines how decisions are made, who’s in control, who represents the business, and how an owner can sell his or her ownership interest in the entity.
“It’s not one size fits all. You might have silent partners, active partners, or individuals who want to be bought out,” Jim says. “You want to make sure you’re covering all the bases with documents that work appropriately for the business.”

Apply for an Employer Identification Number

Another legal document needed to open a business is an Employer Identification Number (EIN). Entrepreneurs will hit a roadblock at the bank if they don’t have an EIN. Banks require a business to obtain an EIN before opening a business banking account. Anyone can apply for an EIN at the IRS website at no cost. Obtaining an EIN is probably the simplest part of opening a new business.
In addition to filing for an EIN online, entrepreneurs can find sample legal documents on the internet. Entrepreneurs can do their own paperwork, but Jim advises against this, based on his experience. In one instance, a client brought Jim an operating agreement with language associated with real estate when the entity didn’t own any real estate.

“The language associated with valuing the real estate entity is going to be totally different than an operating entity,” he says. “There’s a big difference in how we draft the two.”

Role of a Business Law Attorney

Because opening a business involves complex legal details, an attorney plays an important role. Jim recommends working with an attorney who specializes in business law.
“You want somebody with a little bit of experience. They know what to look out for, and they know the issues and where the pain points may be,” he says. “If you have something complex, like multiple owners or unique situations, you might want to interview a couple of attorneys. Ask them about their experience and about the pros and cons of different types of entities.”

Role of the Big 4 for Entrepreneurs

Once you select your legal advisor, he or she will be able to recommend other members of the Big 4. A local financial institution can provide a start-up loan and a line of credit to support ongoing operations. Banks also provide financial services needed to pay employees, pay bills, receive payments, etc. A local insurance agent helps business owners mitigate risk with commercial general liability insurance and worker’s comp insurance. An accountant can set up sales tax, use tax, and employee tax withholding. Plus, accountants file taxes and ensure their clients comply with tax laws.
“If you make a mistake, especially on sales tax or payroll taxes, that’s almost always a death blow to an entity because the penalties and interest associated with those taxes are incredibly onerous,” Jim says.

A Successful Business Launch

Opening a business is a complex process, especially when it comes to paperwork. You can’t just step up to a legal document vending machine, drop in your coins and out pops the legal documents you need. If only a business launch was so easy! Consulting with an attorney, accountant, insurance agent, and banker can help you determine the best trajectory for your new business. These professionals know about tax implications and the federal and state requirements for start-ups. The Big 4 gives new businesses the big break they need to succeed.