Introduction
Getting your legal matters right from the start is crucial as a new entrepreneur. Making legal mistakes early on can lead to serious consequences down the road that jeopardize your business. According to Forbes, some of the biggest legal mistakes startups make include not making clear deals with co-founders, picking the wrong business entity structure, and relying on an accountant for legal advice (https://www.forbes.com/sites/allbusiness/2020/02/01/legal-mistakes-made-by-startups/).
As an entrepreneur, you need to understand the legal implications of all major business decisions. Taking the time to get proper legal counsel shows you are serious about building a company responsibly. It also helps ensure you comply with regulations and avoid potential lawsuits or disputes. While legal matters may seem dry or secondary, they cannot be ignored. This guide will provide tips to help you navigate key legal issues as you start your new venture.
Choosing a Business Structure
When starting a business, one of the most important early decisions you’ll make is choosing the right legal structure. The three main options are sole proprietorship, LLC, and corporation.
A sole proprietorship is the simplest structure – you operate the business as an individual and there is no legal distinction between you and the business. This offers complete control and simplicity, but you are personally liable for all debts and obligations of the business.
A limited liability company (LLC) provides personal liability protection like a corporation while allowing pass-through taxation like a sole proprietorship. LLCs have become a popular choice for small businesses and startups because they offer the best of both worlds. According to Forbes, forming an LLC helps shield your personal assets from lawsuits and business debts (source).
A corporation is a more complex entity that exists separately from its owners. It offers the strongest protection from personal liability but comes with more paperwork, formalities, and regulations. Corporations can raise investment capital by issuing stock, but profits are subject to double taxation.
When registering your business, you’ll file paperwork with your state to establish the legal structure. Each structure comes with ongoing legal obligations like filing annual reports and paying franchise taxes. An attorney can explain these requirements in your state.
Protecting Your Intellectual Property
Intellectual property (IP) refers to creations of the mind, such as inventions, literary and artistic works, designs, and symbols, names and images used in commerce. IP is divided into two categories:
- Industrial property includes patents for inventions, trademarks, industrial designs and geographic indications.
- Copyright covers literary works (such as novels, poems and plays), films, music, artistic works (e.g., drawings, paintings, photographs and sculptures) and architectural design.
IP protection is critical for startups and entrepreneurs because it can provide you with a competitive advantage and protect your hard work and ingenuity from being copied by others. Here are some key ways to protect your IP:
Trademarks
A trademark protects any word, phrase, symbol, design or a combination of these that identifies your company or its products and services. Registering your business name, logo, taglines, etc. as trademarks prevents others from using them and protects your brand identity. According to the U.S. Patent and Trademark Office, you can apply to register a trademark based on actual use or intent to use [1].
Copyright
Copyright covers original literary, dramatic, musical and artistic works like writings, music, films, paintings, sculptures and architectural designs. Copyright protects the form of expression of ideas, not the ideas themselves. Copyright protection is automatic when you create an original work – you don’t need to register it. However, registering your copyright provides stronger protection and makes infringement claims easier to enforce.
Patents
A patent protects inventions or discoveries that provide a new way of doing something or offer a new technical solution to a problem. Patents provide an exclusive right to commercially exploit the invention for a limited period, enabling you to stop others from making, using, selling or importing your invention without consent. You can apply for a patent by filing an application with the U.S. Patent and Trademark Office.
Trade Secrets
Trade secrets refer to any confidential business information that provides a competitive advantage, such as a formula, recipe or manufacturing process. Startups can protect trade secrets through non-disclosure agreements (NDAs) with employees and third parties like vendors. You can also have an employment agreement prohibiting employees from sharing any confidential information.
Strategically leveraging different IP protections allows startups to maximize control over their creations and innovations, which can be instrumental in attracting investors and growing your business.
[1] https://www.uspto.gov/trademarks/basics/register-on-actual-use-or-intent-to-use-basis
Contracts You’ll Need
As a startup, there are several key contracts you’ll need to have in place. These provide legal protection and define relationships as your business grows.
Vendor and contractor agreements outline your business arrangements with suppliers, freelancers, and other service providers. These should cover scope of work, fees, and other terms like ownership of intellectual property.
Partnership agreements are critical if you plan to work with other businesses. These contracts prevent disputes by clarifying each partner’s rights and responsibilities.
Your website or app will need a terms of service and privacy policy. The terms outline rules for use of your platform while the privacy policy describes how user data is collected and handled.
As you begin hiring, you’ll need employment and consultant contracts. These define compensation, benefits, confidentiality, assignment of IP, and other aspects of the working relationship.
If your startup will operate from a physical office or commercial space, you should have a commercial lease agreement. This contract with your landlord will specify rent, length of lease, maintenance responsibilities, and more.
Having the right legal contracts provides startups with clarity and protection during key business relationships and transactions. Consult an attorney to ensure your agreements are comprehensive and enforceable.
Staying Compliant
As a startup, it’s crucial to understand and comply with all relevant regulations and legal requirements. Failing to do so can result in hefty fines, lawsuits, or even force you to shut down. Here are some of the major areas to focus on:
Licenses and Permits: Most businesses need various licenses and permits from federal, state, and local government agencies in order to legally operate. Common examples include business licenses, food handling permits, liquor licenses, and resale certificates for sales tax. Do your research to identify which ones apply to your startup.
Insurance Requirements: You may need certain types and minimum levels of business insurance coverage, such as general liability insurance, workers’ compensation, or professional liability. Requirements vary based on location and industry.
Data Privacy and Cybersecurity Laws: With the rise of data breaches, governments are enacting stricter data protection regulations. Complying with laws like GDPR and CCPA is essential if you collect any customer data. You’ll also need cybersecurity safeguards in place.
Tax Obligations: As a business owner, you’ll have a range of new tax obligations. This includes registering for an EIN, collecting and remitting sales tax, paying estimated quarterly income taxes, filing an annual return, and keeping detailed records.
Consult local government resources, the SBA, and legal counsel to ensure you have all required licenses, insurance, data policies, and understand your tax responsibilities. Staying legally compliant from day one reduces risk.
Sources:
Startup Law A to Z: Regulatory Compliance
Compliance for Startups: All You Need to Know in 2024
Seeking Legal Counsel
As a new entrepreneur, there will likely come a time when you need to seek legal counsel from a business lawyer or attorney. Though legal help can be expensive, it is often worth the investment for certain complex issues or high-stakes decisions where expert advice is critical.
Some examples of when to hire a lawyer for your startup include:
- Reviewing and drafting key contracts like partnerships agreements, vendor contracts, commercial leases, etc. Having a lawyer review these can help spot issues and protect your interests (source).
- Filing patents, trademarks, and other intellectual property registrations. Navigating the legal intricacies of IP protection is best left to an expert (source).
- Making major business decisions like incorporating, raising investment capital, merging with another company, or acquiring another business. These high-stakes moves benefit from legal guidance (source).
Though hiring a lawyer can be expensive, not seeking legal counsel when you need it could potentially cost you far more down the line. Their expertise can save you time, money, and legal headaches as you get your startup off the ground.
LLC vs Sole Proprietorship
When starting a new business, one of the first legal decisions you’ll need to make is whether to structure your company as a sole proprietorship or an LLC (limited liability company). This choice affects the level of personal liability protection, ongoing legal obligations, and taxes for your business.
A key advantage of an LLC over a sole proprietorship is limited liability protection. With a sole proprietorship, the owner is personally responsible for all business debts and legal liabilities. This exposes your personal assets like your home or car if your business is sued. An LLC separates your personal and business assets, so your personal assets are generally protected from business lawsuits and claims (https://www.forbes.com/advisor/business/sole-proprietorship-vs-llc/).
However, an LLC comes with more paperwork and formalities than a sole proprietorship. You’ll need to file articles of organization, have an operating agreement, and file annual reports to maintain your LLC status. Sole proprietorships have minimal paperwork – you simply register your business name and obtain licenses. But less formal structure also means less credibility with customers and lenders (https://www.wolterskluwer.com/en/expert-insights/singlemember-llc-vs-sole-proprietorship).
There are also tax differences to consider. Sole proprietor income is taxed only once personally at your individual income tax rate. An LLC is taxed separately at the business level, and then owners pay personal taxes on income distributions. For low-profit businesses, sole proprietorship taxation may be more advantageous.
LLC vs Corporation
When choosing between an LLC and a corporation, three key factors to consider are limited liability, tax treatment, and costs/paperwork.
With an LLC, owners have personal liability protection but pass-through taxation, meaning the business itself is not taxed and profits/losses are passed onto the personal returns of members. A corporation provides personal liability protection but is taxed as its own entity. Corporations face double taxation on profits, first at the corporate level and again when dividends are paid to shareholders [1].
LLCs tend to cost less to establish and have lower filing fees compared to corporations. However, corporations require more extensive record keeping and formalities like holding board meetings and recording meeting minutes [2].
For many small businesses and startups, the pass-through taxation and lower costs of an LLC make it an attractive choice over a corporation.
Registering Your Business
One of the first legal steps when starting a business is to officially register it with state and federal agencies. Here are some key registration requirements:
If you form an LLC, you’ll need to file articles of organization with your state. This document names your business, establishes it as an LLC, and designates a registered agent for legal service. Each state has its own articles of organization filing process.
All businesses except sole proprietorships need to get an Employer Identification Number (EIN) from the IRS. This number identifies your business for tax purposes. You can easily apply for an EIN on the IRS website.
Most states and local municipalities require new businesses to obtain licenses and permits. Common examples include a sales tax permit, business license, and zoning permits for any renovations. Use the Arizona license finder to search for licenses relevant to your business.
Protecting Trade Secrets
Protecting proprietary information and trade secrets is critical for startups. Trade secrets encompass any confidential business information that provides a competitive advantage, such as proprietary algorithms, source code, unpublished financial data, customer lists, and product roadmaps.
Startups should require employees, contractors, advisors, and partners to sign non-disclosure agreements (NDAs) to protect this sensitive information. As explained in this article, NDAs legally prohibit the recipient from sharing or using the confidential information without permission.
In addition to NDAs, employment and contractor agreements should include non-compete and non-solicitation clauses to prevent employees from taking trade secrets to a competitor. Startups should also restrict access to proprietary data to employees and partners who truly need it to fulfill their duties.
With strong legal contracts and access controls in place, startups can feel confident sharing confidential information needed to further their business, while minimizing the risk of leaks.
Filing Patents
The process of filing a patent begins with conducting a prior art search to ensure your invention is truly unique. This involves searching patent databases like the USPTO’s to find any pre-existing patents that are similar. According to the USPTO’s statistics, over 600,000 patent applications are filed each year, so doing a thorough search is critical.
Once you’ve confirmed your invention’s novelty, the next step is preparing and filing the patent application. This is a complex legal process that involves describing your invention in detail, so it’s highly advisable to hire a registered patent lawyer or agent. The cost of filing a utility patent application is $300-500 for smaller entities, plus legal fees.
Your lawyer will draft the claims, specification, drawings, and other required sections of the application. The USPTO notes that the average time for an initial office action response is about 16 months. It often takes 2+ years for a patent application to be approved or rejected. Having an experienced patent lawyer can help expedite the process and maximize your chances of success.
According to USPTO statistics, only around 44% of patent applications are approved. However, with diligent prior art searching and the help of a patent professional, you can significantly improve your odds. Patents last for 20 years from the application filing date, providing powerful protection and competitive advantage for your invention.
Registering Trademarks
One of the best ways to protect your brand identity is to federally register your trademark with the USPTO (United States Patent and Trademark Office). There are several benefits to federal trademark registration:
Federal registration provides nationwide protection for your mark. It allows you to enforce your trademark rights across state lines and prevents others from using your mark nationwide. According to the USPTO, “Federal registration benefits include being able to bring an action concerning the trademark in federal court, the use of the U.S. registration as a basis to obtain registration in foreign countries, and the ability to file the U.S. registration with the U.S. Customs Service to prevent importation of infringing foreign goods” (source).
When you register, you must specify the classes of goods and services your trademark will cover. The USPTO uses 45 different classes to categorize products and services. You’ll need to identify the relevant classes for your business. Registering in multiple classes does increase the registration fees.
Once your trademark is federally registered, you gain exclusive nationwide rights to the mark in connection with the goods/services listed in your registration. You can enforce these rights by sending cease and desist letters to infringers or filing a lawsuit for trademark infringement. Registration provides important legal advantages if you need to take infringement action.
Vendor and Contractor Agreements
When bringing on vendors, contractors, and freelancers to work on your startup, it’s important to have a written agreement in place to define the terms of the relationship. Well-crafted vendor and contractor agreements will cover key provisions like scope of work, payment terms, intellectual property ownership, liability, and insurance requirements.
The scope of work section outlines the specific services or deliverables the vendor will provide, timeline for completion, and any milestones or performance standards. Clearly defining this upfront aligns expectations on both sides. Payment terms specify compensation amounts, invoicing frequency, and reimbursement of expenses. Make sure to outline payment schedules tied to completion of milestones or project phases.
Intellectual property ownership is another critical issue to address. Often the contractor agreement will state that your startup retains IP rights and ownership of all work product created by the vendor for your business. However, there may be instances where the vendor retains certain pre-existing IP that needs to be called out.
Liability and insurance provisions limit risk for your startup. Require vendors to maintain general liability insurance and name your company as an additional insured. Include indemnification clauses outlining liability in case of loss or damages resulting from the vendor’s work. Consult a lawyer to ensure you negotiate fair and mutually beneficial liability terms.
Well-drafted agreements protect both parties and set clear ground rules for the engagement. Consider having a lawyer review the contract before signing to ensure it covers all necessary clauses and meets your business needs. Useful references on key vendor agreement provisions include: Key Clauses in Commercial Contracts, Types of Contract Clauses
Partnership Agreements
One of the most important legal documents for any new startup with multiple founders is a partnership agreement. This contract lays out the ownership stakes, responsibilities, and decision-making authority for each founder of the company.
The partnership agreement should clearly define the equity split between founders, typically based on each person’s contributions, skills, and involvement in the business. This includes the initial percentage stake each founder has, as well as any vesting schedule that applies. Vesting schedules with a one year cliff are common, meaning founders earn their full equity share over time (usually 4 years).
The agreement should also cover decision making and voting rights. This may be based on equity ownership, or could allow for certain major decisions to require unanimous consent. Defining the roles and responsibilities of each founder is critical as well.
Having this partnership agreement sorted from the very beginning prevents messy founder disputes down the line. It also provides clarity if any founder leaves or needs to be removed from the business. Consulting a lawyer to draft the agreement is highly recommended.
Conclusion
Navigating business law as a new entrepreneur may seem daunting, but taking the time to get set up properly will pay off down the road. Here are some key takeaways from this guide:
- Choose a business structure that matches your goals and needs – LLCs offer liability protection while sole proprietorships are simplest.
- Protect your intellectual property through trademarks, patents, copyrights and NDAs from the start.
- Have properly drafted agreements and contracts in place with vendors, partners, and employees.
- Stay compliant with all applicable regulations and legal obligations from day one.
- Don’t hesitate to seek expert legal counsel for guidance on complex issues.
Additional legal resources like online libraries, startup lawyer directories, and legal clinics can provide affordable access to legal advice. With the right preparation, you can avoid common legal mistakes and focus on growing your business.
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