Starting A New Business
by Seth Akabas
Creating a new business demands a lot of creative thought, planning and energy. We know. We started our firm, Akabas & Sproule, from nothing in 1991. Since then, we have represented dozens of new businesses from their creative thought stages, through their planning, organization and development, and, in a number of cases, through their initial public offerings (“IPOs”) of securities, and even secondary offerings as they grew.
If you’re going to put all that effort, as well as money, into a new venture, you might as well do it right. Interwoven with each step in the early stages of a business’s development are numerous legal issues that you should understand before proceeding.
We have described some of those issues in this article below. This description can’t tell you how to resolve those issues, because you and your counsel need to analyze the particular facts of your proposed venture. Furthermore, these issues may not be — indeed, probably will not be — all of the legal issues that you should consider in founding your business. Here we intend to give you only some ideas and help you to formulate your thinking about the legal side of a new business. This summary can’t replace the careful consideration that you and your counsel need to give to the issues raised here.
Good luck with your new business.
Table of Contents
- Choosing the Type of Business Entity For Your New Business
- Choosing a Name for Your New Business
- Protecting the Confidentiality of Your New Business’ Plans
- Planning for Investments in Your New Business
- Planning for Agreements among the Owners of Your New Business
- Developing Employee Policies for Your New Business
1. Choosing the Type of Business Entity For Your New Business
Initially, you must decide what type of legal entity to use to organize your business. You might even decide that you don’t need a legal entity. Many successful businesses are sole proprietorships.
You may prefer to chose a limited liability entity. Several kinds are available: a limited liability company (an “LLC”), a Subchapter ‘C’ corporation (a “C-corp”), a Subchapter ‘S’ corporation (an “S-corp”), a limited partnership, and a trust are the most common. Other variations of these types are available too. These entities limit the liability of owners, but you must discuss with your counsel how to manage such limited liability entities so that they preserve your limited liability.
The type of business that you intend to run may also influence your decision. For example S-corps and LLCs are what are known as flow through tax entities (see below), which are generally not taxed at the entity level. If the business that you intend to run will probably lose money on a tax accounting basis (such as a real estate venture, which usually has significant non-cash depreciation expenses), then you may want a flow through entity so that the losses can be passed on to the owners. As another example, S-corps are cheaper to organize and govern than are LLCs, but LLCs are more flexible than S-corps in terms of who can be the owners. If you think that your company may want to go public, C-corps are the easiest and most common entity for a public offering of securities, but they are taxed at the entity level. Also keep in mind that each of these entities receives different tax treatment in certain jurisdictions. If your business is a professional service, you way want to use a C-corp or an S-corp that is a professional corporation (sometimes called a “PC”), or a limited liability company in the form of a “professional limited liability company.”
In a “flow through” tax entity, profits and losses are not recognized for tax purposes by the entity; instead, the profits or losses flow through the entity to the owners who must report the profit as income and pay taxes on it. The owners must pay these taxes whether or not any cash is distributed to the owners.
2. Choosing a Name for Your New Business
Your business must have a name, and it can’t be one that is taken already by an existing business. Choosing a name has two aspects: first, the name of the entity (if you decide to create a legal entity); second, the trade name, or other brand, under which you market your goods and/or services.
Before you select these names, therefore, you must check to see that they are not taken already. Clearance may be checked on many levels.
First, the exact name of your entity may not be the same as the name of any other business registered in the state where you are organizing your entity. Therefore, you or your attorney must first check with the office of the Secretary of State for the state where you plan to organize your entity to be sure that no other business is registered under the name that you choose.
Second, you must check that no other business is using the trade name (i.e. the brand name) that you plan to use, or at least that no other business is using it in a way that might lead to confusion between your company’s products and services and the other business’ products and services. The best way to check the availability of a trade name is to retain a special search company to prepare a report on all uses of your planned name and all similar sounding names and have your attorney evaluate the various uses for possible confusion. In some instances, however, you may be able to check the name’s availability with a more limited (and cheaper) search, which you should discuss with your counsel.
Third, you must check that your entity’s trade name, or a desirable variation, is available for an Internet address, and you should register the Internet address concurrently.
As soon as you have picked a trade name, you should discuss with your counsel registering it with the U.S. Patent and Trademark Office. Registration is not expensive and will help you protect your name from use by your competitors and other infringers. In addition, whenever you use your trade name, you should properly indicate it as a trademark, so that all people who see it understand that it is your mark. Unregistered marks should be indicated with a “TM,” and, after your mark is registered, you should use an “®.” You should also consider the need to register it in other countries.
3. Protecting the Confidentiality of Your New Business’ Plans
You must consider whether any aspects of your business or business plan are confidential, that is, whether a competitor’s knowing them would result in material damage to your business. If so, then you may want to take steps to protect your business secrets. You should discuss with your counsel whether confidentiality agreements are appropriate for any people who will become aware of these confidential aspects of your business, such as employees, independent sales reps and consultants. In addition, you should discuss with your counsel the steps that you must take internally in order to preserve your right to claim that your confidential information is legally protected.
For example, if you begin working with a consultant to develop your business idea, you must ask yourself whether, if you had a falling out with your consultant, and the consultant took up your idea and developed a business similar to your idea, would your business be damaged. If the answer is “yes,” then you should work with your counsel to enter into a confidentiality agreement with your consultant before you disclose any critical confidential information.
You should undertake the same thought process with regard to other advisors, contractors, employees and, in some instances, even customers.
You should consider with your counsel whether you have any materials that should be copyrighted. Keep in mind that not only books and articles enjoy copyright protection., but manuals, sales literature, posters, advertising materials, software and website content, to name just a few, may merit copyright protection. Copyrightable material should be filed with the U.S. Copyright Registrar and with the Library of Congress. Registration is easy (a one-page form and samples and a small fee, and registration, though not necessary to enforce some rights, will help to protect your full scope of rights in your creative works.
You should consider with your counsel whether you have any design or process that should be patented. You should be able to patent designs and processes that you invent. Even some novel and unique business models may merit patent protection. During the term of the patent, you can prevent others from copying and using your inventions. Preventing others from using your patents can give you a competitive advantage.
4. Planning for Investments in Your New Business
As you consider taking investments or raising money for your business, either by subscriptions for stock or by loans, you will encounter many securities law issues that you need to discuss with your counsel.
Normally you need not worry about the initial investments by a few founders, and you need not worry about borrowing money in short-term loans (although these transactions should be reviewed by counsel to be sure that any agreement you make is in your best interest and that the documents properly reflect your understanding). If, however, you reach the point when your company is selling securities (including stock, options, or warrants) other than initial investments by founders, then you should be aware that companies may not issue or sell securities under either U.S. federal law or under any state law unless the sale is properly registered or an exemption is available. Securities laws in the U.S. are strict, and violation of them can have major repercussions on your business.
You should also consider that many remedies exist to provide relief for investors who invest money in an entity and lose it. Although these remedies are good for investors, these same remedies present potential liabilities for companies that issue and sell securities to raise financing. Liability can extend even to the companies’ owners, such as you. You must be careful that you make adequate disclosure to all investors of the material facts and of the risks involved in an investment in your business. You need to consult with your counsel about that disclosure and the terms of an agreement that any investor should sign.
5. Planning for Agreements among the Owners of Your New Business
In many businesses that are owned by only a few people, the owners enter into an agreement that governs the relationships among the owners and their rights and duties. This agreement is sometimes called a “shareholders agreement” for a corporation, an “operating agreement” for an LLC, or a “partnership agreement” for a partnership. In the case of an LLC or a partnership, a written agreement is required or recommended in almost all cases.
These agreements usually or often provide, among other provisions:
- under what terms any owner may (or in some cases must) sell his/her interest in the business (particularly whether the interest must first be offered to the other owners before it can be sold to an outsider)
- who will manage the entity
- what actions by the entity (e.g. mergers, acquisitions, dissolution) require more than a majority approval of the owners
- what the duties of each owner is to provide services to the business (for example, as directors, researchers, employees or others)
- how much compensation for services each owner will receive
- how the company will raise further financing
- “come along” rights and “take along” rights (also known as “tag along” rights and “drag along” rights)
You should discuss with counsel whether an owners’ agreement is appropriate for your entity.
6. Developing Employee Policies for Your New Business
If you reach the point at which you hire employees, then you should discuss with counsel whether your company should have an employee manual. An employee manual should set forth the standard terms of employment for all employees (e.g. when salary is paid, how many sick days are allowed).
You should discuss with your counsel whether the statement of any terms of employment creates any rights on the part of employees. Generally, under the law of New York State and many other states, in the absence of a specific agreement as to the term of an employment arrangement, the term is “at will.” “At will” means that the term is at the will of the employer or the employee, and either may terminate at any time immediately upon notice of termination. Certain statements regarding terms of employment in an employee manual or elsewhere may be interpreted by courts to fix a set tenure. You should avoid accidentally falling into a binding obligation to retain employees for a set period or on fixed terms.
Counsel will also discuss with you the very important anti-discrimination laws that may apply to your business and which may provide significant rights to your employees. An employee manual should also set forth the Company’s policies on confidentiality, sexual and other forms of harassment and discrimination. You should also discuss with your counsel how the proper statement of policies on these areas can provide some protection to your company for suits alleging that your company has violated the rights of an employee or a prospective employee in these areas.