As an entrepreneur you know you need something to protect yourself and your company, but what exactly is that something?
When I started my legal consulting business, the most common comment I received from clients was “I have no idea what I need!” I find that as a result of this uncertainty, many entrepreneurs avoid speaking with a lawyer because they think it’s going to cost them an arm and a leg and the lawyer may manipulate them into spending thousands of dollars on documents they don’t even understand. What clients often don’t realize is that avoiding certain documentation could cost them a lot more down the road; it could even cost them their business.
While many of us, when starting our businesses, invest in a coach (or coaches!), the fancy website and social media promotions, we often push the “legal stuff” to the side. So many times I have heard, “I will come back to work with you once I have a few clients so that I can pay.” And this is one of the biggest mistakes you can make. Why? You are about to enter into a very sacred relationship without legally securing it in writing.
What happens if a client stops paying? (Ah, that’s when we hire the lawyer!) What happens if the client demands a refund because he/she wasn’t happy with the services? What if the client steals your content? While these may seem like total Debbie-Downer situations, lawyers are trained to think of the worst-case scenarios in order to help protect you against it.
Invest in a lawyer now. Upfront. It’s kind of like insurance. We don’t anticipate we will get hit by a bus, but in case we do, we have our health insurance. Having legal contracts and support in place before something happens will ensure that you are protected should that client or some third party attack you.
Now, finally, the answer to those burning legal questions that have been keeping you up at night. Here are the most important things to have in place when starting, or really ‘going pro” with your business:
1. Entity formation
What the heck is an entity? An entity is the type of business that you are running. Just like there are different forms of coffee drinks (latte, cappuccino, macchiato), there are different types of companies (sole proprietor, LLC’s and Corporations).
Now, I’m sure most of us have heard of the terms: sole-proprietor, LLC and Corporation — but what do these terms really mean? So glad that you asked!
a. Sole Proprietor. You = Your business. Your business = You.
If you are solely operating with your name then there is no need to involve the state at all. You can run your business using your social security number instead of a tax ID number. When you file your taxes you just file your own personal taxes and can add a separate Schedule C to your return (please discuss with your accountant).
Not dealing with the state and paying all of those fees sounds awesome, right? Totally. But you get basically no protection.This means that there is no separation between your business assets and your personal assets and therefore, no protection. Here is an example:
Sally opens her own business and provides a service to Bob. Something goes terribly wrong and Bob sues Sally for $20,000. Sally’s business is currently only worth $5,000. What happens? Should Bob “win,” he can collect the $5,000 from Sally’s business and the remaining $15,000 from Sally’s personal assets such as her home, car, beloved Vitamix®, etc.
What could Sally have done? She could have obtained some sort of business protection insurance (you will have to discuss with an insurance agent what this would cover in terms of legal actions). Some business owners can actually obtain liability insurance and that will protect their personal assets in most situations; these are what a state would define as “licensed professionals” — normally, this would encompass lawyers, doctors, accountants, etc.
Lastly, when you are a sole proprietor, the business dies with you. If Sally Smith was running a business called Sally Smith Consulting and it was just her running the business, there is no one else that would be carrying on the business, especially one in her name.
How do you get around these potential issues?
b. Limited Liability Company (LLC). The small business fav.
An LLC is a state classification and forming an LLC will, in most situations, act as that barrier that protects your personal assets should a dispute arise. It’s important to note that you MUST have a separate bank account set up for your business; you cannot commingle your business and personal funds. If you do, this protective barrier goes crumbling down.
So back to the Sally situation with Bob except this time, Sally has an LLC. Her business is worth $5,000 but the judge awards Bob $20,000 in damages. Sorry, Bob, you’re out of luck. Bob can collect the $5,000 from Sally’s business but that’s all. Sally’s home, car and Vitamix® are all safe thanks to her handy-dandy LLC.
As I‘m sure you may have guessed, an LLC is not for free. Every state (and often, each county) has a different filing fee and comes with different requirements to form an LLC. As an example, forming an LLC in Manhattan can be well over $2,000 when factoring in the publication fee (New York is one of the few states that requires a business owner to publish that their new business is formed — don’t worry, a lawyer can handle all of that for you), whereas in California, it may only be around $500. While it may seem that California is way more appealing, it’s important to note, however, that California charges a minimal franchise tax of $800 (as of March 2014) every single year while New York does not. So it’s really important to work with an attorney to get all of the details on when fees need to be paid. While it’s super pricey to form an LLC in Manhattan upfront, there are a lot of back-end costs in California.
Based on all the rates for different states, the next question many people ask is, “Where do I form my business?” The answer is really simple — you form your business in the state where you are going to operate your business. While many people know that states such as Delaware and Nevada have tax benefits, others don’t realize that you have to be licensed to do business in the state in which you are operating your business. So sure, you could form your LLC in Delaware, but if you are living and running your business out of New York, then New York is going to require you to do something called a foreign qualification. This puts the state on notice that you are operating a “foreign” entity in their state. And guess what? They’re going to require you to publish, so you are still stuck with those super pricey publishing costs anyway.
In this new virtual world of entrepreneurship, it’s most likely that you are running your business from either your home or from an office within the state that you live. Form your business in that state.
Last LLC topic — taxes. You should always discuss filing your taxes with an accountant. When you are an LLC you get your own buffet style options of how you would like to file your taxes: sole proprietorship, partnership or a corporation. Bon appétit!
c. S-Corporation. Last but not least, the corporation.
In the entrepreneurial world, most people, if forming a corporation, are going to go with the “S” corporation. It is a bit more complicated than an LLC but can be a tax saver. Again, mega important to talk with your accountant or a tax attorney. In this case, you definitely want to have an accountant that you are working with regularly.
I’m going to break this down very simply but not in full, because when you want to form a corporation you really need to sit down with both a lawyer and an accountant. In general, the corporation itself does not pay federal income taxes. What happens is that the corporation’s profits or losses are passed down to all of the shareholders (shareholders are part owners in a corporation). The shareholders then report the profits or losses on their own individual tax returns. If you are an employee or perform a major service to the S-Corp, then you will receive a salary that will be subject to the regular employment tax rates. This salary must be “reasonable” in comparison to your industry and your region. Any other money that you receive on top of your salary is a profit and is not subject to the employment tax rate (subject to a much lower rate).
For example: you form an S-Corp and salary yourself at $50,000/year (which is considered reasonable for where you live and what you do). If your company earns $100,000 that year, only the $50,000 of your salary is subject to the self-employment tax rate while the other $50,000 is not! If you were an LLC, all $100,000 would be taxed at the self-employment rate.
Disclaimer: some states do tax an S-Corp like a regular C-Corporation. Some states also charge an additional franchise tax.
Corporation have lots of rules, requirements and filings. For example, it can only have 100 shareholders and they all must be US citizens. It must hold annual meetings and keep meeting minutes; it must file annual reports and file much more formation information tax returns. It must have a board of directors and officers (note: you can play every role — president, vice president, secretary and treasurer). Basically, make sure you have a team of people to remind you about all of these requirements and making sure everything is getting filed when necessary.
2. Website Must-haves
a. Website Terms & Conditions. Got a website without terms and conditions? You are setting yourself up for potential problems. Protecting your company is super easy because all you need are terms and conditions. This acts as a contract between your business and all site visitors. Depending on the type of business you have, terms can vary, but the essence is that the terms protect your company from potential legal action by visitors to your website and puts visitors on notice that you, as the website owner, own all of the content on the site — get those copycats to go away!
3. Client/Customer Contracts
Huge protection in the land of entrepreneurs. Client agreements set forth the parameters of the relationship between you and your clients. This includes:
a. The length of the relationship
b. Cost of the program (including making all fees non-refundable!)
c. Structure of the program
d. What happens if the client does not make payments
e. Protecting all materials that you provide the client — a provision will be included that all of the materials provided are the ownership of YOUR company and that the clients are not allowed to give them to anyone else (like a little kid would say — mine!).
f. Dispute resolution — just in case you need to take further legal action, you can actually choose that you want to have your dispute in a location that is convenient for you!
g. Governing Law — it’s important to have the contract governed by the state where you run your business, as these are the rules you are already playing by.
I always advise to send the document in PDF (or using an online signature platform like EchoSign) so that the client is unable to make any changes. Never send a contract in Word and always have the client sign first and then provide the client with a fully executed copy for their files.
Having a contract in place protects not only you and your business but also the client. It provides peace of mind for them that if you, as the business owner, did something wrong or didn’t provide a product or service, they would be able to get their money back. Clients want protection too.
4. Employees versus Independent Contractors
Business is booming and you’re earning your well-deserved rock star status so you need to expand your team — or start one! Will you bring someone on as an independent contractor or an employee? Make sure you know the differences ahead of time:
a. Independent Contractor Agreements
Have a virtual assistant? This person most likely would not be considered an employee — nor do you want them to be because then you could be responsible for benefits and taxes. An independent contractor agreement clearly spells out that there is no employment relationship between you and the other person, and as a result, the other person is responsible to file his or her own taxes and obtain his or her own benefits. You would provide this person with a 1099 at the end of the year or at the end of your relationship should it be a shorter time span. This person also cannot act as an agent of the company, meaning they cannot enter into agreements with another person on your (or your company’s) behalf.
b. Employment Agreements
Employment agreements are needed for those individuals you plan on having a long-term relationship with and want as representatives of your business. You, as the business owner, are then responsible for their taxes (an employee will usually complete a W-2 form) and potentially, their health benefits. Having someone as an actual employee means that they can potentially enter into an agreement on behalf of your business. These people represent your company in a public capacity. You can garner much more control of these individuals, meaning you can dictate their work schedule, location and ways that the work is done. Please also note that when you have employees, you will need an employee handbook that will describe worker’s compensation, vacation/sick days, company policies, etc.
Please note the difference between an employee and an independent contractor. Essentially, it depends on how much “control” you have over this person in their working capacity at your company. If you want to control what is being done and how it is being done, then this person would more likely be an employee; an independent contractor would be able to control the means and methods they use to accomplish the task.
So, what is that something you need? Most likely, all of the above.
This document is for informational purposes only and should not be construed as legal advice. Genavieve Shingle is an attorney only licensed in the State of New York and the distribution of this guide does not constitute an attorney-client relationship.
Genavieve Shingle is a member of the DailyWorth Experts program. Read more about the program here.