I'm Ready to Start My Business, But Do I Really Need a Lawyer?
Like so many questions in business and life, the answer is “it depends.” If you already know what form will best suit your business and what tax treatment will be best for your business (and you), the answer is “no.”
However, many soon-to-be business owners aren’t so certain. After all, you are going into business because you’re great with customers, offer useful products, or perform a valuable service - not to read statutes, the tax code, and make legal decisions for your company. Here are some common scenarios new business owners face in which a lawyer’s advice can be a great help:
You Aren’t Sure About What Form Your Business Should Take
This is the most common legal issue new business owners face, and one which should be resolved first. When lawyers discuss a business entity’s “form,” they are referring to whether a business is a sole proprietorship, or some variation of partnership, limited liability company (LLC), or corporation. For liability purposes, limited liability partnerships (LLP’s), LLC’s, and corporations are treated as separate legal entities from the owners. Here are two key business planning considerations that your choice of form will impact:
How Business Decisions are Made
First, the form you choose will determine how business decisions are made. For example, a limited liability company can be “member-managed” or “manager-managed.” In a corporation (whether private or public), different types of business decisions are made by three different groups of people. Shareholders own the business, and elect the board of directors. The board of directors elects officers. By comparison, in a general partnership, all of the decisions are made by the partners.
Who Pays for the Company’s Liabilities
The form you choose will also determine whether you or the other owners are personally liable for the company’s debts and obligations. For example, if two partners in a general partnership borrow money for their business, they are personally liable for the partnership’s debts. Whereas if the owners of an LLC are unable to repay their debts, the Revised Uniform LLC Act provides these owners are not liable for the debts of the LLC. Keep in mind, most sources of funding such as banks may still demand personal guarantees from the owners - which negates that Revised Uniform LLC Act’s protection when it comes to those agreements between lenders and borrowers. Nevertheless, the form you choose is particularly important if a lawsuit is filed, as the form can determine whether the owners can be sued personally, and whether a court can order you and the other owners’ personal assets are on the table to satisfy a judgment.
When choosing an entity form, there are many factors that guide this decision. Will this new venture be a source of active or passive income? How many people will be allowed to share the profits? Should all of these people get a vote? Does every owner deserve and equal vote, or do those who contributed more of their own assets deserve more of a say? Of the owners, who knows the most about the industry? Who has management experience? What is the source of the business’ funding?
You may be wondering, “Why does any of this matter right now? I just want to open up!” As Ben Franklin said, “An ounce of prevention is worth a pound of cure.” The right form for you business must be chosen. As you can see, this decides so much more than what paperwork you have to file. It’s our job as business lawyers to pour our training and experience into that ounce, and position your business for smooth sailing when the ocean gets rough, and plan for the months and years to come.
2. You Aren’t Sure About What Tax Treatment Will Save You/Your Business the Most Money
Along the same line as the potential financial impact on business owners, the form of a business entity has an effect on how the IRS taxes you and your business. This is what “tax treatment” means.
In general, you get to choose what set of rules the IRS uses to tax you and your business. You can be taxed as a sole proprietorship, partnership, S Corporation, or C Corporation.
The income of businesses taxed as sole proprietorships, partnerships, and S Corporations, is reflected on the owners’ tax returns. This is called “pass through” or “single” taxation. Of course, although each of these treatments share the benefit of pass through taxation, selecting a tax treatment is not based on this factor alone. Do the owners want to share profits and losses, debts and liabilities, equally, or divide it a different way? Are any of the owners wanting to reduce their income tax liability in other ventures? Will any of the owners be a passive owner, or will everyone participate in managing the business’ affairs? Each tax treatment offers its own benefits and downsides, all of which should be discussed with a lawyer.
C Corporations owners, on the other hand, have to deal with “double” taxation. An entity taxed as a C Corporation exists as a separate tax paying entity. This means it pays its own taxes on its own income. The double taxation comes into play when the corporation makes a distribution of profits to its owners (the shareholders), who then have to include these distributions in their personal tax returns. This is the preferred treatment for most larger enterprises. Is the double tax worth it to receive a better tax rate on low-end income? Is the objective of the owners to eventually sell the business, or merge with another business? Do the owners want to share in any losses, or keep them within the business itself?
For a small business owner, taxation as a sole proprietorship (if you are the only owner), partnership, or S Corporation will most likely be the best options, but one can never be sure unless a lawyer has the chance to consider all of the facts at play. A lawyer can assess your goals and financial circumstances to help you decide which tax treatment will be right for you, your business, and your family. In addition, the tax code is pesky set of rules and regulations that is constantly changing as the political winds shift. A good lawyer can help keep you informed of these changes, arming you with key information to make informed decisions and have productive conversations with an accountant.
3. The Business Has More Than One Owner
If your business is going to have more than one owner, it is crucial to involve an attorney. One very real, common, and unfortunate scenario occurs when two longtime friends come together and build a valuable company.
Whether it was a partnership, LLC, or corporation, two friends go into business, sharing 50/50 ownership and 50/50 voting rights. They are nearly always able to compromise on any differences to make important decisions for the sake of the business - that’s why they’ve been so successful. Ten years and millions of dollars in value added later, a much larger corporation wants to buy them out, and starts negotiations at a price that would make both partners very wealthy. Friend 1 seeing the opportunity to move onto the next investment or retire early, jumps at the chance to sell. The other friend, believing this recognition is a chance to compete at the next level, digs their heels in and wants to keep the company. If these friends simply ordered a document filing starter kit online they did not receive adequate legal counsel. They are at a stand-still. Unfortunately, this business legally cannot be sold. If one partners tries to sign the papers to authorize a sale, the other partner can sue (and will win). The corporate buyer simply moves on to the next one, and will find a willing seller. Additionally, there is a high probability this decision will not only sour the working relationship (having a negative impact on the successful enterprise they’ve built together), but destroy a lifelong friendship.
This is a very common scenario among two business partners, but a good business lawyer will see these control issues (and many other issues) at the very beginning, and will strive to encourage an arrangement that will be best for the business. In the same vein, an ethical business attorney will advise everyone involved to seek the advice of their own lawyers. One thing you should always remember is a business lawyer represents your business - not any one owner.
4. You Are Forming a Business That Will Have Employees
While many small businesses start with one or two owners who handle everything from marketing to cleaning, there are certain types of businesses that require hiring employees right away (e.g., a restaurant). If your business will have employees from the start, meeting with an attorney is imperative.
Discussing limitation of owners’ liability is critical not only important for the reasons discussed above, but from an employment law and human resources perspective. Unfortunately in today’s society, each employee (whether hired or a rejected candidate) is a potential lawsuit against your business, or you. A business lawyer can help make sure proper interviewing criteria and onboarding processes are put in place to ensure you and your business are safe from accusations of improper hiring conduct - and can prove the same in the event an unhappy employee or rejected interviewee claims their civil rights were violated.
In addition, having a business lawyer’s advice can help evaluate the impact of any benefit plans you want to offer employees, and whether the owners will be able to participate in those plans (surprisingly, not all business and tax structures allow for owners to participate). Even if you will not have employees from day one, choice of entity will still have an impact on these important issues whenever the time comes that you are ready to hire.
Do these situations sound like yours? Does this information raise any other questions?
If any of these situations match yours, or you have any other concerns about putting your absolute best foot forward in your new business venture, call The Law Office of John Podmeyer for practical business planning advice that puts your goals first. If your budget is a concern, that’s understandable. Few new businesses can afford big firm rates. While business counsel is a valuable service, your business still needs money to grow. This firm was started in part to offer the flexibility to negotiate fee agreements based on each client’s ability and the complexity of each individual’s issue. To help, all major credit cards are accepted. Click the “Contact” button above to see how The Law Office of John Podmeyer can help you.
Have you made your decisions, and just need the right documents to file?
If you already know what form you want and what tax treatment you need, there’s no sense paying a lawyer to copy and paste the right documents together to file with the Secretary of State and IRS. Just get in touch, and this office will provide all of the correct documents to file with the Iowa Secretary of State - free of charge.