Starting a business can seem like a daunting task to some, while others approach the matter without a plan of action, which can result in a disastrous outcome down the road. It is important for every individual planning to start his or her own business to set up a road map concerning how the business will be structured and how it will operate.
Any business needs to start with a business plan that establishes the objectives of the business regarding the services or products that it will offer. A documented plan ensures that individuals think through the nature of the prospective business as well as provides the basis for informing potential investors about the nature of the business.
The first legal step in the process is determining the structure of the business. This choice depends on a variety of factors such as management, taxation and liability. The most common choices of entity are a corporation, a limited liability company (“LLC”) or a partnership. A corporation is a legal entity that is separate and distinct from its owners, which protects the owners from being personally liable for the actions and/or debts of the entity while at the same time allowing the corporation to enjoy most of the rights and responsibilities than an individual possesses (such as the right to enter into contracts, loan and borrow money, and own property). A partnership is an unincorporated business organization in which each partner shares responsibility for the company’s profits and losses as well as its debts and liabilities.
The partnership does not pay income taxes, as taxes are passed through to each partner, who reports their share of business profits or losses on their respective tax returns. An LLC is a hybrid entity that has characteristics of both a corporation and a partnership (or a sole proprietorship if there is only one owner). An LLC provides limited liability to its owners, while also providing the availability of pass-through income taxation.
After the legal structure of the business has been determined, the next step is to determine how the business will be financed. The easiest method is for the owner or owners to self-finance the business, but in many cases that is not possible and it must be decided whether to issue equity (equity security in the business) or debt (short- or long-term debt securities). There are several factors that influence the debt versus equity decision, which include:
- The availability of debt: Lenders may be unwilling to lend to the business.
- The availability of equity: The company may not be able to locate suitable investors.
- The business’s need to retain control over the business: If control is a concern, but the business is unwilling or unable to take on debt, the company may consider raising capital through minority investments.
- The costs of issuing debt: If lenders are unwilling to lend to the company, the interest rate may be too high.
- The costs of issuing equity: The terms of equity investors may be too burdensome.
- The business’s existing capital structure: If the business already has debt, is subject to restrictive financial covenants or does not want to provide a guaranty or other credit support, it may only be able to obtain funding through an issuance of equity.
Now that the nature of the business, its structure and how it will be funded have been determined, the next step is deciding the location of the business. Depending on whether the business will rent or purchase the commercial space in which it will operate, it will either negotiate purchase of the real estate or execute a lease agreement. In terms of geographic location, it is crucial that the business location be in proximity to a customer base that will support the business but that it is not in an area with an existing surplus of competing businesses.
At this point in the process, the business is ready to operate and organizing the workforce now becomes a focus of attention. The business will likely have to hire employees in order to carry out the key functions. This will require offer letters to prospective employees and then employment agreements once offers are accepted. Employment agreements should include confidentiality, noncompetition and non-solicitation covenants. In addition, the business should also make sure to comply with all federal, state and local regulations regarding the hiring process.
Other important considerations include ensuring that the business has proper insurance in place as well as obtaining the proper licenses and permits, depending on the services or products offered.
The business is now in the marketplace, offering its products or services and developing a customer base. Nicholas Lipresti, Esq., is an associate with the firm and concentrates his practice in tax, corporate and trust & estate matters. Mr. Lipresti advises businesses on all aspects of a business’s life cycle and would be happy to assist your business.
