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Legal Requirements for Small Businesses

Posted by Ed Bard on

 Small business legal 101

I know what it is to be an entrepreneur and trying to figure out what to do to start a company on the cheap.  What follows are my experiences on what it takes to legally start a small business.  This may not be complete nor accurate for your situation, but it details the actions I took to successfully launch several businesses.

 Step 1: Register Your Business and Company Operating Agreement

To register your business, you must research which federal, state, and local regulations could potentially affect it.  For instance, if your business includes the sale of alcohol, you will need to obtain a federal permit.  In terms of state obligations, you will have to register your business with your state’s business office.  Most states have different registration processes so if you intend to operate your business in more than one state, it is important to keep this in mind.  Localities can have business requirements and restrictions as well.  Continuing our example, if your business sells liquor, you must obtain a liquor license from the city or county as well as register with the city or county for taxes.

A DBA, otherwise known as “Doing Business As” or an assumed name, is the legal term for a business that uses a fictitious name that is not the owner’s legal name.  A DBA can also be used when a business wants to operate separately under a parent company.  You may be interested in using a DBA if you do not want to do business under your own name or if it your name is unavailable.  To register your DBA, you will likely be required to register with the local county or city clerk’s office.  Additionally, your state will likely require you to register your DBA so consumers can be protected.

How to start an LLC

The largest challenge initially was understanding what format to use: LLC, S-Corp, C-Corp, LLP.  You will want to do your own research on which business formation to use.  You can change your corporation structure; however, once you do you can be locked in to the new structure for up to 5 years. The high level pros and cons of each business structure is the following:

LLC:  

  • Pros: Low burden of documentation, limited liability, easy to manage, easy to bring in outside money and distribute profits. 
  • Cons: You pay taxes on all of the company profits at your income tax level – so when reinvesting profits, you are paying personal income tax on unrealized personal gains.  Also, you will very likely face much higher self-employment taxes, and you cannot be paid through payroll – you need to collect a regular guaranteed payment and withhold your own taxes.  Additionally, you have to file quarterly estimated taxes, and some angel groups and many larger investors do not like to invest in LLCs.

S-Corp:

  • Pros: Greater documentation then an LLC but lower than C-Corp.  Can be paid through payroll and maintain limited liability status, likely lower self-employment taxes, no need to file quarterly taxes, limited liability. 
  • Cons: I am told that S-Corps are difficult to bring investor money into, reduced flexibility in operating agreement and distributions.

C-Corp:

  • Pros: Easiest to bring outside money into (especially if Delaware based), can be paid through payroll and maintain limited liability status, likely lower self-employment taxes, no need to file quarterly taxes, limited liability. 
  • Cons: Highest level of documentation, least flexibility, double taxation potential for distributions.

Partnership: I do not know enough about this; however, accountants and lawyers I have talked to have always steered me away from them and had nothing good to say.

For more in depth answers talk to a professional.  You can also review options on Legal Zoom as well as other sites.

Operating Agreements: This is a key document in your company that clearly defines who has the responsibility for the company. Members of the company are listed and internal operations are specified, showing who has authority for various roles and how this authority can change. The operating agreement is necessary for protection and clarification. By listing business members, the agreement also gives these members shelter from personal liability, so that liability for business actions can only be placed on the business itself. The operating agreement is also an ideal place to clarify verbal agreements and ensure that all regulations are being met.  I have personally seen businesses fail where lawyers and owners poured through the operating agreement looking for legal tools to hold the other parties hostage.  For example, a “cram-down” can occur when the business needs more money quickly and one or more or the owners lacks the funds to match their share of the cash in contribution.  The owners with the funds can dictate the price that they buy in and dilute the cash-starved owners quickly.  Another scenario that I have seen is when one owner no longer wants to participate in the business or is not pulling their weight.  A good operating agreement can deal with these and a myriad of other issues.  80% of all business partnerships fail, and I like what Dave Ramsey has to say about the reasons why.  He calls them the Five Ds, “death, disability, disinterest, drugs, and divorce.”

Legal considerations of setting up a small business

Step 2: Get a federal and state EIN and D&B Number

After registration, you will likely want to file for an EIN at the federal and state level.  For the federal level you can get it through Legal Zoom for a fee, or skip the fee and go straight to the IRS: https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online

For the state EIN, you will need to go to your state taxation and or business portal to file once you have your federal number.

If you are doing business with the US Government, you will also need a Dun & Bradstreet (D&B) number.  A D&B provides a D-U-N-S Number, a unique nine digit identification number, for each physical location of your business. D-U-N-S Number assignment is FREE for all businesses required to register with the US Federal government for contracts or grants. You can get these here: https://fedgov.dnb.com/webform

Step 3: Register on SAM.gov to get your CAGE number - FREE

SAM.gov is the central supplier database for the federal government and is where you ultimately input your bank information to get paid.  SAM collects, validates, and stores data from suppliers and makes them available to government agencies for procurement.  As the primary system for government agencies to see supplier information during the acquisition process, all contract or grant seekers with federal agencies, like the DoD, are required to be in the system to sell to the federal government.  Once registered in SAM you will receive your organization’s CAGE code.  The Commercial and Government Entity, or CAGE code is a five-character ID number that identifies contractors.  During the SAM registration you will also identify your NAICS for your business.  The North American Industry Classification System (NAICS) identifies business establishments by business categories.  Your organization can designate multiple NAICS and will allow you to see and bid on future government contracts.

The process to get registered in SAM is as follows:

  1.  Register your business as an SBC with the small business administration SBA.gov in order to receive your SBA SBC ID https://www.sba.gov/user/register
  2. Register your entity in SAM.gov. www.sam.gov

SAM.gov Process

  1. Go to www.sam.gov
  2. Create a User Account
  3. Click “Register New Entity” under “Manage Entity” on your “My SAM” page
  4. Select your type of Entity
  5. Select “No” to “Do you wish to bid on contracts?”
  6. Select “Yes” to “Do you want to be eligible for grants and other federal assistance?”
  1. Complete “Core Data”
  • Validate your DUNS information
  • Enter Business Information (TIN, etc.)
  • Enter CAGE code if you have one. If not, one will be assigned to you after your registration is completed. Foreign registrants must enter NCAGE code.
  • Enter General Information (business types, organization structure, etc)
  • Financial Information (Electronic Funds Transfer (EFT) Information)
  • Executive Compensation
  • Proceedings Details
  1. Complete “Points of Contact”
  2. Your entity registration will become active after 3-5 days when the IRS validates your TIN information.

Once you have received your SAM registration, you will need to register on the DoD SBIR portal, this is where you will ultimately upload your proposal. 

Setting up a new business -- legal considerations

Step 4: Other Legal Considerations (Depending on Your Circumstances)

 Employees and the Workplace

It is necessary to look into federal, state, and local requirements regarding the workplace once your business is registered and you are ready to start hiring.  The U.S. Department of Labor (DOL) website, elaws—First Step Law Advisor, lists federal employment laws, reporting requirements, and other resources that may apply to your business.  There are several federal employment laws that you should understand before beginning hiring practices. 

  • The Family and Medical Leave Act (FMLA) allows eligible employees of covered employees to take unpaid leave in the case of family and medical situations while still using group health insurance.
  • The Americans with Disabilities Act (ADA) protects people with disabilities from discrimination in employment, public accommodation, transportation, communications, and government activities.
  • The Uniformed Services Employment and Reemployment Rights Act (USERRA) prohibits military service-based employment discrimination and protects service members reemployment rights.

Before hiring your first employee, you can obtain an employment identification number (EIN) from the U.S. Internal Revenue Service (IRS).  This number is used to report taxes and other similar documents to the IRS.  The EIN may be required for a business bank account or business licenses by state or local authorities. You can acquire an EIN at no cost and you may apply for it online, via fax, mail, or by phone.  

There are different state and local labor laws. Use the DOL site to find a directory of individual state labor offices.  Local labor laws can apply to smaller employers and include more protections than federal and state laws.  Therefore, it is important to consult with city and county business offices to determine local requirements and certain protections employees may be afforded.

Taxes

You must file an annual income tax return with the IRS unless you have a business partnership.  The annual income tax return is the tax you should expect to owe the federal government yearly.  It is based on the projected earnings of your business.  You will also be responsible for paying a self-employment tax if you are the sole proprietor of your business.  This tax covers your required contributions to Medicare and Social Security.   Certain taxes such as Social Security and Medicare taxes, Federal unemployment tax, and withholding income tax are your responsibility if you have employees.  Finally, check the federal tax requirements for businesses on the IRS’ Business Tax website if your business is a manufacturer or service provider.  Examples of taxes include excise taxes for the operation of large vehicles. 

Products and services labor usually require sales taxes by state and local governments.  A sales tax is a point-of-purchase tax for retail goods and services paid by the purchaser.  You may have to obtain a sales tax permit to collect tax revenue from customers, which requires that you complete returns and reports to government entities.  It is also your responsibility to determine the sales tax for all products or services provided, collect the tax from the consumers, and pass the tax revenue to the applicable state and local entities.

Although most states collect business income taxes, it is dependent on the business’s legal structure.  For instance, a limited liability company (LLC) can be taxed separately from the owner.  Because this does not apply for every LLC as requirements vary by state, be sure to check with a legal advisor.  Additionally, check the SBA’s website and their article, Determine Your State Tax Obligations, for more information.

Zoning

Before choosing a location where you would like to operate your business, you must ensure that the property is correctly zoned.  To do this, you can contact your local planning agency.  There are different zoning restrictions based on whether you plan on operating a home-based business or brick and mortar business. 

A home-based business is typically more restricted than brick and mortar businesses because they are located in residential areas.  Typical restrictions include changing the physical appearance of your home and noise and nuisance restrictions.  Brick and mortar businesses are typically located in a commercial area, which implies fewer restrictions.  However, because brick and mortar businesses fall into two zoning classifications, commercial and industrial, it is important to ensure that your business fits into the property limitations.  Commercial zones tend to be used for retail sales and services and restrictions typically relate to things such as parking availability.  Industrial zones are for businesses involving manufacturing or bulk storage and restrictions include environmental factors such as noise and pollution.

 Registering for Securities

Offering or selling securities requires a registration with the U.S. Securities and Exchange Commission (SEC) or qualification for a registration exemption.  However, if you advertise for investors, you will likely be required to register.  Read the SEC’s A Guide for Small Businesses on Raising Capital and Complying with the Federal Securities Laws guide for more information.

 Professional Licenses and Environmental Regulations

Your business may require special permits or licenses, such as possible workplace inspection and approval by the Department of Labor’s Occupational Safety and Health Administration (OSHA).  Federal, state, and local special permits can include a health permit for food preparations.  Certain businesses may be required to obtain professional or occupational licenses, such as a business conducting real estate sales.

 If you employ people to work for you, you are required to provide a clean, safe, and healthy environment for your employees.  Review OSHA’s Small Business Handbook for more information on the legal requirements before an OSHA inspection.

Additionally, if operating your business impacts the environment in any way, you may face several environmental regulations.  The U.S. Environmental Protection Agency and state environmental agencies will work with you to explain certain regulations.  Typical required permits include anything involving the Clean Air Act and use of wetlands.

Risk Management

Internal and external legal risks are something to consider when operating your small business.  You will likely face many of them and it is important to analyze your business operation to minimize and avoid any potential risks.   Law of agency is a legal situation where an employer authorizes an employee to deal with a customer and employee causes a legal issue resulting in a lawsuit against both the employee and employer.  In this case, you as the employer can be held responsible for the actions of your employee.  To minimize this risk, make sure that your employees only take on tasks that they are qualified to complete.  Additionally, be clear in defining authority and responsibilities.

To limit the possibility of lawsuit against your company, there are a few simple steps to always keep at the back of your mind:

  •  Be clear in your speech and actions
  • Avoid any conflict of interest
  • Separate your personal assets from the business
  • Back up and protect critical data
  • Have a good lawyer available to help with decisions
  • Have adequate liability insurance

Additionally, disputes with partners, employees, and suppliers can arise for various reasons and can potentially disrupt services or sales.  Mitigate the risk of these disputes by being alert to any signs of trouble and documenting all agreements.

There are many facets to starting and operating a small business.  Additionally, there are a variety of regulations and requirements that must be met to legally operate your business.  Fortunately, there are several resources that small business owners can use to ensure they are meeting all regulations and requirements for their business.  Make sure to use those resources for detailed information on these requirements.

SBIR Guide is not a legal firm and assumes no responsibility or liability for any errors or omissions in the content of this site. The information contained in this site is provided on an “as is” basis with no guarantees of completeness, accuracy, usefulness or timelines. Starting a new small business comes with its share of obligations.  It is important to research what licenses and permits will be needed to legally run a small business.  There are many federal, state, and local requirements for small businesses and understanding what applies to your business is necessary to comply with these legal requirements.

 

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