16 Important Legal Requirements for Starting a Small Business

16 Important Legal Requirements for Starting a Small Business

Use this list of legal requirements for starting a small business to prevent issues from affecting your business.
Oct 22, 2020

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Starting a new business is a challenging pursuit. Part of what makes it so complicated is all the legal implications that come with starting a business. As a business owner, you want to make sure you have covered all your legal bases to avoid any fines, lawsuits, or—worst case—even jail time.

Fortunately, there are plenty of legal resources available to small businesses both online and through hired legal counsel. Use this list as a jumping off point, covering the legal requirements for starting a small business. Checking these off your to-do list will help you ensure that you don’t run afoul of any laws. The sooner you take care of these things, the sooner you can focus on what you do best—selling your product or service.

16 legal requirements for starting a small business

1. Designate the proper business entity.

First things first. Choose the proper business entity or structure for your startup. This is crucial because it affects your personal liability, what you pay in taxes, and your fundraising ability. Possible structures include sole proprietorship, general and limited partnership, C-corporation, S-corporation, and limited liability company. Once you decide which structure is best for your company, you need to officially designate it through your secretary of state.

Most small businesses start out as sole proprietorships or partnerships because these require minimal paperwork and set up time. However, these types of businesses also don’t offer sufficient liability protection for business owners. A corporation or LLC is generally a better choice as your business grows, particularly if you’re planning to secure a business loan or raise venture capital.

2. Check which licenses, permits, and registrations your business needs.

Depending on your type of business and where it’s located, you might need specific business licenses and permits from your country, state, county, or city. Licenses, permits, and registrations come in many variations. Examples include local business licenses, building permits, health safety-related permits, permits for home-based businesses, fire permits, industry-related permits (like running a legal practice, hospitality, construction, or manufacturing business), liquor licenses, and more.

The possibilities are many, so make sure to do thorough research—perhaps with the help of your counsel—on what you need to be compliant with the law in your area. Your city or county’s business licensing agency is also a good place to start.

3. Make sure you are paying proper business taxes.

Every business owner is legally required to pay taxes. This includes income tax, self-employment taxes, and for some businesses, sales tax. It’s wise to hire an accountant or tax advisor to make sure you are compliant with all tax laws. Accounting software can also help you figure when to file taxes and what forms you need to fill out.

Most small business owners can’t wait until March or April to pay taxes. The IRS has a pay-as-you-go tax schedule for businesses, requiring business owners to pay estimated taxes on a quarterly basis. Make sure you check the IRS requirements for your business type to avoid any fines and back taxes.

4. Do proper bookkeeping.

In most places, you are obligated by law to record all business transactions according to a specific accounting method. See what’s required of you for your industry and location in terms of record-keeping obligations, and set up a proper filing and bookkeeping system for all documents and transactions. This will greatly help you down the line in doing taxes or if you ever run into other legal troubles.

5. Get a founders agreement in writing.

If your business operates with multiple business owners, it’s important to make sure that each person knows and understands their rights and responsibilities in relation to the business. How this comes about depends on your business structure. If you form a corporation, you need a proper shareholder agreement and articles of incorporation. If you form an LLC, you will need articles of organization and an LLC operating agreement. You also need designated legal counsel to make sure the agreements and articles are sound.

6. Set a vesting schedule for all founders and early employees.

This is a practical measure many startups often overlook when they’re just starting out and excited about getting off the ground. But this will protect your business down the line and ensure a certain level of commitment each founder or early employee brings to the table.

Creating a vesting schedule upon incorporation states that stock ownership will vest over time, preventing investors from selling all their stock whenever they please. Note that most investors require this measure before they’ll make any initial investments.

7. Get your employer identification number (EIN).

In order to open a corporate bank account and to properly file your business tax returns, many businesses need an employer identification number (EIN). You can easily request one for free from the IRS over the phone or by using an online application on the IRS website. Only sole proprietorships and single-member LLCs with no employees are exempt from this requirement.

You need the social security number of the person completing the form for the company (usually the president or CEO). Include information on your business entity and date of incorporation. Make sure to keep a signed copy of this application in your files.

8. Protect your intellectual property (IP).

Intellectual property is the bread and butter of many businesses. IP includes patents, copyrights, trademarks, and trade secrets as well. Be sure to file any patents as soon as possible—a process that can take more than five years. Protecting your intellectual property will be attractive to investors—but it will also help you sleep easier at night. Having exclusive rights to reproduce and display your work will make your life much, much easier down the line and ensure that no one tries to rip any IP rugs out from under you.

IP can be vastly complicated from a legal standpoint, so it might be wise to consult an experienced IP attorney who can help you through the process and provide you the greatest protection.

9. Classify your workers properly.

Many startups often misclassify their early employees. It’s important to know what kind of worker you’re hiring—essentially, the difference between an independent contractor vs. employee. This is important for tax reasons for both you and the employee and will help clarify what is and isn’t expected from you and the employee. If you misclassify an employee as an independent contractor, you could be on the hook for costly penalties and back wages.

10. Purchase workers’ compensation insurance.

In all states but Texas, most businesses with employees are legally required to purchase workers’ compensation insurance. Coverage should begin from the very first day your employee starts working. This insurance covers medical and legal costs associated with work-related employee injuries and illnesses. State laws about workers’ compensation vary, so make sure you check your state’s rules.

11. Make sure you’re in compliance with securities laws.

Founders and investors of LLCs, C-corporations, and partnerships are subject to federal and state securities laws. These laws were made to require companies to provide reliable and accurate information about their businesses to enable a fair market. They also protect from insider trading and trading fraud.

Failure to comply with these laws can result in the startup having to repurchase all of its shares at the issuance price, even if the company has lost all of its money.

12. Follow email regulations.

Email marketing is a huge part of many businesses. When you send emails to your customers or when you are targeting potential customers via email campaigns, you need to find out what the applicable email regulations are. Note that each country has its own set of rules.

Aspects covered by these rules generally include opt-in versus opt-out, B2B or B2C emails, unsubscribe rules, and minimum information to be included in your emails.

13. Make sure your investors are accredited.

The current definition of an accredited investor under the Securities and Exchange Commission rules includes eight categories of investors, but the most general investor accreditation means that the person:

  1. Has at least $1 million in the bank

  2. Has at least $200,000 in annual income

  3. Understands and is willing to take the investment risk

The SEC has guidelines for what constitutes “reasonable efforts” on these accounts. It’s possible to raise funds outside the narrow limitation of accredited investors, but it will open up a Pandora’s box in terms of securities and compliance enforcement. So, if you want to be the most legally sound you can possibly be, go through accredited investors.

14. Establish a privacy policy.

A privacy policy is a legal statement that specifies what a business does with the personal data collected from users or customers, along with how the data is processed and why. Violation of privacy laws can lead to criminal liability—depending on your state, this can mean hefty fines—so it’s important that startups have proper privacy policies in place and carefully adhere to them. The Small Business Administration has a great guide for establishing an appropriate privacy policy for your business.

15. Create a company handbook.

Once you have all the legal headaches sorted out and sounded, make sure everyone in the company is aware and understands your company’s legal liabilities just as well as you do—as a business owner, you could be liable for anything your employees do while representing your organization.

Company or employee handbooks are a great way to instill the values and legal boundaries of your company. It can also help to establish what is and isn’t appropriate behavior internally and externally. Have your legal counsel look this over well or even help you write it, and then get the company together to go over the material.

16. Hire competent legal counsel.

In case this hasn’t been clear throughout, work with lawyers on these complicated legal issues from the start. Startups are often so concerned about expenses that they overlook the importance of sound legal advice that could save them thousands, if not millions, down the line. You really can’t put a price on having the right attorneys on your side.

Ideally, you’ll hire an experienced business attorney on employment law, contract law, securities law, and intellectual property law. You could hire a “general counsel” on your staff at some point, but it’s common for the work to be spread out between different firms and attorneys. The cost is worth avoiding any legal trouble.

The bottom line

Starting a business is hard—don’t let anyone tell you otherwise. But if you are meticulous about getting your startup legal checklist in order, you’ll save yourself from some serious headaches down the line. Some of these items are things you can take care of yourself. But for more complicated tasks, or if you run into questions, it’s important to hire a competent attorney to help you.

This article originally appeared on JustBusiness, a subsidiary of NerdWallet.