Watching the television show “Shark Tank” is an educational journey into the world of start-up business and entrepreneurial mindsets. If you are a proponent of the show, over time, the profiles of the businesses and their methodologies clearly demonstrate what works – and what does not work – when it comes to launching a successful enterprise.
Despite the risks, many cash-strapped entrepreneurs and start-ups bypass legal counsel for one reason: It is often a resource that is perceived as “too expensive.” We’ll discuss why all successful start-ups choose to grow with a law firm or legal representative whom they can trust, and where having a lawyer can help save money and equity in the long run.
The Lean Start-Up
Do all start-up enterprises need a start-up business lawyer? Yes, but the degree of interaction will depend on the scale of the business and sales, value of property, and acquisitions. Frequently, entrepreneurs can overestimate the cost of retaining legal counsel, which can leave them and their business vulnerable.
If you think that lawyers are interested in exclusively representing new businesses that make millions of dollars a year, that is not their most common client profile. In fact, more entrepreneurs are relying on legal counsel to avoid losing equity by using the “lean start-up” model to grow exponentially, while retaining much of the sole proprietor’s rights and earnings. After all, it’s no fun starting a business if you only own a minority share by the time it becomes a national or international success story.
Two areas in which start-up companies need less expense can be averted by using a business formation lawyer. First, the issuance of equity tends to trigger IRS evaluations of the business, as raising funds for business involves adherence to complicated investment securities laws. Second, the protection of intellectual property, patents, and designs.
Read: “Why Lawyers Make Good Early-Stage Startup Hires” by Daniel Doktori and Sarah Reed for the Harvard Business Review.
Incorporation and Asset Protection
For most start-up businesses, protecting personal assets and restricting liability is vitally important, particularly since a disproportionate number of new business ventures fail. Without legal incorporation or limited liability business structures, the owner of the company can be held in civilly liable, and assets including savings accounts, vehicles, and even residential or vacation home properties can be seized in the event of a settlement.
The Limited Liability Company model works well for start-up organizations, and they are one of the most popular formats for legal entities. The first advantage is that the business owner has a restriction to the level of financial liability that can be incurred; personal assets are protected under this business structure, if the proprietor has not made any legal or written guarantees regarding the business.
There are substantial tax advantages to setting up an LLC. The income generated by the business is not taxable at the corporate level; income is taxable to every member who owns a percentage of the company. The structure avoids double taxation (personal and corporate), and allows a greater profit margin for the company, which can then be reinvested to support growth and expansion.
A lawyer can draft the operating agreement that must accompany any LLC, and the agreement is also required to open a bank account for the business. An LLC also requires media statements and published articles about incorporation in business journals, but many business lawyers have media network connections to assist new businesses with the public proclamation of the LLC.
Other models include S-Corporations and C-Corporations, which provide some limitation on the number of shareholders or equity partners that a start-up can have. Limitations are also in place and restrictions regarding foreign investors; each option should be reviewed with a business formation lawyer to determine the best fit for the product, service, and brand. For instance, an S-Corp structure prohibits more than 100 investors external to the founding partners, and all investors listed must be American citizens or green card holders with landed resident status.
Low Budget Legal Essentials
If you are a small start-up and generating capital, there are ways to cut-corners with pay-per-use legal services. Knowing when it is essential to receive legal advice and assistance can help you to reduce expenses, while still ensuring that your business interests are protected. If your idea is a truly unique one that is catching fire, you will need legal assistance to “lock down” intellectual property ownership, and register any applicable patents to help prevent duplication or copied products from competitors.
If your start-up budget is tight, here are the absolute minimum legal essentials:
- Assistance with business structure, LLC, or articles of incorporation.
- Draft of the operating agreement between investors, shareholders, and partners.
- Patent application and registration.
- Registration of intellectual property.
- Labor law and hiring.
- Taxation law (including consequences for issuing shares and equity).
- Establishing terms of service for suppliers, manufacturers, or B2B customers.
It is important to remember that an error of omission is still a mistake that can cost the business and proprietors money. By reviewing agreements, contracts, and state and federal requirements, start-up organizations can avoid costly pitfalls of doing business and legal liability. This includes vendors, consultants, and third-party service providers, including accountants.
Some of the most shocking revelations on “Shark Tank” and perhaps the most tragic in daily business news are those where entrepreneurs who have innovated an exceptional service or product are devoured by a gamut of ‘angel investors’ or opportunistic partnerships. Desperate for capital to grow their vision, entrepreneurs can get stuck in a trap, and relinquish much of their equity, losing the opportunity to truly capitalize fully on intellectual property.
Hiring a business formation lawyer, or one that specializes in start-up law will support strategic growth, while protecting the business interests of the founders and shareholders. While hiring, a full-time legal team may not make sense financially, working with one part-time and establishing a relationship with a lawyer who is familiar with your niche market and business can help avoid costly disruption and set your start-up on a path for growth and success.