What You Should Know About Startup Laws
There are so many prospects for creative entrepreneurs in the rapidly growing startup culture. Knowing your rights and the laws around founding a startup is so important. With the proper knowledge, you will be able to navigate through the early phases of your company without having to deal with legal conflicts around equity, management rights, or other legal matters.
The kind of company entity you should create is one of the first decisions to address. Each of the following business structures has its own benefits and drawbacks: corporations, including C Corporations and S Corporations, limited liability companies (LLC), general partnerships, limited partnerships, and sole proprietorships. Each category has a unique set of tax obligations and legal protections. For instance, if you decide to set up an LLC, you might benefit from pass-through taxation and limited liability protection. This means that tax will not be imposed on the LLC level, and instead, all profits or losses will pass through to the members of the LLC on their individual tax returns. Investors may not be open to investing in LLCs, so this is not the best route if you anticipate needing to raise funds quickly. This is why discussing the exact requirements of your particular business with a business attorney is crucial in helping you to choose the right category.
A company’s equity can be distributed in a variety of ways. Who will control your business and how ownership interests will be distributed are additional key decisions. Equity can be allocated as an incentive for the early managers and other high-level staff or split among the initial investors. Employees may receive shares as an incentive. However, allocating equity too widely might be problematic for a startup company. It’s important to have an effective operational strategy for your business’ equity that doesn’t obstruct growth. Additionally, it’s important to avoid placing excessive financial strain on a growing business. Many businesses struggle to turn a profit in their first year, and this can be especially difficult if you take on too many equity responsibilities.
A company’s founders will usually have the most influence over the direction of their business and are held accountable for its success or failure. This is why it’s important to establish each founder’s goals and expectations early on. This can be done by drafting startup papers, which should have clauses for:
- How the founders’ ownership stock will be divided
- Who will be in charge of running the day-to-day operations
- Who will be in charge of conducting long-term, strategic planning for the company
- How the founders will settle disagreements between them (for example, majority rule, identifying a mediator, identifying someone to serve as a tie-breaking vote, etc.)
Future disputes between original members can be mitigated if your startup documents are clear. Disputes can cost businesses a lot of time and money and can even lead to the end of the business.