Outline: Legal Aspects of Starting your Business
***These are notes from a
seminar I have given in the past.***
I. Introduction.
Roadmap of the basic legal concepts that every small
business owner needs to know.
II. The 4 shields
against liability.
Four levels of protection against liability.
-
Be Careful. You
always will be responsible for your own actions.
-
Insurance. Buy
coverage against certain risks, up to a certain amount.
Understand the exclusions from coverage.
-
Contracts. Equipment
and real estate leases; contracts with your clients.
Lock in the terms of your relationship with the other
side – obligations, warranties, liability caps,
termination rights and obligations.
-
Entity. An entity
shields you from: (i) contract based liability and (ii)
the mistakes of others (not your own mistakes, nor the
mistakes of others under your supervision).
III. If you are a sole
proprietor or a partnership, should you incorporate?
Roadmap:
Question #1: Do
you need limited
liability?
Question
#2: Is limited liability worth the costs of having
an entity? (Is
insurance a viable alternative?)
Question
#3: Will you be taking on partners? Will you have
employees?
Question #4: What are
your tax advantages
and disadvantages?
IV.
Now that you have decided to incorporate, what entity
should you choose?
1.
The basic choices
are: C corporation, S
corporation, LLC.
2.
The basic factors
in choice of entity are:
Will the business provide
professional services? Be careful, you might be a
“professional” and not even know it.
Will all owners be natural
persons? Residents of the U.S.?
Will all owners participate in
the management and operation of the business?
Do the owners want pass-through
tax treatment?
Will there be start-up losses?
Will profits be retained in the
entity?
Will there be special
allocations of profits?
Is there a real possibility that
the business will receive equity financing?
What is your exit strategy (e.g.
a sale of the business)?
V. Things to keep in mind if
your business will have more than one owner.
1.
Your most
difficult and complex task may be simply maintaining a
positive relationship among the principals.
2.
You will need an
agreement between the principals that addresses at least the
following issues:
-
Setting a level of
compensation or return on investment that is fair to
each principal and to the company.
-
Controlling the admission of
new principals into the company, as well as the transfer
of shares.
-
Providing for the duties of
each principal (e.g. will each principal work full-time
for the company and in what capacity?)
-
Balancing the rights of the
principals to control and manage the company.
-
Providing for capital calls,
if any.
-
Setting buy/sell terms so
that principals who leave the company cannot keep their
shares.
-
Using non-compete covenants.
V. Service
Contracts. Why important? Because this topic is
an everyday issue for your business. Essential exchange is
services for money.
1.
Services.
The contract should define the scope of services. 2
standards:
Outcome standard:
Services provider must deliver X outcome (e.g. a turnkey
system) by Y time. Failure to deliver the outcome is
breach. Define the criteria for judging performance
–objective or in purchaser’s discretion.
Efforts standard:
Services provider need only use reasonable care (based on
industry or professional standards) and provide a
workmanlike effort. Promise reasonable availability, skill
and effort, but do not guarantee a specific outcome.
Do not drop your sales
materials directly into the contract.
2.
Money.
Contract should set the amount and schedule of payments
(e.g. milestones).
3.
Substantial
Performance. When must purchaser pay the service
provider? Upon substantial performance.
Purchaser must pay upon
performance that meets the essence of the contract.
Purchaser may not hold out for perfect performance.
Be Careful: Express terms
of contract likely are “essential” terms. Service provider
is not entitled to payment until he performs that particular
item.
4.
Purchaser’s
Rights for Less-than-Perfect Performance. Less than
complete perf still is breach. Now purchaser must pay, but
has a claim for damages for the shortfall between the terms
of the contract and the actual services rendered. In
practice, purchaser frequently is left without rights
because he can’t prove sufficient damages (e.g. performance
that is late a week).
5.
Material
Breach. Usually the service provider is the breaching
party.
Be Careful: Express terms
of contract likely are material. The analysis is always
fact-intensive.
Consequences. At material
breach, the non-breaching party has 4 options:
(i) Suspend performance pending
cure.
(ii) Terminate contract + sue
for damages.
(iii) Continue perf + sue for
damages.
(iv) Waive the breach.
Restituion. Breaching
party usually forfeits right to payment, except for
divisible contracts and occasional restitution (for fair
value of the work actually performed).
6.
Disclaimers and
Limitations on Liability: The 2 Headed Monster.
Disclaimers. Services
provider should disclaim everything other than what he
promises to provide.
Limitations on Liability.
Services provider should try to limit money damages to the
amount paid under the contract for a specified time period
(e.g. 1 year). Also consider a contractual statute of
limitations.
7.
Change in
Services. Contract should provide a mechanism for
changing the scope of services and the corresponding payment
and schedule for completion.
8.
Termination.
There are 2 kinds of termination – voluntary and for
breach. For both, the contract usually will require a
notice period.
Purchaser Fault. The
contract might require that if purchaser voluntarily
terminates or breaches, services provider can recover for
work performed and also a percentage of net profit.
Services Provider Fault.
.
9.
Hiring of
Personnel.
10.
Ownership
Rights.
VII. Setting up your
business.
1.
Research and protect
the name of your business.
2.
Register
your business with the CA Secretary of
State and make necessary filings.
3.
Register
any fictitious business name (e.g. with the Alameda
County Clerk’s Office).
4.
Register your
business with your locality (e.g. the City of Fremont). Get
your Home Occupancy Permit, if applicable.
5.
Contact your
locality’s licenses and permits department (e.g. the Fremont
Planning Division).
6.
Register for and
pay business taxes.
7.
Purchase necessary
insurance, e.g. workers compensation.
8.
Set up payroll
procedures.
9.
Obtain the licenses
that apply to your business, e.g. a state seller’s permit.
Call
me to schedule a legal consultation:
510-796-9144
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