The 2 Most Important Steps to Starting a Business Are Creating A Contract Between the Owners and Buying Insurance
Having a writing that spells out the rights of business owners and buying insurance are the two key steps for any new business. Often it is not necessary to incorporate a start up.
As a business attorney in Los Angeles I am routinely contacted by individuals who are starting new businesses. Almost invariably their questions relate to what type of business entity they should form – should they create a corporation or an LLC or a partnership? My response usually surprises them.
The legal entity under which you do business is a distant third place in the considerations of a start-up company. Often business owners are better off waiting to incorporate or creat a limited liability company until later. For more information on the pros and cons of incorporating a start up read this post. The first thing a startup has to have is a written agreement between the owners of the business about how they will relate to each other – how they will share the profits, the losses, the work on the business and most importantly, what will happen if one or more business owners wants to leave the business or if one of the owners gets a divorce. For more information on the agreements between business owners read this post.
Second, only to an agreement between business owners is the importance of having sufficient insurance coverage for the business. When prospective clients call me about whether to form a corporation or LLC (limited liability company), they are usually surprised when I ask why they need a corporation or a LLC. They always say the something like this; “I want to create a corporation to limit my personal exposure”.
The truth is that the way to limit one’s exposure is through insurance. A general liability policy will go a long way to covering any problems a new business might face. Startups need insurance. And the individuals who are starting the company need to find a good insurance broker with whom to discuss the nature of their business, their possible exposure issues and the appropriate insurance coverage. If the business will have employees then it must also buy worker’s compensation insurance. It’s cheap and it is required by law. You do not need to be a corporation to have an Employer Identification Number (EIN). The I.R.S. will issue you one if you simply ask for it (either online or by using a simple mail in form).
Please do not misunderstand me. I am not saying that it is never appropriate to incorporate your business or form a limited liability company as you start up your business. The more sophisticated the business plan is the more likely it will make sense to incorporate straight away. For example if you’ll be seeking investors you should have a corporation or limited liability company as you will have to follow certain strict laws when you make your investment offerings in order to avoid having to register with the Securities and Exchange Commission.
But in my twenty-one years of experience as a business lawyer, the vast majority of individuals who want to start a business put the cart before the horse. The legal entity is less important than the agreement between the owners and appropriate insurance for possible liability exposure. A common misconception people have is that if they incorporate they can incur obligations which they won’t have to repay if the business fails. Wrong. No bank will give a brand new small business company a loan unless the owners personally guarantee the loan. So the idea that the corporation will insulate the owners from debts is a myth.
Further, if there is an injury caused by a product the business sells or an accident on the premises a corporation might insulate the personal assets of the owners, but you can count on the plaintiff’s lawyer to try to “pierce the corporate veil” which is to say that he or she will argue that for this or that legal reason the personal assets of the owners should be subject to the complaint (the specifics of the argument are too boring to spell out here, just trust me this is what the lawyer will do). All of this drama can be minimized by insuring your new business has appropriate liability insurance coverage.
Whether you intend to create a construction business, a business devoted to entertainment, hospitality, real estate, a restaurant, technology, telecommunications or transportation, if there will be more than one owner, there must be a written agreement concerning: 1) the capitalization of the business; 2) the division of the profits and losses; 3) what happens in the event an owner leaves the business or divorces.
And as I said above appropriate insurance coverage must be purchased. A business agreement and insurance are more important than the nature of the business entity in 95 percent of the start up businesses created in California every year and yet few people consider either the business owner agreement or business liability insurance coverage. Don’t make that mistake!
Beverly Hills Business Attorney Galen Gentry can help you protect your business. Whether yours is a start up or a going concern we can help minimize lawsuit exposure, draft employee contracts, buy-sell agreements, and incorporate your business. With 21 years of experience and the highest rating for legal skills and ethical conduct from avvo.com and martindale.com, Galen can work with you to avoid costly legal problems through proper planning. Call 800 486 6814 for a free, no obligation consultation. Serving clients in Southern California including Los Angeles, Beverly Hills, Santa Monica, Hollywood, The San Fernando Valley, Glendale, Pasadena, Ventura County, Orange County and Long Beach.