Starting a business in our digital age is much easier now than before the internet was born. As a consequence, many entrepreneurs do not seek advice from lawyers and accountants. They just start their businesses, some even as digital nomads. While this may not always imply problems for the entrepreneur, setting up a foundation for the business with the help of a lawyer is quite simple and always recommended.
A solid foundation will reduce stress and, in some situations, improve sleep for the entrepreneur and lower the risk of personal bankruptcy considerably. If you don’t know about potential problems, you have no chance of preventing these problems. This article is not legal advice but can be used as inspiration for subjects you should be discussing with your lawyer. Here are some of the most important potential problems:
Selecting the type of legal entity that best fits the need
When talking about different types of legal entities, the choices depend on the country and state you live in. In general, you can choose between 3 main types of legal entities. The choice has implications on your potential personal liability, tax reporting and tax payments. Other minor considerations include public or private income statements, credit ratings, image to the public, and so on.
The corporation
The corporation is a separate legal entity that aims to shield the owners from being sued. At the same time, the corporation is taxed all by itself, in general, without any direct implications on your personal taxes. Depending on the country, this type has different names, like S-Corp, C-Corp, Ltd., PLC, A/S, AB, AS, S.A. etc. There will be differences for these depending on where you set up your business.
The sole proprietorship
On the other hand, the sole proprietorship is taxed with the owner, and there is no shield from being sued. Whatever you do in your business will have implications for your wealth and the risks you run from having your business. If you have a house, you could lose it; if you have money in the bank, you could lose it; if you have a car, you could lose it, and so on. The Sole proprietorship is by far the easiest type of company to set up, but it is also the riskiest type.
The limited liability company
A mixture between corporations and sole proprietorships is the limited liability company. This type of business looks like a corporation when it comes to getting sued. But for the taxes, it has so-called pass-through taxation where the profits are taxed together with any personal income for the owners. These are called LLC, GmbH, S.r.l etc. in different countries.
While it is pretty easy to set up any of these types of companies, legal advice is recommended. There are differences from country to country and from state to state. It is the single most crucial foundational decision in your business. In most countries, you can’t shield yourself 100% from being sued personally. Still, apart from fraudulent activities, you can be protected as much as possible with either a limited company or a corporation.
Multiple founders
When you want to found your business with one or more partners, the need for legal assistance gets even more significant. You also need to have contracts that regulate the relationship between founders, including decision making and voting rights, ownership, death, the bankruptcy of one of the partners, selling part of the business etc.
Survival rates of small businesses
If you look at the small business survival rates in the US, you will usually see something around 80% after the first year and a figure around 50% after five years. There are variations between industry and between states. The source has a lot of tables showing many variations. For Europe, it varies by country, but the rates are somewhat similar. The five-year survival rates are primarily between 40-60% for all countries in the European Community.
This tendency continues if you look further ahead. Data for the US shows that after 20 years, businesses started in March 1994 have a survival rate of between 20-25%. This implies that four out of five founders of companies within 20 years will need to look at the legal foundation at least once to see what implications a sale, a merger, a bankruptcy, or a company dissolution will have on their personal finances. There will be no surprises for those with the foundation set up properly; for others, it might lead to lots of grief and anger, sleepless nights, divorce and regrets.
Next steps
If you haven’t started your business yet, start it with the proper legal foundation. If you have already started your company, consult with your lawyer. You might still be able to fix the structure. Remember, entrepreneurs that make the right decision are able to live a life less stressful. Good luck!
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