Business Basics and Law — An Introduction
This article introduces some important legal considerations that apply to business. This helps students, startup creators, and small business owners understand important concepts.
As an introduction this is not exhaustive, so after reading this you can do additional research and seek legal expertise as needed. Resources are always limited so the key is building our own knowledge and understanding. That helps us know when legal professional assistance is required, then effectively hire and communicate with that attorney, and then to make a solid business decision.
I will cover these areas:
- Value provided: goods, services, partnerships
- Organization entity type and location
- Governance (management), including risk management, protection, and legal compliance
- Ownership and financing
- Accounting and taxes
- Assets (including intellectual property)
- Starting your own business?
- When to hire an attorney
- Additional resources
1. Value provided: goods, services, partnerships
This would be part of your business plan and is not related to law but I don’t like to leave important things out. So here we recognize that providing value is a business’ first priority (elsewhere, I refer to this as business needs and mission, one of my Four Platforms to Connect). To create or continue a business, it needs to provide something of value. Often this value is in the form of goods (products) or services, provided to customers or clients (individuals or organizations). But in general the concept is providing value to individuals, organizations, or even society.
While creating or providing this value, one may need to enter into contracts (which I cover in another article). There are many ways that businesses can increase the efficiency, quantity, or the reach of the value they provide. This will involve partnering with others in some manner. A business that produces a product needs materials, and that means obtaining materials from somewhere. A business that provides a service may need others to properly deliver it. Companies need to reach customers, and may partner to make this happen.
2. Organization entity type (and location)
Entity formation and consideration of entity type and location is an important business consideration. An entity is often desirable and gets “personhood” within the legal system. An entity can enter into contracts, open bank accounts, receive payments, and pay taxes. Creating an entity also reduces personal legal liability (of owners and managers) for acts done by the organization, facilitates investment or financing, and has other benefits.
2.1. For-profit or nonprofit? The first consideration is whether it will be a for-profit or nonprofit (not for profit) organization.
- A for-profit organization is (you guessed it) designed to earn a profit for the owners. The company and owners will pay their taxes on that profit (as a general principle).
- A non-profit organization is designed to do something for a greater public good, and not to enrich individuals. Thus, a non-profit may be exempt from taxes, might be allowed to receive charitable donations (for which donors could get a tax deduction). In exchange for these nonprofit benefits, the organization may need to file financial documents with the government which may be made public (e.g. IRS 990 or NYS Char 500), and also comply with other rules.
The next two considerations a for-profit business faces is (b) location of formation and © type of entity. Business formation is pursuant to state law, so founders would first decide what state to create their entity in. Each state has their own laws and categories of entities. These decisions are made after considering taxation requirements, potential legal liabilities, and more.
2.2. State of formation
Business founders need to consider what state to create their entity in. The logical choice of formation is where the business will be located. Thus, a business headquartered and operating in New York would first consider New York, and the government entity that administers entity formation is the New York State Department of State.
Many organizations chose states other than their “home” state to incorporate, and Delaware is a popular choice. That is because Delaware has laws, fees, privacy protections, and legal protections for organizations that make it attractive for businesses. Thus, many businesses headquartered outside of Delaware incorporate there. In exchange, the state of Delaware gets fees and taxes from businesses, consumers fees (when they pay for company information), lawyers, and other litigants. None of this is to suggest incorporating in Delaware. Plenty of organizations have blindly chosen Delaware to incorporate and then regret when they are sued in a state far from their home base.
2.3. Entity type
Founders need to choose an entity type, here’s a quick list:
- Sole proprietorship (actually this is not an entity type, but reflects a choice not to create any type of entity, and just do business as an individual)
- C-corporation (incorporated, Inc.)
- S-corporation (an election of a small business c-corporation to be taxed a certain way which might be beneficial for some small business owners)
- Limited Liability Corporation (LLC)
- Professional Limited Liability Corporation (PLLC) (for example, in NY “professionals” like lawyers and doctors can form a PLLC, but not an LLC)
- Limited Liability Partnership
There are pros and cons to each form, just remember that forming an entity requires a commitment to maintaining it and ensuring it complies with any legal requirements.
2.4. Entity name and DBA
When forming, the founders need to decide upon an entity name, which needs to meet certain requirements, as laid out by the state law and perhaps also trademark law. Generally, that name needs to be unique within that state (but someone might have used that name in another state).
Businesses may “do business as” (DBA) another name. That DBA may need to be registered with the state or local government.
2.5. State(s) of operation
Once the business forms in a particular state, they need to evaluate what states they are operating in. They may need to register with those states.
3. Governance (management) (including risk management, protection, and legal compliance)
The organization needs to be governed (managed). In a sole proprietorship this is simple, the individual decides what to do and then does it.
In larger organizations increasing levels of formality are required. The organization is subject to many legal requirements and needs to comply with them. It needs to fulfill its mission (providing value somewhere), but also pay taxes and file financial documents with the government, comply with a large array of legal requirements, and enter into contracts. There needs to be processes to ensure the organization does this properly.
Ultimately, people make decisions, but often there needs to be a process and mechanism to specify who contributes to the decision making and how it is done.
To govern an organization, people need to be appointed to governance roles, and documents may need to be created (see my other articles relating to organization documents such as policies and procedures).
Consider these documents which may indicate how an organization can operate and govern itself:
- Articles of Incorporation
Consider these people or groups of people who play a role in managing and running an organization:
- Board of Directors (Board of Trustees, Trustees, etc.)
- Chief Executive Officer, Executive Director
- Other officers of the corporation and senior management
- Middle management
- Lower level management
- Employees, contractors, interns, etc.
Also consider that management of an organization is going to include decisions about:
- How to best fulfill the organization’s mission (for profits need to generate revenue)
- Protection of the organization and risk management, to include cybersecurity and cybercrime prevention
- Legal compliance, to include registration, licensing, taxation, consumer protection, employee protection, cybersecurity, and privacy.
- Do you need a cybersecurity policy for your startup and you can’t afford expert assistance? See my free cybersecurity policy.
People work in organizations, manage organizations, and are subject to being managed. As we think about laws and issues relating to people, we should consider compensation, contract, employment law, anti-discrimination laws, and privacy.
Generally, employment in the U.S. is “at-will”, meaning there is no guarantee of permanent work for the employee, and the employer does not need to demonstrate good cause to terminate the employee.
Employment contracts may address important areas of lasting importance, to include compensation and benefits, and contingencies for during and after employment. It may include grounds for termination, non disclosure and non compete requirements and more. Since I mentioned “contract”, that implicates contract law, and employment contracts implicate employment law.
5. Ownership and financing
An organization may need money (capital or financing) to start, grow, or continue its operations.
An organization can also obtain a loan (financing) to support it’s operation, and the loan would need to be paid back, typically with interest. The person making the loan needs to be satisfied that the business will actually repay the loan, or has assets (collateral) that are of value to be seized if the loan is not repaid.
An organization is owned by a person, people, or other organizations. Organizations can sell equity in the company (a portion of the ownership of the company) in exchange for money (raising capital), and this can happen in a number of ways.
In sum, here are some ways the organization can raise capital. An important question is whether the money needs to be paid back (a loan) and the terms of that loan, or if it is in exchange for a share of ownership in the organization.
- Personal or organizational loans or financing
- Pre-seed financing
- Seed financing
- Angel investors
- Venture capital and private equity
- Series A round (then, B, C, etc.)
- Initial public offerings (IPOs) (offering public shares in the company, and subject to securities laws).
Here also, these agreements implicate contract law, and potentially securities law, or other consumer and investor protection laws.
6. Accounting and taxes
Lets just say that accounting and taxes are really important.
- Tracking funds helps with making good business decisions.
- Organizations need to protect from internal and external theft and fraud. Good accounting helps.
- When more than one person or organization is involved, all parties want to ensure they are getting their fair share of the profits, and that the accounting is transparent and accurate.
- The government is always involved, and they want to be sure taxes and filings are being made, and are accurate.
You probably guessed but a relevant area of law here is tax law.
7. Assets (including information assets and intellectual property)
Businesses need to consider their assets and value, which will include:
- The ability to provide value
- People (To be clear, people are not “owned” assets of an organization. But having the right people — treated properly — are essential for organizations)
- Physical assets (buildings, equipment, vehicles, inventory, goods, etc.)
- Information assets (computers, data, networks, etc.)
- Intellectual property (copyright, trademark, patent, trade secrets — see my articles on those topics).
This touches on a few areas of law but also ties into our first item of mission.
8. Starting your own business?
If you are considering starting your own business, or doing periodic evaluation of your business, perform some risk analysis. Consider what input is needed (money and time), what are the chances of success (and failure), and what happens if your new business does not succeed (fails).
It is good to dream and to try. It is amazing to think of what certain people have built and accomplished in their business ventures, including their vast (arguably obscene) wealth. Think of people like Steve Jobs, Elon Musk, Jeff Bezos, Mark Zuckerberg, Bill Gates, and more.
It is also important to be realistic about chances of success. Many startups fail. We may want to emulate that startup which is now a billion dollar company, and if they did it, why can’t we? Well, that company now dominates that market and plays hardball against competitors. They may crush your startup without much thought.
Have you heard the saying “Fake it till you make it”? I think that is a terrible philosophy and practice for life or business. Some people will call it fraud. It only worked for Elizabeth Holmes of Theranos for a limited period of time, Bernie Madoff pulled it off for longer, but in the end truth and justice caught up.
You cannot eliminate all risk in life or business, and starting and running a business always involves risk. The key is to try and properly evaluate it, and then try to make the best decision that is right for you.
9. When to hire an attorney
Unfortunately, hindsight is often the best judge of whether you needed to consult an attorney, find the right attorney, or listen to the attorney’s advice.
Ideally, every person and business can obtain good legal counsel for any business decision that affects law. But attorneys are expensive, not every attorney is always right, and even after consulting with a great attorney, business decisions still need to be made, and that is often according to one’s tolerance for risk.
As in all areas of business and life, it comes down to risk management, and some basic questions.
- What decision am I making that affects law and the future of my business?
- What are the risks?
- What are the potential threats (negative events)?
- What are the potential harms from those threats? How costly might they be?
- What legal actions or results might occur?
- What (if anything) should we do to manage those risks? Try to change the terms? Walk away from the deal? Find another way?
- What are the costs for managing that risk? Cost vs. benefit analysis.
It takes a good and ethical attorney to properly advise on legal risks and put them in the context of business risks. Such an attorney will advise you on the relative risks, and whether it is worth investing further. Hindsight is always 20–20, predicting the future is harder!
Often, it is a business decision after weighing the legal risks.
Of course, there are circumstances where pursuing a certain course of action violates the law, and those paths should never be taken.
Understanding business law basics is important for anyone running, creating, or thinking about creating a business. Law never operates in a vacuum, so I try to put everything within the perspective and priorities of what businesses need to think about.
This is a brief summary with many simplifications, bringing complex subject matter to all readers in an understandable and accessible manner. This article is for students and anyone in need of introductory information. It is not legal advice nor business consulting advice, and is not tailored to your circumstances. I don’t even profess to be an expert in all things mentioned above, the point is for you to know when to consult an expert, be able to find the right expert and then intelligently communicate with them.
11. Additional resources
This article was originally published on my website at https://johnbandler.com/business-basics-and-law/ where I also include links for additional reading, and it may be more current and with improved formatting.
Copyright John Bandler all rights reserved.
Posted to Medium on 9/17/2022 based on my earlier article on my website. Last updated here on 9/17/2022.