entrepreneur exploring the legal requirements necessary to start a business

Starting a business involves brainstorming, planning, and ensuring that you comply with all necessary legal obligations. Not only do these requirements ensure that businesses operate within the law but it also protects small business owners and their consumers. 

Let’s take that innovative new business idea and walk through all the requirements you need to consider to successfully start a business that’s legally recognized.

What legally defines a small business?

A small business is an independently owned and operated entity that engages in commercial activity and fulfills the set industry-specific size standards. The size standards are different for each industry and are defined by the government body established to oversee such matters. 

Generally, the size is based on the number of employees and annual receipts for a given period. According to the U.S. Small Business Administration, an organization is considered to be a small business if their:

  • Firm revenue ranges from $1 million to $40 million
  • Number of employees is between 100 and 1,500

In addition, it should have a place of business and not be dominant in its field of operation.

1. Decide on the proper business structure

You’ll need to define your business structure to operate a legally recognized business. A business structure refers to how an organization is structured as recognized in a given jurisdiction. It’s the sole determinant of the nature of activities it can legally undertake. The main types of business structures include:

  • Sole proprietorship The simplest business structure, owned and run by one individual. The business isn’t a separate legal entity from the owner, and the expenses and incomes of the enterprise are part of the owner’s tax return.
  • Partnership Formed by two or more owners in agreement on how to start, manage and operate a business. It isn’t a separate legal entity from the owners, and they share funding, risks, profits, and losses.
  • Corporation (S, C, B) – An S corporation is an entity that has chosen to pass its income, credits, losses, and deductions to the shareholders’ tax returns. C corporation is an entity where the shareholders are taxed separately from the entity. B corporation is an entity with the commitment to creating general public benefit and, at the same time, making profits.
  • Limited liability company (LLC)A structure that combines the characteristics of both corporations and partnerships. It protects owners from their debts or liabilities, and each owner has to include a share of the profits/losses in their personal tax returns.
  • Nonprofit An organization whose mission primarily isn’t to make profits for the owners but to channel revenue it generates to fund a social mission or cause.

Before making the decision, understand the features of each business structure and how they align with your business goals and needs. You can check our complete guide to choosing your business structure to better understand each option.

2. Register your business name

The name of your business identifies your enterprise, which makes it easy for people to notice and understand your business. After you pick a good business name, it’s advisable to register that name to certify and protect it.

You can register the entity name to protect the business name at the state level. You’ll claim the name as yours and no other business can be established under that name. Another way of registering a business name is by trademarking the name. A trademark bars others in the industry from using the trademarked name at a national level. 

You can also register a business name by filing a fictitious name (“doing business as”) statement. It allows a business to operate under another name other than your formal business name or personal name.

If you plan to create a website for your business, you should also register a domain name using your preferred business name. Domain registration rules dictate that there can never be two or more sites with the same name. If it isn’t already taken, you can protect it from being taken by other people, especially your competitors.  

3. Apply for a federal tax identification number

A tax identification number identifies your small business to the tax authorities. A federal tax ID is the Employer Identification Number (EIN) and it’s one of the requirements of how to make your business legal. You’ll need the EIN to pay taxes for your business, apply for licenses and permits, open a bank account, and hire and pay employees.

An EIN is required if your business structure is a corporation or partnership, withholds taxes on wages, or uses a tax-deferred pension plan. You are required to change/replace your EIN if there has been a change in tax status, business name, address, management, and ownership.

4. Obtain the right business permits and licenses

Most business activities are regulated by local, federal, or state agencies. The only way to operate a business legally is to apply for the proper permits and licenses. They indicate that you’ve complied with the set regulations and requirements for running a business within the jurisdiction. 

There is unfortunately no standardized list of permits and licenses you need to acquire. What you need depends on your location, business activities, industry, and government rules. In some cases, you’re required to obtain both federal and state licenses and permits. Also, depending on the city or county, you might be obliged to apply for local business permits.

5. Determine what business taxes you need to pay

You need to know and understand the local, state, and federal taxes that apply to your business. It’ll help you file taxes accurately and make suitable payments on time. The consequences of not paying taxes include property seizure, late penalty fees, and criminal charges.  

Your business structure determines the taxes you must pay and when to do so. However, the five general types of business taxes are income, estimated, employment, excise, and self-employment. 

Check out the IRS tax requirements to determine what taxes your business structure deals with. Still, you can use accounting software or work with a tax professional.

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6. Secure your intellectual property

Intellectual property (IP) is anything created by the human intellect that’s protected by the law from unauthorized use by other people. It enables people to earn financial compensation or recognition for their inventions whenever another person uses their creations.

When starting a business, consider if your product/service has a unique invention that needs to be protected from being copied by others. If not protected, anyone can leverage your creations in their own products and services. 

The following are Intellectual Property rights that you might want to consider:

  • Copyright (author’s right) – Rights issued to creators over their artistic and literary works. It covers creations such as music, books, sculpture, paintings, and films.
  • Patent – Exclusive rights prohibit others from commercially exploiting an invention without the patent owner’s permission. Innovation can be a product, design, or a process of doing things to solve a technical problem.
  • Trademark – Property rights issued for a sign, logo, or word used to distinguish a product/service from other businesses’ products/services.
  • Industrial Design – Rights given for a product’s aesthetic or ornamental aspect. Some of the products qualified include household goods, lighting equipment, jewelry, and devices.
  • Geographical Indication – Sign used on products with a unique geographical origin, qualities, and reputation. It can be used for drinks, agricultural products, handicrafts, and foodstuffs.
  • Trade Secrets – Rights on confidential trade information that can be licensed or sold. Common information includes processes, formulas, designs, practices, instruments, and patterns.

If you’re unsure whether you should file for IP, consult with an IP attorney for professional guidance.

 7. Get business insurance

Business insurance is a form of risk management that protects a business from risks that may occur when in operation. Many risks can affect your business and result in damages and lawsuits. Obtain an insurance policy for your business to ensure you can afford the expenses if need be.

Every business faces unique risks. The type of insurance that fits your business depends on the respective industry. However, some are mandatory requirements set by most state laws. In general, the following are common insurances needs for small businesses:

  • General liability insurance: Protects your business from claims such as personal injury, damage to another person’s property, and bodily injury.
  • Professional liability insurance: Protects a business from lawsuits filed by a client claiming a work mistake in the services offered.
  • Workers’ compensation insurance: Insures employees in case something happens when working. It pays for medical care, funeral costs, death benefits, and income compensation during recovery.
  • Commercial property insurance: Covers machine or building used for business operations except for damage caused by earthquakes and floods.

 8. Develop a founders agreement

A founders’ agreement is a legal contract defining and governing the relationship between cofounders. Its importance is to outline founders’ rights, responsibilities, ownership, and roles.

The contract makes it easy to articulate and align expectations of your shared vision. A well-crafted agreement will provide a mechanism for dealing with future decision-making. It should also be open to adjustments as circumstances change.

The whole point is to avoid business disputes that may come up between the founders. It also addresses dealing with uncertain issues such as the resignation or death of a co-founder.

The right time for drafting a founders agreement is in the early stages of business. It can even be part of the company organization and management team section of your business plan

9. Correctly classify your workers

You need to clearly distinguish the people working for you for clarity in running your business. It’ll help you assign responsibilities to your workers for effective business operations. Still, it makes it easier to pay salaries and file tax returns accurately.

As a business owner, classifying your employees helps pay employees properly, keep work records, comply with requirements if you employ minors, give eligible employees unpaid medical or family leave, and inform workers about their rights in the workplace.

The Fair Labor Standards Act (FLSA) classifies workers as either exempt or nonexempt employees. Exempt employees are workers who are not entitled to overtime pay, while non-exempt employees must earn at least the minimum wage for the hours they work. To make sure you comply with the federal labor and employment laws, it’s advisable to classify your employees. Determining the type of employees you have impacts the type of rights they have and taxation requirements for your business. 

10. Establish a privacy policy

A privacy policy is a legal statement describing how an entity handles personal information it gathers about customers or employees. Personal information may include names, order history, phone number, address, and browsing habits. However, gathering information is voluntary and the visitor has a right not to participate.

Usually, a privacy policy has to do with apps and websites and there should be a disclosure of how the information is gathered, stored, shared, or sold to third parties. The personal information collected is used to give users a more personalized experience. It can also be used for follow-ups and marketing.

A privacy policy is a sign of transparency since you’re informing visitors upfront about your intention rather than gathering information behind their backs. It’s a legal requirement to have and display a privacy policy; otherwise, failure to do so might lead to legal action against your business. Penalties for noncompliance depend on where you live.

11. Write a company handbook

A company handbook is a collection of information regarding a company’s values, policies, mission, and code of conduct. In short, it’s a manual covering what’s expected from the employee as well as what the employer is all about. It’s a resource for employees to familiarize themselves with all they need to understand about successfully working in the organization.

Every employee should have a copy of the handbook so that they understand the policies and practices. The handbook isn’t an employment agreement and doesn’t supersede the employment and labor laws. It’s used to protect the organization from unfair employee claims and lawsuits. If an employee doesn’t comply with the handbook, the company can take action for going against the company rules.

12. Maintain clean books

Maintaining accurate accounting information comes with various advantages for your business. You can check financial statements whenever you want and review the overall health of your business. It makes it easy to plan for the future or make a budget.

Clean accounting books help you plan and pay taxes accurately. A business can be investigated or audited if there’s a suspicion of violating the law. Many companies have been shut down and owners fined or jailed due to inaccurate tax returns and payments. Even if there’s no offense committed, well-kept accounting books will save your business from expensive and tedious audits.

An excellent way to maintain clean books is to hire an accountant if you’re overwhelmed with work and need assistance. Bookkeeping is right up their alley and you’ll save a lot of time. Also, you can invest in business accounting software

These programs are built for users with no time or bookkeeping expertise. You can sync financial data, streamline payroll, generate reports, simplify tax filing, etc.

13. Open a business bank account

A business bank account is a bank account used by a business owner to separate personal finances from business finances. It makes it easier to manage cash flow, track expenses, and keep your business’ finances safe.

Determining which bank to open a business bank account with is a matter of personal preference. However, no matter how much you like a particular bank, it’s essential to consider what works for your business. Compare all the banks accessible to you. Look out for their charges, interest rates, offers and benefits for small businesses, and anything that works to your advantage.

Another thing to consider is the methods of accepting payment for your business. If it’s a cash-only business, you’ll be depositing your business’s money. But, for electronic payments, you’ll have to consider transaction charges. 

Also, when using online and mobile payments, consider transferring funds into the bank account options. Check payments come with certain charges for paper transactions.

The requirements for opening an account vary from one bank to another and depend on the type of business. But, the most common documents you must submit include EIN/Social Security number, business license, business formation documents, and ownership agreements.

Seek out a professional to legally establish your business

Unsure of how to handle some of these startup steps? It may be worth connecting with professional legal counsel to ensure you have your bases covered. That way you can spend more of your time on planning out, managing, and ultimately growing your business.

Looking for a guide to help you get your business up and running? Check out this step-by-step resource for starting a business. It walks you through everything from coming up with your idea to getting your first customers.

AvatarKaroki Githure

Karoki is a freelance content writer and blogger with experience writing about entrepreneurship, business, freelancing, and self-development. Apart from writing, he loves a little bit of adventure and creating beats/instrumentals on his digital audio workstation (DAW).