Safeguard Your Interests
You don't want to let your idea out of the bag too soon, especially if you are leery that potential competitors will benefit. You don't want your employees to, either. To protect intellectual property assets-including trademarks, patents and trade secrets, have employees, contractors, consultants and business partners sign a Confidential Information and Invention Assignment Agreement. This agreement states that all intellectual property created or disclosed by the company remains the property of the company.
To protect your invention, apply for a Provisional Patent. This lets you use a "patent pending" notice to keep others from copying your invention while you focus on starting your startup. We offer a free Provisional Patent Application that you can fill out to submit to the US Patent and Trademark Office and start the process.
You can also include a non-compete clause in an Employment Agreement that prohibits an employee from competing against you or soliciting your employees or customers for a limited time after leaving the company.
Set up a Legal Entity
The next step is to decide which legal entity formation best fits your business.
Legal structures include:
- Sole Proprietorship.
- Limited Partnership.
- Limited Liability Company.
Each one requires business owners to use different tax forms, and each one comes with its own pros and cons. As you read more about each type, remember our incorporation specialists are available to guide you.
A sole proprietorship is a business owned by one person that is not registered as a limited liability company or corporation by the state. If you are a sole proprietor, you own all the assets but also all the liability and debt. You are both the business and owner under the law. Under this type of entity, you can report profits and losses on your personal income tax return.
A sole proprietorship requires little paperwork to set up but also offers no limited liability, which means creditors can go after you personally to settle debts.
If a business is owned by two or more people and is not registered as a corporation or limited liability company, it is a partnership by default. Partners are responsible for their own taxes on their shares of income, and all partners take on responsibility for liability and debt.
There are three main types of partnerships:
- General Partnership, in which partners share profits, management, losses, liability and responsibilities.
- Joint Venture, which is similar to a general partnership but lasts only for a specific period of time.
- Limited Partnership, which identifies "active" and "passive" partners (active partners are active in the management and day-to-day operation, while limited partners are mainly investors and not involved in the day-to-day operation).
Partnerships are generally easy to start and result in little, if any, business taxes. You don't need a formal agreement, though it is suggested to put everything in writing. Liability is not limited, which means creditors can go after you personally.
The exception is Limited Partnership, which must be formed under a state's limited partnership law. An agreement must be filed with the state. Limited partners have limited liability, up to how much they invested, when it comes to debts, while general partners are personally liable. This can help a company get investors, because likely they will be limited as far as liability, but may provide a concern for the general partners who end up shouldering most of the liability themselves.
A corporation means the business, not business owners, are liable for business debts. Corporations file taxes separately from owners, and owners only pay taxes on profits they personally receive. While owners may lose their investments, their personal assets are protected.
Each state has its own regulations as to how a corporation is set up. You will need to register your legal name with your state government and set up a business name.
We offer an articles of incorporation worksheet to help you gather the information needed to form a corporation.
Corporations let you raise revenue because you can sell stock once you incorporate. Stock certificates offer proof of purchase of stock to a stockholder.
Corporations are expensive to set up and fall under closer government scrutiny. They also pay more taxes. Seek help of a business attorney before proceeding and, if in need of legal advice, reach out to a Rocket Lawyer network attorney for help.
Limited Liability Company
A limited liability company, or LLC, shares characteristics of both a corporation and a partnership or sole proprietorship. It offers limited liability to its members, like a corporation, but unless the entity chooses to be taxed as a corporation, the income flows through to owners and they declare profits and losses on their personal income tax returns.
This type of business structure is formed under state law, which differs in each state when it comes to LLCs. According to the Internal Revenue Service, none of an LLC's members are personally liable for its debts.
Most members' earnings, however, often face self-employment taxes. That may end up costly for members.
The Internal Revenue Service refers to S corporations as corporations that pass corporate income, losses, deductions and credit to shareholders for federal tax purposes. What that means is that the shareholders report income and losses on their personal tax returns.
The company must first file as a corporation, and then file paperwork requesting to be classified as an S corporation.
The Small Business Administration states that an S corporation provides tax savings because shareholders who are not employees are not subject to employment tax on the net income of the business. Income is paid to them as 'distribution,' not as 'wages,' and is taxed at a lower rate. An S corporation can also continue dong business easily if a shareholder leaves.
An S corporation requires each shareholder to receive "reasonable compensation," or it risks being flagged by the Internal Revenue Service. The SBA cautions that if shareholders aren't paid fair market value, the IRS may reclassify their earnings as 'wages.'
Whether to Incorporate
Forming an LLC or a Corporation protects your business name, prohibiting other businesses within your state from using your name and includes benefits like limited liability for shareholders.
It gives you legitimacy that helps when raising funds and partnering with other companies. It also offers liability protection because your business is a separate entity, which protects your assets including your house, car and savings.
Remember that before you incorporate, you need to have a solid Business Plan in place.
To learn more, check out our section on why to incorporate.
Other Steps to Protect Yourself
When starting a startup, it pays to safeguard yourself. Open your own mail so you can track finances, and make sure you are the first person to see any complaints or new business opportunities. Make sure to use passwords and other computer steps, and avoid storing sensitive financial data online.
Share your financial data with your accountant and lawyer, but limit who else sees it. Play it safe, requiring anyone with whom you share confidential information to sign a Non-Disclosure Agreement.
Finding Legal Advice
Startups may not want to spend money on legal advice, but it can help you avoid legal pitfalls and protect your assets. We offer Non-Disclosure Agreements, as well as information on protecting trademarks, patents and service marks. Consult with one of our Rocket Lawyer network attorneys for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.