The Best Way to Legally Organize Your Small Business

Shelley Tucker interviews Philip Krause of the Kansas City law firm of Polsinelli Shugart. Mr. Krause is also the chair of The Missouri Bar Business Law Committee.

Recorded 5-22-2009

Question 1: When a person decides to start a new business, do they need a lawyer, and if so, what kind of lawyer do they need?

Point 2: When you are starting up a new business, you are going to be calling back to that lawyer many, many times for questions, from very minor to questions that are very complex, and so you’re going to have to have a very good relationship with that lawyer.

Point 3: Bring your lawyer into your plan, so they’ll know more about your products, your services and what your goals are.

Question 4: Once you have a lawyer, what kinds of issues will you be sitting down and talking to your lawyer about regarding organizing your small business?

Point 5: Lawyers also determine how successful your business can be and will be.

Question 6: What are the key issues to consider in selecting the type of legal entity to use for a business?

Point 7: You want that relationship. You want to pick that lawyer who’s going to protect your investment, your good name, and your pocketbook and your future earnings on this business. So I can understand why the selection of that lawyer is so vital.

Question 8: What is the biggest mistake you see people make when they’re starting a business? Maybe they’re overzealous or maybe they’ve got "pie in the sky" dreams that they’re going to make a fortune and that’s not too realistic. What are the biggest mistakes?

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Text Transcript of Audio Interview

Welcome to the Law in Your Life, a Missouri Bar podcast for the public.  I'm Shelly Tucker.  Our guest is Phillip Krause with the Kansas City law firm of Polsinelli  Shughart.  Mr. Krause is also the chair of the Missouri Bar Business Law Committee.  We're discussing the best way to legally organize your small business. 

Mr. Krause, when a person decides to start up a new business, that's a good thing, but do they need a lawyer and if so, what kind of lawyer would they need?

 I believe when you're ready to start a business you definitely need a lawyer, but more than a lawyer, you need a good team of professionals, including an accountant, as early as possible in the process and they will help you avoid some commonly made mistakes from the outset.  You should find a lawyer who specializes in the area of corporate business law and if possible, you'd like to find one who has a lot of experience in doing just this, helping people start businesses.  I recommend that you should interview several lawyers.  That will help you make a better decision.  When you find a lawyer you like, make sure you're clear in understanding what the lawyer will charge you and how he will charge you and when you would be required to pay.  Another thing that I think you should do ─ absolutely even before this ─ is prepare your business plan.  That will be your roadmap.  Now a great resource is provided by the Missouri Secretary of State in their Business Services Division and online they have what they call the Small Business Advocacy Center with really good information, very understandable, and the web site is www.sos.mo.gov/business.

When you are starting up a new business you are going to be calling back to that lawyer many, many times for questions, from very minor to questions that are very complex, and so you'll need to have a very good relationship with that lawyer.

Exactly.  I think you should think of your lawyer as part of your management team, and the more your lawyer knows about your business, the better the lawyer can help you.

Bring your lawyer into your plan so they'll know more about your product, your services and what your goals are.

Exactly.  You want a relationship with your lawyer that is of the kind that says if I need to make an important decision I want my lawyer involved.  You do not want a relationship that says I'm hesitant to call my lawyer because it's just too darn expensive and it may or may not be a good investment for my business.  The client relationships that I have that work the best are when I'm really a part of the team.

So once you have chosen your lawyer, what kind of issues will you be sitting down and talking to your lawyer about regarding organizing your small business?

I like to ask right up front: What is the financial purpose for your business?  We all know business is ─ at its heart ─ to make money.  I divide them into two kinds of businesses.  One kind is a lifestyle business: I like to say it’s a long-term business for income production. In other words, the owner's desire is to make a long-term regular income from the business.  A good example of that would be a retail store.  Another kind, though, is quite different and you might say it’s a shorter term, but the idea is that you’re going to grow substantially a business and then have an exit strategy ─ typically a sale or some kind of a large transaction.  In this type of  business, the goal is not to have an income but to cash out and make a substantial return on the investment within a foreseeable period.  That often happens if you have created some kind of a new or novel product or service.  After I understand what their goal is for the business, then the next issue is: How are you going to structure it? That question is heavily dependent on the first one we just talked about.  Are you going to be a sole proprietor or do you need to create some kind of a legal entity such as a corporation, limited liability company, a partnership?  There are a myriad of kinds of entities.  And then another very important point to consider is that many businesses have some kind of a proprietary new idea or invention or a new kind of know-how and for these businesses it's key to discuss how the business is going to protect for the long term the intellectual property that will drive the business.  There could be multiple strategies such as patent, copyright or trade secrets.  Those are all key building blocks to putting together the business.  You also need to know if  there is going to be more than one owner ─ is it going to be one person, is it going to be a husband or wife, are there going to be outside investors who bring capital to the table?  All of those factors then will help determine how the business is structured.

 They'll also determine how successful it can and will be?

 Lawyers like to think that we are the key factor to make businesses successful.  We’re not, but we can help you if we do a good job helping you put it together.  We can give you the framework through which you can make your business successful.  I can tell you if that part is not done well it can certainly add to a failure of a business.

What are the key issues to consider in selecting the type of legal entity to use for a business?

There are really two categories of issues when you pick whether the business is going to be a corporation or some other type of entity or a sole proprietorship.  The two issues are: liability protection for the business owners; and secondly, how will the business and its owners be taxed.  So liability and taxation.  On the liability side, you have to make a determination whether the business  has a lot of risk factors for the ownership.  If, for example, you are simply writing articles to submit for publication, that’s not a high-risk business. But if  you’re selling a new drug, that could be a very high-risk business.  If it’s a low-risk kind of business and the liability of the owners is not too important, you might pick a partnership, or if there’s just one owner, a sole proprietor.  If there are significant risks, then other legal structures come into play, such as a corporation and limited liability companies that provide very strong liability protection for the owners.  In other words, the business is at risk for the liability of the business, but the owners are not.  In the tax category of these issues, if you don’t do anything special and you do business as a corporation, then the profits of the corporation are likely to be taxed two times. It is taxed the first time when the corporation pays taxes on its profits.  The shareholders, the owners, are also taxed when they receive dividends, so that means the profit of the enterprise gets double taxed.  That’s not necessarily inherently good or bad, it just can be expensive if it’s not appropriate and there are ways to avoid the double tax results.  Some possibilities are partnerships, or a limited liability company, or making an S corporation election for a corporation. This allows the corporation itself or the entity itself not to be a tax paying organization and instead all profits of the business are taxed directly to the owners, incidentally, whether or not those profits get paid to the owners.  So two distinct tax structures: a double level tax structure or a tax flow-through structure.  Another key issue in selecting the kind of legal entity is whether the business is going to have to raise outside money from outside investors.  Some structures are not as useful to raise outside money, others work better.  For example, a partnership tends to be less useful; a limited liability company, and particularly a corporation, are more effective to use to raise outside capital.

 You want that relationship; you want to pick the lawyer who is going to protect your investment, your good name, your pocketbook and your future earnings on this business, so I can understand why the selection of that lawyer is so vital.

 The lawyers in this area do think we have a significant value to add as you create that starting structure to run your business.

 What’s the biggest mistake you see people make when they’re starting out the business?  Maybe they’re overzealous,  or maybe they think they’ve got pie in the sky dreams, that they’re going to make a fortune and it’s not maybe too realistic.   What are some of the mistakes?

 That’s a great question.  It’s something I see often and it’s something I’m not often asked about, but when I am asked, this is what I tell people who start a business.  Presumably you’re starting a business because you’re good at something and the something you’re good at, you believe is going to earn you money. When you’re starting a business, that is a hard thing to do.  Make sure as you do it that you are focusing on the things that you do well, that you think are going to make money, and then identify the things you don’t do as well and find somebody else to do them.  The classic characteristic of entrepreneurs is that they find other things very interesting and fascinating, and often they divert their energy and their attention into areas where they are not as talented.  My recommendation is to find those things you’re not good at and find somebody else to do those.  The legal issues that a new business needs to solve often are not within the range of the talents of the business owner.  Find a good lawyer and ask the lawyer to do those things for you, and then you do the things that really will make your money.  Find a good lawyer early, then use that lawyer wisely and avoid doing those things yourself.

Comments

[Forex Brokers]

I do think that while starting a business a good lawyer and an accountant will help you get where you want to. Great bullet-points! I will sure use these in the future- thank you.

[irs tax lawyer]

If you have tax problem you should consult with IRS tax lawyer.

[Carlene Schnitzer]

It's the responsibility of all salary-earning individuals to pay taxes to the government. Taxes are very important for the existence of a nation. The best tip is to get a good lawyer and accountant. When in doubt, ask the IRS and I'm sure they're more than willing to help.

[Shane Adams]

I'll be taking note of those eight points. These are going to be useful when we have to do some risk management. Point number 5 sounds like the catalyst for starting your business. Well, that is if the lawyer agrees and thinks that your business is going to be successful.

[wrapping machine]

Great article. i realy like the part saying that we sholud cooperate with our lawyers. thanks.

[Premium Juli]

Thanks for the article, it was interesting to read!

[Chris]

Thanks for the interesting information! Waiting for more interesting articles!