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Legal Information for Startups

I’m not a lawyer nor am I offering any legal advice to anyone. What I have done instead is compiled some information put together by members of the legal profession that are relevant to startups seeking capital.

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If you want to be taken seriously by customers, suppliers, and everyone else, you are strongly advised to incorporate rather than operate as a sole proprietorship. Unincorporated businesses tend to trigger “here today; gone tomorrow” suspicions in most business people. Even if they have no concerns about your integrity, there will be questions about your level of business sophistication if you are unincorporated.

The message here is: set up a corporation or LLC for everything but a short-term business whose existence will be numbered in months rather than in years.

Business Legal Structures

When someone starts a business, one of the important decisions that he must make is to determine what type of business organization it will be. The three main choices have been, until recently, sole proprietorship, partnership, and corporation. Some prefer offshore corporations, please consult a professional for more information on these types of structures. This decision is crucial in terms of the tax consequences, the authority given to individuals associated with the company, and potential liability (that is, the financial responsibility) for each person connected with the business.

In 1977 Wyoming was the first state to enact a law authorizing a new type of business organization, the limited-liability company (LLC). By 1997, all 50 states had passed legislation authorizing the establishment of limited-liability companies, although each state’s laws differ slightly from one another.

The most common business legal structures are:

* sole proprietorship

* general partnership

* limited partnership

* limited liability partnership

* corporation (including S corporations)

* professional associations

* limited liability companies

* business trusts

* professional corporations

There are six common issues that distinguish the different business forms:

* taxation

* liability

* risk and control

* continuity of existence

* transferability

* expense and formality

Taxation and risk and control are the more significant issues. In addition to these common issues, there also are issues specific to each form.

A one-person company generally has only three choices of business form: sole proprietorship, corporation, or a limited liability company. Multiple people typically have the additional options of general partnership, limited partnership, or a limited liability company.

Liability is a risk that one exposes oneself to when starting a business. Two types of risk are tort risk and contract risk. A tort is an intentional or unintentional harm to the person or property of another. Some examples of tort risk are worker injury, product liability, automobile liability, and general liability, such as when somebody falls on a wet floor. Examples of contract risk are financing risk and risk with vendors and customers.

Tort risk can be protected against by using insurance. Ninety-nine percent of businesses can get an insurance policy against all tort risks. Excess insurance beyond standard liability limits often is not needed. For example, in medicine most people will settle claims at policy limits, because otherwise too many activists would protest if physician’s personal assets could be easily taken.

Liabilities associated with contract risk can be limited in the contract itself. For example, software user agreements may have a general liability limitation equal to the price paid for the software.

Traditionally, there was a tradeoff between liability and taxation. However, S corporations and LLC’s have changed that tradeoff so that a company can have limited liability and pass-through taxation.

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