Three Questions For Every Start Up
You like churros….we get it. You also happen to own an oven and the internet. Wait a second… why not start a churro business? We’ve all been there, the moment of divine inspiration, a way to make money by doing something you love. But how? Who do I sell to? Do I buy a storefront? Where will I get my start up money? How do I protect my personal assets? Should I take out a loan against my house? Do I need a business license or some sort of corporation? First of all, don’t start a churro business. But if you do, you should start by considering the following three questions.
1. What kind of business entity do I want be?
Maybe you are thinking, what is a business entity? Do I have to pick one? The short answer is no, you don’t have to choose a business entity but you are going to be considered an entity by the law anyway, so why not choose for yourself and take advantage of the options? There are several kinds of business entities, each with specific advantages and caveats. While the process of becoming a business entity can be relatively simple, the choice is crucial. The key things to think about when choosing an entity are liability, taxation, and ownership. For example, a limited liability company (LLC) will typically protect you as an individual from contractual liability and certain tort liabilities incurred by your employees (but not torts committed by you personally even if in the course of business). So, if you take out a loan in the business’ name and the business is unable to repay the loan, you will be protected from personally responsibility to repay the debt (as long as you did not sign a personal guarantee). Or, if an employee accidentally makes a jalepeno churro too hot and you get sued for burning someone’s mouth, it’s likely that only the business will be liable.
Probably the most important aspect of entity choice is taxation. With both an LLC and a Partnership, pass through taxation requires both the owners and/or shareholders to pay taxes on their portion of the profits, just like you would on a pay check from a company you worked for. However, if you form what the IRS deems a C-Corp then you will not be taxed on the profits and the corporation will be treated as if it is it is a person. Finally, entities can control the issues of ownership and authority. Do you want to be in complete control of your business? Do you feel comfortable handing over some decision-making power to a board of directors? Do you want others to have a fiscal stake in the entity? If you choose an LLC you have flexibility to decide if you want to have sole control or if you would like to invite other members or shareholders to have a say in matters. If you form a C Corp, you need shareholders, directors and officers. In limited situations the shareholders can also serve as both directors and officers and retain more control of the company but the general structure is mandatory.
Liability, taxation, and control are all things that add to the risk and decision making burdens in any start-up. Understanding the differences between entity structures and choosing the one that best suits your business can minimize your risk and help you make efficient business decisions .
2. Where will your financing come from?
Common funding ideas for new businesses are personal finances, seed financing, crowd sourcing or investments from venture capitalists. Personally financing your business is the least complex option, but requires careful planning as new businesses regularly incur unexpected expenses. Seed investments typically involve family or friends financing the business in the form of a loan or in return for equity in the business. Often when a skilled investor (even if family or friends) engages a new business they seek a certain amount of control over the company in concert with a stake in the companies’ profits. Sometimes investors may suggest convertible debt financing which essential gives the investor the option to turn the money you owe into equity once the business becomes profitable. With seed financing, you want to protect the relationship you have with your investor as well as your business. The best way to achieve both of these goals is to clearly lay out the nature of the relationship in an investor agreement.
Additionally, some unique businesses seek funding from venture capitalist firms. The difference between venture capitalists (VC) and a single investor is that a VC firm’s entire business purpose is to fund new businesses in return for equity and control in the company. Venture Capitalists are looking for huge profit margins and typically don’t invest in brand new ideas. Dealing with venture capitalists can be a highly structured process, including attorneys working on both sides of the deal. Additionally, these investments often require the new business give up substantial control of the company.
Engaging investors and precisely defining their role is crucial. Unlike choosing an entity, creating agreements with investors requires a lot of time and can be very complicated. Start-ups are typically short on both time and money, making superfluous disputes with your investors especially taxing and generally jeopardizing the entire endeavor. If you want to avoid messy arguments with investors you need to clearly define the nature of the relationship between your business and the investor in the form of an investor contract.
3. Do I have intellectual property and if so, why should I protect it?
Why should you care about intellectual property as a start-up? Intellectual property is your ideas, your inventions, and sometimes the creative processes that make your business unique and attract others to engage your idea. If you thought it into existence and want to use it in the world, the Federal Government is able to give you a property right to that idea or invention. There is a good reason large tech companies have entire departments devoted to collecting patents: they don’t want to waste time being dragged into court for every new line of code they write. Intellectual property rights come in the form of patents, copyrights and trademarks. Below is a list giving the legal definition and examples of each.
Word, phrase, symbol or design that identifies the source of a service rather than goods: logos, names, symbols catchphrases, mascots.
Works of literature, architectural design, software, graphic arts, motion pictures and sound recordings: books, building designs, photographs, computer games, drawings, any form of music
Any person who invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent.
The invention also must have (1) some usefulness, no matter how trivial (2) be novel (3) be non-obvious to somebody who understands the technical field of the invention: apps, sporting goods, christmas lights, computer hardware, computer software, kitchen ware, make up, chemical compounds, prescription drugs.
Your interest in Intellectual Property as a business owner is all about protection and investment. You want to protect your ideas and inventions from competitors by obtaining a patent or copyright. Further, businesses often unknowingly use other entities patents in their business processes without permission, which can lead the way to patent infringement lawsuits. There are companies–coined non-practicing entities or NPEs–out there whose sole purpose is to buy patents and engage in litigation against businesses infringing on those patents. Being held hostage by NPE for patent infringement is a waste of time and money and can be prevented by having an attorney analyze your business practices and conduct a patent search. Additionally, obtaining patents can make your business more attractive to investors as having secured rights to intellectual property provides an entry barrier to competitors attempting to enter your market space.
Though intellectual property seems like a cumbersome idea and the last thing a busy start-up owner should be considering, including an IP strategy in your business plan is crucial to protecting your ideas and defending against frivolous law suits. The first step is analyzing your business for any IP rights that your business is utilizing. Once you understand the IP rights involved in your business you can search for any patents you may be infringing in addition to pursuing patents, copyrights or trademarks.
Got all that?
Hopefully these three introductory questions will help you think through how to form and guide your start up. Engelhart Law exists to protect your brand, protect your time, and protect your assets. Our goal is to cut through a complex and confusing legal world to provide you with the ability to focus on managing your business. If you have any questions feel free to contact us.