Starting a business is exciting and nerve-wracking. Whether you are a sole proprietorship, small consultancy or a manufacturer with big plans to scale fast, setting up your new company properly is important to create and preserve your limited liability protection. With eight years of experience working with Washington and Idaho entrepreneurs ready to make their dreams a reality, I’ve seen the pitfalls that come when the fundamentals of the business aren’t set up correctly.
Imagine you’re a small business owner with two years of profitable operations under your belt. The first phase of your business flew by — and you did everything yourself. Now you are ready to hire a team, and you need to go back and make sure all the details are in order.
When you log on to the Washington or Idaho Secretary of State’s website to make sure your business registration is up to date and type in your company’s name, you see there are multiple. Other people have claimed the same assumed business name as your corporation and someone else now has the name of your company registered to them. It turns out, you were so busy that you didn’t keep up with your filings until now. You had no idea that your corporate entity would be automatically dissolved if your business fails to file annually with the Secretary of State. Now, you have a competitor operating with the same name as your corporation and you can’t get the name back. Unfortunately, because this was ultimately your mistake, you don’t have a strong claim to sue them.
To avoid situations like this, small business owners need a competent attorney on their side from the start. It’s much harder to rectify common mistakes after the fact than it is to set your business up for success from the beginning.
Another common error I’ve seen is a lack of an operating agreement in LLCs or lack of shareholder agreement for S-Corporations where there are multiple owners and the business is brand-new. A small business operating agreement should include the distributions and allocations of money so that each member understands the profits they are entitled to. For example, if you set up a multi-member LLC to complete landscaping and lawn services, and one member puts up the capital to purchase the equipment for the landscaping projects while the other four do the landscaping and lawn services work, the member who invested the up-front capital for the equipment would want to be paid back before any profits are distributed to the other members. To make this happen, all that needs to be spelled out in an operating agreement.
Without an operating agreement, lawsuits between members are more likely, and corporate veil and limited liability protection is weaker. In Idaho and Washington, the Secretary of State only requires one governor to be listed with the Secretary of State, which can be a member or a manager. This means you aren’t required to list all of your members or shareholders with the state. In fact, the person you list doesn’t even have to be an owner of the company. Without an operating agreement, someone who works for you could make a claim that they are a shareholder or a member. Then, it’s on you to prove that they are not in fact an owner of the company in court.
Many business owners are on the fence about whether they need an LLC or an S-Corporation. They may be unclear on the tax implications of each, or they don’t fully understand what it means to take on shareholders. In these cases, a competent attorney can save you years of stress and thousands, if not millions, of dollars.
Getting clear on the fundamental legal basics of setting up and operating your new business will reduce stress, make it easier to acquire real property or one day sell the business and it will help you stay out of court.
Cora Whitney is an attorney at Smith + Malek and practices business law in Idaho and Washington. She will lead a free Small Business Law Clinic on Wednesday, May 26, at 11 a.m. Register here.