Building a startup brings a combination of exhilaration, ambition, and nerves. Amid the excitement of bringing your idea to life, there are a lot of legalities at play.
It'll be crucial to navigate legal requirements to protect your brand and keep it running smoothly. Choosing the right business structure is the first step in understanding the essentials, which are paramount to your success and sustainability.
In this Legal Essentials series, we’ll be exploring the key legal aspects that every entrepreneur should be well-versed in to build a strong foundation. Whether you're a seasoned entrepreneur or a first-time founder, read on to better safeguard your startup's future.
Since we work in colorful Colorado, we'll be providing local links to give fellow Coloradans a legal cheat-sheet. However, these tips and steps apply to startups in any state. Check out our startup studio for even more startup services.
1. Outline Your Business Identity & Goals
Before you can determine which contract and forms are necessary for you business, you need a clear map of what your business is. Consider the following questions, as they'll be vital for making decisions throughout. But these can change and evolve as your business does.
What is your official brand name?
What is your product or service?
Who is your customer?
Who are your suppliers?
Who are your employees? What are their positions?
Who are your business partners? Your investors?
Sure, these questions sound simple, but writing them short and sweet is the tricky part. Here are a few more to consider:
What are your business goals?
What is your mission statement, your "why?"
Who will you work with?
What is your end goal?
Who is your target market?
What are your financial projections?
2. Choose Your Business Structure
There are numerous legal structure options for startups. We’ll explore the most common so you can better consider which will match your business best.
This is the simplest form of business: It’s owned and operated by one person. The sole proprietor is responsible for all aspects, including debts and liabilities. Since they own 100% of their business, financing options are limited to their own assets, like personal savings accounts, CDs, and self-employed retirement plans. Business income and losses are reported on personal tax returns, so taxation is straightforward.
Pros: Simplicity and full control.
Cons: No separation of business and personal.
Examples: An accountant, baker, consultant, fitness coach, freelance writer, graphic designer, housekeeper, landscaper, and photographer.
In the state of Colorado, if you choose to register as a sole proprietorship, check out these steps from the Chamber of Commerce Team to get started.
This structure consists of two or more individuals who share ownership and management responsibilities. There are two main types: general partnerships, where partners share profits and liabilities equally, and limited partnerships, where there's at least one general partner with unlimited liability and one or more limited partners with liability restricted to their investment. Partnerships are not separate legal entities, and income or losses pass through to the individual partners, who report them on their personal tax returns. Partnerships rely on financial contributions from the partners, so they have a limited ability to raise capital.
Pros: Distribution of decision-making, shared workload, generally easier and cheaper to form, and pass-through taxation (avoids the double taxation that corporations face).
Cons: Unlimited personal liability, potential for conflict and disagreements, and limited capital.
Examples: Refer to the list for sole proprietorships, but now with multiple employees. Family businesses, firms and consultants, tattoo parlors, and musical groups are usually partnership businesses.
Colorado startups looking to register as a partnership, check out these instructions from LLC University.
Limited Liability Company (LLC)
This structure combines aspects of a corporation and partnership, providing limited liability to its owners (called members) while offering flexibility in management and tax treatment. Members' personal assets are typically protected from business debts and liabilities.
Pros: Limited liability, flexible management structure and profit distribution, pass-through taxation, and generally fewer formalities and paperwork compared to corporations.
Cons: State-based regulations (making multi-state operations challenging), potential self-employment tax, and more challenging circumstances to raise capital than with a corporation.
Examples: Small businesses, startups, law, accounting, and consulting firms, real estate ventures, family businesses, joint ventures, franchise, and creative ventures like film production companies, design studios, and marketing agencies.
Does an LLC sound right for your CO startup? The Colorado Secretary of State's website has a PDF checklist and link to the registration form.
C Corporation (C Corp)
With this structure, the business is a separate legal entity from its owners (called shareholders). C corporations provide limited liability to shareholders and allow the company to raise capital by issuing stock. C corp profits are taxed at the corporate level, and dividends are taxed when distributed to shareholders.
Businesses with high growth potential that are planning to raise significant capital often choose C corps. If this sounds right for your team, consulting with legal and financial advisors will be crucial due to the complexity involved.
What does the C stand for? It’s actually named for the Internal Revenue code subchapter ”C.” Same goes for S corporations (B corporations, however, stand for Benefit).
Pros: Limited liability, ease for raising capital, employee benefits, and perpetual existence (meaning the corporation continues to exist even if shareholders change).
Cons: Double taxation, subject to extensive state and federal regulations, more formalities, more paperwork, and more expenses.
Examples: Tech startups, biotech and pharmaceuticals, e-commerce and retail, franchises, manufacturing, hospitality and entertainment, and fast-growing consumer goods brands.
If a C Corp sounds right for your Colorado startup, visit the Colorado Department of Revenue for filing information.
S Corporation (S Corp)
This is very similar to a C corporation, but with pass-through taxation. An S corp offers limited liability to its shareholders while allowing income and losses to pass through to individual tax returns. This makes the business structure particularly beneficial for smaller businesses seeking corporate structure benefits.
However, there are eligibility restrictions on the types of shareholders and classes of stock as well as a maximum of 100 shareholders (who must be U.S. citizens or residents).
Pros: Limited liability, pass-through taxation.
Cons: Eligibility and ownership restrictions, limited growth potential, more formalities and paperwork.
Examples: Refer to the list for C corporations, but now they have a top priority of quick and rapid growth.
Interested in registering as a Colorado S corporation? Make sure to review the filing requirement changes from the Colorado Department of Revenue.
Benefit Corporation (B Corp)
A type of for-profit business that is committed to the triple bottom line, or three Ps: People, Planet, and Profit. In order to be designated a B corp (which is administered by the non-profit organization B Lab) the business needs to meet specific social and environmental performance standards.
Becoming a B Corp is a voluntary choice, but the certification can be attractive to socially conscious consumers and investors. Companies that choose this path are making a public commitment to consider the impact of their decisions on multiple stakeholders, including employees, communities, and the environment.
Pros: Positive social & environmental impact, legal protection, and attraction of purpose-driven consumers and employees.
Cons: A complex certification process, potential limit to competitiveness due to social and environment priorities, and potential "greenwashing" concerns.
Examples: Businesses selling outdoor apparel & gear, organic & sustainable foods, health and wellness, sustainable fashion, along with socially responsible financial services, renewable energy, tech companies, social enterprises, employee-owned companies, and education and training organizations.
Bcorporation.net is a great place for any interested startup to learn about the pathway to certification.
A type of organization that operates for purposes other than making a profit. Instead of distributing profits to owners or shareholders, any surplus funds generated by a nonprofit are typically reinvested in the organization to further its mission. Nonprofit organizations are often focused on charitable, educational, religious, scientific, or social goals.
Nonprofits may qualify for federal and state tax exemptions, allowing them to retain more resources for their mission-related activities. However, they are required to comply with specific regulations to maintain their tax-exempt status, which can be administratively burdensome.
The benefit is that nonprofits can prioritize their mission and social impact without the pressure to generate profits for shareholders: they can attract donations and grants from individuals, corporations, and foundations interested in supporting their cause. Reliance on donations and grants can lead to financial uncertainty, making it challenging to sustain operations during economic downturns.
Nonprofit organizations play a crucial role in addressing social and community needs, but the decision to adopt this structure should align with your startup's specific goals and the nature of your organization's activities.
Pros: Tax exemption, philanthropic support, and a mission-driven focus.
Cons: Limited revenue streams, regulatory compliance, and financial constraints.
Examples: Charities & foundations, educational institutions, healthcare organizations, social services, environmental conservation groups, arts & cultural organizations, community development, and religious organizations.
You can view the Articles of Incorporation for Colorado nonprofits on the Secretary of State's website to start registration.
3. Consider & Consult
Even if the right business structure for your startup seems clear, it's wise to get a second opinion. Whether you need to discuss the decision with partners, future employees, or even future clients, it's important to be transparent with your business decisions.
If you're considering a corporation style, it's advisable to consult with a legal professional. Talk with experts who specialize in business law to ensure that your startup is in full compliance with all relevant laws and regulations. The specific legal requirements for your startup may vary based on factors such as your industry, location, and business model.
We hope this deep-dive into business structures has helped you consider which style will work best for your startup. Want more advice from startup leaders? Visit our startup studio to work with a professional who will guide your startup from idea to MVP.
It's important for us to disclose the multiple authors of this blog post: The original outline was written by chat.openai, an exciting new AI language model. The content was then edited and revised by Lindey Hoak.
"OpenAI (2023). ChatGPT. Retrieved from https://openai.com/api-beta/gpt-3/"