Kentucky attorney Scott Townsend recently blogged about why it’s important for entrepreneurs to establish the proper form of business entity when they start up a new business or venture. Chief among his reasons were to create an identity, and start building credibility for the start-up, and to protect the founders from from personal liability related to the business. Although I don’t disagree with Scott’s reasoning, I don’t believe that neglecting or failing to establish a business entity remains as a significant problem in today’s business law climate. That’s in large part because of the Internet. Forgetting about Legal Zoom, and the various other sites that market DIY legal forms to non-lawyers, each of the fifty states has its own website with all of the information and downloadable forms you need to establish one of the various business entities.
Over the past two decades or so, the entity of choice for most start-ups and entrepreneurs seems to be the Limited Liability Company (LLC). This is because of the flexibility of the LLC (e.g., number of members/owners, can be taxed as a sole proprietorship, partnership, or corporation), and how easy it is to set up (most states don’t even require an operating agreement). Unfortunately, a lot of people rush into setting up an LLC for their new side business or venture without doing their homework, and without adequate legal knowledge or advice, which can leave them vulnerable to a variety of unanticipated dangers. What those dangers might be depend on variables such as what state you’re in,
capitalization (i.e. how you fund the company), the business’s purpose, whether you’re selling a product or service, how many employees, whether you use subcontractors or third-party components or materials, and so on. It’s true that many of these issues can be anticipated by an interactive web form, but there are so many nuances that are missed that way.
People ignore these risks because they think it will cost too much to consult with an attorney. Sometimes they get along just fine on their own. But sometimes disaster strikes. In this context, disaster usually means unfavorable tax consequences, a partnership dispute, or worse—litigation. If you get served with a lawsuit—even if it’s frivolous—just to respond to the lawsuit, you’ll have to find a lawyer, and then pay them double or triple the amount of a business startup consultation. Consulting with an attorney when you’re getting your business started won’t insulate you from a lawsuit, but it will help you avoid litigation, and will put you in a better position to deal with a lawsuit if one pops up unexpectedly.
Relying on a prefab DIY legal form isn’t necessarily all bad, but forms are just one (small) part of establishing a business.