BODACIOUS Secret No. 2: Select The Right Business Entity
It may (or may not) come as a surprise, but over 50% of small businesses fail within the first four years of existence. The leading causes of failure include a general lack of knowledge in running a business, lack of subject matter expertise, and neglect or fraud. Statistics also show 30% of startups tend to break even, while another 30% continually lose money.
Some industries carry a higher success rate than others. For example, finance, insurance, and real estate are 50% more likely to survive the first four years in existence.
Another rather interesting statistic on the nature of startup success relates to the number of founders. Research has shown that the probability of a business’s survival increases when a business is established with multiple founders. Research has shown that enterprises having numerous founders tend to raise 30% more money, demonstrate three times the user growth, and are less likely to scale prematurely.
I’m not sharing these stats because I’m sadistic, I’m merely laying out the reality that starting a business is hard and carries lots of risks. Now here’s the good news, in fact, the really good news. There are things a young business can do to beat these odds.
The Right Business
First things first- know thyself. Just because you like going to coffee shops doesn’t mean you’ll be great at owning and running a coffee shop, especially if you have no experience running a restaurant of ANY KIND. A lack of knowledge and experience in the business you wish to start could mean the early death of your startup. Small business bankers like to see potential clients who seek to borrow money demonstrate some track record of knowledge and/or success in the industry. Once you can gain some working knowledge about how that business can be profitably run, your chance of succeeding at your startup vastly improves. Selecting a business which compliments your talents, network, gifts, and experience can make all the difference in your business beating the odds.
Based on your choice of business, selecting the right business entity can provide the appropriate level of legal protection for you and your assets. In figuring out the correct entity, you’ll want to consider the level of expense in state maintenance fees, the level of oversight required by state regulations, and the minimum organizational expense involved in running the business.
For many young technology companies, the right answer lies somewhere with operating as a sole proprietorship, a partnership, or an LLC.
In general, proprietorships are the among the easiest to establish. The administrative process to operate a business as a proprietorship is minimal. In general, there are no government forms to complete (unless you wish to establish a d/b/a (Doing Business As entity). Moreover, there are generally no government maintenance fees to pay. Sole proprietorships often do not require annual state reporting, and the tax treatment is rather simple. The downside to sole proprietorships is that the owner is personally responsible for the debt of the business, and personal assets may be at risk in the eventuality of business-related litigation.
Partnerships are very similar to sole proprietorships in ease of establishing, maintaining, and government reporting. In addition, owners may be personally liable for the debt of the business and personal assets may be at risk in the unfortunate eventuality of business-related litigation. One big difference between proprietorships and partnerships is the need for a partnership agreement. A partnership agreement is often necessary to work out the joint owners' responsibility in running the business, ownership interests, and buy-out provisions among other things.
Limited Liability Company (LLC)
For many technology companies that sell products or services, establishing an LLC is the preferred business approach, even if only one owner. An LLC (which stands for Limited Liability Company) provides limited personal liability to the company’s owners in certain circumstances. The downside to operating as an LLC is the expense in setting up and maintaining the LLC with the state. If your business has offices in more than one state, you’ll want to consider establishing a foreign LLC, which is generally a lot more expensive to maintain than the parent LLC. However, establishing foreign LLCs in states where companies have operating offices is strongly encouraged.
Even though an LLC requires registration, maintenance, and annual reporting, the benefit of shielding the owners from the personal liability of business debts or product liability is well worth it for most companies. Furthermore, investors typically like to see a business operating as an LLC for ease of investment and establishment of a company’s ownership of intellectual property assets.
Establishing a successful technology startup takes a lot of effort and planning. Start with what you know, and perhaps even what you love, and protect accordingly.
About this Series
Bodacious a legal information series related to intellectual property and technology law issues, such as patents, trademarks, copyrights, privacy, business formation, and litigation law issues. The information in this post focuses on the 9 Legal Secrets Every Entrepreneur Should Know To Have A More Bodacious Business.
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Contact Precipice IP, PLLC for more information about ways to manage your company’s intellectual property. www.PrecipiceIP.com
Angela Grayson is the Principal and Founder of Precipice IP, PLLC. She practices before the U.S. Patent and Trademark Office and is a registered patent attorney. Ms. Grayson is licensed to practice before the Mississippi Supreme Court and is admitted to the Court of Appeals for the Federal Circuit and the U.S. Supreme Court Bar. Contact Angela Grayson @ 479.259.2966 or 601.427.4773