When You’re Working Full Time, With A Start-Up On The Side

Many of Kalia Law Group’s clients are budding entrepreneurs who, often prudently, have not quit their day jobs and are instead working on their brainchild during evenings and weekends. Working on your start-up on the side can be a really smart idea, for the obvious reason that you can still get a regular paycheck while you develop your idea and see if it is commercially viable and interesting to investors.

Staying at your current job gives you time to review your potential market, take time to find a great co-founder and make sure that your idea holds water. Start-up experts point out one of the biggest problems for a start-up is acting too soon, with too little information. For example, most start-ups know their product very well, but may ignore their potential competition.

At some point in their development, though, startups need to consider getting serious, which may mean quitting your day job and/or forming a legal entity. Many start-ups may not be aware of the legal risks of running a business. The more complex the development of your start-up, the more legal risks you are likely to face and the more likely it is that we could advise that you create an entity such as an LLC or corporation in order to protect your assets.

Another issue we frequently encounter is that our clients may be prevented from pursuing their startup idea by agreements that they have signed with their current or former employers. This is something to consider if you have a day job as well as your startup, and you should certainly have someone look at your current and former employment agreements to make sure you can actually do what you want to do.

Statistics show that fully 10% of all Americans eventually have their own small business. Because investment capital is generally the biggest issue in starting a business, many new businesses also start up through “family” investments. When asked to “invest,” many family members fail to understand exactly what they are getting, for what they give.

Family businesses often have special advantages that encourage investing: years of trust, great business connections, good reputations, and a family network to help bring in sales. When it comes to investing in a family member’s business, however there are even more reasons to talk with a lawyer. Without legal advice, the losses of a business investment may actually spill into personal bank accounts. Even profits the investor should get might not be recovered, if the family member is dishonest or incompetent.

The type, and also the business form, of a family business “investment” is crucial. Depending on the physical location of the investment or business, you will have choices between making a personal loan, a secured loan, or entering partnership agreements (the most common type of investment), LLCs, or other types of corporate ownership. By structuring the business investment properly, a lawyer can help take flash points out of potential disagreements. Some corporate investments can be seen as “closely held” companies, without the special protections corporations have. Who, for example, has the final say in using the investment? What happens when it comes time to calculate a change in the business (such as growing the business)? If an investment is set up badly, a lawsuit may wipe out not only the business assets (if any), but also possibly an investor’s personal assets.

You will want to be clear about your rights to recover the investment: do you own part of the business’s cash assets, or inventory, and you should be able to require an accounting of the business at any time? You will also want to talk with a lawyer about your priority with other creditors, in terms of making a claim for your investment, if (for examples) the business goes into bankruptcy, or the titled owner of the business should die or get divorced.

State and federal laws on taxation will also vary, depending on how the investment is used, and how business liabilities and debts are structured. Talking with a lawyer can help avoid enormous liabilities in your personal taxes if the business succeeds or fails.

Not all problems, from taxes to profits, can be planned for in a family business. Some families acquire new members through marriages, divorces, and births. These new faces can change the friendliness of an investment. These dynamics also make it important to have good legal advice available to get out of the investment. By the same token, there is also the possibility a family relationship might improve by a working relationship. The point is that the same advice, which applies well to non-family business investments, applies even more strongly when dealing with family members. Some family members may enter into a business arrangement, in the belief they “can work it all out later.” One way to avoid many of the complications of how to say “No” when investing is by meeting with a qualified lawyer, before investing in any tie that may bind.

On January 1, 2012, California introduced two new corporate forms: the “flexible purpose” corporation and the “benefit” corporation.  Both forms are designed to encompass businesses that operate for profit but also have social objectives.

California is the first state in the country to offer flexible purpose corporations, which allow California companies to pursue both profit and social or environmental causes.  Flexible purpose corporations specify a “special purpose,” such as environmental sustainability, in the Articles of Incorporation.  Directors are permitted to consider such purpose in making decisions, and they are shielded from liability in the event that pursuing the special purpose does not maximize company profits.

Benefit corporations must have general social welfare goals, and management must consider general social objectives in their decision-making.  Like flexible purpose corporations, benefit corporations shield directors from liability based on pursuing their social objectives. and d pursue social welfare objectives and have more transparency requirements that traditional stock corporations.

Neither of the new corporate forms offer a tax exemption, but they are attractive choices for companies that wish to seek profit while also considering broader social or environmental goals.

With the end of the year quickly approaching, it’s a good time to tie up loose ends.  If you have a corporation, partnership or LLC that you are no longer interested in maintaining, you may want to consider winding it up before the new year which may bring additional tax/or reporting requirements.

The specific steps to dissolving a company depend on many factors including type of entity, state of incorporation,  the company’s financial situation, and whether the company is still operating.  However, most companies will need to take the following steps: 1) make sure that it is up to date on taxes, both in the state of incorporation and in any states in which it is doing business; 2) vote to dissolve the company; 3) file appropriate forms with the state and federal government; 4) pay outstanding debts and 5)  distribute in order of priority of all the company’s assets.

When you are incorporating your company, one of the first things to decide is where you want to incorporate.  Lots of companies choose Delaware – but why?  There are a few reasons.  One: Delaware corporate law allows corporations a lot of freedom and flexibility.  Two: Delaware laws are investor-friendly, and many investors will require companies they invest in to be incorporated in Delaware.  Three: Delaware has a huge body of corporate case law and a special Court of Chancery, so its court decisions are more predictable than in other states.  Four: it’s easy to do business with Delaware.  The state’s administration is a well-oiled machine and its agents are straightforward and efficient.

However, that doesn’t mean that you should run out and form your entity in Delaware or change your state of incorporation to Delaware.  If you’re not doing business in Delaware, there are additional costs associated with registering in Delaware – one being that you need to pay for an agent for service of process.  You also may need to qualify to do business and comply with other requirements in the state in which you’re actually working.

So Delaware is not a slam-dunk.  Many of my clients find the most important factor in deciding whether to go to Delaware is whether they’ll be seeking investment.  If so, they often decide to start in Delaware so they don’t have to switch later when VCs tell them they need to be in Delaware.  If clients aren’t planning to seek institutional investment they often find it simpler to incorporate in their own state.  After all, there’s no place like home.