Business Formation Checklist for Startup Companies
2020 was a challenging year. The public health crisis from COVID-19, and the resulting economic recession, upended the lives of many. However, the American spirit of innovation and perseverance in the face of adversity appears to show no sign of going away. According to the latest business formation statistics from the U.S. Census Office, business applications and formations are growing at a significant pace. Business applications and formations are up across every sector of the country.
In light of this trend, we have developed a business formation checklist for startup companies and entrepreneurs who are looking to start off on the right foot. This checklist is a basic guide to the key legal steps of forming a company.
1) Business Name
The first step to starting a business is picking the name. Depending on the type of business entity you wish to form (corporation, LLC, partnership, etc.), make sure you include the required components of the business name and avoid any restricted words. For example, when forming a corporation, nearly every state in the US requires that the name of the corporation include the word “corporation,” “limited,” “incorporated,” “company,” or the abbreviation of one of these words. In addition, state law typically prohibits the registration of two business entities with identical names so make sure your business picks a name that has not already been registered in the state where you are starting up.
Business names should be distinct. Giving your business a distinct name is a good idea because it provides stronger trademark protection and reduces the chance that you will be infringing on someone else’s trademark. To learn more about maximizing your brand value via trademark law, read our blog on brand protection. Regardless of the name you settle on, you should hire an attorney to help you with this for two reasons. First, an attorney will help you make sure the name is available within the state you are doing business. Second, an attorney experienced with trademark law will help you make sure the business name you select does not infringe anyone else’s trademark rights.
2) Certificate of Formation
The second step in our business formation checklist for startup companies is to draft a certificate of formation. Also referred to as a certificate of incorporation, this document is what you eventually file with the secretary of state’s office to legally form your business. For example, if I were starting a corporation in Tennessee to manufacture medical devices, after completing step 1 (picking a name), I would file my certificate of incorporation with the Tennessee Secretary of State’s office to officially form the company.
A certificate of formation must include several components. Typically, you are required to identify the name of the company, the address of the company’s principal office, and the address of the company’s registered agent. Depending on whether you are forming a corporation or an LLC, you may also need to identify the number of owners/directors of the company, as well as information on the equity interests that will be issued by the company (such as shares of stock).
3) Equity Issuance
Step three in our business formation checklist for startup companies concerns equity distribution to the founders. This step is crucial for all entrepreneurs looking to start a company. Every company needs to issue (aka distribute) equity to the owners. Generally speaking, equity represents the owners’ stake in the company and is identified on the company’s balance sheet or cap table.
An entrepreneur starting a corporation must set the amount of shares that the company is authorized to issue as well as the par value, rights, and preferences associated with these shares of stock. An entrepreneur starting an LLC must take similar action. Because an LLC does not issue shares of stock, but instead issues what’s called “membership interests,” an entrepreneur starting an LLC must decide how to distribute the membership interests in their LLC among the owners. A few things to consider would be whether to create a class of preferred membership interests, whether profit and loss will be specially allocated among the owners, whether the voting rights of the respective members will be different, and much more.
There are a lot of factors to consider when deciding how to distribute equity in a company. For this reason, it is extremely important to retain an attorney to help you through the process. An attorney will be able to talk you through the various options for distributing equity and can tailor a solution specific to your desires and needs. There is no one size-fits all approach when it comes to equity distribution, so talk to an attorney and make sure you are comfortable with your setup. To learn more about equity distribution among the founders of a company, read our blog series titled Avoiding Key Legal Mistakes in Startup Companies.
4) Organizational Meeting
Once you have selected a business name, filed the certificate of formation, and issued equity to the owners, your company is ready for its first organizational meeting. Congratulations on making it to this step!
Your company’s first organizational meeting may involve the company’s board of directors (if a corporation) or the company’s members (if an LLC). Regardless of who it involves, your first organizational meeting should address the following:
Ratify the company’s formation;
Adopt bylaws;
Elect officers to manage the company and approve employment contracts for initial personnel;
Establish a bank account and any restrictions on banking (such as who may make withdrawals);
Adopt a fiscal year;
Approve expenses associated with starting up the company;
Approve any company contracts for signature; and
Authorize other necessary action.
The list above is just a snapshot for what your company’s first organizational meeting might involve, but it is by no means comprehensive. Consult with your company’s legal counsel to figure exactly what tasks needs to be completed in the first organizational meeting. Don’t forget, while the organizational meeting might involve some mundane details, this should be an exciting day in the life every entrepreneur because it represents significant action on the part of the company. Celebrate the small victories along the way!
5) Tax Matters
Step five in our business formation checklist for startup companies concerns taxation. It brings to mind the famous quote by Benjamin Franklin: “In this world nothing can be said to be certain, except death and taxes.” Because taxes are a given, every entrepreneur and startup company needs to pay attention to tax matters to try and mitigate the possibility of any surprise tax bills.
After forming your company, it is necessary to obtain a federal Employer Identification Number (EIN) from the IRS. This number will be required for tax purposes when it comes time to file a return every year, but it is also necessary for purposes of setting up a bank account and handling the company’s internal accounting. A company obtains an EIN number by completing IRS Form SS-4.
In addition to obtaining an EIN, it is important to make any special elections concerning your business’s tax treatment within two months and 15 days from the date of formation. Every business is going to be taxed according to a default method established by the IRS. However, the owners of a business may decide that it is more advantageous to be taxed in a different manner than the applicable default method. For this reason, entrepreneurs should consult with tax counsel for advice concerning the eligibility for alternative tax treatment and the advantages and disadvantages of each respective treatment. A tax attorney will likely be able to assist your company with developing and implementing a comprehensive tax strategy that minimizes your company’s tax liability.
6) Business Registration and Licensing
The sixth and final step in our business formation checklist for startup companies deals with business registration and licensing. Now that your business is officially up and running, it is important to survey the law applicable to your organization and determine what registrations and/or licenses your company is required to obtain. For example, depending on the number of employees you have, you may be required to register with your state’s labor department or workforce commission. In the State of Tennessee, every employer with five or more employees must secure workers’ compensation insurance coverage for their employees either by purchasing a policy from an insurance carrier or by qualifying as a self-insured employer with the Department of Commerce and Insurance. Depending on the employer’s industry, the requirements may be different.
Beyond specific labor regulations, most companies must obtain general business licenses from every county or municipality in which they are doing business. There are likely even more licensing requirements depending on what industry a company operates in, so be sure to retain an attorney who can help you navigate any applicable regulations.
Putting It All Together
This checklist should serve as a reference for every entrepreneur or startup company looking to make sure they proactively address the legal hurdles associated with forming a business. Taking these six steps will help a company position itself for success, but, like any sound business, it is always best to retain legal counsel who can personally guide you through the process and then assess the company’s position as it moves along.
If you have questions about forming your business or what to do in response to the legal issues your business is facing, please contact us. Our attorneys are ready to assist you with your legal needs.
Photo by Austin Distel on Unsplash
*The material and information in this blog is for general informational purposes only. In no way is this information to be construed as legal advice for a particular situation.*