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In the early stages of a business, it's easy to get passionate about your product or service. The legal requirements to operate legally are not as exciting. Requirements vary widely depending on your industry, type of business, and location. While there's no substitute for the advice of experienced legal counsel, this guide outlines some of the most important legal requirements for starting a small business in 2024. Before you get too far with your business plans, make sure you understand what you need.
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Business structure and designation requirements
Once you have a clear mission and strategy for your business, the next important step is to decide on the legal structure for your business. The choice you make will affect everything from how you operate your business to the liabilities you face to how you pay taxes. Below are the most common options for small business owners:
Sole proprietorship
The simplest structure for a sole proprietorship is a sole proprietorship. With a sole proprietorship, business owners have a high degree of control and flexibility with relatively few regulatory burdens. No paperwork is required to set up a sole proprietorship; it's automatically set up as soon as you start your business. However, if you use a business name other than your own, you'll likely need to register your business name as a DBA with your state or local government.
A sole proprietorship does not form a distinct business entity, meaning there is no legal distinction between the assets, liabilities, and other liabilities of the business and the assets, liabilities, and other liabilities of the owner. This creates a risky situation for the owner, who must assume responsibility for the legal or financial failure of the business. As a sole proprietor, you cannot hire a partner and your ability to obtain a loan for the business depends on your personal creditworthiness. Sole proprietors report business income and expenses on their personal tax returns and pay income and self-employment taxes on profits. Some business owners test their business ideas as sole proprietors before committing to a more formal structure and paying the higher fees associated with that structure.
partnership
There are several types of partnerships. If you start a business with others and do not form a formal business entity, your business is automatically considered a general partnership. Like a sole proprietorship, partners in a general partnership are fully liable for all business debts and obligations. They are also liable for the actions of their partners. This is the main reason why most lawyers encourage businesses to form an LLC or corporation rather than remain a general partnership. A general partnership is taxed similarly to a sole proprietorship, and partners report their share of income, expenses, credits, profits, and losses on their personal tax returns.
Other types of partnerships include:
A limited liability partnership (LP) provides for at least one “general partner” to bear personal liability for the operation of the business, while the other partners are passive investors with limited liability. Limited liability partnerships are common in certain industries, such as real estate development. Limited liability partnerships (LLPs) also provide limited liability for partners, but the details vary by state. In some states, liability protection is the same as an LLC, while in others, protection extends only to liability for the other partners' negligence. Some states require that one of the general partners bear full liability. Also, in some states, only professionals with certain licenses, such as doctors, lawyers, and architects, can join an LLP.
Related: Limited Liability Partnerships and Limited Liability Companies
Limited liability company
A limited liability company (LLC) balances the relative ease and flexibility of a partnership structure with the increased risk protection and potential tax advantages of a corporate structure. LLC owners (called “members”) are not personally liable for business obligations. By default, LLC members are considered self-employed and file and pay taxes in the same way as general partnership or sole proprietorship owners; however, LLCs can also choose to be taxed as a corporation. To form an LLC, you must file articles of organization with your state.
LLCs also require an operating agreement that details how the LLC will be run and the rights and responsibilities of its members. Many small business owners choose LLCs for their simplicity and flexibility.
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With a corporation, owners' liability for business obligations is limited to the amount they invested in the company. Business creditors cannot go after owners' personal assets. Corporations have a clearly defined organizational structure that includes a board of directors, officers, and owners, who are called shareholders. Corporations may pay corporate income tax as a C corporation or be subject to pass-through taxation as an S corporation. Corporations tend to be subject to more stringent record-keeping and reporting requirements than LLCs.
A corporation is formed by filing articles of incorporation with the state. Corporations also require articles of incorporation. Corporations are a good choice for businesses looking to attract outside investment because they have a predictable structure and their shares are easier to transfer.
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Trade name registration requirements
Business owners should consider the various ways to register and protect their business name.
Entity Name
When you form an LLC, corporation, or any other type of business entity, your business name is registered with the state. The state will not allow another business to form with the same name as you.
trademark
A federal trademark helps protect your business name nationwide. You can apply for a trademark through the United States Patent and Trademark Office. Although a trademark is not required to operate a business, it may be a good idea to register your name to protect the exclusivity that comes with a registered trademark.
DBA
A “business name” (DBA) is also known as a “trade name” or “assumed name.” Typically, a business must register a DBA if it is using a name other than its official legal name. Sole proprietors and partnerships do not need a DBA if they are doing business under the owner's name. LLCs and corporations do not need a DBA if they are using the business's legal name. Multiple businesses in the same state can share the same DBA name. Depending on your state and the type of business you run, you may be required to register a DBA with your state or locality.
domain
A domain, or web address, is unique to you and can be essential to your business's online presence. While there is no legal requirement to acquire a domain, acquiring a domain name that matches your business name can help brand your business and minimize confusion with other businesses online. Obtaining a domain name does not establish a business entity or satisfy any other legal requirements, nor does it grant you any exclusive rights to use your business name.
Taxpayer identification number
A Federal Taxpayer Identification Number, also known as an Employer Identification Number (EIN), is a nine-digit number for businesses. Nearly all businesses are required to obtain an EIN, but sole proprietors with no employees and single-member LLCs may be able to use the owner's Social Security number instead. An EIN can be obtained for free on the IRS website. The IRS website's EIN application page provides specific, detailed information about the requirements.
Licenses and Permits
Business owners need to anticipate potential requirements from all levels of government.
Many businesses whose activities fall into federally regulated sectors, such as transportation, agriculture, the manufacture and sale of alcoholic beverages, broadcasting, and the use of natural resources, require a license or permit issued by the federal government.
State and local licenses and permits may also be required for different areas of business. It all depends on state and local laws. For example, if you sell products in a state that collects sales tax, you need a sales permit. Most areas require your business to obtain a general business license or permit. There may also be additional state or local licensing requirements that apply to your specific industry. Your city or county business licensing agency is a good place to find out what special permits or licenses you may need.
Business Insurance
No matter how well run your business is, you can't eliminate liability risk. Risk is part of the cost of doing business, and it pays to be prepared for it. In some situations, certain insurance policies may be legally required as a safeguard, similar to personal auto insurance.
Many businesses rely on insurance brokers to help them determine the “coverage” (and amount) that is appropriate for their situation. Common types of coverage include:
General liability insurance is the recommended minimum coverage for any business. It insures against nearly universal liability, including damage to company property and bodily injury that occurs as a result of business activities.
Product liability insurance covers damage caused by defective products and can be important for businesses that manufacture and distribute goods of any kind.
Professional liability insurance, also known as “malpractice liability insurance”, covers claims for professional negligence made by any company employee.
Commercial property insurance provides additional coverage for land and facilities that may be damaged due to issues such as fire, flood, and vandalism.
Workers' compensation insurance covers employees who are injured on the job and is required for all businesses that employ employees in every state except Texas.
Auto liability insurance covers accidents caused by company-owned vehicles and employees driving during work hours.
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Conclusion
Depending on your location and the type of business, properly registering, naming, licensing, and insuring your new small business can be a daunting task. It's worth doing this right, because legal troubles can quickly mount from regulators, other businesses, customers, and even your company's employees. Small business founders take on a lot of risk when starting a small business venture, but you can mitigate much of this risk by making sure you handle the legal requirements of starting a business as soon as possible.
FAQ
There are seven steps to forming your own limited liability company (LLC).
Decide on a company name Designate a registered agent Obtain a copy of your state's LLC Articles of Incorporation Prepare your LLC Articles of Incorporation File your Articles of Incorporation Create an Operating Agreement Keep your LLC active
What is the difference between an LLC and a corporation?
Although limited liability companies (LLCs) and corporations are similar, they are distinctly different business structures, each with their own advantages and disadvantages. Corporations generally have a more standardized, strict operating structure, and more record-keeping and reporting requirements.
What is the best business structure?
The best business structure for your business will depend entirely on the type of company you are setting up, your industry, and what you want to achieve. However, a successful business structure will be one that helps your company set realistic goals and accomplish the tasks set out for it.