Business ownership can be highly rewarding, but have you ever wondered what happens if you get caught running a business illegally?

There can be major consequences for running a business without meeting the legal requirements. I once met a woman who had to serve 100 hours of community service per month for operating a business without a license.

Another business owner I know was fined $10,000 for classifying employees as subcontractors incorrectly. Some entrepreneurs even face criminal charges for improperly operating a business.

With this in mind, you need to understand how to legally start a business. This guide will help you with the process to legally establish and run a business.

We’ll discuss choosing an appropriate business structure, registering your company’s name, and getting business licenses. You can either read straight through or click on any of the links below to jump to the section that interests you:

Keep reading to learn how to operate your business and stay within the legal requirements.

Step #1. Choose the Right Business Structure

When you choose a business structure, you’ll be making a decision that impacts legal liability, taxes, and management. During business planning, carefully analyze the different types of legal structures. Small businesses often choose sole proprietorships, partnerships, or limited liability companies (LLCs).

Each legal structure has pros and cons that impact your business goals and how you’ll operate your business. You should consider your strategic goals and mission before you choose a business structure.

If you make a mistake, you may find it challenging to change your business structure as you grow. You’ll have to update information in every location, which can be a major undertaking.

Keep reading to learn about each type of business entity.

Sole Proprietorships

When you establish your own small business, a sole proprietorship is the simplest business structure because you and the business are a single entity. In other words, your business isn’t considered separate from your personal assets.

Small business owners like sole proprietorships because they are less regulated and easier to manage. However, despite these benefits, a sole proprietorship makes you personally liable for any financial risk that’s tied to your business.

Therefore, debts or legal problems will impact both you and the company. Business creditors can pursue your house and personal vehicle to settle business debts, and personal creditors can take your business.

In addition, your small business profits are taxed at your personal income tax rate. This can be a huge disadvantage if your income is in a higher tax bracket than corporate or dividend taxes.

Before you start a sole proprietorship, weigh these risks against the convenient benefits for sole proprietors.

Partnerships

A partnership requires two or more people to be co-owners of the company. This structure can be subdivided into a general partnership, limited partnership, and limited liability partnership (LLP).

Each type of partnership has different levels of liability and managerial responsibilities. Partners in general partnerships are equally responsible for debts and obligations incurred by the business.

Meanwhile, limited partnerships consist of a general partner who manages the business and any number of limited partners who don’t directly operate the business. The limited partners are only exposed to risk on the money they invest in the business. A limited partnership is a good option for a silent investor.

A limited liability partnership requires all partners to equally manage the business, and it shields each partner from liability for the others’ decisions. This type of organization may be useful in law firms and other professional organizations.

All these structures benefit from joint decision-making and pooling of resources. If you decide to create a partnership, you should create a contract defining each partner’s duties, profit distribution, and buyouts. Clear contracts prevent disagreements and guarantee efficient management within a partnership.

Limited Liability Companies

Small business owners often create a limited liability company for small businesses. With an LLC, your business is a separate legal entity. An LLC shields the personal assets of its members by providing protection against business debts and risks.

An LLC combines the benefits of a corporation and the pass-through income of a sole proprietorship. LLC owners can use pass-through taxation or file as an S corp.

With an S corp, the business claims half the self-employment taxes as payroll taxes, pays the owner a salary, and can reward the profits as dividends. Dividends currently have a lower maximum federal tax rate.

Corporations (C Corp)

Incorporating a business creates a more intricate structure that offers substantial benefits, liability protection, and fundraising opportunities. To establish a corporation, you’ll need to file articles of incorporation in your state.

Corporations are their own separate legal entities. They can enter contractual agreements as well as initiate or face litigation while protecting shareholders. There are two main types of corporate structures: C corporations and S corporations.

A C corporation protects your personal assets by providing limited liability and can also issue stock. A C corp also has double taxation, meaning that both the business earnings and shareholders’ dividends are taxed.

An S corporation, on the other hand, avoids double taxation by taxing profits and losses to the shareholders as dividends. This allows you to avoid self-employment taxes on profits.

Corporations often have a board of directors that are independent of the company. The board advises the executives, while shareholders are owners who may vote on some initiatives.

This complexity adds more regulations but provides the best liability protection and more opportunities for growth.

Step #2. Register Your Business Name

Choosing a business name is an essential part of creating your brand’s identity. Your name represents your brand and should describe your products or services. Registering a business name prevents other companies from using the same name within your state.

Both state and federal government agencies may require you to register a business name depending on your industry. In most cases, you can complete the process online or via hard copy.

Trademarks

A trademark protects your brand at the federal level. This is one of the most common ways to keep competitors from using your registered business name, logos, and slogans. Learn how to trademark a business name.

Doing Business As

You can operate your business under a different name than the official legal entity name. State or local governments often require a “doing business as” registration if you want to conduct business using a fictitious name.

Step #3. Obtain Necessary Licenses and Permits

Most small businesses require at least one business license or permit to operate legally. The licenses and permits vary depending on factors such as the industry, state laws, and business activities. You’ll need to comply with the legal requirements to avoid penalties and fines.

Licenses and permits may be overseen by federal, state, and local entities. Each governmental organization has its own set of regulations that apply to many businesses.

Reach out to local government offices or seek legal advice when starting a small business to make sure you know how to get your business license.

Federal Licenses

Some industries are required to get federal licenses. To find out whether there are federal requirements in your industry, check your local government’s website for guidance on what you need. Most will tell you if you need to interact with federal agencies.

State Licenses

Check the secretary of state’s office for your area to find out more about permit and licensing requirements. You may need a general business license and special permits for your industry.

Local Permits

Most major cities and some counties require licenses to operate a business. You may even need a separate permit or license for each business location if you’re a mobile service provider or you have multiple storefronts.

Step #4. Apply for Tax Identification Numbers

An employer identification number (EIN) is a nine-digit number that acts as a tax ID for businesses. It’s required for most business entities. You’ll need an EIN for payroll taxes, business banking, and loans.

You can apply for an employer identification number on the IRS website.

State Tax ID Numbers

Check if your state requires businesses to have a state ID number. If so, make sure you understand the future reporting requirements for your business location at the local level.

Step #5. Open a Business Bank Account

Establishing a business bank account is beneficial for earning trust from customers and suppliers. Having a separate account also makes it easier to handle financial tasks like paying business taxes and managing payroll.

You’ll need your ID, business formation documents, and employer identification number when opening a bank account. Most businesses will need at least a business checking account, but you may also want a credit card and savings account.

Every business bank account has different limits for transactions and cash handling. For more information, check out our blog about business bank accounts.

Step #6. Acquire Business Insurance

You’ll want to get small business insurance to protect against liability. Some clients and regulatory agencies may also require you to carry specific policies.

We recommend using Simply Business.

General Liability Insurance

General liability is the bare minimum a small business should have to protect against bodily harm and property damage claims. General liability also extends protection to incidents of accidental damage or libel and slander. Having this type of insurance ensures that you’ll be able to cover expenses related to your legal defense.

Professional Liability Insurance

A professional liability policy safeguards against allegations of negligence or mistakes made while providing professional services. You may also hear this insurance referred to as errors and omissions insurance.

Product Liability Insurance

If you make or sell goods, you’ll need product liability insurance. This form of insurance serves as a shield in case you’re sued over a defective product. It typically covers legal fees and settlement costs for eligible claims.

Step #7. Develop a Compliance Plan

Your small business must comply with all legal requirements to avoid expensive penalties and potential litigation. Your compliance strategy should include:

• Marketing and promotional activities
• Financial management
• Employment regulations

Seek advice from a lawyer who specializes in your specific field and region to understand any legal responsibilities you might have missed and how to correct them.

For day-to-day compliance, use checklists to confirm that employees are following all rules and regulations. This proactive measure will help you monitor compliance and identify potential areas for improvement.

Step #8. Protect Intellectual Property

Protecting your intellectual property is a key aspect of safeguarding your assets and maintaining your competitive advantage against other businesses. You’ll want to use a mix of patents, copyrights, and trademarks.

Patents prevent others from reproducing or using your inventions without permission. Meanwhile, copyright protects against others using your creative works. You’ll also want to trademark your logos and branding to keep competitors from copying them.

These measures may be used as the basis for an infringement lawsuit or as a way to generate other forms of revenue by selling the right to your content.

Step #9. Maintain Good Records

Your small business should maintain accurate records for tax purposes, tracking your financial progress, and adhering to legal obligations. Adequate documentation helps you maintain licenses and prove compliance with IRS regulations.

Make sure to keep contracts, invoices, and receipts with details about your income and expenditures. You can also use accounting software like QuickBooks to put everything in order.

Documentation streamlines the process if you’re audited. Maintaining diligent records is especially important for corporations because they may be required to prove every business transaction.

Step #10. Seek Professional Advice

Working with attorneys, accountants, and human resources professionals will make it much easier to comply with all laws and regulations that apply to your industry. We strongly recommend building a business relationship with experienced professionals in your industry and location.

Conclusion

By now, you should have a stronger understanding of what it takes to start a business. Small businesses are legally required to follow all applicable federal, state, and local requirements. Writing a business plan can help you keep track of your obligations as a new business or startup.

You’ll need to choose a business structure, register your business name, get licenses and permits, and protect your intellectual property. Don’t hesitate to consult licensed professionals as you work on starting your own business. Experts know how to navigate complex topics such as documenting business transactions and minimizing personal liability.

Is there anything else you still need to know about how to start a business legally? Let us know in the comments below.