Starting a Business: Legal Structures and Government Regulations

improve cash flow

It’s no secret that starting a business is risky; filled with uncertainty, high demand for resources (time, money, etc), and conflicting demands that you must manage. Many people struggle while they are going through the process of starting a business, finding it hard to know what they need to do at each stage in their journey. In fact, I worked for years with the US Small Business Administration (SBA) to help entrepreneurs bring their vision to life through one-on-one consulting and seminars. One of the biggest demands when it came to advice involved legal structures and government regulations necessary to get your business off the ground.

starting a business
Image courtesy of SCORE

About half of small businesses fail within the first 5 years, many in their first year or so of operations. After 10 years, you find only about 30% of small businesses survived, according to the same source. As you can see from the graphic above (produced by SCORE-the service corp of retired executives, which is part of SBA), a variety of reasons account for this failure with the biggest risk coming from cash flow problems.

Now, I’m not an attorney so I can’t give you legal advice but I can share the insights into success with some early decisions faced by entrepreneurs gleaned over my time with the SBA. Also, recognize that starting a business in other countries involves different laws and regulations, so please consult a local attorney for specific advice in your country. I’ve couched my advice in generalities faced by most entrepreneurs looking to start a business. Thankfully, there are plenty of other companies out there that can help you with a task like this, and the level of support can vary greatly depending on the option you choose. This gives you the opportunity to have a business built on your behalf or just a little bit of help along the way. Let’s take a look at some of your options.

Starting a business: Legal structure

You have various options when it comes to legal structure for your new business. Each has its advantages and disadvantages. Some overriding considerations surround how your legal structure affects taxes and how to protect your non-business assets in the event of a cash flow problem or failure. So, let’s jump right in.

Franchises

Large companies trying to expand their operations quickly often sell franchises to entrepreneurs. Companies like McDonald’s are a great example of this.

Advantages:

  • access to a proven business model so you waste fewer resources experimenting to find the right one
  • advertising supported by the franchise owner (such as McDonald’s) provides access to diverse consumer groups that really rev up your revenue
  • training, in fact, McDonald’s operates Hamburger University and all franchisees and their management must attend classes
  • brand recognition and a loyal customer base developed over the years that reduce the risk

Disadvantages

  • cost, most franchises require a cash buy-in and monthly fees (often as a percentage of revenue)
  • performance measures require you to meet certain milestones or you face the potential of losing your franchise
  • rules and regulations that enforce conformity so you can’t make the business your own, even if the current operation faces challenges. For instance, some franchise operations require you to purchase expensive equipment to remain in the organization, although anti-monopoly laws in the US protect every business, including franchise businesses, from requirements to buy from a specific company including the franchise owner.
  • threats to your brand name from other franchisees who don’t maintain the standards set by the franchise owner
  • lack of support, as inept franchise operations might relinquish much of their responsibility to support your operation, thus requiring expensive legal efforts to enforce the contract

Partnerships

You can form a partnership with someone else or several other folks. This form of business commonly forms using a contract that spells out the contributions (both financial and functional) and rewards shared among the partners. In this case, you need to create a governance structure or appoint roles so there are clear administration and decision-making responsibilities.

Forming a partnership with another business is also a great way to tap into the tacit knowledge and brand reputation of the partner firm. For instance, starting a business that operates in another country requires a partnership with a local business to gain access to the cultural nuances necessary for success. Some countries require these partnerships as a requisite for doing business in the country.

Advantages:

  • access to expertise, intellectual property, and brand reputation/ loyalty
  • contracts spell out the rights and responsibilities of each partner
  • access to capital (potentially)

Disadvantages:

  • lack of control. For instance, the partnership between Chrysler and Daimler-Benz started with the promise of sharing engineering expertise (Daimler) and access to the US market (Chrysler). Yet, cracks started showing up quickly as each envisioned a future where they were the leader. The partnership ultimately broke down and cost the partners a ton of money in costs, both tangible cost and opportunity costs
  • challenging enforcement of the contract involving legal expenses when the partner doesn’t perform as expected

Independent operation

Most entrepreneurs choose to start a business as an independent business where they own the entire company or share ownership with investors. In this category, you have both lifestyle businesses, designed to replace the owners’ income (such as a landscape or plumbing business) and entrepreneurial businesses designed with the expectation of substantial growth beyond the owner(s). Starting a tax business or any independent business comes with a lot of paperwork and regulatory documents. If you don’t have these documents filled out correctly, it could cost you a ton of money in excess taxes and fines. Hiring an expert to take care of these documents is often a wise investment.

Advantages:

  • total control of all aspects of the business
  • all profits accrue to the owner (and the taxing authority)
  • less bureaucracy so you can pivot quickly when the situation demands

Disadvantages:

  • risky, not only might you lose your investment but, if not organized properly, your personal assets
  • you have competing responsibilities that require almost superhuman focus to get things done
  • it requires you to possess a variety of skills needed in your business and it’s nearly impossible to have all these skills. Alternatively, you need substantial financial assets to hire employees to perform some functions where you lack expertise

Resources to get your business started

In addition to the agencies I discussed above, such as an attorney and tax advisor, you should consider other types of firms to fill any roles where you lack expertise. While this might seem an unnecessary expense, you can often save money in the long run by building economies of scale and reducing costly mistakes. And, don’t forget you can get small projects done using the gig economy.

economies of scale
Image courtesy of The Balance

The government in your local area is another good source of knowledge when you’re trying to get a business off the ground. There are loads of options available from government organizations, like the SBA in the US, that makes it easier for you to get your business started. From simple advice to loans and grants, your government is a powerful tool, and you need to ensure you take full advantage of this resource to get the best results.

Local chambers of commerce, business groups, and getting advice from experts online are all great tools to help you get started. Other personal connections also make a great resource to help with starting a business. Just remember that you shouldn’t ask professionals in your network to work for free. It’s fine to ask a friend to give you feedback but never asks one for financial or legal advice, for instance. That’s their livelihood and they must be paid for their efforts. I have a friend who owns a photography business who constantly complains on Facebook about “friends” asking him to take photographs for free. Don’t be that person.

Conclusion

As you can see, making formation decisions and getting the right support when you’re starting your own business are critical for success. There are a lot of options, so carefully consider your options and the costs (both tangible and opportunity costs) of making a poor decision. Thankfully, though, there are loads of tools that can help you with starting a business.

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