Laying Down the Law in LLC, IP, and Hiring

With most of the start-up focus on accounting and banking advice, when does an entrepreneur need legal services? More often than he or she might prefer, as two area legal professionals explain.

Entity identity

Frank Sutherland, an attorney with Lathrop & Clark, said legal fundamentals begin with the need for limited liability protection through the formation of a business entity, typically a limited liability company or some type of corporation.

LLCs were introduced into law in the early 1990s to provide a more simplified form of entity, while still providing limited liability protection in the event of business failure. Another common choice is a corporation with a subchapter S-election, hence the name S-corporation. With the S-election, there are tax consequences similar to those of a limited liability company. While there are exceptions to the rule, the preferred ownership status is that of a "disregarded" entity that brings pass-through taxation, meaning the net income of the business entity is assigned to one or more owners in proportion to their ownership interest. The net income is treated as if it were earned in the absence of that entity.

The subject that takes up the most amount of time when establishing the business entity is the structuring of the stock purchase and redemption agreements if there is more than one owner, Sutherland indicated. Negotiations involve how multiple owners arrange their relationships, how much capital each contributes, how people can leave and how they can join, and who has decision-making power with respect to what issues.

Attorney Melissa Warner, a member of Axley Brynelson's Business Practice Group, said tax implications and ownership structure are the factors that most influence the choice of business entity. "It depends on what the business is," she added. "There is no clear-cut formula to say, 'If it's this, then go with an LLC. If not, do a corporation.' It's not a cookie-cutter answer."

As the name suggests, limited liability does not mean complete protection. Due to the requirements of personal guarantees, limited liability will not protect an owner against default on a bank loan or a lease. "Even though you have limited liability related to a number of aspects of your business, it's important for an entrepreneur to speak to a lawyer to understand where he or she will still have personal exposure, and there will almost always be some area," Sutherland said.

While business insurance is not in an attorney's wheelhouse, Sutherland said he refers entrepreneurial clients to an insurance agent who can write a policy based on the inherent risk associated with the type of business being pursued. "A lot of times, lawyers tend to focus on the business entity without realizing the insurance is just as fundamental to protecting an individual who is starting a business," he stated.

Another area where an attorney can be helpful is with certain aspects of the business plan. A lawyer's role in business planning is more limited than those of bankers and accountants but could be crucial in areas like intellectual property. Whether it's a patent application, especially as the nation transitions to a first-to-file system, or the need to comply with trademark and copyright law, legal advice can save time and money.

"I'm aware of situations where entrepreneurs have launched their business only to receive a cease-and-desist letter six months or a year out, stating that a third party has rights to their name or logo," Sutherland stated. "This requires them to change all marketing materials, change signage, and start all over from a goodwill standpoint in developing their reputation in the market."

As entrepreneurs begin to hire, they must follow employment law. "Once you're big enough to say, 'Yes, I'm going to hire an employee,' this is a good time to meet either your attorney or an employment attorney in the same firm," Warner noted. "When you meet with the attorney, you need to say, 'I'm going to hire. What should I do and not do?' So they can protect themselves, and put together an employee handbook."

When a new business owner decides to add employees, attorneys also offer protection by writing confidentiality, non-compete, and non-disclosure agreements. Non-disclosure agreements protect an employer, when presenting an idea to a third party, from having a novel concept stolen.

There are times when non-compete, non-solicitation, and confidentiality agreements are combined, but they can also be stand-alone agreements that must be tailored to specific business needs. For example, when the success of a business is dependent on a trade secret that employees are privy to.

Non-compete and non-solicitation agreements tend to go hand-in-hand because employers want to avoid situations where employees come into a business; learn about customers, clients, and ways of doing business; and then use that information for their own benefit after leaving the company.

"These agreements take real balancing," Sutherland said, "but Wisconsin courts do not look favorably on infringement of non-competes because they want everyone to participate in the marketplace."

While keeping an attorney on retainer is an option, entrepreneurs pay for most legal services on an hourly basis. The timing of those payments must be discussed upfront due to limited budgets. "We're pretty flexible," Warner said. "We may set up reasonable monthly payments over a few months, versus five years."

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