An Introduction to Business Law & Your Options
If you are running a business you should know all you can about corporate law, and how it can be used to make your business stronger and your cash flow better.
The U.S. favors the consumer-this means you need insider info to make sure that your liability is protected; your business is financially and legally safe.
This lens will explain the ins and outs of corporate laws that can make or break your business, and how you can use them to your advantage. This will in turn should show your clients that you are legally savvy and worthy of their continued loyalty.
Bottom line: More clients, more business, more money in your pocket.
A Brief History Of Business
All commerce begins as a simple exchange. You have something I need or want, I have something you need or want, and each of us is willing to give up what they have for the other. Children learn this on the playground early on when exchanging marbles, toys or other items.
Anthropologists speculate that formal courtship and mating rituals among early humans started out as business transactions; men - who did most of the hunting - wanted sex, women wanted meat for themselves and their offspring. Later, this expanded into other sorts of exchanges: hides for dried food, simple jewelry for tools and spear points, etc.
With the development of agriculture and the concept of private property, commerce became a much more complex activity. Agriculture resulted in population growth and the formation of the first urban communities. New kinds of laws were required to sort it all out. Currency, or money, was developed as a convenient way to assign values to a wide range of goods and services, since simple barter exchanges - depending as they did on a "double coincidence of wants" - were rarely practical. For example, suppose I was a furniture maker and you were a wheelwright. I may need a new wheel for my delivery wagon - but you may not necessarily need or want a new table and chairs. Money allowed me to exchange my furniture for something of recognized value that could be easily collected and stored, then used in another, completely different exchange.
The Origins Of Corporations
Corporations were a very early development. As trade expanded beyond localized areas - as in the case of the Phoenicians, who maintained trade connections from India to present-day Britain - the process of trade became too unwieldy and expensive for one man to deal with. Even one ship loaded with valuable goods represented a considerable investment as well as considerable risk. Early corporations formed for the purposes of (A) raising more capital for business ventures that any one man could raise on his own, and (B) spreading the potential losses so no one individual took the brunt of a liability. Therefore, an association of Phoenician merchants could pool their investments to purchase multiple ships and cargoes, secure in the knowledge that the inevitable loss of one or two ships would not be catastrophic for the investors (lives of the captains and crews notwithstanding).
This relatively simple type of corporate structure continued to be used through Roman times. Typically, these were not permanent organizations however, but groups of investors assembled for a specific purpose. The idea that a group of people could have an identity separate from that of its individual members was a concept introduced by the Germanic tribes that invaded Rome starting in the fourth century of the Common Era. By the Middle Ages, this concept found its way into canon law, which held that the Church organization was more than its members - and that as an organization, it was for all intents and purposes, immortal. This, combined with theories and customs governing the relationship between the organization (in this case, the Church) and its head (the Pope) laid the foundation for the basis of modern corporate law and structures.
About C-Corporations & S-Corporations
C-Corporations are huge in the US and you need to know about them.
This is the most common kind of corporate entity. Most major companies as well as numerous smaller ones fall into this category. Although widely used, a C-Corp structure may not be the best one for a small net-based business run by one person.
The reason is that Federal and most State laws require that the operations of a C-Corporation be overseen by a board of directors and that shareholders be consulted on major business decisions. This Board of Directors manages the corporation and appoints officers to run things on a day-to-day basis.
If you plan to expand your Internet business substantially - if you believe it has a shot at becoming the next Google or Craig's List - a C-Corporation is definitely the way to go. As a C-Corporation, you have no limit to how many shareholders you may have, allowing you to raise unlimited amounts of capital through the sale of stock.
A C-Corporation is also able to deduct the cost of employee benefits (such as health insurance) as a cost of doing business. Otherwise, if you plan on staying small and intend to maintain maximum control over as much of the operation of your business as possible, formation of an LLC or an S-Corporation is a better choice.
An S-Corporation - sometimes called a "small business corporation" - is really little more than a C-Corporation that has chosen to operate under specific tax laws as outlined under Chapter One, Subchapter S of the Internal Revenue Code. The initial administrative paperwork required is the same, regardless of whether you are forming a C-Corporation or an S-Corporation, since this is done at the state level. Once this paperwork has been approved by the state in which you are incorporating, you'll need to fill out and submit IRS Form 2553, also called "Election by a Small Business Corporation".
With an S-Corporation, the shareholder (that's you) is able to pass corporate earnings and profits directly through to his/her own personal tax return. Anyone providing work for an S-Corporation (including yourself) needs to receive a wage or salary meeting "the standards of reasonable compensation."
How To Protect Yourself And Your Customer
You need to know how and why it's important for you to protect both yourself and your customer in your business.
If you are a 'netpreneur - if you have managed to build and continue to operate a successful business in cyberspace - you've come to appreciate just how much easier Internet commerce is. Many of the traditional issues faced by small businesspeople - such as setting up an actual storefront and having to pay rent or a mortgage on the building, having to have liability insurance, finding storage space for merchandise (if applicable), not to mention having to deal with municipal codes and zoning laws, licensing, and more - are not applicable in cyberspace. An internet business can be operated right from a spare bedroom in your house, and if you're actually dealing in tangible goods, you may never have to store or even see them as successful online auctioneers will attest.
An internet business faces many of the same tax and liability issues as a brick-and-mortar business, however. And unless you've been on a desert island for the past twenty years, you've probably come to realize that the business law in the U.S. tremendously favors corporate interests, providing them with rights, privileges and protections that are simply no longer available to individuals and the mythical "little guy" (by which we mean the "Sole Proprietor" - read on).
The reason goes back to a little-known amendment inserted by a law clerk on a case dating back to 1888. In this case, Santa Clara Co. vs. Southern Pacific Railroad, a law clerk wrote his own words into the judge's opinion that essentially gave corporations the same rights under the 14th Amendment of the Constitution as natural human beings. The 14th Amendment states:
"All persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the state wherein they reside. No state shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any state deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws."
Since then - and especially over the past twenty-five years - large corporations have used this status to get involved in the political process, influencing lawmakers to pass legislation in their favor that have allowed them to grow tremendously in size and power.
Because of various abuses and the healthy, traditional American fear and distrust of any person or institution grown too large and powerful, recent years have seen the beginning of a backlash against corporate power and the doctrine of "corporate personhood." This has in turn led to some strange perceptions among many that corporations are somehow evil and destructive to democracy.
The fact is, a corporation, in and of itself, is neither good nor evil. It is simply a tool - a "legal fiction" that allows entrepreneurs to incur some risk without danger of losing everything they own. While it may be true that these laws have been misinterpreted, twisted and abused by many powerful, wealthy groups of men (and the occasional woman), these same laws can be used to your advantage when it comes to protecting yourself and your assets. These laws don't care whether yours is a multi-billion dollar operation or consists of just one person. Your small, home-based Internet business can enjoy the same protections as Bechtel or Halliburton - and having an "LLC" or "Inc." after your name can add a great deal of credibility as well as open the doors to the same types of opportunities! Best of all, you will enjoy the same protections and tax advantages.
It's very important that you and your customers are safe so make sure you take caution when setting up your business and work with a good Law professional.
Complying With The FTC
You may have heard of the federal trade comission. This is the organization that makes sure businesses run honestly and fairly.
What the FTC labels as "unfair or deceptive acts or practices" refers to:
- advertising claims
- marketing and promotional techniques
- general sales practices
These rules are applicable to all forms of communication, from print advertising to live demonstrations. Since the dawn of the Internet Age back around 1994, over 100 legal actions have been taken against on-line businesses allegedly engaged in "unfair or deceptive acts or practices." FTC issues rules, which are clear prohibitions against these acts, and guidelines, which are examples designed to help netpreneurs such as yourself in complying with FTC rules.
The three basic principles of advertising law are no doubt familiar to you, but they bear reviewing:
- Ads must be truthful and contain no misleading material
- The advertiser must provide evidence, or "substantiation" of any claims
- Ads must meet a test for fairness.
Whether you write your own ad copy or hire a professional, you should readily be able to identify any claims of product or service benefits and determine if any express (stated) or implied claims might be misconstrued. Any claims that fall into that category require disclosure, or qualifying information.
It may seem unfair to you as an honest merchant or service provider, but legally, you are required to phrase your advertising message in such a way that it absolutely cannot be misconstrued in any way - and failing to do that can leave you or your company liable. Fortunately, compliance is not difficult. A common way to fulfill this obligation is to use disclaimers such as: "Your results may vary," or "not proven to work for all situations." It is however your responsibility to determine (A) which claims may require substantiation, and (B) what information should be included in any disclosure.
Now, it's important to understand that a disclosure can only qualify a claim or limit it so your potential customer doesn't receive a misleading impression. It's not a license to make a false claim. If a disclosure completely contradicts your claim, that claim is false and requires modification.
Beyond qualifying claims about a given product or service, a disclosure is also required in order to provide your potential client about the terms of the transaction. You'll see good examples of this if and when you start searching online for paralegal help in incorporating your business. The most reputable firms will have a clear statement on at least one of their web pages (and usually more) that goes something like this:
"Fees listed here are in addition to required state or jurisdiction fees."
In other words, while they're shouting to the heavens that "YOU can INCORPORATE in CORPORATE HEAVEN TODAY for only $99.95!" they're also letting you know beyond all doubt that it will actually cost you more that that.
You now know a bit about how the FTC helps your business stay safe and fair to customers.
Profit or Non-Profit?
You may not know if you need or would want to incorporate as a non-profit or a profit. To find out read on...
Most netpreneurs are hoping to strike it rich - and if you're one of those clever enough and lucky enough to come up with something that people will pay good money for, chances are you'll be one of them.
On the other hand, more and more people are discovering that there are things in the world to which a monetary price cannot be attached - and the value of which may not necessarily be measurable in dollars and cents. For example, the fine arts - contemporary painting or sculpture, modern classical music, and great theatre are institutions that rarely find any kind of support from commercial markets (in fact, the technical definition of "classical" music is that which is primarily state-supported - something commonly done in Europe, Japan and China, but almost never in the U.S.).
If you are among those who aspire to be a patron of the arts and are content to make a modest living while doing so, a Non-Profit entity may be for you.
Also called a "Not-for profit corporation," a Non-Profit is a non-stock entity (in other words, it cannot issue stock to shareholders) that as the name implies, is not intended to make profits. Such corporations are founded with a specific goal or purpose in mind, usually - but not necessarily - related to education, charity work or the arts. As such, they may be - and often are - exempt from many taxes and tax regulations.
A Non-Profit may certainly generate income, and indeed needs to do so in order to stay in operation. It can accept, hold and trade monetary instruments as well as tangible goods, and - despite the name - can legally make a profit - technically called "revenue" - on such transactions. The use of such revenue - and how much revenue can be made legally - is subject to scrutiny, however, and is tightly regulated. Since it has "members" (like an LLC) rather than "shareholders" or "stockholders," capital is generally raised by soliciting donations from the public, or from private industries. Depending on the purpose of your Non-Profit organization, such donations may be tax-deductible for the donor.
At this point, you may be wondering what the point is. After all, if you're not allowed to make a profit, how is having a Non-Profit Corporation supposed to provide you with a livelihood? While it is true that a non-profit cannot issue stock nor pay dividends, it is still like any other corporate or LLC entity in that it can retain employees and provide reasonable compensation for its director(s).
Another major advantage to having a non-profit corporation - especially in the arts - is the ability to apply for government grants, such as those offered by the National Endowment for the Arts (NEA). In 1995, the new Congress changed numerous laws, making these grants unavailable to individuals. However, a non-profit organization can apply for these grants on behalf of individuals, should they wish to commission a work of art.
The same is true of charitable and educational organizations. Numerous Federal and State grants are available to non-profit organizations that cannot be applied for any other way. So - what is your passion? The arts? Education? Providing affordable housing to low-income people? Historical preservation? There are even non-profit sports organizations. You won't get rich, but by incorporating as a non-profit entity, chances are good that you'll be able to pursue activities that nourish your soul while retaining the ability to pay the bills.
Offshore Incorporation Options
If you've always wanted to Incorporate offshore for tax benefits but have no idea where you can incorporate, this list will help you.
British Virgin Islands
A BVI Corporation can be formed in 3 business days. The main advantage is that only one director or shareholder is required. This can be one and the same person, or it can be another corporation. There is no requirement to appoint local shareholders, directors or a secretary. A BVI Corporation can maintain a bank account in the BVI as well as hold shares of another BVI company. It may not carry on business activities with BVI residents, act as an insurer, or initiate any business connected with banks or trusts without special licensing.
This is an island group located in the Indian Ocean just off the east coast of Africa and north of Madagascar. An offshore corporation can be set up in Seychelles faster than almost anywhere else - often in as little as one day. Since passage of the International Business Companies Act of 1994 - regulating offshore trusts, offshore banking, offshore insurance, international shipping and aircraft registration - offshore financial services has become the major industry. A Seychelles Corporation requires one director and one shareholder - however, either or both of these may be a natural person or a corporate entity. Local residents may act as proxy directors or shareholders, and corporate meetings may be held anywhere in the world. Legal requirements regarding management structure is possibly the most flexible of anywhere in the world.
Since the first Portuguese traders arrived in 1513, Hong Kong has been a center of trade and commerce. The former British Crown Colony reverted to the control of the communist government in Beijing in 1997, however the agreement between the U.K. and the People's Republic of China insures that Hong Kong will remain virtually autonomous and continue to maintain its own systems of law, monetary policy and customs through the year 2047.
If you plan to do any business in Asia at all, you should investigate setting up a Hong Kong corporation. Aside from having the least restrictive economy in the world, Hong Kong is virtually the crossroads of Asia with easy access to the Philippines, Indonesia, Singapore, Vietnam, Thailand, Taiwan and the PRC. Taxes are low and the taxation system is much simpler than many other places. In addition, flow of information is virtually unrestricted over a state-of-the-art infrastructure.
Formerly known as British Honduras, this country offers many of the same benefits of other off-shore locations as far as privacy, taxation and ease of operation. In fact, under Belize corporate law, bookkeeping and annual accounts are not even required! The Belize IBC Registry is fully computerized, and a corporate entity can be formed in as little as an hour.
There are some caveats, however, as the stability of this country may be in question. Although legally an independent member of the British Commonwealth, neighboring Guatemala has long claimed Belize as a province of its own country. As of this writing, the border dispute has yet to be resolved.
In January 2005, there were civil disturbances among the citizens over substantial tax increases in light of government incompetence and corruption. Union employees refused to report for work for two days, and citizen frustration boiled over into a violent demonstration in front of the National Assembly Building in Belmopan. It was the third such disturbance in twenty years.