A “Natural Birth” for Your Business

Nina L. Kaufman, Esq.

Nina L. Kaufman, Esq.

Nina L. Kaufman, Esq., owner of Ask The Business Lawyer, is an award-winning business attorney, speaker, and Entrepreneur Magazine online contributor. She saves consulting and professional services companies time, money, and aggravation by serving as their outsourced legal counsel.

Posted on March 3, 2012 in Business Partners

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Entrepreneurial women are the best. They see a need; they have a passion; they want to make the world a better place; and they have a nary a pause for thought before bringing their dream to fruition.

But here’s a situation where a couple of deep breaths might be in order.

“Jane” and “Amina” own “Growth,” a children’s toy and clothing store in Sedona, Arizona (I’ve changed names and locations for illustrative purposes). They shared a vision with “Rosa” and “Ingrid” to revive a now-defunct holistic wellness center (called “Petals”) for mothers, which would provide classes, education, and events. The four of them signed a lease for Petals. Part of Petals’ space will be filled by Growth. The four women would like to pursue non-profit status . . . eventually . . . but are overwhelmed with the paperwork (no surprise) and just want to get started.

What are some of the legal (and other) issues that these nascent business owners face?

1.   Personal liability.  Without some form of limited liability entity — whether for profit or not-for-profit (also called, colloquially, non-profit), the personal assets of all four women are very much at risk. Given that they want pregnant women and small children to enter their premises . . . oh, the personal injury hairs are standing up on the back of my lawyerly head! One good slip-and-fall, and there’s a miscarriage in the vestibule, brain damage to a young child . . . AAAUGH!! Plus, should Petals not succeed in business, the landlord who leased them the space might look to each of them personally to pay out the balance of the lease term.

2.    Form of business. One of the significant issues that goes into a choice of entity is how (and how much) you will be taxed. There’s a big difference in the tax rules between operating as a for-profit entity (corporation or limited liability company) and not-for-profit corporation. And changing horses mid-stream (from for-profit to not-for-profit) — assuming their state would even let them do that — might turn into an expensive tax headache. Plus, not-for-profit tax rules can become thorny, such as when your income from for-profit sources (like Growth’s contribution of rent) exceeds a certain percentage of your income from donations.

3.    Ownership. One of the main differences between a for-profit corporation and a not-for-profit corporation is the recipient of the profits earned. In broad strokes, in a for-profit corporation, the profits can be distributed to the owners. In a not-for-profit corporation, the profits are distributed to those people or programs whom the corporation has promised to champion. How much do Jane, Amina, Rosa, and Ingrid want to earn? If Petals will be for-profit, the sky’s the limit; if not-for-profit, their salaries may be limited to what is considered “reasonable” compensation.

4.   Partnership. If the four decide that they want to pursue Petals for-profit, they should seriously consider having a partnership agreement among them.  Don’t even get me started on all of the reasons that one of them might need to leave the Petals business. Also, Jane and Amina will want to make very clear the fact that they already have an ongoing business (Growth), to which they will be devoting a significant portion of their time. Or, will Rosa and Ingrid be partners in Growth, too? Better make that clear.

Suggestions:

There are three important steps that these entrepreneurs should take:

First, breathe deep.  Better to get centered and think through the process rather than rush into it. Even human babies take 9 months to gestate.

Second, at the very least, sketch out a business plan (yes, even if for a not-for profit organization). Although not-for-profit status may give the group different avenues for funding, it can take a long time to get the necessary tax-deduction approvals from the state and the IRS. What will be the costs in running the business (whether as a for-profit or not-for-profit)? What are the regulatory and other issues (such as certification of teachers for the education/classes? Health inspections if food will be served?)?

Finally, don’t go it alone. These are some real danger areas if they mess up legally. Fundraising is becoming an increasingly regulated area, so they need to know what they can and cannot do to avoid trouble. They should speak to a local attorney, as well as to an accountant who also understands not-for-profit fundraising and taxation (among other professionals, like insurance.

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