How to Start a Business: Legal Structure & Formation Guide

Step 1: Choose Your Business Structure

The most consequential early legal decision is choosing your business entity type. Each structure affects your personal liability, tax obligations, ability to raise investment, and operational complexity.

Sole Proprietorship

The default if you do nothing — you and your business are legally the same person. No formal registration required (beyond any required business licenses). Simple, but you have unlimited personal liability for business debts and legal judgments. Your personal assets (home, savings, car) are exposed.

Best for: Testing a business idea, very low-risk freelance work, or businesses where you can't be found liable for much.

Limited Liability Company (LLC)

The most popular entity for small businesses. Creates a legal separation between you and your business, protecting personal assets from most business liabilities. Flexible management structure. "Pass-through" taxation — business income and losses flow to your personal tax return (avoiding the double taxation of C-Corps).

Formation cost: $50–$500+ in state filing fees, depending on state.

Best for: Most small businesses, real estate investors, consultants, solo professionals, and small teams.

S-Corporation

A corporation that elects pass-through taxation. The key tax advantage over an LLC: if you pay yourself a "reasonable salary" as an employee-owner, the remaining business profits pass through to your personal return without being subject to self-employment tax (15.3%). For profitable businesses, this can mean significant savings.

S-Corps have restrictions: maximum 100 shareholders, all must be U.S. citizens/residents, only one class of stock allowed.

Best for: Profitable small businesses where the owner works in the business and can clearly justify a "reasonable salary."

C-Corporation

The standard corporation. Separate legal entity with its own tax return. Subject to "double taxation" — profits taxed at the corporate level, then again when distributed to shareholders as dividends. However, C-Corps can raise investment from institutional investors and venture capital, issue multiple classes of stock, and offer employee equity (stock options) more flexibly.

Best for: Businesses planning to raise venture capital or go public. Required by most VC investors.

Partnership Structures

General partnerships offer no liability protection. Limited partnerships (LP) and limited liability partnerships (LLP) provide liability protection for some partners. Rarely the best choice for most new businesses without specific reasons.

Step 2: Register Your Business

Once you've chosen a structure, here's what registration typically involves:

File Formation Documents with Your State

• LLC: File Articles of Organization with your state's Secretary of State office
• Corporation: File Articles of Incorporation
• Registered agent: Most states require a registered agent (a person or service with a physical address in the state to receive legal notices)

Get an EIN (Employer Identification Number)

Apply for a free EIN from the IRS at irs.gov. You need this to open a business bank account, hire employees, and file business taxes. Takes minutes online.

Open a Business Bank Account

This is not just good practice — it's essential to maintaining the liability protection of your LLC or corporation. If you mix personal and business finances (called "piercing the corporate veil"), a court can hold you personally liable for business debts.

Register for State Taxes

Depending on your state and business type, you may need to register for state income tax, sales tax, payroll tax, and/or other business taxes.

Obtain Licenses and Permits

Most businesses need some combination of:

• General business license from city/county
• Industry-specific licenses (contractors, food service, healthcare, financial services, etc.)
• Zoning permits if operating from a specific location
• Professional licenses if you're a licensed professional (attorney, accountant, contractor)

Operating without required licenses can expose you to fines and liability.

Step 3: Create Your Operating Agreement or Bylaws

This step is skipped by many new business owners — and it causes enormous problems later.

LLC Operating Agreement

An operating agreement is an internal document that governs how your LLC runs. It's not required by most states, but it's essential for:

• Defining each owner's ownership percentage and capital contributions
• Specifying how profits and losses are distributed
• Establishing voting rights and decision-making procedures
• Describing what happens if an owner wants to sell their interest, leaves, or dies
• Protecting the LLC's liability shield by demonstrating it operates as a real business

Without an operating agreement, you fall back on state default rules — which may not match how you and your co-founders actually want to run the business.

Corporate Bylaws and Shareholder Agreement

Corporations need bylaws (internal rules for governance) and, if there are multiple shareholders, a shareholder agreement defining ownership rights, transfer restrictions, and what happens in buyout scenarios.

Co-founder warning: If you're starting a business with one or more partners, a detailed operating agreement or shareholder agreement is one of the most important investments you can make. Co-founder disputes are one of the leading causes of startup failure — having written agreements about ownership, roles, and exit scenarios prevents disputes and provides a framework for resolving them.

Step 4: Protect Your Intellectual Property

Your business name, logo, products, software, and creative work may all be valuable intellectual property that deserves protection.

Trademarks

A trademark protects brand identifiers — your business name, logo, tagline, or product name. Federal trademark registration with the USPTO gives you nationwide protection and the right to use the ® symbol. File early: someone else registering your name in another state can create significant problems.

Search the USPTO trademark database before committing to a business name to ensure it's available.

Copyrights

Copyright protection is automatic for original creative works (written content, software code, artwork, photography) from the moment of creation. Registration with the U.S. Copyright Office is not required but strengthens your ability to sue for infringement and recover attorney fees.

Trade Secrets

Customer lists, formulas, processes, and other confidential business information may be protected as trade secrets. Protection requires reasonable efforts to maintain secrecy — including non-disclosure agreements (NDAs) with employees, contractors, and business partners.

Step 5: Get Your Contracts Right

Every significant business relationship should be documented in writing. Critical contracts for most businesses include:

• Client/customer agreements: Define scope of work, payment terms, intellectual property ownership, liability limitations, and dispute resolution
• Vendor and supplier agreements: Terms, pricing, delivery, warranties, and termination rights
• Employment agreements: Compensation, duties, confidentiality, non-compete provisions (if enforceable in your state), and termination procedures
• Independent contractor agreements: Properly classifying workers is critical — misclassifying employees as independent contractors creates significant tax and legal liability
• Non-disclosure agreements (NDAs): Protect confidential information shared with employees, partners, vendors, and investors
• Commercial lease: If you're renting space, a commercial lease is a major commitment — have an attorney review before signing

The handshake deal myth: Oral contracts are generally enforceable but notoriously hard to prove. For anything significant, get it in writing.

Step 6: Insurance

Your entity structure provides liability protection from many business claims — but not from professional negligence or other specific risks. Most businesses need:

• General liability insurance: Covers bodily injury and property damage claims from customers or third parties
• Professional liability (errors and omissions): Essential for service businesses — covers claims that your advice or work caused financial harm
• Business property insurance: Covers your equipment, inventory, and physical space
• Workers' compensation: Required in most states if you have employees
• Cyber liability insurance: Increasingly important if you handle customer data

When to Hire a Business Attorney

You don't need an attorney to file an LLC — it's a straightforward form. But a business attorney adds substantial value in these situations:

• You're starting a business with co-founders (operating agreement/shareholder agreement)
• You're raising money from investors (equity structure, securities law compliance)
• You need a customized operating agreement or complex ownership structure
• You're entering significant contracts (commercial leases, large vendor agreements)
• You're buying or selling a business
• You're in a regulated industry (healthcare, financial services, cannabis, childcare)
• You need intellectual property protection (trademark registration, licensing agreements)
• You're facing a business dispute or lawsuit

Many business attorneys offer flat-fee packages for standard formation work. The cost of doing it right at formation is almost always less than fixing problems later.