Establishing a Business: Legal and Financial Aspects
Our page on Developing a Business explains the early steps involved in setting up a business, including having a business idea, researching your possible market, and writing a business plan. This page discusses the legal and financial aspects of establishing a business.
From registering your business with the right authorities, through obtaining licences and permits, to finding finance, there is a lot to think about.
This page aims to help you through the process and make it as pain-free as possible.
Setting Up Your Business: Legal Aspects
The first step in setting up your business is to decide on its precise legal form. Options may vary in different countries, but there is likely to be an option for a company, one for you in business by yourself (in the UK, this is known as a sole trader), and perhaps some kind of limited liability partnership, which may be most appropriate for professional services companies like accountancies or consultancies.
It is worth taking advice on the legal form as it will have implications for your tax status—both business and personal—as well as the legal requirements for accounts and disclosure, and even your personal liability for company debts. Good sources of advice include lawyers, accountants and small business advisers in banks and elsewhere. This advice may be expensive, but it could save you a lot of money in the long term.
You may need to change your business status over time: what works well when you first set up the company may not be so appropriate after a year or two. It is therefore important to continue to seek advice from experts over time.
Naming your business
You need to think carefully about your business name. It is the public face of your business, and needs to show what you do, and how you do it. It also needs NOT to have any inadvertent associations with anything unpleasant, or already be trademarked by someone else.
Be particularly careful if your first language is not English, and you are setting up a business with an English name!
More practically, your business also needs to be easy to find using search engines. A search for your business name should bring you up on the first page. It is therefore worth searching for your planned name before you register it, to check what comes up.
You also want to check that your most obvious domain name is still available. Try to avoid domain names with hyphens or other difficult punctuation.
Permits and Licences
Some businesses also require a permit or licence to operate, for example, those in particular sectors.
You will need to check whether you need this, and also how to obtain it if so. Again, small business advisers are likely to be good sources of information.
In many countries, you are required to register with the tax authorities as soon as you become self-employed—and not just when you start to make enough money to have to pay tax.
There are also requirements about registering businesses. It is therefore worth checking in advance to be sure that you understand the situation, and have taken all the necessary steps to ensure that your business is operating legally.
Your business plan should set out clearly how much money you think you will need to start your business, and operate it for the first few months, until you start making some money.
The next step is to find a source of funding. Possible sources include:
Your own savings. You may not want to plough your life savings into a business, but potential investors will be looking to see that you have made a considerable investment in the business before they will give you any money. Expect to fund quite a large chunk of the initial costs of the business yourself. It is therefore worth keeping the start-up costs as low as possible.
Family and friends. A lot of small businesses rely on small loans or investments from family or friends, especially in the early days. This is a good source of income, but do remember that you have ongoing relationships with these people. You need to be absolutely clear (both to them, and to yourself) about what will happen to their money if your business fails.
Banks and building societies. Banks and building societies are used to lending money to small businesses. They often have business advisers on the premises, who can help you through the process, and also add to your business by providing useful advice about the legal form, or other sources of funding. Remember, though, banks are businesses too: they will only lend to you if they see a reasonable prospect of getting their money back, and you will have to pay interest on the loan. You may also have to agree to a personal liability for the loan, so that if the business goes bust, you will still have to repay the money, so be careful to read the small print.
Grants from councils or governments. In some countries, or some areas, there may be particular grants available to help set up small businesses, as a way to encourage entrepreneurs. It is worth looking into this, as the terms may be more generous than bank loans, and this support may also require less security.
Angel investors. These are individuals or small groups of individuals who are prepared to invest money in new businesses in return for some equity. They are often successful entrepreneurs themselves, and therefore may also add value to the business by sharing their expertise or contacts. They will, however, want a good return for their investment, so will be looking for a share of the business that matches their financial input as a percentage of overall value.
Crowdfunding. The idea behind crowdfunding is that large numbers of investors (‘peer investors’) all invest a very small amount, so that nobody loses very much. It is often done via websites. Businesses may offer ‘quirky’ rewards for investment, such as use of early prototypes, rather than equity. A number of concept cars have been funded in this way: deposits for the model have paid for its development.
Debt vs. Equity
In obtaining finance, you need to consider the balance between debt and equity.
- Debt is loans from banks or friends and family, which you need to pay back on agreed terms.
- Equity is where investors give you money in return for a share in your business.
Because investors have a share in your business, they will often expect to have more control, too. However, you do not have to pay a dividend to investors, especially if you are not making a profit, and so equity can be cheaper.
The ratio between debt and equity is sometimes called the gearing ratio, with companies with more debt having a higher gearing ratio.
There are advantages to both high levels of debt and high levels of equity, so you will need to decide on the balance yourself.
It is often best to use a combination of methods to raise money, as this gives you maximum flexibility.
Insurance and liability
You will probably need to obtain various types of insurance for your business.
These may include:
- Insurance for your premises and/or stock, against fire or other damage;
- Public liability insurance; and
- Insurance to cover your employees, if any, for example, for sickness absence, and to ensure that you are not liable for big payments.
Some of these will be a legal requirement, and others will be common sense. Still others will be optional, but you may feel that they are advisable. The point is to remember that insurance is a way of covering risk. There may also be other ways to do this, and you may feel that these are more appropriate.
Small business advisers will be a good source of information about insurance requirements, as will insurance companies (though be aware that they will want to sell you insurance) and government websites on employee benefits.
You now have a business idea, backed by a solid business plan. You have a legally-established business form, and you have funding. The next step is to start to operate including recruiting staff and promoting your business.
Our page on Establishing a Business: People, Places and Promotion explains more about this.