Starting a Business
Thinking of going into business for yourself? There are, of course, many questions to be answered before you launch your business. First, you must decide whether you have the experience, skill, business know-how, and sheer stamina it may take to be successful. You must decide what that business will be, where it will be located, whether you will start from scratch or buy an existing business, how much capital you will need, and so on. Preparation of a thorough business plan is very important in obtaining financing. And, finally, there are many legal questions to be answered, some of which are covered in this pamphlet. For full information on how local, state and federal laws would affect your business, you should consult your attorney at an early stage. Business lawyers can help you identify and manage the paperwork associated with the organization, licensing, contract, employment, and other laws and rules that you must obey if doing business in Illinois. They should also be helpful in finding sources of business plan advice, financing, and additional professionals needed for government compliance and business operations.
For-profit business owners can operate as individuals, can work with others more or less informally, or can form business entities. Forming a business entity allows each owner to receive ownership contributions, define owner rights to manage, contract for, or get paid by the entity, and to limit liability to customers and other non-owners. Owners may have “fiduciary duties” to each other, such as the obligation not to profit from business deals that should go to the entity, to account for income and profits belonging to the entity, and to obey the group's instructions in dealing on behalf of the entity. Nonprofits have additional and different registration, tax exemption qualification, reporting, and ownership rights laws, which are discussed in more detail in a separate guide.
The type of business organization you will use is entirely your choice. Different organizational forms have widely different tax, liability shield, ownership rights, and authority of owners and others to act for or to govern decisions by the business.
The simplest form is a sole proprietorship. The business owner puts in all the money, makes all decisions, pays federal income tax on net income using Schedule C to Form 1040, has no state level income tax to pay on earnings, and is fully liable for any contracts or wrongs the business makes with or does to others. Any name used apart from the owner's name will need an Assumed Business Name Act registration, county by county.
Where two or more people or companies associate with each other to make a profit, they are, by law, a partnership. They can contract with each other to define the contributions each partner must make, the management rights of different partners, and the authority of different partners to bind the entity in contract. All partners are liable for all the partnership's debts and injuries to others, unless the entity registers with the Secretary of State as a limited liability partnership, which allows them to limit liability for entity responsibilities to their ownership shares, for a filing fee of $100/partner (min. 2), up to $5,000. Partners pay federal tax for their ownership based on their share of net income, and also a state tax of 1.5 percent on net entity income, in addition to the individual state tax they owe.
Limited liability companies limit the member's liability for entity debts and other obligations to their ownership shares. Any number of members are allowed, of any citizenship. The filing fee for LLC Articles of Organization, as of this publication date, is $150, with $75 fees due for annual reports. Members contract with each other to define contributions, management rights, rights on purchase or sale of the entity or their interests in same, and authority to act for the entity in an Operating Agreement. LLC members are partners for federal income tax purposes unless they elect to be taxed otherwise. They pay the same 1.5 percent additional state tax on net entity income as other partners.
Business corporations also limit shareholder liability for entity debts and other obligations to their ownership shares. The filing fee for Articles of Incorporation is at least $175 (more if invested capital is high), plus $100 for annual reports. Federal tax law permits corporations which are 51 percent owned by US citizens to file elections under Subchapter S, which gives partnership-like tax on net entity income without additional entity level income tax. Numbers of owners are limited, though partnerships of multiple Sub S companies are allowed. The additional state tax on sub S net income is 1.5 percent. Other corporations pay federal income tax under Subchapter C, with corporation income tax, and then additional individual income tax to owners who receive dividends, salaries, or other distributions of income from their companies. There is a state corporation income tax on all C corporations (though not for sub S entities), and an additional state tax of 2.5 percent on net entity income. Shareholders can establish share class rights in the Articles of Incorporation, and may also enter into voting trusts and/or shareholder agreements to define their obligations to make contributions, their management rights, their income shares, and their rights when the entity is sold or otherwise terminates.
Benefit corporations are another organizational option. You may designate the corporation as a benefit corporation if the business activities will include a public benefit to society or the environment through community, environmental, health, or arts engagement. A benefit corporation integrates social enterprise and public impact with traditional business profit-making goals. The articles of incorporation must state that the entity is a benefit corporation and additional reporting and compliance rules apply.
Before deciding how to organize your business, you would be wise to contact your corporate law attorney and accountant, to work through legal and tax issues, and to set up compliance assistance for reports and regulations that govern your proposed operations.
Selecting and Registering a Business, Product, or Service Name
You may conduct your business under your own name, the names of your partners or business associates, or under an assumed name. You should remember not to choose a name that is the same or deceptively similar to the name of another business, or you may face legal action. LLC and corporation names cannot be registered in Illinois if they are too similar to others on the Secretary of State's register. You may also be able to obtain further legal protection by registering your business or product or service name(s) with the appropriate state and/or federal trademark registration agencies, and seek damages, and attorney's fees against others who improperly use your names.
License to Do Business
A license for your proposed business may be needed from the state or from local governments where business premises are located, or both. The Illinois Department of Financial and Professional Regulation (IDFPR) site governs more than 150 different lines of business, from banking to plumbing, that may have ownership limits, exams or other educational qualifications to practice (for instance, barbers need more training hours than lawyers), license fees, and ethical limits on client solicitation. Lawyers are registered by the supreme court and not the IDFPR. Insurance companies and public utilities have their own governing agencies. State law may also require permits for operations that could cause air, water, land, or hazardous materials problems for others. Similarly, there may be industry or product specific federal, state, or local permissions or registration or health and safety or economic regulations that must be followed.
Many local governments have home office and other zoning restrictions on where and how businesses can operate, and may have additional tax and license fees, especially in Chicago and other home rule communities. A general business license is usually a basic form of local registration, which requires zoning, health department, and other clearance to issue. Local building codes may apply, as well, to require construction plans and permits for occupancy.
Most licenses require annual renewal, with fees to the relevant state and local agencies that regulate the specific type of business or the area where the business operates. Permits and other registrations, zoning determinations, or building code decisions may last until a change of operations requires new permissions, or for multiple years.
Registering to Do Business and Pay Taxes
Several federal and state tax registrations may be required for individuals and business entities. A sole proprietor can operate under his or her Social Security number. Individuals who employ others, partnerships, and business entities need to apply for an employer identification number from the federal Internal Revenue Service. The form used registers the business, which means income, employment tax, and any special federal taxes by line of business may need to be reported to the IRS.
State registration is also required. The Illinois Department of Revenue needs the EIN for use in its REG-1 form, which can be submitted online or by post, and registers the business as liable (or not) for state income, sales, special excise (e.g., on used tires or vending machines), and other revenue based taxes. The Department of Employment Security requires a Report to Determine Liability (UI-1) under the state and federal unemployment insurance tax laws, whether or not the business employs people besides the owner.
Local registration may also be required. Chicago and other cities may impose hotel, amusements, road, and other taxes on their businesses and residents.
Your Compliance Calendar
Once a business is licensed, and registered, with all needed permits for operation, the federal, state, and local governments that impose and their departments that administer particular taxes or other requirements will want annual or other periodic fees, taxes, and reports. Your lawyer, bookkeeper(s), accountant, and other subject matter experts (such as industrial hygienists for OSHA training and injury reports, environmental testing and engineering firms for pollution related permit negotiations, and the like) can and should help you stay in compliance, and should help you identify new rules as they come into effect (or old ones that go away).
A compliance calendar is a useful tool, which can identify when, where, and what government paperwork and payments may be needed throughout the year. Significant reports (and, in many cases, payments) required for most businesses include:
- Individual owner income tax quarterly estimated tax and annual 1040s.
- Business entity owner shares on individual owner tax forms, or entity quarterly and annual forms and payments if entity level income tax is due.
- Employer or contractor-based withholding of federal and state tax (initial reports for each employee, quarterly and annual withholding or employer shares of tax due, UI periodic and annual reports, 1099's for independent contractors and other payees).
- Sales tax returns when required (based on level of sales, can be daily, weekly, monthly, or annual).
- Federal, state, and local excise (specific transaction type) and other special tax returns and associated payments due when required.
- Entity annual reports, annual license renewal forms, local registration forms as required, the former generally to the Secretary of State.
- Entity annual audits, reviews or agree-upon procedure engagements with external auditors for purposes of examining, reviewing or evaluating the financial statements for financing or other purposes.
- Compliance requirements under certain financial arrangements, including various loan covenant compliance requirements.
- Periodic renewals for pollution based and/or line of business based permissions to operate in Illinois or its political subdivisions.
- Internal document review and external contract or other systems reporting and permissions renewal cycle dates.
- Intellectual property maintenance filing due dates.
- Periodic owner and other stakeholder financial reporting and scheduled distributions.
Anyone hiring, employing, and ending the employment of individuals must comply with state contract law, federal and state statutory law, and common law decisions by state and federal judges. For example, employers may not discriminate against any applicant because of race, color, religion, national origin, and a number of other classifications (such as sexual orientation) that may be protected by federal, state, and local laws. Laws also regulate the wages (including minimum hourly rates), hours, and working conditions of all employees, particularly minors. Depending upon the type of employee, a company must pay overtime pay after the employee works a number of hours each week. Larger companies are required to provide health insurance to their employees under federal law. Union organization efforts may be protected under federal and state law. Companies are also required to provide private insurance policies that pay for injuries and death that arises out of and is in the course of employment. Wrongful termination judgments have been as high as $600,000 in Illinois, so great care is needed in employment and contractor relations risk management and associated documents.
Companies often try to save money by arranging for work to be done by independent contractors instead of using employees. Although contracting with individuals as independent contractors is lawful, some companies try to avoid the payment of taxes and benefits by misclassifying individuals who are economically dependent on the firm as independent contractors rather than employees. This may result in penalties imposed by state agencies as well as the Internal Revenue Service, and reclassification of such contractors as employees, with additional liability for pay and benefits due to individuals with employee, not contractor status.
Depending upon the circumstances and the risks to be encountered by a company, some companies obtain liability insurance to cover costs of defense and any insurable claims resulting from employment practices violations. Good hiring, employment, and contracting practices should also be documented using the following:
Job descriptions, which list the functions, supervisory relationships, and other position-specific terms of employment or contract type.
- Individual contracts of employment or retention (for independent contractors), defining at-will (can quit or be fired for any reason) or term and other general employment or contract conditions, individual salary and benefits, stock options or other incentive compensation, vacation (if individual), nondisclosure, noncompete (if allowed), dispute resolution terms (such as arbitration or mediation), severance pay, and other terms of employment or retention.
- A general policy manual (should be labeled and signed off on as changeable at company will, not a contract) to cover breastfeeding, wage and hour rules, vacations, time off for voting, and other legally required or advisable policies for employment and/or independent contractor work with the company.
- Records of complaint resolution and policy enforcement, to show the company is making a good faith effort to comply with all relevant labor laws.
Securities Sales and Other Finance Sources
Selling stock, notes or other interests in your business may be a good way to raise funds to grow or operate the business, and an alternative to obtaining a traditional bank loan. However, any time you sell stock, most types of notes, or other interests in your business to family, friends or other investors, federal and state securities laws apply. Such sales must be registered under those laws unless an exemption is available. To qualify for some exemptions, you may need to file documents with governmental agencies either before or after a sale is completed. In any type of securities sale, prior disclosure of all facts material to the potential investor's choice to back you is required. Failure to comply with federal or state securities laws can result in personal liability and company penalties. Corporate lawyers, broker-dealers, accountants, and business valuation professionals may all be used in preparing disclosure documents, registration or information filings, and follow-on investor reports.
Factoring (sales of receivables), business loans from bank and non-bank sources and other non-ownership relations with companies (like equipment leases or extended time to pay suppliers) may be important additions to your new company's financial methods. Each type has contracts and other documentation your business lawyer can help you understand, prepare, and negotiate.
There are more than 6,000 companies in the U.S. and abroad that raise funds for new and existing operations by selling franchises. These are permissions to use a brand name, along with associated services like joint advertising, group purchasing, product and signage and uniform “look and feel” artwork, copyright, trademark, and other identity management, and training for owners and staff in how to operate one or more units in a franchise system. The Federal Trade Commission and most state governments have franchise registration and disclosure document content laws and rules, and most systems issue national documents and franchisor agreements as a part of the process of signing on as a new unit owner. You should work with your business lawyer and financial advisors to review the franchise agreements, system rules, and the franchise disclosure documents before you sign any agreement. Most disclosure documents must list all franchisees in their systems, and these can be very helpful sources of information on how to succeed as a unit owner. Franchise agreements typically impose very significant financial and legal obligations upon the franchisee. Such franchisees may be partnerships, or have other sources of financing to negotiate, like bank loans. Leases, licenses, and other operational legal issues may or may not be defined and negotiated through the franchise system. System support and some terms of general franchise agreements may be negotiable, and ongoing enforcement often involves working with other unit owners to encourage system management compliance with contract and process obligations, product improvements, and outreach to new customers.
Contracts and Collections
Every vendor prefers to be paid, and you, as a business owner, will need to work with your business lawyer to encourage suppliers and customers to live up to their payment and performance obligations. Courts or arbitration agencies can help you enforce terms of written contracts, but you are even better off if you can arrange to be paid in advance, to get credit card authorization, or to get other payment assurances (like co-signer guarantees on loans) to avoid the costs of credit agencies and collection counsel. Every industry, and most types of transactions, have contract types and issues likely to be used again and again. For software creation, “work for hire” or intellectual property rights retained by programmers may be as significant as their hourly or daily rate of pay. Doctors contract with hospitals and physician groups to define terms of employment, and also with insurers and other payment sources to define rates of pay and billing systems needed to collect for different medical procedures. “Software as a Service” agreements, like magazine subscriptions, can keep customers loyal, instead of requiring resale work for every unit of use. Time of performance and performance quality standards help define what may produce contract damages if violated, and attorney's fees, collection costs, liquidated damages, and arbitration clauses all can help you enforce your deals. Lawyers with contract drafting, negotiation, and collections expertise may be worth more than their weight in gold if they help you obtain and keep the profits you have earned.
Bankruptcy and Reorganization
U.S. Small Business Administration studies indicate that two-thirds of all businesses survive at least two years, and half last more than five. Profitable operations to allow expansion, adequate capital to cover commercialization of innovations until profitability, and the inevitable crises that will afflict operations on the way to success are important in allowing this level of success. Lack of cash flow, fights with business partners, IRS and other tax collections, customer injuries and other judgments, owner divorce, and other disasters (natural and man-made) may kill a business. If future cash flow is possible, federal bankruptcy laws and courts may provide owners a “fresh start,” with the chance to pursue other ventures. For less dire financial straits, renegotiation of loan and supplier credit terms, injection of new capital by partners or private equity sources, customer and employee associated cost reductions and state law assignments of income or assets for the benefit of such creditors may all provide enough relief to resume profitability, with or without bankruptcy court intervention. The costs of bad credit ratings and of reorganization and bankruptcy processes are high, and the legal issues often require specialized legal counsel, not just general business practice firms.
Businesses can and should produce annual or other periodic dividends or other distributions to owners, but their biggest paydays are often associated with successful exit events. This may mean sale of the business to children, to key employees, or to business partners. It could involve purchase of the company—or of a successful product line or division—by a “strategic” buyer that wants access to your customers, your intellectual property, or your management team, or all of the above. It might instead mean sale to or investment in the company by a private equity firm, particularly for companies with more than $2 million in annual profits. Inheritance and income tax minimization, management transition and team building to suit the new owners and investors, customer and key employee relationships and contracts, and the complicated “mating dance” of potential investor or buyer identification, term sheet negotiation, transaction due diligence, deal closing (with transfer of funds immediately or over time), and post-closing dispute resolution are again issues where legal, accounting, valuation, bank, and other (e.g., environmental site assessment) professionals can help you through the stresses of a deal or deals.
Most businesses are family affairs, and there will be people who need to be taken care of in any transition. Investment advisers, estate planning lawyers, “key person” insurance brokers (to fund buyouts or ownership changes on death or disability), and other support institutions (like retirement homes or residences for disabled family members) can all be important parts of the transition planning process.
Prepared by the Illinois State Bar Association's Business and Securities Law Section (2019)