May 22nd, 2020
Making the Leap From a Hobby to a Business: Things to Keep in Mind When Starting a new Work-From-Home Business
Author: Kristin N. Burtzlaff
From colorful mask-making to distilling hand sanitizer to cooking fresh meals – new work-from-home businesses are cropping up everywhere and providing important products and services to their local communities during the current COVID-19 pandemic. While many of these entrepreneurial individuals may still consider these products and services as a hobby, pastime, or merely a short-term solution in response to the current pandemic, hobbyists should recognize the substantial benefits – including liability protection and potential tax benefits – that come with formalizing their hobby into a business. These are just a few of the many considerations in making such transition.
Why A Limited Liability Entity is Crucial
When starting a new business, it is normal to focus on building the business itself and keeping costs down rather than getting caught up in legal formalities. However, by ignoring these legal formalities, the business and its owners may face serious repercussions that can be avoided by forming a limited liability entity. Importantly, a business that is organized through a limited liability entity, rather than as a sole proprietorship or general partnership, protects the owners’ personal assets from creditors in the event a dispute arises and a judgment is obtained against the business.
Forming a limited liability entity can be a relatively straight-forward process that requires filing the appropriate paperwork with the applicable state business authority and drafting an agreement between the owners that addresses the management and operational aspects of the business. There are a variety of limited liability entity forms available, but the most common is the limited liability company (LLC) due to its informality and flexibility in structuring how the business will be managed and operated. Other limited liability entities include limited partnerships and corporations.
The main purpose of the entity’s operating agreement is to provide the rules of the road for operating the business and to reduce future confusion about who has the authority to make the business decisions, which can lead to an expensive, drawn out business dispute. Typically, these agreements will address:
- Who is in charge of the day-to-day operations of the company;
- Who gets to make larger decisions for the business;
- Who can transfer their ownership in the business and in what circumstances;
- How the value of an ownership interest is determined; and
- Certain tax-related matters
While the cost of drafting an operating agreement tailored to the needs of the business and its owners may seem expensive, it will save the business from having to pay substantial litigation costs necessary to settle a dispute arising out of ambiguities in the operating agreement or the relationship of the owners.
Get an Employer Identification Number and Open a Bank Account
Once the limited liability entity is formed and the operating agreement has been signed, the business should obtain an Employer Identification Number (EIN), which is essentially the social security number for the business. This will allow the business to open a separate bank account in the name of the business for purposes of depositing revenues generated by the business as well as paying business-related expenses. Importantly, a business should avoid commingling business and personal funds and should track its business and personal expenditures to avoid the possibility of litigation relating to whether the entity should be stripped of its limited liability protections.
Customer agreements provide important protections for businesses by managing the expectations of the product or service being provided at the outset of the relationship. Typically, these agreements will address the amount of product or the scope of services that the business will provide, the costs for such product or service, and tailored disclaimers about the product or service. These agreements do not have to be long or complicated documents but are a great way to ensure that both the business and the customer are on the same page throughout the business relationship.
Agreements for Employees or Independent Contractors
After the business has its operations in place, the business may consider hiring an employee or engaging an independent contractor. When entering into an employer-employee relationship or a business-contractor relationship, having an agreement in place that clearly reflects the business relationship helps avoid future confusion and can demonstrate compliance with applicable Federal, State, and local employment laws. Depending on the complexity of the work to be provided, these agreements will typically address compensation, the scope of work, fringe benefits, and/or restrictive covenants (e.g. non-competition, non-solicitation).
If you have questions about starting or expanding your own work-from-home business, the experienced business and tax attorneys at Stein Sperling are available to advise you. Please call to schedule a consultation.
You can find more on issues affecting businesses and individuals in our COVID-19 Resource Center.