COVID-19 has certainly wreaked havoc on many of the aspects of our day to day lives. We all know people who have been affected either by contracting the virus themselves, or indirectly through losing their jobs, or worse. One interesting effect the virus has had in the United States is leading many to consider additional ways they can make money. Often referred to as a “side hustle”, these small ventures have been growing in popularity, and perhaps more so, in necessity as many are looking for ways to help make ends meet.
Just because your side hustle may be small, doesn’t mean you are immune from potential legal troubles that can come if you don’t follow the right processes. In the same way that the foundation of a home is arguably the most important step in the long-term health of a house, building the proper legal foundation for your side hustle is essential to ensure no legal problems can derail your venture in the future, and to make sure you are poised for growth that can come. To make sure you have the proper legal structure in place for your side hustle, here are a few key legal points you’ll want to consider when building your next venture.
What type of business entity should I use?
First of all, yes you should absolutely form your business entity under one of the options we discuss below. The type of business structure you choose ultimately will have tax implications, personal liability implications, and affect your ability to sell your venture down the road. The default answer many people go to when starting a side hustle is to file as a Limited Liability Company. While the Limited Liability Company is incredibly flexible and a good option for many, it is not necessarily a one size fits all legal structure for all businesses. Here are the various options to consider, and the type of side hustles that should use them.
Sole proprietorships are simple to form, and provides to proprietor complete and total control of the business. They own 100% of the venture and can do whatever they see fit with it. The difficulty here, is that this is not technically a separate business structure which means if something goes wrong, the owner is personally responsible for any and all debts, or legal trouble that can come from the business. A sole proprietorship should be used in something like a small neighborhood lawn mowing business, or lemonade stand, or informal services offered like haircuts.
If there is more than one person in the side hustle, a partnership may be the way to go. There are various forms of partnerships, including limited partnerships, which consist of a general partner who has a high level of control over the company but is completely exposed to liability, and a limited partner who has less control over the company but also limited liability as a result. There are also limited liability partnerships which provide limited liability to each of the partners. These types of structures are most often used in law firms, accounting firms, and the like. They can also be used if two people want a less formal way of conducting their business.
Limited Liability Company (LLC)
An LLC is the perfect hybrid between a corporation and a partnership. Perhaps the most beneficial aspect of using an LLC is the protection it provides. In the event the LLC is sued, or goes through bankruptcy, members of the LLC don’t have to fear of being come after personally. Only the LLCs assets will be in trouble in these events.
The profits and losses of an LLC are passed through to the personal income of the members, without the need to pay a corporate tax rate. However, members of an LLC are technically considered by the government to be “self-employed” and must pay taxes toward Medicare and Social Security.
LLCs are very flexible, and are used in a wide variety of industries. It is important to note though, that they can be fragile in the long term, for some state laws require an LLC to dissolve in the event one of the original members leaves the LLC, making the remaining members have to go through the process of filing the LLC all over again.
We’ll discuss the various forms corporations below, but all forms of corporations have a few things in common. First, and perhaps foremost, is a corporation provides the highest level of legal and liability protection to owners of the business. All corporations have ownership in their companies in the form of “stock”. Here are the form of corporations that may be right for your side hustle:
A C-Corp is the most common form of entity opted for when the long term vision of a company is to either be acquired, or go public. C-Corps are also especially good forms to have when seeking to fundraise for a company’s growth. Profits are taxed twice in a corporation, first at the general corporation level of company profits, and then again when dividends are paid to shareholders. Unlike an LLC, a shareholder can leave the corporation without having the corporation going to through a dissolving period.
An S-Corp has many of the positives a C-Corp has, while being able to avoid corporate taxation. Indeed, profits and losses an be passed directly to shareholders without the need to pay tax at the corporate level. An S-Corp is limited to only having a maximum of 100 shareholders, and can only have one class of stock.
Closely Held Corporation
These types of corporations are usually used in lucrative family businesses, where the family wants to divide ownership evenly, and have the legal protections a corporation can provide. Generally, these types of corporations are not eligible to publicly sell stock ownership in the corporation.
Business structures are definitely not one size fits all, and your situation may require a hybrid of multiple of these forms. If you anticipate your side hustle becoming something significant someday, it is well worth your time to discuss with an attorney and or accountant what type of entity will fit your situation best.
Do I have any intellectual property that needs to be protected?
Often one of the most overlooked aspects of starting a side hustle or business is considering the proprietary nature of the goods or services you are planning to sell and or offer. The constitution and statutes of our country are set up in a way to provide competitive advantages to those who are innovative and inventive. Below is a list of the types of intellectual property.
So important is patent law that the founding fathers provided a clause in the constitution for its provision. Article 1 Section 8 Clause 8 states, “To promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.” Simply put, a patent is a legal document providing an inventor the ability to be the sole seller of their invention for a period of 20 years. So, if you created a product that has never been used before, or even something that is a vast improvement from a previous product, you could potentially qualify for patent protection.
A trademark is typically the business or product name for your side hustle. It can also be a logo, a catch phrase, or something similar. It is extraordinarily important that you make sure your desired business or product name is not already being used and or registered already with the United States Patent and Trademark Office. Getting protection for your trademark can eventually be one of the most valuable assets of your entire business down the road.
Typically, a copyright is sought for something artistic, such as a painting, sculpture, or literary such as a book, music lyrics, a movie script, and the like. Copyright protection, however can also extend into fields that may be more relevant to your side hustle such as computer coding. Yes, the code your write to develop your app, or website can be copyrighted and protected.
The biggest example of a trade secret is the Coke Formula. Meaning, the recipe and method for creating a product is so unique that it should be protected from others copying it. This may apply to you if you have a way of making a food or beverage, or even a method creating a consumer good.
I cannot emphasize enough the importance of considering what it is from the outset you’ll be providing or selling as a side hustle, and considering what, if any, intellectual property you have that needs to be protected. This needs to be done right from the very beginning. This properly protected intellectual property can often be the most lucrative part of your side hustle, setting you up for licensing or acquisition opportunities.
What forms do I need to file? Do I need a business license?
This can often be the most confusing part of the process. And lead to the most headaches as a result. Don’t be like those lemonade stands that get shut down by the city for not getting a business license. The truth is, the paperwork you need to file and the licenses you need to get are totally unique to your individual circumstance. A majority of the time, the forms you’ll need to fill out and file can be found on your state’s secretary of state website. Here is an example of one state’s business page on the secretary of state website:
Bringing it All Together
As you prepare to start your venture or side hustle, have the bigger picture in mind. Many of the world’s most influential companies had incredibly humble beginnings, and their founders didn’t necessarily foresee what their side hustle would become. Taking the time, though, to provide your side hustle or business with the proper legal footing to get started, and eventually grow will save you incredible amounts of headaches and legal troubles down the road. Here at MZJ, we help businesses big and small curate legal structures that allow them to thrive in today’s global economy. Contact us today if you have questions related to the side hustle you are starting!