An entrepreneur needs to be well versant with the law of the land, at least to the extent to which his firm will be affected. Ignorance of the law can be very detrimental to the survival of the firm and could prove costly in the end.
When setting up a business, there are some important legal matters that the entrepreneur will have to deal with, no matter how much he would love to just dive in and get started.
If he neglects these legal steps, he will find that maintaining the business down the road becomes much more difficult, and in some cases, impossible.
It’s in his best interest to take these legal aspects seriously and get them sorted out as soon as possible when starting a business. The emphasis on this section is to bring out the salient legal aspects that affect the running of a business and what the entrepreneur needs to know. The legal aspects the entrepreneur needs to be aware of are;
Key Legal Considerations for New Businesses
1. Laws that can affect the business
By looking at the legal documents which are usually available for all to see, the entrepreneur will be in a position to assess the effect of each law that is relevant to his kind of business venture.
One important thing that he should be interested in, for instance is the issue of taxes. The entrepreneur should assess how the Government will tax him and his business under the various forms of business ownership.
On the same note, he may also be interested in knowing the tax incentives available for his type of business. It may work in his favor in subsequent periods.
2. Laws concerning capitalization
The firm cannot survive as a business without proper capitalization, and this will include both matters of equity and debt. Equity is gained through sales of business ownership interest, such as stock shares while debt is acquired through financial loans from lending institutions.
Before the entrepreneur even thinks about starting the business, he’ll need to have a good relationship with his bank or an established financial institution. If he doesn’t have adequate capital, the business will fail, regardless of how thorough his business plan was.
3. Law concerning the various forms of businesses
This will determine whether the entrepreneur can be sued for issues arising between the business and his customers. It is extremely important, and often neglected when starting a business, but this can actually make or break the entrepreneur during those crucial first years when the business is trying to be established and grow.
The entrepreneur would not want to be left with liability issues, debt problems, or unnecessary obligations. The kind of legal entity will also determine the tax strategy that the government applies to the business. The entrepreneur should protect himself from liability issues, and he should ensure that he is not personally held responsible for any unfortunate happenings.
4. The nature of business contracts
A business contract is a legally binding agreement between two parties for an exchange of services that are of value. For a contract to be valid, an offer must be made and accepted. Using a contract in business dealings helps ensure an agreement is acted on, insofar as a broken contract could result in a lawsuit or out-of-court settlement and the payment of damages caused by the breach.
The best way the entrepreneur can avoid a dispute or potential litigation, however, is to prepare a solid agreement in which he is confident he has negotiated the best terms for his business.
Sources of Finance for Businesses
Businesses can acquire finances from various sources. These include;
Owner's Capital
This is often the only source of capital available for the sole trader starting in business. The same often applies with partnerships, but in this case there are more people involved, so there should be more capital available.
This type of capital though, when invested is often quickly turned into long term, fixed assets, which cannot be readily converted into cash. If there is a shortfall on a Cash Flow Forecast, the business owners could invest more money in the business.
For many small businesses the owner may already have all his or her capital invested, or may not be willing to risk further investment, so this may not be the most likely source of funding for cash flow problems.
Ploughed back profits
Firms make profit by selling a product for more than it costs to produce. This is the most basic source of funds for any company and hopefully the method that brings in the most money.
Borrowings
Like individuals, companies can borrow money. This can be done privately through bank loans, or it can be done publicly through a debt issue. The drawback of borrowing money is the interest that must be paid to the lender.
Issue of Shares
A company can generate money by selling part of itself in the form of shares to investors, which is known as equity funding.
The benefit of this is that investors do not require interest payments like bondholders do. The drawback is that further profits are divided among all the shareholders
Overdraft
This is a form of loan from a bank. A business becomes overdrawn when it withdraws more money out of its account than there is in it. This leaves a negative balance on the account.
This is often a cheap way of borrowing money as once an overdraft has been agreed with the bank the business can use as much as it needs at any time, up to the agreed overdraft limit. But, the bank will of course, charge interest on the amount overdrawn, and will only allow an overdraft if they believe the business is credit worthy i.e. is very likely to pay the money back.
A bank can demand the repayment of an overdraft at any time. Many businesses have been forced to cease trading because of the withdrawal of overdraft facilities by a bank. Even so for short term borrowing, an overdraft is often the ideal solution, and many businesses often have a rolling (on going) overdraft agreement with the bank.
This then is often the ideal solution for overcoming short term cash flow problems, e.g. funding purchase of raw materials, whilst waiting payment on goods produced.
Bank Loan
This is lending by a bank to a business. A fixed amount is lent e.g. $5,000 for a fixed period of time, e.g. 3 years. The bank will charge interest on this, and the interest plus part of the capital, (the amount borrowed), will have to be paid back each month.
Again the bank will only lend if the business is credit worthy, and it may require security. If security is required, this means the loan is secured against an asset of the borrower, e.g. his house if a Sole Trader, or an asset of the business.
If the loan is not repaid, then the bank can take possession of the asset and sell the asset to get its money back. Loans are normally made for capital investment, so they are unlikely to be used to solve short-term cash flow problems.
But if a loan is obtained, then this frees up other capital held by the business, which can then be used for other purposes.
Leasing
With leasing a business has the use of an asset, but pays a monthly fee for its use and will never own it. Think, of, someone setting up business as a Parcel Delivery Service, he could lease the van he needs from a leasing company.
He will have to pay a monthly leasing fee, say Kshs.50,000, which is very useful if he does not wish to spend Ksh.800,000 on buying a van. This will free up capital, which can now be used for other purposes.
A business looking to purchase equipment may decide to lease if it wishes to improve its immediate cash flow. In the example above, if the van had been purchased, the flow of cash out of the business would have been Ksh 800,000, but by leasing the flow out of the business over the first year would be Ksh 600,000, leaving a possible Ksh 200,000 for other assets and investment in the business.
Leasing also allows equipment to be updated on a regular basis, but it does cost more than outright purchase in the long run.
In an ideal world, a company would bring in all of its cash simply by selling goods and services for a profit. At some point the company may need to invest in big investment that will yield returns in the near future. For this reason, a time will eventually come when the company will need to acquire funds from any of the above mentioned.
When evaluating companies, it is most important to look at the balance of the major sources of funding. For example, too much debt can get a company into trouble. On the other hand, a company might be missing growth prospects if it doesn't use money that it can borrow.
Business Amalgamations
Business amalgamation refers to the process where, by mutual agreement, the owners of two or more business combine resources to operate as one legal entity. This can take any of the following forms.
- Merger and Acquisition
- Take over
- Franchise
