[Disclaimer: this post is not meant to be legal advice. The information presented here is solely for general information and is not to be relied upon as counsel or legal advice. When making any important business decision including setting up business entities, taxes, and intellectual property, always consult with an attorney. Drop Ship Lifestyle and the authors of this content expressly disavows any liability for this content. You are responsible for making your own legal decisions.]
Drop Ship Legalstyle: Legal Considerations Before Starting Your eCommerce Store
Quite simply, if you’re running your own business, you need to protect yourself from legal liability. In fact, many manufacturers and wholesalers will only deal with legal entities that are protected from liability.
Should something happen on the consumer’s end, as retailers we may be exposed to liability for the product being defective or faulty.
Who, me? Yes, you.
Have you read your supplier agreements? Is there any language in there that your supplier will indemnify you in a lawsuit for product liability, negligence, or any other prospective claim made by a consumer or anyone else?
You may not have even thought about asking to be indemnified. And, chances are, even if you were to ask your supplier, your request will be outright ignored and deep spaced into your supplier’s legal department.
So, where does that leave you?
You have to shield yourself from liability. The first step in doing this is to create a legal entity that protects your personal assets. The second step is to purchase liability insurance.
School’s In: Business Formation 101
In this post, we’ll talk about sole proprietorships, LLCs, and S-Corps.
Two of the biggest considerations when it comes to choosing a business entity are not death and taxes, but liability and taxes. They’re close, but fortunately for us, not the same thing.
A sole proprietorship is a one-person shop. The sole proprietor’s income and that one’s person’s income is one and the same.
This means that the businesses income would be filed in conjunction with the person’s income as there is no separation of the business and the person. However, sole proprietorship do not provide the owner/person with liability protection as there is no distinction between the person and the proprietorship.
If – for whatever reason – the sole proprietorship were to be sued, the sole proprietor’s personal assets are subject to attack.
Listen up! That means that if you are operating as a sole proprietor and your business gets sued, your property – even if it’s completely unrelated to the business – is potentially up for grabs.
The assets in your personal bank account, your car, and your personal home (including the kitchen sink) that you own together with your spouse might be taken away from you if the amount of damages were that severe.
So, let’s shore up some of that liability.
LLC or Limited Liability Company is a legal entity that separates business owners from their business. What this means is that the business is recognized as a person in the eyes of the state and therefore has its own liability.
So where do you file for an LLC?
Each state has different requirements for filing and for paying taxes. Where you’re organizing your business is very important so make sure that you explore your options and refer to your state requirements. Each state will have it’s own criteria when forming a business.
Let’s first cover the corporation.
Similar to an LLC, the corporation limits personal liability. The first main differences between an LLC and a corporation is that an LLC is owned by one or more members where a corporation is owned by its shareholders, managed by officers, who are controlled by a board of directors.
The second main difference is that a corporation is double-taxed. The first tax is the tax on the corporation’s profit and the second tax is a tax on the dividends the corporation pays out to the shareholders. However, you can make an “S-Corp” election so that there aren’t any taxes at the corporate level but only on the shareholder level.
Keep in mind that you can change your business structure should it make sense for you to do so.
Product Liability Insurance
As the old proverb goes, “expect the unexpected when you least expect it.”
Such is the way of the world and the very litigious United States of America. If, for whatever reason, there is a defect or fault of some kind in one of the products you sell, consider your head being on the chopping block.
And “defects” here is used very broadly and includes defects in the design of the product (inherent danger), defects in the manufacture of the product (assembly defects), and even defects in marketing (insufficient instructions, labels, or warnings).
As part of the distribution chain of the product, you (as a retailer), distributor, wholesaler, manufacturer, and the producer of particular parts can all expect to be named as defendants in a lawsuit. Depending on the state and legal theory in which the case is brought, these types of lawsuits favor the plaintiffs.
Although your personal assets will be protected and shielded by your business entity, your business, and its assets will be the subject of attack – even if you did absolutely nothing wrong!
As a general rule, if you receive any formal legal documentation (and especially when you see your business name on the defendants’ side of the “versus”), you should consult an attorney.
Yes, of course, you don’t want to consult an attorney. Because it’s expensive right?
Fortunately, a good product liability insurance policy will cover attorneys’ fees. Spending that extra bit of money each month – especially if your business is in a lawsuit happy state like New York or California – is well worth the peace of mind that your business has another level of protection and you won’t have to pay out the nose in legal fees should that old proverb come to pass.
The Tax Man Cometh
One main consideration is “tax nexus.” Governments will always want their cut. Tax issues related to eCommerce, and drop-shipping in particular is a fast evolving area of law. The states are slowly making it more and more difficult for us to offer our products entirely tax-free (unless we eat a part of our margins).
Generally speaking, a tax nexus is created and you’ll be liable for paying sales and use taxes to the state where you set up your business when the shipping destination and your business are in the same state (the location of your business is considered very broad and includes the state in which your business was set up in addition to each state in which your business has an employee; if you are in New York and you set up your business in Delaware, you have two states in which your business is located (instead of filing in only New York and your business being in only one state).
Typically, your business is not liable for sales and use tax if your business, the distributor, and the shipping address are all in different states. The end customer is generally liable for the sales and use tax. When the shipping address and the distributor are in the same state, this is when things get really tricky.
Technically, the item is an item for resale.
Usually, in this case, the distributor is liable for sales and use taxes. However, the distributor can avoid paying taxes by having an out-of-state sales exemption certificate on file.
This is why many distributors, manufacturers, and wholesalers will require you to provide a formal exemption certificate (called by different names in each state) before doing business with you.
Of course, there is a lot of nuance in this area and we always advise that you consult with an attorney. We’ll chime in with any major developments in this area and keep you posted. Tax Jar also has some great resources (and a Shopify app) that keep measure of collecting taxes simple and efficient.
Today Is A Good Day To Apply To Become A Legal Entity
You should apply to become a business entity as soon as you can.
Yes, this is even before you start building your first store.
In many states, there is a lag time (and additional paperwork) from when you file to become a business entity and when you will receive a formal Certificate of Authority or Certificate of Resale (or whatever it may be called in your state).
While you are in this lag period, you can build out your first store with demo products and all of the bells and whistles you’d like to add before calling your first supplier for approval. Sometimes, suppliers may not even ask for your business’ formal Certificate of Authority in which case, no worries.
However, you’ll want to avoid the embarrassing situation where you’re asked for one and you don’t have it. Perhaps nothing is more deflating than losing credibility with a gold supplier because of a completely avoidable mistake.
One of the first things you can do is check whether your prospective business name is available in the state where you are registering. A simple online check should only take a few minutes. Meanwhile, you can shoot right on over to the IRS website to apply for an Employee Identification Number for your business.
You’ll need to have your EIN and the formation documents for your legal entity before heading over to the bank to open a business bank account for your business.
If you like the bank where you do your personal banking, consider using them for your business banking. There are benefits to doing so.
When opening a business account, you might have to have a specified amount of funds in your business account each month. Otherwise, you might be charged each month for falling below the minimum. Some banks will allow you to apply the funds that you have in your personal account towards that monthly minimum.
While at the bank, also consider applying for a new credit card for your business. Use that card for business purposes as well as establishing a credit rating for your new business. Using a single credit card for your dropshipping business is a really great way to quickly load up on the perks that come with the card (did somebody say frequent flyer miles?).
So, quick recap here: form your business entity as early as you can. Get cracking on the paperwork for your business’ Certificate of Authority or Certificate of Resale (or whatever it may be called in the state in which you form your business).
While waiting for the Certificate, that’s when you should build out your store. Otherwise, you may have a store that is all ready to go except you can’t call suppliers because you don’t have your Certificate.
You’ve Got Issues, Intellectual Property Issues
You may have noticed that some logos and brand names have a superscript “TM” or an R in a circle - ® - next to them.
If you’ve ever wondered what those are and if you should have them too, here’s some helpful advice to help you stop wondering.
These little guys can actually pack a super powerful punch. They denote that the logo or brand name is subject to trademark protection. How much protection depends on a whole host of factors and whether it’s a TM or an ® next to the logo or brand name.
The TM, in essence, is a common law and “informal” trademark. The owner of a logo or brand name can place the TM next to the logo or brand name that the owner wants to be protected. This costs you nothing.
Yes, it’s free. As in there really isn’t any reason why you shouldn’t (with some caveats that probably don’t apply; consult an attorney if you have any questions before using a TM).
Truth be told, though, this protection is of limited value. As in, you can’t sue anyone for trademark infringement without a formal trademark.
What it actually does is helps the owner establish a “first use” of the trademark to outwardly demonstrate to the world that any time this logo or brand name is seen it emanates from that business.
Over time, it will hopefully begin to engender trust, brand loyalty, and become a visible reminder of the business without immediately being associated with a particular product.
Each time you use your trademarked logo, brand name, etc., keep a record of its use. For example, if you advertise your store using a banner ad on an influencer’s blog in your niche, make note of the site, dates of advertising run, and how many impressions the ad had.
All of this will be in preparation for filing for the very formal and authoritative ®. In addition, your use will prevent someone else from using your trademark in those places where you’ve used it (and if you’ve used it online, that’s potentially all of the United States).
The ® is a formal trademark as registered with the United States Patent and Trademark Office. The filing process is relatively simple for trademarks and, especially compared to filing for patents (the preparation and filing for which may run you into the thousands of dollars) is inexpensive.
The law used to require that you used a TM for at least five years before filing for the formal ®. These days, you can spend $225 and file for the formal ® even before you have a product in commerce.
Though, as a dropshipper, you’ll likely refrain and spend your bootstrapping cash for more important things, like building your store and your AdWords campaign.
You’ve Got Mail, But You Wish You Hadn’t
If – when researching a niche and ideas for a store name and logos - you see a name or a logo that you were thinking of using (because, hey, great minds think alike but someone came up with your idea before you), best to stay away.
There will be many more names and logos you (or your outsourced UpWork of Fiverr designer) can come up with. Be creative.
If, by some misfortune, you happen to use a name or a logo that is being used by someone else – and especially if they trademarked their name and logo – expect to receive a Cease and Desist letter.
This is a very fancy way for a lawyer to say “Hey bud, we caught you with your hand in the cookie jar. Stop doing it [cease] and don’t do it again [desist].” You’ll likely simply want to quit your brand and use of your logo. Though, you may have some time to do so along with domain name redirects to protect your Google juice and SEO.
If you notice that someone else is ripping off your name and logo, make sure to consult with an attorney before firing off Cease and Desist letters of your own. There is a law out there that says that you may be giving up certain claims in a prospective lawsuit if you don’t include particular provisions in your letter.
Be Intellectual About Your Intellectual Property
Some great advice to keep in mind is that if you don’t have an exit plan for your business, it’s a job. For many of us, it may be difficult to think of having an out and selling our store (which may be months or years away), but we’re building our stores for present cash flow as well as building it up as an asset for a future sale.
Any diligent purchaser worth their salt will do a full check on your business as a prospective asset and should inquire whether the asset is free can clear of any intellectual property claims.
Woe would be the seller that almost closed on a six figure sale for his or her store – including the logos, brand name, etc. – only to find out that purchaser discovered that another company can easily lay claim that your logo or brand infringes on their trademarks.
Start thinking about protecting your assets – including your intellectual property – now, as you’re building your business, instead of when you’re prettying things up for a sale.