Ask an Expert: Legal Considerations for Your Fashion Business

In response to my blog post Three Costly Legal Mistakes Your Business Should (and Can) Avoid, a reader asked two questions: “First, what are three costly legal mistakes to avoid in regards to a fashion line forming an LLC? Second, we intend to have employees and outside investors one day. Does that mean that we would need to dissolve the LLC?”    

Let me start with the legal entity structure.  As a general rule, if your business needs outside investments to finance its operations, it is preferable to organize it as a corporation.  Many angel investors and venture capital firms will not invest in an LLC because of its pass through taxation.  Their main concern is with the so called “phantom income” that is allocated to members while no dividends are distributed.  Investors do not want to find themselves with a tax liability on their hands. 

Also, professional investors prefer to invest into corporations that are organized in Delaware.  Why Delaware? Delaware business law (statutes and precedents) has come to be considered as the national corporation law since lawyers are well familiar with it, having studied it in law school, and the most well-known business-related decisions have come out of Delaware courts.  Delaware hosts the oldest in the country (since 1792) Court of Chancery that only deals with matters of corporate law and where judges are appointed based on merit, not elected.  Approximately 64% of Fortune 500 companies and more than 50% of public companies in the United States are Delaware corporations. Professional investors are well familiar with the structure of a Delaware corporation and the fiduciary duties of its directors and officers. 

If you have already incorporated your business as a New York LLC, do not despair. You can convert your entity into a corporation and even move it to Delaware. This, however, may not be cheap. You will need advice of an experienced accountant and a corporate attorney, because if not done correctly, the conversion may result in negative tax consequences for the members.    

Corporations are also preferable as a legal entity choice when you plan to award equity to employees as incentive compensation. Even though LLCs can grant membership units to employees, this process is complicated. Also, LLCs cannot offer incentive stock options. 

In terms of the legal mistakes to avoid for a fashion startup, I would suggest the following: (1) focus on creating and protecting your brand domestically and abroad through filing trademark applications with the USPTO; (2) enter into a written partnership agreement with your partners; (3) make sure that everyone who consults or works as a freelancer for your company signs an independent contractor agreement so that your company owns the intellectual property they have created; and (4) enter into written agreements with manufacturers and other business partners/customers/providers that cover material terms of the relationship; avoid handshake deals.   

Arina Shulga is the founder of Shulga Law Firm, P.C., a law firm that focuses on representing small and growing businesses (www.shulgalaw.com).  Arina conducts a monthly free legal clinic at NYC Business Solutions office in Brooklyn.  She writes a blog www.businesslawpost.com and is active on Twitter (@Businesslawpost).  If you have a question or comment for Arina, please leave her a note below. 

Note that this blog is for informational purposes only and should not be relied upon as a legal advice. 

If you have a question about your business, Ask an Expert. And, if you found this post helpful, please share it with your friends and colleagues on Facebook, Twitter, LinkedIn, and email.    

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The views, opinions, or expressions provided by Arina Shulga do not necessarily represent the views, opinions, or expressions of the City of New York, the New York City Department of Small Business Services, and/or NYC Business Solutions.