Law and Small Business & Startups

Legal mistakes commonly made by small businesses

July 16, 2014
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Starting a small business can be both an exciting and stressful time. Often times, legal considerations and requirements can get lost in the shuffle — and only come to light when the business owner is attempting to sell the business or is getting sued.

The purpose of this post is to point out some common legal mistakes that we see befall small businesses and hopefully help you avoid them in the future.

Failing to retain professional advisors

An experienced business attorney can be invaluable in protecting a small business from significant liabilities. While this can require some outlay of resources early in the life of the business, the goal is to avoid paying a lot more money in the future.

Failing to form an entity that limits personal liability

Businesses that are run as sole proprietorships or partnerships cannot protect the sole proprietor or partners (or their respective assets) from the liabilities of the business. Corporations (“S” Corporations or “C” Corporations) and Limited Liability Companies (LLC) provide the business owners with protection from personal liability for the businesses debts, assuming that the business owners do not fall prey to the mistake below.

Maintain corporate formalities

Corporations and LLCs are legal entities that are separate and distinct from their owners and protect the owners from the liabilities of the business, provided that the distinction between the business and the owners is maintained. Business assets should not be commingled with personal assets. Personal obligations should not be paid out of bank accounts belonging to the business. Shareholder and director meeting minutes and resolutions should be kept in writing. Failing to maintain these formalities may lead to the owners losing the liability protection provided by the Corporation or LLC and becoming personally liable for the company’s debts and obligations.

Lock down any intellectual property

The intellectual property of a business (software, code, know-how, domain name, logos, business name, etc.) can sometimes be the most valuable asset of the business. A business can protect some of its intellectual property by pursuing a trademark, copyright or patent, as applicable, for such intellectual property. The business should also consider affirmatively protecting its intellectual property by having its employees, contractors or agents execute confidentiality and invention assignment agreements. To maximize the value of the business, the owners should consider transferring to the business any intellectual property owned by the owners but used in the business. Additionally, businesses need to make sure that their owners, employees and contractors are not still parties to confidentiality, nondisclosure, invention assignment or other similar agreements that may jeopardize the intellectual property of the business going forward.

Employment issues

Hiring employees involves more than simply making an offer of employment. There are state and federal requirements that the business must comply with in hiring employees, and these requirements can be extremely time sensitive. A business should consider having an employee handbook, which may include workplace safety rules, hiring and termination practices and other similar topics. Any proposed handbook, however, should be reviewed by an experienced employment attorney.

Failing to get agreements in writing

While oral agreements may be enforceable in certain instances, it can be time and resource consuming to attempt to enforce those contracts in the future. Well-written agreements can help provide certainty in the business relationship going forward (ideally) and alleviate any potential ambiguities in the performance under the agreement. Well-written agreements can also limit liabilities and provide additional recourse should one of the parties fail to perform. For example, in Michigan, the general rule is that each party to a lawsuit is responsible for its own legal fees and costs. An exception to that general rule, however, is if the underlying agreement provides for reimbursement of the legal fees and costs for a particular party. When executing a contract, make sure that the business is a party to the agreement and that the signor is executing the agreement on behalf of the business in his/her capacity as an officer/director/member/authorized agent, as applicable, of the business.

Failing to consider succession planning issues

What will happen if one of the owners of the business dies or becomes disabled? What if one of the owners gets a divorce from their spouse? What if one of the owners wants to sell his/her interest in the business to an unknown third party? These and similar issues can be addressed in a shareholders' agreement, buy-sell agreement or similar provisions in an operating agreement. Without these agreements or provisions, existing owners may get stuck with a new owner that does not mesh well with the business. Additionally, in the case of divorce, the existing owners may find a disgruntled ex-spouse as a new owner in their business, which could be less than ideal. In order to ensure the continuing success and viability of the business when these difficult issues present themselves, the business owners must be aware of and address these succession planning issues in the early stages of the business.

This list is not exhaustive by any means, but represents some of the more common mistakes that we have experienced in representing small businesses.

Consulting with experienced legal counsel can help you identify and address these common pitfalls early in the life of your new business and protect you and your business from significant liabilities down the road.  

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