4 common legal mistakes made by startups
One of the most rewarding aspects of my legal practice is working with small business startups. Every owner is beyond excited about their business concept, and it is so much fun listening to them explain how they plan on conquering the world.
But what makes the work so rewarding is helping small business owners identify and plan for their future by making sure everything is structured properly from the get-go.
Here are four common mistakes we see small businesses make from the beginning, and hopefully you can avoid making them in your new business:
Doing business as a sole proprietor instead of an LLC
Don’t let the legal industry fool you — the process to set up an LLC in Michigan is easy. All you need to do is fill out a two-page Articles of Organization and send it with a $50 check to the state of Michigan. Now, there are potentially a lot of questions and options that should be thought through behind the scenes; but if you are the only owner of your small business, there is simply no reason not to organize it as an LLC. By doing work as a sole proprietor, you are exposing all of your personal assets to business creditors and potentially missing out on tax savings.
Working with partners without a written ownership agreement
While setting up a single-member LLC is easy and very inexpensive, introducing multiple equity owners into a business creates a level of complexity that demands having a written agreement in place between the owners. This often takes the form of an LLC operating agreement, where ownership and management questions can be dealt with up front while everyone still gets along. An operating agreement answers questions like: What happens if the company needs additional capital? What happens if there is a voting deadlock among members? What happens if one of the owners wants to leave the company? Taking the time to think through the relationship issues among owners when a business is first starting will always pay dividends down the road by creating a road map for the inevitable bumps along the way.
Failing to understand personal guarantees and obligations
In my more than 13 years of practicing business law, I have become accustomed to hearing many tales of woe from clients who got into trouble, most of which come about as innocent mistakes and the client becomes a better business person as a result. But the one mistake that will never cease to amaze me is a business person’s failure to understand when and where they are personally on the hook for repaying a debt. Always, always, always have a plan to pay your taxes first, because the IRS will find a small business owner personally responsible and take your personal assets. And always read every word of every business credit agreement to understand exactly which ones contain a personal guaranty.
Hiring without understanding employment law issues
Start-up businesses often try to avoid having employees for as long as possible by calling everyone “independent contractors.” But just because someone works for you part-time without benefits doesn’t mean they are not an employee. The IRS and DOL have made this issue a point of emphasis in recent years and care more about whether a business controls how the work is done, rather than the actual number of hours worked. Someone working only 10 hours a week could be an employee if you provide all of the equipment and tell the person exactly how the job should be done.
And having employees comes with a new level of complexities: What employment law posters do you need at the workplace? When do you have to provide overtime? Can you give benefits to some employees, but not others? Taking a few hours to go through a hiring checklist with a HR consultant or employment law attorney can save many headaches down the road.