Avoiding Common Legal Pitfalls of Small Businesses – Part I

On Behalf of | Mar 23, 2021 | Business Law |

Small businesses make legal mistakes all the time. Many may go unnoticed. But some of these mistakes can be very costly and difficult to recover from. For decades we have represented many start-ups and emerging businesses, and we have seen the same mistakes being made over and over.

This article is the first in a series designed to help small business owners avoid making the same errors. Having experienced business legal counsel on your team will help you avoid these traps.

Mistake No. 1: Ignorance of the law

We have all heard the phrase, “ignorance of the law is no excuse.” It’s true. But laws are numerous and complex. How do you deal with that? First, don’t be intimidated. You cannot afford to ignore legal issues just because laws are overwhelming and scary. Learning a little about the following basic areas of the law can help keep you out of hot water:

• Best practices for setting up and operating your business (from a legal perspective)
• Major employer-employee laws and how to handle them
• What to know if using independent contractors
• Basic contract rules
• How to protect your ideas and inventions (patent, copyright, trademark, trade
secrets, confidentiality agreements)
• Securities laws – if you ever want to raise outside capital for your business
• Governmental regulation of your business – particularly if you are in a heavily regulated industry such as banking or other financial services, insurance, etc.

Mistake No 2: Starting or maintaining your business as a sole proprietorship or general partnership rather than a corporation or limited liability entity

In a sole proprietorship, the owner of the business is liable for all debts and obligations of the business. Under state law, partners are jointly liable for the debts and obligations in general partnerships. If the business encounters a problem, all of your investment in the business – as well as all of your personal assets – are potentially at risk. Legal entities such as corporations, limited liability companies (LLCs), and limited partnerships provide a “shield” to protect your personal assets.

But beware – it is not as simple as going on-line, creating an LLC and saying “whoo-hoo, I am all good now!” And please do not use online self-help tools to incorporate your business. While these ideas seem tempting, often times you will wind up paying down the road. There are many legal considerations in properly setting up and operating your business from a legal perspective that deserve the attention of and your investment in experienced legal counsel.

Mistake No. 3: Not clearly documenting Owners’ rights and responsibilities

Shareholders, members or partners should have a written agreement that answers the following questions:

  • How much capital will each person contribute?
  • What happens if the business needs more capital?
  • Can an owner sell their interest to an outsider?
  • How much time and effort is each person expected to contribute to build the business?
  • What happens if one person leaves the business? Divorces their spouse? Dies?
  • Will the stock or other interest be bought back from the person leaving the business, the surviving spouse, or the estate of a deceased owner? How? And on what terms?

Owner’s agreements are critical to avoiding costly and protracted distractions when circumstances change.

Mistake No. 4: Not keeping proper corporate records

Improper record-keeping can cause problems with the IRS and state taxing authorities, result in personal liability and limit your ability to obtain bank financing or raise equity capital. Yet small businesses are notorious for failing to keep required corporate records. Failure to document meetings of the board of directors and shareholders, failure to record stock issuances, and failure to document stock transfers are just a few of the common infractions of rules that exist to protect the status of a corporate entity.

Good corporate governance and practices are essential to maintaining the “corporate shield” that protects your personal assets. And don’t forget about your financial and tax matters. Having an experienced business accountant on your team to assist you with keeping sound financial records and preparing your taxes is critical to avoid tax problems. It will also prove invaluable should you seek to sell your business down the road.

At McIlnay Button Law, a full-service business law firm, we are here to help you navigate through the common legal issues faced by business owners and avoid the unnecessary risks and costs associated with them. Please contact us at 262-421-8059 or via www.mcbusuinesslaw.com.