When you create your business, your hopes are high, and, unfortunately, so are your risks. Many small businesses make very major legal mistakes and put their businesses at risk simply by not knowing simple legal issues they face, and by not obtaining the best help available to help them navigate the legal arena.
In general, there are six general pitfalls that business owners are vulnerable to, that can create troubles in their businesses and cost them money, time, extreme stress and headaches.
The following mistakes are easily overcome, if you understand and plan for them:
1. Not forming an LLC or corporation immediately. Many entrepreneurs decide to start and continue their business as a sole proprietorship “until the business gets off the ground.” This can be a very serious error, for two reasons.
The most familiar reason is that forming a separate business entity separates your business and personal assets, and protects your personal assets and finances (and credit record) from damage or loss due to business problems.
When you do not have an asset protection entity such as a limited liability corporation for your business, you enter into a risky world where everything you own is threatened to be lost . Given the number of lawsuits today and the number of non-LLC business owners who are losing everything they own, this safeguard is a must have. However, this is not the only risk.
When you wait until the business is a going concern and has financial worth before you form a separate entity, such as a limited liability corporation, the Internal Revenue Service may take an interest in this and impose a steep tax. All of the owners of the company may find themselves owing a huge amount of tax monies to the IRS, which could have been avoided by forming an LLC early in the life of the business.
2. Not issuing ownership interests at the outset. If you are the only owner of your business, this will not be of interest, but if the company has multiple founders, you should pay close attention. It’s quite common for people starting a business together to work out the details of who does what, who will own what interest, and all the ins and outs—and then not actually issue the ownership interests in the business.
It may seem acceptable to just go on with an understanding of what everyone does and owns, but this is a business, and it’s vital that you take care of these things formally. You must issue ownership interests in your limited liability corporation or corporate business at the start.
If you later decide that you want to borrow money, take on a strategic partner, or sign a major agreement with a vendor, you may have to prove the ownership interests before they will do business with you.
Not doing so can create delays and challenges later when operating your business. Third parties, before doing business with you, will want to see written documentation of ownership interests. They will expect that ownership interests have been issued and that these reflect the actual makeup of the company.
The more troublesome issues can arise because time can make memories fuzzy. You may end up in a situation where your other business owners have different recollections of what was agreed upon when it comes to ownership. This can ruin not only your personal relationships with the other owners, but your company, as well.
And, of course, there is the previously discussed fact that the owners can face a huge tax bill if ownership interests are not documented and issued in a limited liability corporation after it starts earning money.
This is an easy matter to avoid, simply by issuing ownership interests when the company is first established and formed and making sure that everything is in order from the beginning.
3. Not vesting service partner ownership interests. Many business owners take on partners who contribute to the company in the form of a service, introductions or connections, or some other non-financial contribution.
When you take on service partners of this nature, be careful to “vest” their ownership interest in your limited liability corporation or corporation. This means, quite simply, that the ownership interest is only issued when certain requirements are met. For service partners, this is usually when the service obligation is completed. If the obligation is not met, then the ownership interest is not issued or subject to return.
This protects you and your partners from losing part of your business to someone who has not met their obligations to the company. While you expect the best from everyone, you could quite easily be giving up part of your company to someone who did not meet his agreed upon requirements. If the ownership interest is not vested, and is issued outright, you cannot take it back without the consent of the owner, so you could be stuck with an unwelcome and nonperforming owner [spin] benefitting from your business.
No reasonable person will object to a vested condition when it is being granted for services that have not yet been performed. Vesting the ownership interest will protect you and your partners in your limited liability company or corporation.
4. Not requiring confidentiality agreements before sharing key information. This is a very serious [spin] problem that can cost you a great deal of money and devastate your company. This is every bit as important as forming an LLC or corporation from the start.
Before you show confidential information to anyone, you should require to sign a nondisclosure agreement. This is simply an agreement that they will not share or use your confidential information for any reason other than the reason you’re sharing it with them.
This would include any guarded information, including your business plans, marketing and sales strategies, pricing, methods and processes. And it especially includes intellectual property; you can actually lose the right to valuable intellectual property rights such as patent rights if you disclose certain information without a confidentiality agreement.
Of course, some people will refuse to sign a confidentiality agreement. You will have to choose who you wish to work with and whether they have business integrity. However, you should also add a confidentiality notice to all written documents. This may provide trade secret protection for your company depending on your state laws.
5. Not getting a transfer of ownership from contractors. You are probably using outsourcers to create information and perhaps products, software or other intellectual property for your business. This is a very effective practice; it saves you money and time, and helps reduce your overhead and increase your profits.
Make sure, when the project is finished, that ownership is transferred to your limited liability corporation. The contractor initially has ownership of the completed work until they transfer those rights to you. A work for hire agreement is the most common way of transferring these rights.
Make sure, if you work with an overseas contractor, that you have the proper ownership and protection agreements in place.
6. Not hiring the right lawyer. The worst mistake a business owner can make is hiring a lawyer who works in any or every field of law. When you hire a generalist, that attorney will cost you far more money, because they will have to do a lot of research and study to learn the ins and outs of business legal matters.
Given that you pay based on a billable hour, you end up paying higher dollars to give your lawyer an education. Because they do not work in just business law, they will not be aware of the breadth of issues that are relevant to your business.
And, even worse, you may end up not receiving proper and complete advice you need to protect you and your business. A generalist who does not deal in business law issues on a daily basis will lack the expertise to know the practical and real risks. So, you may end up spending more money in legal fees to get improper and bad advice.
When you hire a attorney for your company LLC or corporation, make sure you hire a business specialist attorney with experience and knowledge related to the issues you face in your business industry.
These legal problems can sound scary, but the main reason for learning about them is that they are easy to plan for, by hiring the right business lawyer for your company and executing the right agreements at the right time. Start with getting legal entity protection. Here is where you can get free LLC information.