6 Common Legal Mistakes Small Businesses Make & How to Avoid Them

Starting a business is thrilling, but even small legal missteps can lead to big problems down the road. Many entrepreneurs get so caught up in the creative and operational aspects of launching their small business that they overlook critical legal protections. Here are some of the most common legal mistakes small businesses make and how to avoid them.

1. Choosing the Wrong Business Structure

Why it’s a mistake: Many small businesses default to a sole proprietorship or general partnership, usually because it’s the easiest and cheapest option. However, this decision can expose owners to unnecessary personal liability and tax obligations, limiting growth potential and increasing risk.

How to avoid it:

• Research and seek advice: Before choosing a structure, consult with both a business attorney and a tax professional to understand the pros and cons of each entity type. LLCs, S-Corps, and C-Corps offer different levels of liability protection, tax advantages, and scalability.
• Consider your long-term goals: Think about where you want your business to be in 3-5 years. If you plan to seek investors, a corporation may be more attractive. If you want a flexible management structure, an LLC could be a better fit.
• Factor in taxes: The tax obligations vary widely between business structures. For example, an S-Corp allows for pass-through taxation, potentially saving money on self-employment taxes, while a C-Corp is subject to double taxation.

2. Not Protecting Intellectual Property Early On

Why it’s a mistake: Entrepreneurs often delay or neglect to secure their intellectual property (IP), which can result in stolen ideas, branding disputes, or forced rebranding. Competitors can capitalize on your work if it's unprotected.

How to avoid it:

• File for IP protections early: Start by trademarking your business name, logo, and key branding elements. If you’ve created a unique product, process, or invention, consider filing for a patent. The sooner you secure IP rights, the better.
• Register copyrights: For original works like website content, product designs, and marketing materials, registering copyrights can prevent unauthorized use.
• Monitor your IP: After registering, monitor for potential infringements. If you spot unauthorized use of your brand or products, take legal action immediately.
• Use NDAs (Non-Disclosure Agreements): When discussing your business ideas, product designs, or strategies with potential investors, partners, or employees, make sure NDAs are signed to protect sensitive information.

3. Skipping Contracts with Co-Founders or Partners

Why it’s a mistake: Many small businesses are formed between friends or family members, leading to an informal approach to ownership and responsibilities. This can create conflicts later, especially if the business becomes successful and disagreements arise over profit sharing or decision-making.

How to avoid it:

• Draft a detailed partnership or founders’ agreement: Even if you trust your partners implicitly, formalize your relationship with a clear agreement. This should cover roles, responsibilities, ownership percentages, and profit-sharing arrangements.
• Include an exit strategy: In case one partner wants to leave or there’s a dispute, your agreement should outline how this will be handled. Will departing partners be bought out? What’s the valuation process for their share?
• Regularly revisit and update agreements: As your business grows and changes, revisit the partnership agreement to ensure it still reflects everyone’s expectations and the company’s goals.

4. Ignoring Employment Laws

Why it’s a mistake: small businesses often grow quickly, and it’s tempting to take shortcuts when hiring, especially when budgets are tight. However, misclassifying employees as independent contractors, failing to comply with wage laws, or overlooking anti-discrimination protections can lead to costly fines and lawsuits.

How to avoid it:

• Classify workers correctly: Understand the difference between an employee and an independent contractor. Misclassification can lead to penalties, unpaid taxes, and back pay claims. Consult the IRS’s guidelines or work with an attorney if you’re unsure.
• Comply  with wage and hour laws: Make sure you’re paying employees at least the minimum wage and providing overtime pay if applicable. Keep track of hours worked and ensure your payroll is in compliance with state and federal laws.
• Follow anti-discrimination and harassment laws: Ensure you have policies in place to prevent workplace discrimination and harassment. This includes providing training to employees and having a clear reporting process in case issues arise.
• Prepare written employment contracts: Clearly outline job roles, compensation, benefits, and termination procedures in employment contracts. This protects both you and your employees in case of disputes.

5. Not Maintaining Corporate Formalities

Why it’s a mistake: Simply forming an LLC or corporation doesn’t automatically protect you from personal liability. If you fail to maintain corporate formalities, such as keeping proper records and separating personal and business finances, creditors may be able to “pierce the corporate veil” and go after your personal assets.

How to avoid it:

• Hold regular meetings: Even if you’re the only owner, hold annual meetings and document key business decisions. This demonstrates that your business is a separate legal entity.
• Keep detailed records: Maintain accurate records of all business transactions, contracts, and financials. Keep minutes for board meetings or significant business decisions.
• Separate business and personal finances: Open a dedicated business bank account and avoid using personal funds for business expenses. Pay yourself a salary or draw, rather than using business funds for personal purchases.
• Consult with a business attorney: Work with a lawyer who can help you stay in compliance with corporate governance requirements. This will protect your business from future legal challenges.

6. Underestimating Compliance Requirements

Why it’s a mistake: Failing to meet legal obligations like registering for necessary licenses, permits, or tax filings can stop your business in its tracks. You may face fines, business closure, or legal consequences if you operate without the proper credentials.

How to avoid it:

• Research industry-specific requirements: Certain industries, like food service or construction, have specific licensing and permitting requirements. Make sure you understand what’s needed before you start operating.
• Stay up to date on tax obligations: Depending on your business’s location and structure, you may need to file local, state, and federal taxes. Consult a tax professional to ensure you’re aware of all filing requirements.
• Consult with a compliance attorney: For businesses in heavily regulated industries, working with a compliance attorney can help you navigate the complex web of legal requirements. They can also help ensure your business meets OSHA, environmental, or other regulatory standards.

Conclusion:

Starting a business involves more than a great idea—it requires a strong legal foundation. Avoiding these common legal pitfalls from the start can save you time, money, and potential legal headaches down the road. If you’re unsure where to begin or need help with any of these steps, our firm is here to guide you through the process.

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Disclaimer

The information provided in this blog is for general informational purposes only and does not constitute legal advice. While we strive to ensure the accuracy and completeness of the content, it may not reflect the most current legal developments. Readers should not act upon this information without seeking professional legal counsel tailored to their specific circumstances. The use of this blog does not create an attorney-client relationship between the reader and our firm. For personalized legal advice, please contact our office directly.

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