Legal Considerations when starting a Small Business

By | Small Business

Brad Bunt, director of the Kilgore College Small Business Development Center in Longview Tex., said legal issues are “the most overlooked and underthought aspects of small business.” Bunt, who has counseled small business owners for 25 years and once operated Subway Sandwich franchises, said persuading owners to consider the legal implications of their businesses can be difficult. “Failing to explore those issues can be ruinous to your business and your personal life,” he said.

He said liability and taxation are two legal issues he discusses first in a small business course he teaches. “It’s important to set up the right legal structure early on,” he advised. “If you set up as a sole proprietorship and someone falls, or gets sick on one of your products, they can not only sue your business, they can sue you. They can take all of your personal and business wealth. I’ve seen people wiped out by lawsuits. The right business structure can protect you. A C-Corp or an S-Corp or a limited liability company (LLC) separates you from your business, your personal assets from your company’s. The IRS likes that separation, too.”

He said small businesses also need to create company policies and procedures, beginning with personnel manuals and speaking with employees about sexual harassment and discrimination and displaying the federal policies regulating workplace behavior. “Forming a legal entity like a corporation is a lot harder than a sole proprietorship,” he said. “You have to prove you have regular meetings and be prepared to take minutes to prove that legal entity exists.”

He said judges in lawsuits frown upon companies that claim to be corporations, but operate like sole proprietorships.

Avoiding spending money not always wise

Bunt said he understands why small businesses try to avoid spending money. “I always recommend that even if you do the paperwork on your own, have an attorney review it and list the attorney as the legal representative of your company, so that attorney will be mailed any paperwork if you are sued,” he advised, adding that the Small Business Administration’s 1,200 Small Business Development Centers can help perform patent and trademark research for small businesses, checking names and trademarks with the secretary of state’s office.

Bunt noted that immigration audits are growing more common in Texas and other border states and pose potential legal risks for employers. “The proper employee paperwork must be kept in order for employers to protect themselves. Even if the paperwork provided by the employee is fake, if it appears legitimate and the owner has no reason to conduct a full-fledged background check and keeps it on file, it offers protection. But without it, employers can face huge problems and fines.”

Compliance and Small Business

Luke Wake, senior staff attorney for the National Federation of Independent Business’s Legal Center in Sacramento, Cal., said risk assessment is a key step in gauging potential legal problems.

Wake said liability across a broad range of issues is a growing concern to small business owners. “The ones we hear about most concern wage and hour disputes and wrongful termination,” he said. “Those can happen even if you’ve done everything right. You have to make sure you have the right documentation to show you have been compliant.”

Wake said he spoke with an NFIB member about a wage and hour suit. “The owner said he’d been in business for 19 years without a lawsuit,” he said. “You never know when you’re going to get hit. Even if it’s a frivolous action, you may need to consider talking about a settlement, simply because it could be cheaper than litigation. You have to consider the possibility that you don’t win.”

Sort out legal assistance before you start your business

He said business owners should consult a tax attorney even before they organize their company to determine which model suits them and best protects their personal assets. Wake also suggested insurance coverage for personal injury issues and even against lawsuits.

He said some issues require a lawyer, such as workers compensation. “You can get dinged big time if you don’t do it right,” he said. “And if you’re dealing with independent contractors, unionization, OSHA exposure or similar issues, it’s a benefit to have  an employee handbook for those issues.”

He warned small business owners to be aware of potential contractual issues, addressing at the outset indemnification clauses, attorney fees and disincentives in vendor and other contracts. “There are all sorts of unexpected events people don’t think about,” he said. “Make sure your contracts are vetted by attorneys well-versed in commercial litigation.”

Katie Vlietstra, vice president of government relations for the National Association for the Self Employed (NASE), recommends new business owners reach out to other owners or get involved in local rotary clubs or chambers of commerce to glean advice about attorneys and legal options.

Vlietstra said owners sometimes find themselves in legal and financial trouble for co-mingling their money. “I especially see it in people who’ve done things a certain way for many years and now are facing huge challenges because they never changed their original practices,” she said. “That can cause huge problems and headaches.”

Michael Beene, former NASE general counsel in Dallas, Tex., said small business owners need to make time to assess the risks in their business model.  “You have to do your legal filings correctly. Sit down with your CPA and legal advisor and understand how and why you’re doing this business,” Beene said.

He said when small businesses begin to add employees they assume greater risk. “Owners need to understand employment law and get good advice up front, because finding out after the fact is a lot more expensive and can damage professional relationships.”

Beene recommended owners consider a general commercial liability insurance policy to protect themselves from lawsuits. “It’s more affordable than you think and encourages you to protect yourself and move exposure from you as an individual.”

Beene said small business owners should ask themselves if they own the rights to their website content and how can they protect their intellectual property, such as recipes, logos, and website content or product specs.  “You don’t want to invest in a name, logo and brand, only to get a cease and desist letter from another company. Make sure you own the content of your website if you hire an outside contractor,” he said. “It’s worth it to hire someone to protect your name, intellectual property and trademark. I know many people who realized that too late.”

Legal Issues with Partnerships

Michael O’Malley, a mentor with the Fairfield County, Conn., chapter of SCORE (formerly Service Corps of Retired Executives), said one of the most common legal questions asked by newly minted small business owners is about partnership agreements.

O’Malley, who launched two clothing companies on New York City’s Seventh Ave., said it’s preferable to create partnership agreements even before the first dollar of revenue is booked.

“Money has a way of changing relationships,” he observed. “You don’t necessarily have to hire a lawyer to create the partnership agreement, but it should be mutually agreed upon and signed and notarized. It’s almost easier to obtain a divorce than to separate a business without a partnership agreement. And it’s the most painful thing to see: people of good will, often good friends, at each other’s throats. It can be very painful, messy and costly.”  

Another frequently overlooked issue is succession planning. “Most entrepreneurs don’t want to think about it, but they need to work out how the business will be passed on or sold. And they should probably seek some legal advice about that.”

O’Malley said SCORE chapter mentors can’t provide legal advice, but they can help. “We offer assistance on a variety of legal issues that can help entrepreneurs decide when they do and don’t need to hire lawyers. We support them on their journey and help them to ask the right questions.”

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