Legal Considerations when starting a Small Business

5 minute read

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.”