Top Legal Mistakes Business Owners Make
As a business owner, you’re investing in yourself and your passion. But this can lead to legal challenges that threaten your business’s success.
For instance, let’s say an online magazine misclassifies writers as contractors instead of employees and later faces an employee-initiated lawsuit. A strong legal foundation can help prevent these issues and other costly mistakes.
1. Not Creating an Entity
When you start a business, there is a lot to think about. You have to manage employees, ensure excellent customer service, and work on marketing, among other things. A common mistake business owners make is neglecting the legal aspects of their company, which can be very costly.
One big mistake is not creating an entity when you first start a business. This leaves you and your personal assets vulnerable to business liabilities. Forming an LLC or other type of formal entity provides personal liability protection and helps establish a clear distinction between your personal and business assets.
In addition, when you create a legal entity, you can accurately document and own collective assets such as intellectual property or cash. This is important for a number of reasons, including attracting investors and limiting tax liability. In addition, if you’re not a formal business structure, you may not be able to deduct expenses or take advantage of certain tax benefits like the ability to use startup losses as capital gains and converting ordinary income to long-term capital gain.
It’s also essential that you choose the right business structure to meet your goals and fit with your current business model. A lawyer can help you decide which type of entity to choose based on your business needs and goals. They can also advise you on how to transition from a sole proprietorship to an LLC, C corporation, or S corporation for maximum tax benefits.
Some business owners make the mistake of waiting to incorporate until they’re already making taxable sales or they’re thinking about selling the company. This can be a huge mistake, as the longer you wait to incorporate, the more it may cost you in terms of legal fees and taxes.
2. Misclassifying Employees
Employee misclassification is a costly mistake that can wreak havoc on your business. Whether it’s employees who have been erroneously classified as contractors, or your company is paying overtime to an incorrectly classified employee, you can face significant fines and penalties for misclassification. The IRS, state and local regulators, and other government agencies outline specific rules to classify workers, such as if a worker is paid on a set schedule or if they control when and how work is performed.
Many companies misclassify their employees to avoid payroll taxes, minimum wage laws, health benefits, and other labor costs that come with traditional employment. In some industries, such as the gig economy, employers misclassify workers intentionally for flexibility. Whatever the reason, misclassification can cause your company to lose billions in lost tax revenue and expose it to legal risks, including investigations or enforcement actions by government agencies.
When companies discover that they’ve misclassified workers, it is essential to take quick action to correct the issue. This can include determining which workers have been misclassified, addressing back pay and other tax obligations, and communicating changes to affected workers. In addition, ongoing compliance measures should be established to prevent future issues.
Employee misclassification disrupts normal business operations and leads to a negative impact on your company’s reputation. This can make it harder to recruit talent and build a trusting relationship with your team. In addition, the resulting legal proceedings and regulatory agency investigations may cause a disruption in your internal operations, which can hinder productivity. If you’re facing a worker misclassification issue, it’s best to consult with legal professionals for guidance on how to proceed. These experts can help you navigate complex issues, like determining which workers have been misclassified and how long this has been happening.
3. Not Creating a Contract
Whether it’s with clients, vendors, or partners, creating legal contracts is essential. These documents should clearly define relationships, roles, and responsibilities. Contracts can also help mitigate legal issues if things go wrong. Having a process for handling disputes can make the difference between winning and losing a lawsuit.
Often, small business owners create contracts without consulting a lawyer. This can lead to poorly drafted terms and conditions that won’t hold up in court. An experienced attorney can review contracts to ensure they meet all legal requirements.
Another common mistake that business owners make is including themselves in a contract. This can put your personal assets at risk, even if you normally enjoy liability protection by operating your company as an LLC or corporation. It also co-mingles your personal and business finances, which can expose you to risks that you could not anticipate or plan for.
This is a common mistake because it can expose your company to legal risk, and it can be difficult to resolve if something goes wrong. It’s important to have dedicated business bank accounts and credit cards from the start, and keep meticulous financial records for all business transactions.
Another common mistake that business owners make is failing to set clear expectations with their customers. Ambiguous terms and policies can cause customer dissatisfaction, which can damage brand reputation and lead to costly disputes. It’s important to set clear guidelines regarding things like return and exchange policies, warranties, and fee schedules. Putting these details in writing is an excellent way to prevent conflict and ensure that expectations are met.
4. Not Creating a Marketing Plan
Having no marketing plan can result in missed opportunities to reach potential customers. This can lead to a loss of revenue and a lack of trust from customers. This is why it’s important to create a comprehensive marketing strategy that includes a budget for advertising, social media and website development.
Another mistake that business owners make is not taking the time to incorporate properly. Incorporating too late can expose entrepreneurs to personal liability and unnecessary legal fees and expenses. This is why it’s essential to take the time to incorporate early, especially when your company is starting to turn a profit.
In addition, many small businesses neglect to pursue standard contracts before hiring employees and entering into any other business deals. Without these agreements, it can be difficult to limit your liability. It’s also important to clarify terms of service and warranty policies to avoid any disputes or customer dissatisfaction.
Finally, it’s also important to protect your intellectual property by trademarking your business name and copyrighting all written content. Otherwise, your competitors may steal your ideas and gain an unfair advantage. Taking the time to protect your intellectual property is essential to maintaining brand integrity and building trust with customers.
5. Not Creating Intellectual Property
Intellectual property is one of a business’ most valuable assets, allowing it to differentiate itself from competitors, generate revenue and establish brand reputation. It is important to create, register and properly manage IP rights to protect the business from potential infringement.
Without a clear understanding of IP, entrepreneurs can find themselves in legal trouble. This can include a range of issues from data theft (which costs businesses an average of $4.24 million annually) to losing the ability to protect patents, trademarks, copyrights, and trade secrets.
It is important to think about IP early on, even while developing the prototype or product. For example, if you are working with a third party to develop your product, it is worth thinking about whether the agreement contains intellectual property clauses. This can prevent you from spending significant amounts of time and money on a project that cannot able to be patented. It can also prevent others from taking your ideas, designs and innovations and using them for their own benefit.
Similarly, you should consider whether the terms of your employment contract may infringe on your business’s IP. For example, some employers prohibit employees from working on side projects during work hours and require them to sign a non-compete agreement upon leaving the company. It is also worth considering whether to have co-founder agreements, buy-sell provisions, and IP documentation in place, as well as including intellectual property clauses in all contracts with employees or contractors.
Many small businesses get into trouble because of poor human resources management. This can include misclassifying employees as contractors instead of employees, resulting in labor laws violations and costly litigation. It is also common for a business to fail to set up dedicated business bank accounts or credit cards and maintain detailed financial records. This can result in confusion or disputes with customers and damage to the brand reputation.