Starting a new business requires a lot of time, effort, and patience. However, while it’s easy to focus on the operational side of your new enterprise (e.g., UVP, marketing, equipment), there are quite a few legal challenges to overcome as well. Unfortunately, many new businesses don’t consider the legal side of things, so they make costly legal mistakes.
Fortunately, we’ve compiled a list of the top seven legal mistakes that entrepreneurs make so that you can avoid them. This way, your new business will be compliant and start on the right foot. Let’s begin.
1. Choosing the Wrong Business Entity
First and most Expensive legal mistakes are choosing wrong Business Entity. Your business entity matters for a couple of reasons. First, it will dictate your tax structure, which will be crucial when managing your company’s finances. Second, your entity type can separate you from your business, which is helpful to avoid incurring massive debts and obligations. Finally, your business entity helps determine the type of financing you can get or whether you can open a merchant account. There are four primary entities you can choose from, including:
- Sole Proprietorship – This option works if you’re the only person in your business, and that will never change. As a sole proprietor, you can’t hire employees, and your business income can be tied to your personal finances. Usually, this entity type works best for freelancers or independent contractors.
- Partnership – If you’re going into business with one or more people, you can form a partnership. The essential element of a partnership is the agreement, which outlines the roles and duties of each partner. This entity allows you to hire employees and limit your personal liability for company debts. However, if you want to add partners or one person wants to leave, you must essentially dissolve the business and reform it accordingly.
- Limited Liability Company (LLC) – An LLC is an easy and affordable option for many businesses. Like a sole proprietorship, one person can form an LLC with themselves as the sole owner. However, as the name implies, the owner is not responsible for business liabilities. Also, you can form LLCs with multiple partners, and it’s easier to add or remove them. Another advantage is that business earnings “pass-through” to the partners, meaning you don’t have to pay separate taxes.
- Corporation – A corporation is an excellent option if you want to create a business entity that’s not tied to any individuals. Corporations need CEOs and a board of directors, but it’s much easier to replace these people without reformatting the business. S-corporations allow for pass-through income to help you save on taxes. C-corporations get taxed as a business, then taxed for your income.
2. Not Creating an Operating Agreement
Partnerships have a partnership agreement, and LLCs have an operating agreement. In both cases, the agreement outlines the rules and financial obligations of the business. While it’s not 100-percent necessary to have an operating agreement for your LLC, it’s a valuable legal document that offers some specific protections, such as:
- Limited Liability Status – Without an operating agreement, you might be held liable for your company’s debts and obligations.
- Partner Agreements – Never rely on an oral agreement since it’s not legally binding. If you and your business partner have agreed to split duties, this document outlines those responsibilities. Otherwise, one party could alter or renege on the agreement without legal consequences.
- State Protections – Each state has its own rules regarding LLCs and how they operate. If you don’t have an operating agreement, your LLC defaults to the state’s regulations.
Fortunately, it’s easy to find operating agreement templates online. Your agreement doesn’t have to be notarized to be legally binding, either.
3. Not Documenting Contracts and Agreements
Another Legal Mistakes are not doing documenting contacts and Agreements. As mentioned, an oral agreement is not legally binding. So, while it might be easier and more efficient to have oral contracts between you and other partners, doing so could wind up costing you later on.
As you form your business, you’ll need to set up contracts with various entities, such as clients, customers, and vendors. It’s crucial to generate legal documents for each of these agreements to protect everyone involved. Otherwise, if someone doesn’t follow through on their side, you have an opening for a lawsuit.
Even if you trust the other person implicitly, a formal contract is still necessary to avoid any potential unpleasantness. Remember, it’s always best to separate business and personal interactions. Mixing the two is a dangerous proposition.
4. Not Following Employment Laws
Not Following Employment Laws is one of the Legal Mistakes that new business owners make. Realistically, you’ll have to hire employees to run your business. However, when you’re first starting, you might not have the funds or the time to set up all of your employment best practices. Unfortunately, if you’re neglecting employment laws, you could get sued. Some key points to remember are:
- Employees vs. Independent Contractors – Employees are on your company’s payroll, meaning that you handle the various taxes that get taken out of their checks. They’re also allowed to participate in company-wide benefits, such as health insurance or a 401k. Independent contractors are independent entities often hired for a specific project. Using contractors can limit your liability, but it’s harder to build loyalty since they cannot get benefits.
- TimeKeeping – You should utilize a comprehensive timekeeping service or app to ensure that everyone gets paid what they’re owed. Without a tracking system, it’s hard to verify whether an employee is getting paid fairly for their work. It’s also imperative to have everyone clock in and out diligently to avoid missed punches or overtime.
- Overtime Rules – States have different rules regarding overtime. For example, in California, overtime starts after eight hours in a single day. In other states, overtime only counts once an employee reaches 40 hours in a week. Make sure you understand the regulations and pay your workers accordingly.
5. Failing to Get Relevant Licenses and Permits
Forming your business entity is just the first step. Depending on what type of company you’re running, you’ll likely need to get additional permits and licenses. Some examples of these permits include:
- Seller’s Permit – You need this to sell products to customers.
- Foodservice License – This document is necessary if you’re selling food to people.
- Liquor License – If you’re selling hard alcohol, you’ll need a different license than if you’re just selling wine and beer.
- General Business License – Almost all states require that you have a business license to operate at all.
Failing to get all the necessary documentation means that your enterprise can get shut down by the authorities.
6. Not Protecting Intellectual Property
Your company’s intellectual property can include various items, such as your brand assets, product designs, recipes, marketing content, and more. If you don’t protect this property, other entities could steal your ideas and use them for their own purposes. There are two ways to protect intellectual property: trademarking and copyrighting. Here’s a breakdown of each option:
- Trademarking – A trademark protects elements that distinguish one business from another. So, you can trademark brand assets and marketing content because they’re specific to your company. You don’t have to register a trademark, but it helps to do so with the United States Patent and Trademark Office.
- Copyrighting – A copyright exists as soon as you create original work. This can include a new product, a recipe, or marketing content. You don’t have to register a copyright, but doing so can make it easier to prove that you created it.
If you have any proprietary products you created, you might want to file a patent. A patent means that you have legal ownership of the item, and no one else can use it without your permission. Filing a patent is more complicated and costs money, but it offers excellent protection for your IP.
7. Not Having Legal Counsel
As you can see, there are quite a few areas where you have to be legally compliant. While this guide can help you avoid potentially sticky situations, it doesn’t count as legal advice. Instead, you should retain a lawyer so that you can ask specific legal questions. This way, you don’t have to worry about Legal Mistakes, and you can protect your business.
Fortunately, you don’t need to hire a high-priced lawyer. Sites like Rocket Lawyer or Legal Zoom allow you to connect with business attorneys quickly and affordably. Before you do anything, be sure to ask a lawyer to protect your business.
Now that you know the legal mistakes most companies make, you can figure out how to avoid Legal Mistakes. Starting a business is challenging enough without the threat of legal action.