Back when I practiced law full time, I saw entrepreneurs make silly legal mistakes all the time, and while some were fairly benign, others were disastrous. What I learned is that knowing which pitfalls to watch out for can make all the difference between business success and failure.
Here then are the five most common legal mistakes that small business people make, and should be avoided:
1. Starting the business as a sole proprietorship instead of a corporation. Individuals and partners are liable for all debts and obligations in sole proprietorships and general partnerships. If you start the business as one of those two kinds of entities, and the business encounters a legal problem, your personal assets will be at risk. But if instead of a sole proprietorship or partnership, you start the business as a corporation, LLC or limited partnership, you avoid that possibility and thereby you greatly reduce your risk.
2. Not documenting partners rights and responsibilities. With the excitement and all of the things to do, it is easy when starting a business to not clearly delineate who will do what. Yet that can be a big mistake. Just imagine what can happen when you think that you are in charge of day-to-day operations — and your partner thinks the same thing. Therefore, founding shareholders or partners should have a written agreement that addresses the following questions:
- How much time and effort is each person expected to contribute?
- Who will do what?
- How much capital will each person contribute?
- What happens if the business needs more capital? What happens if one person leaves the business?
- What happens if one person dies?
3. Ignorance of the law. An old legal maxim is, “Ignorance of the law is no excuse.” And it’s true. Not knowing your legal rights and responsibilities can get you into a heap of hot water. So, here is what you need to learn:
- Basic contract rules.
- How to avoid being considered negligent.
- How to protect your ideas and inventions via copyright, patent and trademark law.
- Basic employer-employee regulations.
- The governmental regulation of your industry.
4. Not having written agreements. All of your important business agreements should be in writing for several reasons. First, oral agreements are difficult to enforce and sometimes are not enforceable at all. More importantly, memories fade over time, people change their stories and people “remember” the agreement differently. Putting it in writing avoids these problems.
5. Getting involved in litigation. Litigation fees can put you out of business. Beware the lawsuit!