Top 5 Legal Mistakes to Avoid
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:
- 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.
- 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?
- 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.
- 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.
- Getting involved in litigation. Litigation fees can put you out of business. Beware the lawsuit!
Creating An Employee Stock Ownership Plan
One trait I have noticed, shared by the great, most successful small businesses, is that they often give employees a stake in the business; an ownership share. Rather than it being just another place to work and draw a salary, a small business that an employee partially owns makes that employee a committed entrepreneur. As a result, they usually are more motivated, more dedicated, and more conscientious.
So it is a smart idea to consider if you want to keep the best people on staff.
For employers and employees alike, the most popular employer-sponsored retirement plan is the 401(k) since contributions are tax deductible for employers and tax deferred for employees. Although participation is optional, employees today know they need to fund their own retirement and usually appreciate the opportunity to do so.
Investments made by the 401(k) contributions can be made by employees or by the plan administrator; know however that with a 401(k), the more options you give your employees, the more expensive administration will be. Expect administration costs to be at least $1,000 a year as reports must be filed with the IRS, the Department of Labor, plan participants, and so forth.
The question that you the small business owner must answer is whether you can afford to match funds contributed by employees. It is expensive to match employee contributions dollar for dollar, even if the dollars are tax deductible.
Either way, to set up a 401(k) plan, or some other tax-deferred retirement plan, you need to speak with a financial planner or your accountant.
There are also three types of stock ownership plans that you could implement:
- Stock Options: Here, your business would award the option to buy company stock at a specified price, and the employee then has a certain amount of time to exercise the option and become a part owner of the company. Approximately 10 million employees in business both public and private hold stock options at any one time.
- Employee Stock Ownership Plans (ESOP): These are a sort of retirement plan akin to a 401(k), although in this case, instead of creating a diversified portfolio, with an ESOP, the retirement funds are invested in the stock of the employer. Under this scenario, the company contributes cash to buy its own stock (usually from the owner) which is then shared among the employees. There are significant tax benefits available under this plan. It is estimated that about 8 million employees invest in ESOPs.
- Employee Stock Purchase Plans (ESPP): These allow employees to buy stock at a discount (usually around 15%.) The employee can then either sell the stock for a profit, or simply hold onto it.
While it is true that you will be giving up part of your equity to create some sort of an employee stock ownership plan, the benefit is that in the process you will be creating a more motivated workforce. For more information on creating some sort of employee stock ownership plan, contact the National Center for Employee Ownership at www.NCEO.org.
Getting the Most from Your Chamber of Commerce
Want to know an easy, affordable way to grow your business? I will share this secret with you: Join your local chamber of commerce. Indeed, chambers of commerce can be one of the best friends your small business can have.
Think about it: The whole purpose behind a Chamber of Commerce is to help small businesses succeed. Indeed, over 85% of U.S. Chamber members are small business owners. And what kind of business are you involved in? Right, a small business. So your local Chamber is a place committed to your success.
At your local Chamber, will find a host of programs and resources intended to make your life easier and your business more profitable. And considering that most small businesses are out there all alone, having a network of like-minded entrepreneurs on your side can really be nice.
Let's consider the various ways a Chamber of Commerce can help a small business:
- Programming: Much, nay, most, of the programming done by Chambers is intended to help their members grow their businesses. Chambers bring in speakers, offer educational seminars, create informational newsletters, host luncheons, spotlight successful members, facilitate small business counseling, supply relevant demographic materials, sponsor business expos, and offer a variety of other programs intended to help grow members' businesses.
- Networking: As indicated, one issue many small business owners have is that they are out there on their own, without a whole lot of support from anyone else. But if you join your local Chamber, that will change in two significant ways.
- First, you will suddenly be mixing with a host of like-minded people – small business owners who, like you, are juggling payroll, taxes, a tough economy, and home life. There will be people to bounce ideas off of, and ideas from others that can be applied to your business as well.
- Second, Chambers of Commerce regularly have mixers, offering you the chance to meet and do business with your fellow Chamber members.
- Lobbying: Legislation of all sorts on the state and national level have profound impacts on small businesses. However, most small businesses have neither the time, resources, understanding, nor desire to lobby on a particular bill. That's another place where a Chamber of Commerce can help.
According to the United States Chamber of Commerce, "We're the loud voice you need to be heard in the political arena, to represent the important issues that affect small businesses. With your input, we can make a difference and provide tangible results."
- Getting involved: Chambers always have a variety of committees that allow you to participate in your community on issues of importance to you. By joining one of these committees, you can make a difference and have your voice heard.
- Discounts: Chambers offer their members discounts and deals on everything from health insurance to computers to education, and on.
So yes, joining a chamber of commerce is usually a very good idea.
The Bankruptcy Option
I know that bankruptcy is a frightening word, but I also know that it need not be. I spent many years as a bankruptcy lawyer and came to appreciate the bankruptcy process and how, in the right circumstances, it can really help a business. Bankruptcy puts you back in control of your business finances. If you are at a place where bankruptcy is an option, then it is safe to assume that things are pretty tough right about now. I bet the creditors are calling, threatening to sue, or already suing you and your business.
Bankruptcy can reverse all of that.
So the first piece of good news is this: As soon as you file your paperwork, the bankruptcy court issues an order called an "automatic stay." The stay is a federal court order sent to all of your creditors telling them to leave you alone. No more calls, no more threatening letters, nothing. They can take no actions to collect their money after you file — even lawsuits are halted by the stay. The stay puts you back in the driver's seat of your company's finances.
There are four types of bankruptcies available to your business. The type you file depends upon your situation and goals. Below are the four types (Note: Each "Chapter" is a chapter in the bankruptcy code.)
Chapter 7: Most individual bankruptcies are Chapter 7s. For an individual it is a good process since it is quick (four months or so), relatively inexpensive, and almost all debts are completely wiped out (called "discharged" in the lingo.)
The problem for a business is that Chapter 7 (also known as a straight bankruptcy or liquidation) shuts down the business. If that is your goal, great, because that is what will happen. If your small business files a Chapter 7 bankruptcy, all operations will cease, the business will go out of business, and a bankruptcy trustee will be assigned to sell the assets of the business for the benefit of your creditors. All business debts will be discharged, as will all personal debts if the business is a sole proprietorship or a partnership.
If your goal is to stay in business, then consider one of the other chapters below.
Chapter 11: When you hear about a company emerging from bankruptcy, that is a Chapter 11 they are emerging from. A Chapter 11 is used to restructure the business. Under this chapter, exiting management of the business continues to run the business, although the bankruptcy court must approve significant business decisions.
Creditors are appointed to a committee that works with the company to develop a plan of reorganization. The plan may allow the company to pay 10 cents on the dollar to its creditors, or it might be 100 cents. It all depends. Once he plan is fulfilled he debts are paid (it usually takes several years) the company emerges from bankruptcy.
Chapter 12: Chapter 12 is for farmers only.
Chapter 13: Chapter 13 is like a mini Chapter 11. Whereas Chapter 11 is usually used by larger corporations, Chapter 13 is a reorganization plan for smaller companies that want to keep their doors open, such as sole proprietorships. While not the optimum path you wanted your business to take, bankruptcy is not as bad as most people fear. Sometimes, you just need a little forgiveness to get back on track.