When you create your business, your hopes are high, and, unfortunately, so are your risks. Many entrepreneurs make very substantial legal mistakes and put their businesses at risk simply by not knowing fundamental legal issues they face, and by not seeking out the best help available to help them navigate the legal channels.
In general, there are six basic pitfalls that entrepreneurs are vulnerable to, that can create havoc in their businesses and cost them money, time, extreme stress and headaches.
The following mistakes are easily overcome, if you understand and address them:
1. Not creating an LLC or corporation immediately. Many business owners decide to start and continue their business as a sole proprietorship “until the business gets off the ground.” This can be a very serious mistake, for two reasons.
The most familiar reason is that forming a separate business entity separates your business and personal assets, and protects your personal assets and finances (and credit record) from damage or loss due to business problems.
When you do not have a liability protection entity such as a LLC for your business, you enter into a risky world where everything you own is threatened to be lost . Given the number of lawsuits today and the number of non-LLC business owners who are losing everything they own, this protection is absolutely necessary. However, this is not the only risk.
When you wait until the business is a going concern and has financial worth before you form a separate entity, such as a LLC, the IRS may take an interest in this and impose a steep tax. All of the owners of the company may find themselves owing a huge amount of tax monies to the IRS, which could have been avoided by creating an LLC early in the life of the business.
2. Not issuing ownership interests at the outset. If you are the only owner of your business, this will not be an issue, but if the company has multiple owners, you should pay close attention. It’s quite common for people founding a business together to work out the details of who does what, who will own what interest, and all the ins and outs—and then not actually issue the ownership interests in the business.
It may seem acceptable to just operate with an understanding of what everyone does and owns, but this is a business, and it’s vital that you take care of these things officially. You must issue ownership interests in your LLC or corporate business at the beginning.
If you later decide that you want to borrow money, take on a strategic partner, or sign a major agreement with a vendor, you may have to prove the ownership interests before they will do business with you.
Not doing so can create delays and obstacles later when operating your business. Other parties, before doing business with you, will want to see written documentation of ownership interests. They will expect that ownership interests have been issued and that these reflect the actual makeup of the company.
The more disastrous issues can arise because not everyone remembers things the same way. You may end up in a situation where your other business owners have different views of the division of ownership. This can damage not only your personal relationships with the other owners, but your company, as well.
And, of course, there is the previously mentioned fact that the owners can face a huge tax bill if ownership interests are not documented and issued in a LLC after it starts earning income.
This is an easy mistake to avoid, simply by issuing ownership interests when the company is first established and formed and making sure that everything is in order from the beginning.
3. Not vesting service partner ownership interests. Many entrepreneurs take on partners who contribute to the company in the form of a service, introductions or connections, or some other non-financial contribution.
When you take on service partners of this nature, be careful to “vest” their ownership interest in your LLC or corporation. This means, quite simply, that the ownership interest is only issued when certain requirements are met. For service partners, this is usually when the service obligation is completed. If the obligation is not met, then the ownership interest is not issued or subject to return.
This safeguards you and the other owners from losing part of your business to someone who has not met their obligations to the company. While you expect the best from everyone, you could quite easily lose some ownership rights to someone who did not meet his end of the bargain.
No reasonable person will object to a vested requirement when it is being granted for services that have not yet been performed. Vesting the ownership interest will protect you and your partners in your limited liability company or corporation.
4. Not requiring confidentiality agreements before disclosing that can cost you a great deal of money and devastate your company. This is every bit as important as creating an LLC or corporation from the start.
Before you show proprietary information to anyone, you should require to sign a nondisclosure agreement. This is simply an agreement that they will not share or use your confidential information for any reason other than the reason you’re sharing it with them.
This would include any guarded information, including your business plans, marketing and sales strategies, pricing, methods and processes. And it especially includes intellectual property; you can actually lose the right to important intellectual property rights such as patent rights if you disclose certain information without a confidentiality agreement.
Of course, some people will refuse to sign a confidentiality agreement. You will have to choose who you wish to work with and whether they are trustworthy. However, you should also add a confidentiality notice to all written documents. This may provide trade secret protection for your company depending on your state laws.
5. Not getting a transfer of ownership from service providers. You are probably using outsourcers to create information and perhaps products, software or other intellectual property for your business. This is a very good practice; it saves you money and time, and helps reduce your overhead and increase your profits.
Make sure, when the work is completed, that ownership is transferred to your LLC. The contractor initially owns the right to the completed work until they transfer those rights to you. A work for hire agreement is the most common way of transferring these rights.
Make sure, if you work with an overseas service provider, that you have the proper ownership and protection agreements in place.
6. Not hiring the right attorney. The worst mistake a business owner can make is hiring a lawyer who works in any or every area of law. When you hire a generalist, that lawyer will cost you far more money, because they will have to do a lot of research and study to learn the ins and outs of business law.
Given that you pay for their time, you end up paying higher dollars to give your lawyer an education. Because they do not work in just business law, they will not be aware of the breadth of issues that are relevant to your business.
And, even worse, you may end up not receiving proper and complete advice you need to protect you and your business. A generalist who does not devote his time business law issues on a daily basis will lack the expertise to know the practical and real risks. You may, in other words, be very badly served if you do not hire a lawyer with knowledge and experience in business law.
When you hire a lawyer for your company LLC or corporation, make sure you hire a business specialist attorney with experience and knowledge related to the issues relevant to your particular business situation
These legal problems can sound threatening, but the main reason for learning about them is that they are easy to avoid, by hiring the right business attorney for your company and executing the right agreements at the right time. Start with getting legal entity protection. Here is where you can get free LLC information.