Starting and running a business is an exciting endeavor, but it comes with a variety of legal challenges. Many founders focus on building their product, marketing their brand, and attracting customers, but they often overlook critical legal aspects that can impact the future of their business. In the early stages, legal issues may not seem urgent, but they can quickly become expensive and damaging if not addressed properly.
As an attorney specializing in transactional business law, I frequently see entrepreneurs make the same mistakes. These common legal missteps can lead to unnecessary liability, missed opportunities, and lost profits. Here are the five most common legal mistakes entrepreneurs make with tips on how to avoid them.
Failing to Properly Structure the Business
One of the first legal decisions every entrepreneur must make is choosing the right business structure. The business structure you choose affects your personal liability, tax obligations, and overall operational flexibility. Many entrepreneurs make the mistake of either operating without forming a legal entity or choosing the wrong one.
Mistake to Avoid: Starting a business without forming a legal entity or using a structure that doesn’t align with your goals.
How to Avoid It: It’s crucial to select the appropriate business entity for your needs. The most common options are:
- Sole Proprietorship: Easy to set up but offers no personal liability protection.
- Limited Liability Company (LLC): Offers personal liability protection, tax flexibility, and is relatively simple to manage.
- Corporation (C Corp or S Corp): Provides limited liability, but may involve more paperwork and higher costs. The S Corp structure offers tax advantages for some businesses.
Entrepreneurs should consult with a lawyer and an accountant to determine which structure best suits their business needs and goals. Once you choose the right entity, you’ll gain the protection necessary to safeguard your personal assets and ensure tax compliance.
Not Drafting Clear Contracts and Agreements
Many entrepreneurs are eager to get started and avoid the expense of formal contracts, especially when entering into business relationships with partners, suppliers, or employees. However, verbal agreements or poorly written contracts can lead to misunderstandings, legal disputes, and costly litigation.
Mistake to Avoid: Relying on informal agreements or using generic templates that don’t reflect the specific needs of your business.
How to Avoid It: Every business relationship, from partnerships to vendor agreements, should be governed by a well-drafted written contract. Key contracts to consider include:
- Partnership Agreements: Clearly define each partner’s responsibilities, ownership percentage, and the terms for dissolving the partnership.
- Supplier Contracts: Specify the terms of the relationship, including payment schedules, delivery timelines, and penalties for non-performance.
- Employment Contracts: Set expectations around job duties, compensation, benefits, and non-compete clauses.
- Non-Disclosure Agreements (NDAs): Protect sensitive business information when dealing with third parties or employees.
Working with a lawyer to draft customized contracts tailored to your business will help avoid confusion, protect your interests, and prevent future disputes.
Neglecting Intellectual Property Protection
Intellectual property (IP) is often one of the most valuable assets a business owns. Yet, many entrepreneurs fail to adequately protect their intellectual property, whether it’s a product design, brand name, logo, or proprietary software. This oversight can lead to others copying or using your IP without permission, and in some cases, can damage your reputation.
Mistake to Avoid: Failing to protect your intellectual property through patents, trademarks, copyrights, or trade secrets.
How to Avoid It: Make sure to register your intellectual property with the appropriate government agencies:
- Trademarks: Protect your business name, logo, slogan, and other distinctive elements of your brand. This helps you retain exclusive rights to use your brand identity.
- Patents: If you have developed a new invention or process, file for a patent to prevent others from making, using, or selling your invention.
- Copyrights: Protect original works of authorship, such as written content, music, software, or art.
- Trade Secrets: Keep confidential information, such as formulas, processes, or customer lists, protected with non-disclosure agreements and security measures.
Securing your intellectual property rights early on will help prevent costly legal battles and ensure that your innovations remain exclusive to your business.
Ignoring Employment Law Requirements
As your business grows, hiring employees becomes necessary. However, many entrepreneurs fail to properly navigate employment laws, which can result in legal violations and penalties. This includes issues related to wages, benefits, workplace safety, and employee classification.
Mistake to Avoid: Misclassifying employees as independent contractors or failing to comply with wage and hour laws.
How to Avoid It: To avoid legal headaches related to employment, ensure that you comply with both federal and state employment laws:
- Employee Classification: Ensure you correctly classify workers as employees or independent contractors based on the nature of their work and relationship with your business. Misclassifying employees can lead to significant penalties.
- Wages and Overtime: Understand and comply with minimum wage and overtime requirements, particularly under the Fair Labor Standards Act (FLSA).
- Employment Agreements and Policies: Draft employee contracts that clearly outline expectations and company policies, including non-compete clauses and intellectual property assignments.
- Workplace Safety and Compliance: Adhere to Occupational Safety and Health Administration (OSHA) guidelines and ensure a safe work environment for your employees.
By establishing clear employment practices and following all legal requirements, you’ll reduce your risk of lawsuits and help foster a positive work culture.
Overlooking Tax Obligations and Compliance
Entrepreneurs often focus on growing their business without fully understanding their tax obligations, which can lead to issues with the IRS or state tax authorities. Whether it’s sales tax, payroll taxes, or income tax, staying on top of tax requirements is crucial to avoid hefty fines and penalties.
Mistake to Avoid: Failing to understand your business’s tax obligations or neglecting to file taxes on time.
How to Avoid It: Make tax compliance a priority by:
- Understanding Your Tax Structure: Depending on your business entity, taxes may be levied on the business itself or passed through to your personal tax return.
- Tracking Expenses and Income: Keep detailed records of all income, expenses, and deductions to ensure accurate tax filings.
- Hiring a Tax Professional: Work with an accountant or tax advisor who specializes in small business tax law. They can help you stay compliant and take advantage of deductions that can lower your tax burden.
- Filing and Paying Taxes on Time: Set up systems to ensure timely filing of tax returns, including sales tax, payroll taxes, and estimated income taxes.
Proper tax planning and diligent compliance will help avoid penalties and ensure that your business remains financially healthy.
Starting and running a business requires more than just entrepreneurial drive—it also requires a solid understanding of the legal landscape. Avoiding common legal mistakes, such as failing to choose the right business structure, neglecting intellectual property protection, or not adhering to employment laws, is crucial to the success and longevity of your business.
By taking the time to set up your business properly from the start and seeking professional legal advice, you’ll be able to avoid costly mistakes and focus on growing your business with confidence. Always remember that a little upfront legal preparation can save you a great deal of time, money, and stress down the road.