Top Ten Legal Mistakes

8/9/2019 Top Ten Legal Mistakes

1/5

TOP TEN LEGAL MISTAKES SMALL BUSINESS

OWNERS MAKE AND HOW TO AVOID THEM

Our experience, as well as those of our clients, has left us sensitive to the numerous

legal mistakes small business owners make. We offer this in an effort to help youavoid them.

Pre-Formation

1. Starting a business while employed by a potential competitor, or hiring

employees without first checking their agreement with the current employer and

their knowledge of trade secrets.

The law is clear that if someone is currently working for a company, particularly if heor she is a key employee, they cannot operate a competing business. Even just

incorporating may spark a lawsuit from the current employer. Would-be

entrepreneurs should first go to their current employer and either resign, or tell themwhat theyre doing and ask them if theyd be interested in investing. Amazingly, that

is often a very smooth way of ending that relationship. Under no circumstancesshould they misrepresent the nature of the new business.

Even after leaving the current employer, one cannot use or disclose the companys

trade secrets. Under the so-called Inevitable Disclosure Doctrine, if someone has beenexposed to trade secrets at their job and leaves to work for someone else, and if their

responsibilities in their new job are sufficiently similar, some courts will conclude

that it is inevitable that they will use the information they had from the earlier

position. They could face an injunction prohibiting them from working for the newemployer until a number of months go by and whatever trade secrets they had are

stale.

It also helps to know whether potential recruits are subject to covenants-not-to-

compete. States vary in terms of how enforceable they are, but one shouldnt assume

they are not. One should also check to see what assignment of inventions might havebeen signed. Personnel files should be reviewed and recruits should check theirs, to

be certain that a covenant-not-to-compete or an assignment of inventions wasnt

tucked into a signed non-disclosure agreement.


2/5


3/5

Limited Liability Companies (LLC) LLCs are often subject to annual taxesor annual reporting fees. Amounts vary by state and do not depend on whether

or not you turn a profit.

Corporations Corporations are required to keep many different records,including recording every major decision and holding annual formal meetings.

If you fail to do so and are sued, a judge can find that the corporation was asham (this if often called piercing the corporate vail). Investors can also sueyou if they think youre not operating the business in their best interest.

For most people, starting a one person business, operating as a sole proprietor at theoutset makes sense. But, if your business is especially likely to be sued, is funded by

outside investors, or might be profitable right from the start, consider forming an LLCinstead. For most people starting a business with more than one owner, an LLC is

preferable to a partnership as you get limited liability but need to do less record

keeping than a corporation, and the same taxation as a partnership.

Post Formation

5. Mistakes After Incorporating and/or Creating an LLC: A company that does

not follow proper formalities may inadvertently create personal liability for its

shareholders or members. In addition, a company that fails to maintain proper recordsmay lose credibility with potential investors performing due diligence.

Some of the mistakes small businesses often encounter include:

Failing to issue and record stock or member certificates. After forming acorporation or LLC, shares or membership certificates are issued to theowners. Without issuing the share/certificates, there is a potential of having

the corporation pierced in a lawsuit because the court will claim that thecompany is just an alter ego of the individual.

Failure to hold the meeting of the shareholders or directors in a corporation.Every corporation when it is first formed needs to have an initial meeting with

the shareholders and directors in order to adopt the Article of Incorporation,By-Laws and to issue the shares for the company. This initial meeting is also

an opportunity for members of an LLC to create an Operating Agreement that

is crafted for their particular needs.

No resolutions or other documents are kept for the ongoing venture. Everycorporation needs to maintain corporate records and meeting minutes. Acorporation resolution is a written document that gives someone in the

company authorization to perform a specific action. For example, if the

business needs a loan, the resolution would be written and signed with thedirector of the company giving authority to an individual to open the loan and

use it for business purposes. Similar documents should be kept in the LLC

format. Many partnership formations also fail to create necessary initialdocuments, such as having a signed partnership agreement which includes a


4/5

defined exit strategy that allows either party to walk away or buy each otherout, without destroying the business.

The On-going Concern

6. Failing to Clearly Document Partners Rights and Responsibilities

This mistake is usually made at formation by not having a properly crafted Operative

Agreement. The consequences of that early mistake are revealed as the business

begins to operate. Founding shareholders or partners (or members of an LLC) shouldhave an agreement that answers at least the following questions:

How much time and effort is each person expected to contribute? How much capital each person contributes? What happens if the business needs more capital? What happens if one person leaves the business? What happens if one person dies? Will the stock or partnership interest be brought back from the estate of the

deceased or from the person leaving the business?

7. Unclear Expectations and Rules for Employees

It is important to set clear expectations and rules for your employees. Make sure theyacknowledge that they are At-will employees, which means they can quit or be

terminated at any time without exposing your business to liability. It is also important

to inform your employees that discrimination, sexual harassment and other illegal acts

will not be tolerated.

Human Resource Manuals, also known as employee handbooks, do not have to be in

writing, however, a policy manual is the clearest way of spelling out what is and isnot acceptable. A manual is not the only legal way to make policies known. It can be

shared verbally, employees are fired every day for violating a spoken policy. In fact,the firing is more proof of the policy.

Notwithstanding this, many companies mishandle employee issues. Companies thatare not careful when documenting relationships with employees and independent

contractors, accidentally may change their status from an At-will employee to an

employee with special rights upon termination, or from an independent contractor toan employee for whom the company must provide benefits and withhold taxes. In

addition, employee obligations such as non-competition, non-solicitation,

confidentiality and intellectual property obligations should be properly negotiated atthe time of hiring to ensure enforceability.


5/5

8. Ignorance of the Law

Just because laws are numerous and complex doesnt mean your business can ignore

them. Learning little about the following basic areas of law can keep you out of legalhot water:

Basic contractual rules. How to protect your ideas and inventions (copyright, patent, trade secrets). Major employer-employee laws. Security laws effecting how you can raise capital for your business. Governmental regulation of your industry.

9. Getting Involved in Litigation

Litigation fees can be astronomical, and they can quickly drain management time andresources. Consider alternative means of dispute resolution, such as mediation or

arbitration. Or, if a reasonable settlement offer is available, think seriously abouttaking it instead of spending more time in litigation.

10. Failing to Hire the Right Professionals

A company that hires knowledgeable legal, accounting and tax advisors who are usedto working with early stage companies can avoid many of the common mistakes. A

company should hire and consult with those advisors in the early stages of its

formation. Compliance with applicable laws can be relatively inexpensive ifexperienced professionals are brought on board at the right time. The cost to fix those

mistakes however, is not.

Documents

Top Ten Legal Mistakes