Are You Hurting Your Small Business? Take a Look at Six Legal Pain-Points of Small Businesses and How to Avoid Them.
By Keith Strahan
When it comes to protecting your small business, preparation is key. Just as avoiding the doctor does not mean you’ll never get sick, avoiding critical conversations with your attorney will not make you any less susceptible to legal trouble.
Strahan Law Firm, PLLC was built upon two ideas: First, a firm belief that many lawsuits filed against today’s small businesses are completely preventable, and second, the principle that access to time-saving, money-saving, and stress-saving legal counsel should be both affordable and convenient. According to the Court Statistics Project, median costs for a business lawsuit start around $54,000 for a liability suit and can reach over $91,000 for a contract dispute, so, rather than waiting until it’s too late, let’s talk about six common legal pain-points of small businesses and how you can start avoiding them today.
- Organizational Structure & Documents. At the outset of any new business, choosing the proper organizational structure is paramount. The choice you make will determine critical aspects of your business such as who can be an owner, how many investors you can have (if any), what your personal liabilities are, and how you are taxed. Sole proprietorships and general partnerships are the easiest to create; however, they also leave business owners open to a whole range of issues.
Without being a corporation or a limited liability company, you may be opening yourself up to unlimited personal liability for the debts of your company. Take for example the entrepreneur who starts a house-painting company and whose painting ladder falls down and injures an innocent passer-by. If this entrepreneur is only a sole proprietor, the injured person will be able to not only sue the company, but the entrepreneur herself. While there are limits as to the extent that personal property can be lost in litigation in this scenario (in Texas, you won’t lose your homestead and you will be allowed to keep one vehicle, etc.), the results could be devastating.
The first step you can take to protect yourself is to look into the different requirements for forming various entities in your state. Sit down with a pen and paper and answer the following questions: What are the risks associated with your business? Do you want investors (most investors prefer a corporation for its stock options)? Do you want to have pass-through taxation? Are you performing charitable work that may qualify for federal 501(c) exemptions? Would you consider selling your business in the future? A good attorney will be able to help you answer these questions and offer options based on your decisions. They will also get your formation documents completed in about a week’s time. While proper formation may cost you around $300 in filing fees, it could save you much, much more.
Note: If you own multiple investment properties, multiple businesses, or own a business with several different components, consider looking into a Series LLC if it’s available in your jurisdiction.
Along with having the right organizational structure, we cannot stress enough the importance of having well-drafted operating agreements (for LLCs) or bylaws (for corporations). The National Law Review writes, “The operating agreement functions as the backbone of the LLC and sets a system in motion that should run smoothly and guide the business so that the day-to-day business can be handled efficiently. An operating agreement should be crafted with the specific company it will pertain to in mind, with particular attention paid to company goals and the relationship between the members. Companies really need to work with an attorney to draft the operating agreement – careful drafting in the beginning will save a lot of stress in the end. An operating agreement is also a good way to show a court that the owners have been conscientious in setting up the business legitimately to maintain the shield from personal liability. If drafted carefully, it can also handle internal conflicts and provide peaceful resolutions to problems that arise. Ultimately, it also allows the company to run the way the owners want it to, rather than run according to the default provisions of the LLC Act.” Because operating agreements and bylaws needs to be narrowly tailored to your specific business, using free or form documents found online without substantial revision is not advised. You may be able to save money, however, by calling an attorney only after finding one of these free documents, considering which provisions do and do not pertain to you, and deciding with your cofounders exactly how you want the business to be handled.
- Employee Agreements. It is important to clearly document all employee-related matters and expressly outline your expectations. A good employment agreement will spell out what you expect from your employee (such as job responsibilities, drug and alcohol policies, and behavioral guidelines) as well as what your employee can expect from you (such as wages, company culture, advancement opportunities, and benefits).
As one attorney writes, “If you don’t protect your rights with an appropriate employment agreement, you risk having your employee later leave to compete with you, or you risk not acquiring intellectual property rights to your employees’ inventions related to your business. You also create the potential for disputes because your employees’ and your company’s respective rights and responsibilities will not be clearly defined in writing.”
To shield yourself from any issues, start by creating a form employment agreement that you will use for all of your employees going forward and brush yourself up on current labor laws. Do the same for independent contractors and interns, too. Unless otherwise agreed to, employment in Texas is considered to be “at will,” meaning that you can fire your employee (or they can quit) at any time, for any reason, or no reason at all. If this is the type of employment arrangement you desire, make sure to specify this in your agreement. Similarly, inquire into any previous employment agreements or non-compete agreements prospective employees (and cofounders!) may have with their previous employers before committing to a business relationship. Creating an employee agreement is a fantastic investment because you will only pay your attorney once and be able to reap the benefits of it for years to come.
- Intellectual Property. This section not only applies to IP your company creates, but also IP created by other companies that you might be infringing upon. Even non-technology or low-technology companies can face IP issues with items such as logos and slogans, written advertisements and pamphlets, and even websites!
The good news is that copyrighting is automatic, although registration in still available. Original pieces of work become automatically copyrighted as soon as they are “fixed in a tangible medium of expression.” That is, a piece of work is “fixed” when it is embodied in a tangible form that is perceptible by the human senses either directly or with the aid of a machine. The Copyright Act of 1976 requires that the work must be embodied in a form that is “sufficiently permanent or stable so as to permit it to be perceived, reproduced or otherwise communicated for a period of more than transitory duration.” Examples of works that are “fixed” are a short story printed on paper, a photograph, a song that is recorded on audio tape, or an e-mail message that is stored in a computer. Works that are not considered to be “fixed” would include a speech that is not transcribed or a live broadcast that is not simultaneously recorded. The bad news is that trademarks and patents must be carefully applied for through the United States Patent and Trademark office.
Studies show that those who hire an attorney to file a trademark are 50% more likely to get the trademark approved than those who file themselves, and the percentage with patents is even higher. Big companies have the funds to crank out patents like poems and almost always hire expensive “watchdog services” to actively and forcefully police their IP for infringement. A significant mistake small businesses make in this area is either failing to police their IP or failing to register it all together.
Attorney fees for filing trademarks typically range between $1,000-$2,000 and $5,000-$15,000 for patents, depending on complexity; however, there are a few steps you can take yourself to save you time and money: (1) If you are using any logos or are considering trademarking them, do a diligent search through the Patent and Trademark Office’s Trademark Electronic Search System (TESS). This system is fairly user-friendly and should provide you with an excellent overview of other marks that are “live,” “pending,” or “dead” that are the same or similar to your mark. TESS allows text-only searches as well as image searches, but image searches require looking up the image codes (also found on the website). (2) If you have already registered your IP, look into an affordable monitoring service such as Trademark Panda. After all, a trademark is only as strong as your policing efforts. (3) Finally, carefully review every piece of material that you use and have not produced yourself – where does it come from and is it licensed? Immediately cease use of all unauthorized material.
- Taxes and Company Records. Small businesses are notorious for failing to keep adequate company records. Items like meeting minutes, shareholder and board of directors resolutions, and stock issuances are commonly forgot about and could leave a business open to liability. The same goes for tax documents, which could actually save you quite a bit of money if you are itemizing deductions and business expenses. Staying proactive means staying organized ad nauseam. Invest in a filing system and get introduced to an accountant (services like Thumbtack allow you to name your price range and request quotes from professionals, including accountants. You can view the quotes before deciding whether or not to contact them.) Spend time creating form documents that you will use for all meeting minutes and resolutions. Review your tax documents and locate any and all missing pieces. Also, put together a formal company book to house your operating documents, formation documents, stock certificates, and other important information. Attorneys can put one together for you for around $300, or you can purchase a kit for around $150 and go at the task yourself.
- Supplier, Vendor, and Service Contracts. If you remember one thing from this article, remember this: PUT EVERYTHING IN WRITING. Simple contract disputes make up approximately 60% of the 100 million lawsuits filed in the United States each year. If something goes awry, oral or “handshake” agreements are harder to prove and may not even be valid based on the nature of the transaction. Complicated or important contracts are better being left up to your attorney, but if all else fails, at least get the “KPDS” on paper (Key Terms, Parties, Dates, and Signatures).
- Investor Funds. Before you accept or consider accepting investor funds, make sure you are aware of the applicable securities laws. Investors invest with the expectation of getting a return on their investment. If they end up losing money, they may open an investigation into the reasons for their loss. If you fail to give the proper disclosures or fail to follow any securities law related to your transaction, you may be faced with an extraordinarily expensive lawsuit.
Unfortunately, the best advice we can offer relating to securities law is to consult an attorney. The SEC did not promulgate these regulations to be concise or easy to understand and attorneys spend their entire careers becoming experts. One possible resource to consider is Y Combinator, a successful seed accelerator, which offers a variety of sample documents to serve a guides for small businesses who seek additional funding. While we have not reviewed these documents in detail, they are a fantastic starting point.