Fatal Legal Mistakes Business Owners Make: a 10-Part Series
Regardless of the economic environment, running a successful business is hard work and requires daily attention. Staying ahead of competition is always a concern. Your products and services require constant improvement and technological developments may force you to innovate rapidly. Planning, marketing, bookkeeping, staffing issues, management decisions, budgeting, all of it comes fast and none of it can wait. You often have more to do than can reasonably be accomplished in a workday, let alone a workweek.
To succeed, you must prioritize all of the major business hurdles coming your way. The challenge is that your legal priorities are often pushed to the backburner, waiting patiently for you to turn back to them, while other business needs clamor for your attention. But unless you make time for these important legal aspects of your business, they may not remain slowly simmering, but instead boil over with disastrous consequences for your business.
This 10-part article series will explore 10 legal mistakes that can be fatal to a business (even a seemingly well-established one). The illustrations and guidance provided are designed to help you spot these mistakes early. Each of these mistakes is preventable with proper planning and preparation.
This 10-part series will explore the following common mistakes:
1. Failing to set up a proper business entity
2. Failing to maintain corporate formalities
3. Failing to segregate business funds and enterprises
4. Failing to use a registered agent
5. Failing to protect business IP
6. Failing to follow prudent employment practices
7. Failing to implement restrictive covenants with employees and contractors
8. Failing to establish a buy-sell arrangement
9. Failing to fund the buy-sell arrangement
10. Failing to create (and update) an estate plan
Read on for illustrations of how easily these mistakes can arise, how fatal they can be for even the most successful business, and how to avoid them entirely with dedicated planning.
Mistake 1: Failing to Set Up a Proper Business Entity
Starting a new business is a rush of adrenaline. Everything is new and exciting. But failing to set a proper foundation makes your business more likely to collapse.
Janet was thrilled to start her own business. For over 15 years, she and her husband Rick had only ever worked for other people, following their instructions (despite often having better ideas) and enriching their bank accounts. But after finally building up sizeable savings, Janet and Rick decided to go out on their own. Rick brought the technical knowledge to the new business and Janet would handle the financial affairs.
Within months of opening the doors, a customer approached Rick and Janet with an incredible opportunity. Given how new their business was, the job would take them out of their comfort zone, but it offered the promise of an incredible payday. Rick and Janet jumped into the job headfirst, working late nights and weekends to meet the customer’s tight deadlines. The customer was very demanding, but Rick was ultimately was able to satisfy his concerns and Janet made sure their fledgling business didn’t suffer financially under the heavy workload.
Six months after the job was completed, Janet received a demand letter from a lawyer who represented the customer. The lawyer claimed that Rick had been negligent in his work and had misled the customer about Rick’s skillset. The customer threatened to file suit against Rick and Janet unless they paid over $200,000 for damages the customer claimed he had suffered. Complying with such a demand would wipe out all their profit for the year and leave the business cash strapped.
Rick and Janet immediately sought advice from a lawyer, concerned about whether their business could survive a lawsuit. Their concern turned to distress, however, when their lawyer told them that their personal assets were at risk because they had not operated the business as a corporation or limited liability company.
How to Avoid Mistake 1
When properly set up and maintained, both a corporation and a limited liability company protect you from liability arising from owning and operating a business. The law recognizes a corporation or limited liability company as a separate “person” with separate finances, assets, and liabilities. Any company obligations remain at the company level, and the business owners’ personal assets are protected. So long as the business is properly maintained, Texas law makes it very difficult for a disgruntled customer, vendor, or employee to get at a business owner’s personal assets.
Setting up a formal business entity provides you with numerous other advantages. Formal business entities create wealth because the owners have something concrete (stock or membership interests) that they can sell to third-parties or transfer to their family members as part of an estate plan. A formal business enterprise also enables the owners to bring in other owners by selling part of the business. And while corporate governance and tax paperwork may be minimally time-consuming, the advantages of properly forming a business entity often outweigh those administrative headaches.
If you have not set up your business and formally registered it as a corporation or a limited liability company with the Secretary of State, you are waiting for problems that inevitably will come.
In the next article, I’ll address the fatal mistake of a business failing to maintain corporate formalities despite being properly formed.