There are so many things to get right when you’re just starting a new business, and a number of things you’ll inevitably get wrong. Every new business owner ends up learning some things the hard way, but you can avoid a lot of potential trouble by listening and learning from other business owners’ mistakes. Here are a few common legal mistakes new entrepreneurs make that you should be sure to avoid.
Failing to get the right documentation
In the early days of a new business, you have limited funds and are looking for any opportunities to cut costs that you can. You may think you can get by with the cheap and easy corporate documents you can buy online, but according to Tina Willis, Orlando accident & injury lawyer, that’s a big mistake – especially if you’re starting a business with multiple shareholders.
Whenever there are multiple shareholders, it is absolutely essential that they hire a real corporate lawyer, if not during formation of the business, as soon as possible after incorporation.
“Whenever there are multiple shareholders, it is absolutely essential that they hire a real corporate lawyer, if not during formation of the business, as soon as possible after incorporation. Ideally, each shareholder would have their own corporate lawyer,” she explains.
Her own husband experienced the pitfalls of skipping this step in his first business. When he decided he wanted to sell his shares and move on, the lack of documentation left him with little power to do so. “This ultimately required us to hire a corporate litigation lawyer and spend a lot of time and money fighting a profoundly unfair situation.“
Her husband’s not alone in this experience. It’s often tempting early on when everything’s going well to assume that things will stay that way. Says Syed Irfan Ajmal of Ridester, “The hardest time to have a written agreement with your co-founder is when you guys are just starting. But that is also the most optimal time to do it.”
The first few months of a new business may feel like a honeymoon period where it’s easy to get caught up in the excitement and overlook asking the hard questions, but honeymoons end and you need things to stay stable when you start facing the nitty gritty of keeping a business going every day.
You can hire a lawyer early on to get everything in writing, or you can risk facing higher costs (both financial and emotional) later on if things become contentious.
Not getting the right permits
Every city has its rules about where businesses can be located and how they can be run. To make sure you stay on the right side of the law when opening up your business – especially if it’s a business with a storefront – you have to do your research into permits.
Janell Woodbury of Exit Strategy Games learned this the hard way when she found a great location with cheap rent to open up her new escape room business. Turns out, that cheap rent ended up costing her big when she realized she had overlooked the need for proper permits.
My new business was shut down for 3 1/2 months while I paid incredibly high fees to ‘attempt’ to get the right building and rezoning permits.
“I assumed I'd have to simply pony up the money for the right permits to rectify the situation. I couldn't have been more wrong. My new business was shut down for 3 1/2 months while I paid incredibly high fees to ‘attempt’ to get the right building and rezoning permits,” she shares. And she considers herself lucky that she was eventually able to get the right permits at all. A lot of time and money could have been saved if she’d done her research upfront.
Not choosing your name carefully.
You’ve probably already figured out that choosing the perfect name for your business is challenging. You want it to be meaningful to what you do, sound good, have an available domain name, and be easy to remember – all of which is hard enough. But there are legal issues you have to consider as well.
When Caton Hanson, Founder and Chief Legal Officer for Nav, first started the company, they went with the name Creditera because “the .com domain name was available and we thought the name helped convey the service we offered.” But not only did customers have a hard time remembering the name, but they had overlooked that another business in their space had a similar name.
“That firm sued us,” he says. They could have fought it, but it would have cost money and they weren’t entirely attached to the name anyways. They decided it was easier to pick a new one.
Skipping the liability insurance
This is another warning of Tina’s. “many small business owners do not even think about the possibility of being sued by a personal injury lawyer (like myself), for something like a slip and fall on their property, negligent security, or other types of premises liability cases.”
A lawsuit over something that seems small to you could end up ruining your business if you’re not properly covered. And Keri Lindenmuth of the Kyle David Group goes one step further in her recommendation for ecommerce business owners, “If they're collecting data from customers, selling products on a website, etc., they need cyber liability insurance to keep them protected from any future lawsuits should a data breach or cyber attack occur and jeopardize their customers' data.”
Even if large businesses are bigger targets than you are, it doesn’t mean you’re safe from cybersecurity issues.
It seems like every week we hear about a new hack or data breach. Even if large businesses are bigger targets than you are, it doesn’t mean you’re safe from cybersecurity issues. You should do what you can to protect your customers’ data, of course, but it’s also worth it to get the proper insurance to protect your business as well.
Using the wrong legal structure
A lot of businesses go for the easiest legal option when getting started: an LLC. Zach Hendrix, Co-founder of GreenPal, did so because it’s “quick and easy and cheap. We figured it was the best way to get our company up and rolling.”
He’s not alone, Jesse Silkoff, Co-founder and President of FitnessTrainer.com, did the same thing. “We had learned about LLC's during one of our business classes in college together and decided we would set the company up as an LLC.” It seems at first like the most obvious thing to do.
But both Zach and Jesse hit up against the same common issue eventually: an LLC doesn’t work if you want to raise money from outside investors.
According to Zack, this was a mistake that “ultimately cost us $20,000 in legal fees to correct.”
Don’t go for the cheap, easy option when choosing a legal structure for your business.
If he had started the business as a C-Corp instead of an LLC, he’d have saved a lot of money in legal fees and a lot of time and effort besides. Don’t go for the cheap, easy option when choosing a legal structure for your business. Take time to think through what you want for the future of your business so you can make sure you choose the structure that makes sense for the long term.
Not keeping personal and business separate
This advice is particularly relevant for single business owners. Vicenzo Villamena of Global Expat Advisors says it’s important not to co-mingle funds, “if you mix your personal funds with those of the LLC, you are risking the limited liability characteristics of your company. This means that your personal assets could be at risk to creditors.”
He further suggests that by being a single owner, you’re at greater risk of being audited. “You report your SMB profit/loss on your personal tax return, which is generally subject to more scrutiny than a business one.”
If possible, forming a partnership with someone else – even if they only take on a 1% stake in the business – can reduce your risk considerably.
Not understanding (and respecting) copyrights
Dineen Pashoukos Wasylik of DPW Legal sees two main ways this hurts new businesses. The first is that they fail to secure the copyright of work that they hire independent contractors to create.
“If you pay a third party – instead of an employee working within the scope of his or her employment – to create this content for you, it most likely is not a ‘work made for hire’ under the Copyright Act,” she explains. “Just paying for it is not enough under U.S. Copyright laws.”
“I had one client fall down this trap and learn that he did not have permission to use the logo he had paid a designer a lot of money to design.” That’s an expensive lesson to learn.
Many people make the mistake of assuming that if they find an image using a Google image search and it does not have a copyright notice on it, it is free to take and use.
The other main area where copyright matters is with the images you use on your website and social media posts. “Many people make the mistake of assuming that if they find an image using a Google image search and it does not have a copyright notice on it, it is free to take and use on your own website or Facebook post,” she says.
If only it were so easy. It turns out, the original owner’s copyright is enforceable even if they don’t mark or register it. “I have represented several clients who were sued for using stock photos on their website that they mistakenly thought were free to use,” says Dineen.
Make sure you stick with images you either create yourself, or ones you've bought the proper license to use.
Not checking your employment contract
If you’re leaving behind a full-time job to branch out into starting your own business, you have to be careful. If your new business offers similar services to the company you’re leaving, you could find yourself in legal hot water.
I've represented clients who have been threatened with lawsuits by their former employer, and it creates a costly and stressful headache for the small business owner.
“Many employment contracts contain non-competition clauses, meaning that they dictate how and where that person can open their own business and the circumstances under which they can compete with their former employer,” says Erin Jackson, a Chicago healthcare business attorney at Jackson LLP. “I've represented clients who have been threatened with lawsuits by their former employer, and it creates a costly and stressful headache for the small business owner.”
According to Erin, most businesses will be quicker to send a threatening letter than they will to go to court, which is costly and can be embarrassing for both people. Nonetheless, small business owners face a risk and, if they do receive a letter, will want to hire a lawyer at considerable cost to help them with their response.
It’s best to review your contract before you branch out and discuss your options with a lawyer to make sure you start your business on solid legal ground to begin with.
A lot of these legal pitfalls are the kind of thing you would never know to think about without hearing what someone else has been through. By doing your homework and getting all the legal basics into order from the start though, you can save yourself a lot of trouble and expense. Let the hard lessons of other new business owners help you get it right from the beginning.
Have any questions about these legal pitfalls? Let us know in the comments!