Legal Matters | Archive

Avoid common legal mistakes in business

by Dave Faulders
for Virginia Business
July 2007

Small companies frequently make legal mistakes that could create significant issues that divert attention from their core business. From time to time companies should perform a "legal audit" to help alleviate time-consuming, possibly disastrous, consequences of making legal mistakes. This article will outline some of the important ways to avoid common legal mistakes that can adversely affect companies.

Chose the proper legal entity
Operating your business as a proprietorship or general partnership without the liability protection that another form of entity provides can expose you to unnecessary personal liability. By forming and operating the business through a corporation or limited liability company, your liability will in most instances be limited to the amount you invest plus amounts you personally guarantee.

Keep proper corporate records
Improper record keeping can cause problems with the IRS, hamper your ability to raise equity capital and could result in personal liability by "piercing the corporate veil" of the company. Failure to document meetings of the board of directors and shareholders, failure to record stock issuances and failure to document stock transfers are common infractions that can threaten limited liability protection.

Safeguard equity
Successful owners safeguard their equity by choosing co-owners carefully. If a co-owner doesn't work out, changing the arrangement can lead to substantial legal fees and costs at a time when the business can't easily afford it. If possible, enter into a "buy-sell" agreement with your co-owners. Also, carefully drawn stock-option agreements and other arrangements can link equity ownership to performance, securing your value in return for parting with equity.

Protect intellectual property
Intellectual property (patents, trademarks, confidential information, know-how) is often vital to success and building value of the company. To protect yourself, conduct appropriate searches and obtain appropriate licenses to avoid violating the rights of others. Be sure that your employees aren't violating non-compete agreements with prior employers or improperly using a prior employer's customer lists or other confidential information.

Carefully hire employees
Mistakes made or misunderstandings from a casual hiring process can result in aggravation, legal fees and costs. Document your employment arrangements at least in a brief letter so people know what has and has not been promised. Be sure all employees are "at will." Retain some discretion over bonuses, and structure them to promote retention. It's also important to inform your employees that discrimination, sexual harassment and other illegal acts will not be tolerated.

Properly negotiate and document agreements
Contracts and leases presented by banks, landlords and suppliers as standard forms generally are written in favor of the party presenting the contracts. These are negotiable! Review all contracts carefully and ensure they meet your business needs. You need to negotiate as much flexibility as possible to enable you to respond to future business developments.

Approach personal guarantees cautiously
Many contracts that you enter may require your guarantee. Your guarantees to banks, landlords, suppliers and others may expose you to a much greater personal liability. Where possible, try to avoid personal guarantees. If you must give a guarantee, are your guarantees limited where possible? Are your co-owners on the hook for their fair share?

Do not inadvertently violate securities laws
Many new business owners mistakenly believe that securities laws only apply to companies that are traded on national stock exchanges. Shares of stock in a corporation and membership interests in an LLC are considered securities under state and federal laws. It is illegal to sell securities in a transaction that is not exempt from registration under the securities laws. It is also illegal to misrepresent or omit material facts. Violations may create a variety of difficulties for the owner and the company.

Select competent and dedicated advisers
There is a lot to keep track of, but you have a business to run. A team of loyal and competent advisers can help you handle all of these issues, save you time and enable you to focus on the areas vital to business success. You will need an accountant, lawyer and insurance agent. But, if carefully chosen, your outside professionals can function as a board of advisers and provide ideas and guidance on many topics.

In short, keeping focused on the core business of your company will enable it to succeed, but having your attention diverted by time consuming - but easily avoided - legal issues might hasten its demise.