Costly Legal Mistakes Small Business Owners Make
THE TOP FIVE COSTLIEST LEGAL MISTAKES SMALL BUSINESS OWNERS MAKE AND HOW TO AVOID THEM
By: George L. Sigalos, Esq.
- Lack of proper entity formation, liability and tax planning
Small business owners, particularly those who are just starting a small business for the first time, often neglect to consider potential liability and tax consequences of structuring their business. Frequently, many operate as self-proprietorships. It is strongly recommended a small business owner operate their business through a limited liability entity, such as a corporation or a limited liability company or a limited liability partnership (depending on whether there are multiple owners). These serve to limit the personal liability of the owner of the business if structured properly. Failure to use a limited liability entity to conduct your business can lead to a potential personal liability, meaning your personal assets can be exposed to the claims of creditors of the business. You should consult an attorney on these issues. Tax planning is also important. The choice of entity can affect your liability for taxes on the income your business earns. While typically most small business owners use what is known as a pass-through entity, such as an “S” corporation or a limited liability company, through which to operate their business and receive income, there are subtleties in tax treatment depending on the type of business, particularly with the new tax laws. Failure to properly structure your business from a tax standpoint can lead to payment of unnecessary taxes. You should consult your tax advisor regarding these issues.
- Lack of proper contracts with vendors, suppliers, customers
As a business litigator, all too often I am called upon to represent business owners who did not properly document their dealings with another party through a well-written contract. While Florida law recognizes and enforces verbal agreements, proving the terms of a verbal agreement is difficult and can lead to expensive litigation. Unfortunately, sometimes business owners are reluctant to spend the money “up-front” obtaining legal advice and having proper contract documents prepared for their vendors or customers, only to find later on that this investment would have saved a lot of problems, time and expense because the rights and duties of the parties were not clearly delineated in a proper contract. It is worth a small investment of money, usually a few thousand dollars, to have proper contract documents prepared for your business. Failure to do so can, and frequently does, result in unnecessary litigation expense later on. As the old adage goes, an ounce of prevention is worth a pound of cure.
- Addressing employment issues and claims
One of the most difficult and expensive issues facing small business employers are the plethora of federal and state laws governing employment relationships. Many of these laws, particularly federal statutes such as the Fair Labor Standards Act (dealing with unpaid wages and overtime pay), the Family Medical Leave Act (dealing with mandatory time off for employees facing family medical issues), Americans with Disabilities Act (dealing in part with employees who have disabilities), provide fertile grounds for litigation by employees against their employers and tend to be favorable for employees. While many of these laws have certain minimum size thresholds in order for the business to be subject to them (e.g. a certain minimum number of employees), a violation of these laws can be extremely deleterious to your business. It is very important to have proper understanding of these laws and systems in place to make sure they are complied with. The cost of compliance can certainly be expensive. However, failure to properly comply can result in expensive litigation that can be financially ruinous to a small business. Typically, the employee is entitled to have their legal fees paid by the employer, if the employee is successful, but not the other way around. You might consider using employee leasing services offered by large payroll companies (such as Paychex or ADP for example), where the payroll company assumes liability to defend you in the event of any employment suit under certain terms and conditions and in exchange for certain fees. You may also consider purchasing employment practices liability insurance (“EPLI”) to protect against these risks. (See No. 4 below)
- Lack of proper insurance coverage for various aspects of your business
There are numerous types of insurance applicable and available to businesses. These run the gamut, from standard property and casualty insurance liability (if someone slips and falls on your premises, the claim is covered by insurance subject to a deductible) to more sophisticated insurance such as EPLI (discussed above), errors and omissions (typically if you are a business providing professional services of some sort), products liability (if you are selling a physical product etc.). There are also “umbrella” or excess liability coverages available for small businesses. “Key man” life insurance and disability insurance are also important for business owners. You should consult your insurance agent regarding the types of insurance available and suitable for your business.
- Litigation exposure and expense
While lawsuits are something that most businesses can hopefully avoid, or even mitigate such as by having proper and adequate insurance coverage (see above), there are times when many businesses are faced with having to litigate a case in court, either because someone sued the business, (e.g. failure to pay a vendor, etc.) or the company has reason to sue someone (e.g. failure of a customer to pay an invoice). Some types of claims, such as for breach of contract or non-payment of invoices, typically are not covered by any type of insurance. I have represented many business owners over the years who find themselves involved, however reluctantly, in litigation with another party. When those situations arise, it is important to consider the potential for a reasonable compromise and settlement of the claims at issue. Civil litigation, particularly business litigation, is expensive and time consuming and should be avoided if possible. Mandatory arbitration clauses in your contracts may sometimes help reduce the cost and expense of litigation by requiring private arbitration of disputes. While, this can also be expensive, it is not typically as much as court litigation. While you may feel you are “in the right” on a particular case, sometimes the cost and risk of litigating a case to conclusion are not justifiable and business decisions have to be made to compromise the claim. Seek advice from your attorney in this regard.
This publication is for general information only. It is not legal advice, and legal counsel should be contacted before any action is taken that might be influenced by this publication. This information may not be up-to-date, complete, or accurate, and is subject to change without notice. Any representation or warranty that might be implied through this information is expressly disclaimed.