- by David G. Bates –
After more than 20 years of serving as a business lawyer for a number hugely successful businesses, I know that becoming a prosperous company most often depends on being in the right market, at the right time, with the right solution, with sufficient capital, with the right management team.
But even a business with each of those attributes may fail to achieve its potential if its owners make these all too common mistakes regarding legal matters:
- Failing to incorporate and observe corporate formalities. Business owners expose themselves to personal liability by failing to use a correct corporate entity to operate the business and failing to observe the necessary corporate formalities – such as co-mingling business assets and personal assets.
- Failing to have an owner’s agreement. Business owners enter into business together with dreams of success and great optimism. However, the unexpected occurs, priorities change, divorces occur, owners die, friendships go bad, disagreements happen, some owners work harder than others, and the direction of the business changes. Failing to enter into a written agreement anticipating such situations frequently results in the demise of a business.
- Raising capital in violation of securities laws. Raising capital in violation of state and federal securities laws may expose business owners to personal liability and even require owners to pay treble damages
- Promising ownership to employees without due care. Promising ownership to employees, strategic partners and vendors without written agreements specifying defined vesting schedules and ownership restrictions and using equity as currency without considering the long-term consequences is frequently a costly and irrevocable mistake.
- Underestimating the cost, time and unpredictability of litigation. Litigation is an awful way to resolve business disputes, typically requires significantly more time, money and attention than anticipated and litigation results are rarely completely satisfying.
- Failing to protect or respect intellectual property. Business owners must take steps to protect trademarks, trade names, copyrights, patentable ideas, software, trade secrets and other intellectual property, including entering into agreements with all employees and independent contractors regarding assignment of intellectual property and confidentiality agreements. Owners must also ensure not to infringe on the intellectual property rights of others.
- Mistakenly relying on oral agreements. All important business arrangements, terms and conditions and agreements should be in writing. Over time, memories differ, owners of vendors and customers change, and confusion and disagreements arise. Disputes will be avoided if all agreements are in writing.
- Not understanding contracts. Careful lawyers select every word and every provision in a contract with a specific purpose. Business owners should not enter into a contract if they do not understand and agree with every provision. It is too expensive and takes too long to rely on a judge or arbitrator to interpret a vague contract. Owners should not agree to be bound by material provisions they do not find acceptable.
- Using poor contract forms for critical agreements. Certain agreements will be used repeatedly, and those standardized agreements should be carefully prepared to avoid litigation and limit the business’ potential liability.
- Not dealing with issues directly and in writing. When problems arise with another party, business owners should review the applicable contract, determine the appropriate actions, and document issues in writing. Failing to document issues in writing from the outset leads to misunderstandings, may result in unintentionally waiving rights, and complicates resolution.
- Treating employee issues too casually. Mischaracterizing employees as independent contractors, maintaining a locker room atmosphere, failing to pay required overtime wages, ignoring applicable employment laws, or paying employees “under the table” are very expensive mistakes. An army of attorneys are willing to take these cases on a contingency basis, and many claims include mandatory attorney’s fees for the employee and punitive damages.
- Not entering into agreement with employees. When appropriate, enter into non-competition, non-solicitation, confidentiality and non-competition agreements with key employees.
- Failing to pay taxes. As tempting as it may be to delay paying applicable taxes as a method for “managing cash flow,” failing to pay income, sales and payroll taxes will result in fines, penalties and personal liability.
- Not appreciating that every company is a technology company. Today, every company is a technology company. Engaging in business over the Internet, licensing critical software, and storing data in the cloud trigger critical legal issues that are not readily apparent and require particular attention.
- Ignorance of the law. Ignorance and complexity of the law are not defenses for ignoring laws or not complying with applicable local, state and federal laws. Business owners must understand and comply with all applicable laws.
- Misunderstanding or lacking insurance coverage. Maintaining proper insurance coverage often avoids litigation. In situations where litigation cannot be avoided, insurance coverage will protect the business from having to bear the exorbitant costs of litigation.
- Hiring subpar professional advisors. Business owners must select competent attorneys and accountants with specific experience in relevant industries that approach the relationship as team members and not by-the-hour hired guns.
- Not planning for the exit. Operate the business to create value for the next owners and have a succession plan in place. Business owners will fail to maximize the value of the business upon a sale if the business’ success too heavily relies on too few key individuals, critical relationships, or non-assignable essential agreements
Knowledge alone of the above list of legal mistakes frequently made by business owners is not sufficient to ensure the success of a business. Business owners who invest the time and energy to address these issues proactively are more likely to avoid costly consequences and to achieve the maximum potential for their businesses.