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6 common legal mistakes entrepreneurs make and how to avoid them

04/13/2016

This article is part of DBA, a series on Mashable about running a business that features insights from leaders in entrepreneurship, venture capital and management.

Most seasoned entrepreneurs will tell you that starting a business is one of the most rewarding experiences in life. At the same time, many will caveat that getting a business off the ground is harder than most people think.

For founding startup teams, a bit of preventive care and planning can go a long way.

When it comes to legal issues, the natural reaction is to put them off and hope they never happen or go away. Hard-to-understand "gotcha" rules and regulations, the odd language of "legalease" and the high hourly rates most lawyers charge are just a few things that make the law intimidating.

To take the sting out of the law, below are a few of the most common legal mistakes entrepreneurs make — and tips on how to avoid them.

1. Incorporating at the wrong time

Forming a legal entity, like a limited liability company or corporation, is extremely important. These business entities shield entrepreneurs from personal responsibility for certain business obligations. But with the privilege of having the legal entity comes responsibility — and cost. An entrepreneur should be sure that his or her business is more than just an idea, and that he or she is ready and willing to invest time and money to maintain the business as a separate, legal entity.

Would-be entrepreneurs might find themselves with a lot of legal and tax fees — on top of government-imposed fees — just for having a legal entity, so they should carefully consider timing for incorporation. When the benefits of limited liability and having a real company outweigh the likely administrative costs, it may be the time to take action.

 

2. Accepting handshake deals

Too often, entrepreneurs value speed over accuracy when it comes to detailing relationships with partners, vendors, customers and even employees. They might accept "handshake deals" or verbal agreements.

Unfortunately, there are more than a few horror stories of novice entrepreneurs believing verbal agreements are set in stone.

No matter the case, put it in writing. Most contracts are never disputed, and far fewer end up in court. Think of the contract like a prenup: Something you hope never to need, but something to have just in case. The "just in case" scenario is always a massive headache and wallet drain when there are no written documents to help parties settle.

Contracts should be well-defined and signed by all parties involved — whether that means outlining roles and ownership with a co-founder, making an offer to an employee or drafting business points with a vendor.

For all key agreements, get it in a signed, written contract. Even if it ends up in a drawer and is never seen again, it is nice to know it's there.

 

3. Stumbling over technicalities

After a business's initial formation, many business owners think they can put off basic legal and admin issues.

A few of these basics include: corporate formalities such as meeting minutes and ownership (stock) ledgers; keeping business and personal finances separate; administrative filings, such as a statement of information; keeping business licenses up to date; and for businesses with employees and contractors, making necessary withholdings or tax reporting on Forms W-2 or 1099. These tasks may seem mundane, but they are incredibly important.

New entrepreneurs should familiarize themselves with the requirements in their respective states. For instance, California corporations are required to fill out a simple one-page form about their company every year, the fee for which is $25. But for those who miss the deadline, the penalty is $250.

Stay on top of these simple tasks by creating a business calendar to make sure important dates don't slip by; many services that help form entities often offer this service.

 

4. Becoming an employer without adequate preparation

All business owners must understand how to avoid becoming an accidental employer. A business owner might think her or she is hiring an independent contractor — but the circumstances of the job and employment hierarchies dictate that the hire is actually an employee.

To keep this from happening, entrepreneurs should familiarize themselves with the guidelines the IRS uses to determine employee status. Basically, the IRS looks at and evaluates the following:

  • Behavior: How does the worker do his or her job?

  • Finances: How is the worker paid or reimbursed?

  • Relationship: Is there a written contract? Is the worker's role integral to the business?

If a business treats a worker like an employee, the IRS is more than happy to classify him or her as such.

This is a very tricky law. Massive companies in the news today are fighting re-classification of contractors to employees, and are likely spending a lot of money on the issue (the outcome could cost millions of dollars). So for those business owners who aren't 100% sure, consult a legal expert early on to get targeted advice.

 

5. Putting the wrong investment into intellectual property

Intellectual property — think: trademarks and patents — is an extremely valuable asset to a new business and needs to be protected. Unfortunately, developing and maintaining an intellectual property portfolio can also occupy a lot of time and resources, which often leads to confusion and frustration among entrepreneurs.

New entrepreneurs unfamiliar with the law often find themselves either not protecting their intellectual property, or going overboard doing so. Both can lead to costly legal consequences down the road. Not protecting intellectual property can lead to someone else stealing a company's "secret sauce," which can be irreplaceable.

Entrepreneurs who go overboard trying to protect their intellectual property can find themselves bogged down, overwhelmed, and unable to safeguard all the "ironclad" names and logos.

When dealing with something as important as a company brand, entrepreneurs are wise to remember that there is a common law trademark upon use — and that federal registration is a step to take when a company is ready and can afford to manage, upkeep and police marks.

Business owners should think twice before going overboard on trademarking names and logos, at least until they're sure the branding will stick. The government does not give refunds. A number of online companies can handle the filing work, and when the time is right, a company should consider looping in an attorney to assess the situation.

 

6. Engaging professionals only after a problem arises

By far the biggest mistake of all is becoming an "emergency entrepreneur" — someone who puts off all legal issues until her or she is being sued. The time to engage with a legal professional is not when threatened with a lawsuit.

Healthy people see the doctor or dentist for preventative care; healthy businesses should take the same approach, and establish a relationship with a good lawyer early on in a business's lifecycle. A good lawyer will want to get to know the intricacies of a company, including how the employees tick and their tolerance for risk, long before alarm bells go off. Many attorneys even often offer free or low-cost initial consultations, in order to build a long-term relationship.

Another thing new businesses can consider is legal plan options. For less than the price many lawyers charge for an hour, many businesses can get a year of coverage and a lawyer to call in the event of a problem or legal query.

Knowing more about the legal pitfalls and landmines out there will help keep any business entity on a solid foundation. This way, entrepreneurs can focus on the reason they started the business in the first place: growing a company where they are the boss.

Chas%20rampenthal-2395
Chas Rampenthal

Chas Rampenthal is the general counsel of LegalZoom, a Glendale, California-based provider of online legal solutions for families and small businesses. He has more than a decade of experience advising businesse...More

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