The economy is in the grip of a stubborn recession. Unemployment rates are high. Consumer spending is low. According to the Small Business Administration, more new businesses close than open. Only half of new businesses make it past the five year mark, while just one third of new businesses are able to continue past their first 10 years.
All of this adds up to one fact: new businesses have a lot to contend with in today’s commercial landscape. This means new businesses have to work harder than ever before to ensure their survival, and part of that means avoiding costly mistakes.
The list of issues facing any business can seem endless. There are operational, tax, intellectual property, and legal concerns. Of course, you can’t avoid mistakes if you don’t know how to recognize them, so we’ve compiled three of the most basic and expensive legal mistakes new businesses commonly make.
1. Owners expose themselves to personal liability.
There are numerous types of business structures to choose from. No company in America is just “a business” – it’s an LLC, a general partnership, an LLP, an S-Corp, a C-Corp, a sole proprietorship… the list goes on.
One of the key elements which differentiates this smorgasbord of legal structures from one another is the issue of liability. Some structures provide complete protection, while others offer none at all. For just one example, let’s contrast an S-Corp against a general partnership.
In a general partnership, the partners are saddled with personal liability for the business. That means if you make a bad investment, accrue business debts, or are sued, your personal assets are vulnerable.
Your car, the contents of your bank account – it’s all fair game for your creditors. In an S-Corp, by comparison, shareholders enjoy limited liability. This means they cannot be held personally liable for debts or financial obligations incurred by the business.
Obviously, an S-Corp arrangement isn’t appropriate for every business; but many other structures, including LLCs, C-Corps, and LLPs, also offer personal liability protection. The bottom line is, you shouldn’t expose yourself to personal liability if you can avoid doing so.
2. They don’t use written contracts.
Everyone knows there are oral agreements, and there are written contracts. Unfortunately, not everyone realizes that these formats do not offer equal benefits. After all, an oral agreement is still a contract, so what’s the difference? Aren’t you just skipping over a lot of dense paperwork?
This is a dangerous, short-sighted line of thinking. Oral agreements may sometimes be valid, but they leave the parties involved extremely vulnerable to endless, unresolvable conflict. If you have a written contract, you will always have a tangible, permanent guidepost to refer to if a dispute, alteration, or even lawsuit should arise.
Without the benefit of a contract which has been signed or documented as agreed to, disagreements tend to devolve into an unproductive game of “That isn’t what we agreed on!” or, “That’s now how I remember it!” Without any hard textual evidence, it’s simply one party’s word against the other, meaning breach of contract becomes difficult to demonstrate.
3. They don’t use non-compete agreements.
A non-compete agreement can serve several purposes, depending on why it’s being used and the state that you are in. If you are a new business owner, there are two basic ways to utilize a non-compete:
1. Employees. If you have your employees sign a non-compete agreement, they will be legally prohibited as per the terms of your agreement from disclosing valuable company information to competitors (e.g. formulas, sales leads, designs).
For example, Coca Cola and KFC are renowned for their “secret recipes.” If those recipes were ever revealed by trusted employees, those businesses would be ruined. You can imagine how devastating an information leak could be to a fledgling enterprise.
2. Owners. You may also want to use a non-compete agreement with your potential competitors. For example, if you are purchasing a business, the former owner could simply open a new, similar business, with the financial benefit of already being known and established in their community.
If you use a non-compete agreement when you are acquiring a business for yourself, you will be protected from competition within a certain geographic area, industry, and/or time frame.
At the end of the day, it’s difficult to imagine a reason why new businesses wouldn’t want to use non-competes. By utilizing this basic agreement, you can save your company a headache (or even total destruction) in the future.
Opening a new business is easy enough – it’s operating and growing the business which are the tough parts. However, if you take care to avoid these basic legal mistakes, your chance of succeeding is that much higher.
About the author: Jerry is a New Jersey bankruptcy attorney focusing on corporate clients. He is a frequent author on a wide variety of topics facing business owners.