Avoid Business Collapse: Top 10 Legal Mistakes and How to Prevent Them

Before founding crowdspring, I spent 13 years practicing law (representing small, medium, and Fortune 500 clients worldwide).

During this journey, I had numerous opportunities to counsel startups and small businesses. A typical conversation thread often centered around the legal hurdles confronting these entities and the best ways to avoid them.

Here are the top 10 legal mistakes often made by startups and small businesses and crucial tips on how to avoid making those mistakes:

1. Neglecting to form a business entity

It’s not uncommon for small businesses, especially startups, to conduct operations without first establishing a business entity. This can lead to the owner’s personal assets being at risk in case of a lawsuit or debt.

Why this is a problem: The business world can be unpredictable. You expose your assets to potential lawsuits or debts without forming a business entity. For example, if your company can’t pay a supplier, the supplier could potentially go after your personal assets to settle the debt.

How to avoid this problem: Seek legal advice on forming a business entity. This may be an LLC (Limited Liability Company), a corporation, or a partnership. These entities can protect your personal assets by separating them from the company’s assets.

2. Not creating a shareholders’ agreement

When multiple individuals form a company, they often overlook creating a shareholders’ agreement. A shareholders’ agreement outlines what happens if a shareholder wants to leave, dies, or wants to sell their shares.

Why this is a problem: Disagreements regarding the division of shares without a shareholders’ agreement can arise. This can disrupt the smooth operation of your business, leading to conflicts and, potentially, court disputes.

How to avoid this problem: Have a lawyer draft a comprehensive shareholders’ agreement. It should clearly outline the terms of share division, procedures for transferring shares, and steps to resolve shareholder disagreements.

3. Inadequate employment agreements

A casual, informal approach to employment agreements can lead to significant problems later. Clear employment agreements are crucial, regardless of the size of your business.

Why this is a problem: If an employment agreement is not detailed enough, misunderstandings may arise about job expectations, compensation, and termination terms. For instance, without an explicit agreement, an employee may claim ownership of a project they worked on for your company.

How to avoid this problem: Consult a lawyer to help draft thorough employment agreements. These should include terms on job roles, salary, dispute resolution, and ownership of work.

4. Neglecting privacy policies and terms of service

Businesses operating online often overlook the importance of a comprehensive privacy policy and terms of service.

Why this is a problem: Failing to disclose how you handle customer data or not having clear terms of service can lead to lawsuits, fines, or even a website shutdown

. For instance, you could be liable if a customer’s data is breached and you didn’t disclose your data handling practices.

How to avoid this problem: Consult with a lawyer to draft a comprehensive privacy policy and terms of service. This will ensure that you comply with all relevant laws and regulations.

5. Misclassifying employees as independent contractors

To cut costs, many businesses misclassify their employees as independent contractors. While this may seem like a money-saving move, it can backfire legally.

Why this is a problem: Misclassifying employees as independent contractors can lead to fines and penalties. If, for example, an employee classified as an independent contractor gets injured on the job, you could be liable for their medical expenses and other costs.

How to avoid this problem: Understand the legal differences between an employee and an independent contractor. Consult a lawyer if unsure, and classify your workforce accordingly to avoid legal complications.

6. Ignoring local and international regulations

Businesses, especially those operating online, often fail to consider the legal implications of serving customers in different localities, states, or countries.

Why this is a problem: Every locality, state, or country has its business regulations. Non-compliance, even if accidental, can result in legal issues, fines, or potential business closure. Imagine halting your operations because you overlooked a local sales tax regulation.

How to avoid this problem: Get familiar with the regulations of every locality, state, or country you operate in. Engage legal experts knowledgeable with international and local business laws to ensure compliance.

7. Neglecting to protect intellectual property

Many small businesses believe they have no intellectual property (IP) risk. This belief is often mistaken and can lead to problems.

Why this is a problem: Failing to protect your intellectual property can lead to others taking advantage of your work. For example, if your employees invent new technologies for your business without an agreement, they might claim ownership of those inventions.

How to avoid this problem: Understand the basics of intellectual property law. Protect your IP by applying for patents, copyrights, or trademarks as necessary. Consult an IP attorney to ensure you’re not leaving your business vulnerable.

8. Overlooking the intellectual property rights of others

Even non-tech businesses can face significant intellectual property issues. This includes potential patent, trademark, and copyright disputes.

Why this is a problem: Infringing on others’ intellectual property rights, whether knowingly or unknowingly, can lead to lawsuits. For instance, using a logo similar to another company’s trademarked logo could land you in a legal dispute.

How to avoid this problem: Be aware of your industry’s existing patents, trademarks, and copyrights. Consider hiring an intellectual property attorney to thoroughly search and avoid potential infringements.

9. Getting tangled in costly litigation

Litigation can be costly and time-consuming. Often, the only winners are the attorneys involved.

Why this is a problem: A lengthy litigation process can distract you from running your business and drain your resources. Sometimes, the legal fees can be higher than the cost of settling the dispute out of court.

How to avoid this problem: Prevent litigation by seeking legal advice before making important decisions. Include mediation and/or binding arbitration provisions in your agreements as an alternative to litigation.

10. Trying to navigate legal waters without professional help

Many small businesses attempt to cut corners by avoiding legal consultation. Some use online resources as a substitute for professional legal advice.

Why this is a problem: Legal missteps can cost your business significantly more than hiring a competent attorney. Whether it’s a poorly drafted contract or overlooked regulation, the price of a legal error can be steep.

How to avoid this problem: Hire an attorney with expertise in your business area. Though the upfront costs might be high, an attorney can prevent costly legal issues, saving your business money in the long run.

Remember, each business situation is unique and requires careful consideration. Experienced attorneys can save you time, aggravation, and money by providing the right advice at the right time – don’t compromise your business by failing to get legal advice when necessary.

And incidentally, if you wondered whether I could “speak” like a lawyer, I can:

Disclaimer: This article is meant to provide information, not legal advice. Always consult with a licensed attorney for legal matters related to your business.