By Claudia Pollak, Esq., Updated October 19, 2020
Entrepreneurs must navigate through a maze of legal issues and decisions when launching a new business. At the outset, you may think some seem inconsequential – but this could be a mistake. The choices you make today will have a lasting effect on the viability and profitability of your new business venture. Below are some of the most common mistakes made by first-time entrepreneurs, and what you can do to avoid making them yourself.
Choosing the Wrong Business Structure
The type of business entity you select will affect your liability exposure, income tax obligations, and opportunities to raise capital throughout the duration of your venture. Sole proprietorships, C-corporations, S-corporations, and limited liability companies (LLC) all have their advantages and drawbacks. Sole proprietorships are simple to start up, but leave your personal assets vulnerable and offer a tax advantage in that no separate corporate tax is paid. C-corporations and S-corporations both shield the personal assets of the owners, but has different tax obligations. Additionally, maintaining the protection afforded by the corporate business structure requires a certain amount of record-keeping and filings with governmental agencies. LLCs offer liability protection and are often most appropriate for small businesses because of their tax-pass through nature.
The “Gentlemen’s Agreement” – A Handshake and Your Word
Your word may be your honor, but a written contract is the only way to be sure all parties share a mutual understanding regarding their obligations. Whether it is your best client, that independent contractor you’ve been courting, or vendors you have known for years, do not assume everything will go according to plan. Putting your agreement in writing not only ensures that everyone’s expectations are clear, but it is also valuable evidence in the courtroom, should things not proceed according to plan. Bottom line – get it in writing!
Adding Partners Without a Written Agreement
It’s easy to sweep this one aside when you are passionately focused on the work of getting your business off the ground. And those new partners likely share your same passion. However, until a detailed written agreement is drafted and signed, you may be unclear about each other’s expectations in the short term, or, if your business is wildly successful, tied up in protracted, long-term litigation, to establish who owns what (Facebook comes to mind). Redirect some of that passion, and benefit from the goodwill it creates, to negotiate the appropriate agreement early on that covers responsibilities, ownership structure, provisions for transferring ownership, and what happens when there’s a disagreement about the direction of the company.
Failing to Protect Your Intellectual Property
Protect your business’s most valuable asset, its intellectual property. Intellectual property refers to creations of the mind, including inventions, literary and artistic works, designs, and symbols, names, and images. Ensure that the founders transfer and assign any intellectual property to the company that they created prior to the company’s incorporation. While generally, the company owns the intellectual property developed by its employees, because founders often do not enter into employment agreements with the company for their services, intellectual property developed by founders during the performance of their services after incorporation of the company may not be owned by the company. With respect to outside consultants, unless there is a written contract in place that transfers ownership, the consultant will own the intellectual property that is created. A new business should ensure that it enters into a written contract with its founders as well as its consultants and other third parties to transfer ownership of the rights to intellectual property to the company.