6 Legal Mistakes Small Business Owners Make (and How to Avoid Them)

Are you guilty of any of these oversights?
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To prevent issues later on once your business has grown, make sure to keep accurate bookkeeping in the present. (Photo: hafakot/Shutterstock)

You know everything there is to know about your business — but what about the legal issues that affect it? Not understanding the laws that govern what you do or following best practices can trip up small business owners and land them in hot water that boils away their bottom line.

“Some of my clients take what I call a ‘ready, fire, aim’ approach to starting their business, meaning they don’t think through the entire marketing, sales and fulfillment process, and they call me because they have a legal issue,” said Richard Trimber, head of the business law practice at General Counsel, PC. Trimber’s firm provides general counsel services to private businesses and handles issues related to business law, litigation and employment law.

Here are six of the most common — and most costly — legal mistakes small business owners make according to Trimber and ways to ensure you’re not guilty of any.

Relying on verbal agreements instead of signed contracts

Some small business owners verbally agree to do work, skipping the sales contract and accompanying statement of work. That can be disastrous, said Trimber, because when something goes wrong, a finger­-pointing contest often results.

“Have your attorney create a detailed agreement. It makes you seem more professional if the terms and conditions are outlined and the scope of work is detailed. You’ll increase sales, and when changes are needed, you can charge for them,” Trimber said.

Skimping on bookkeeping and accounting

As your business grows, tax and financial management become very complex, Trimber said. Sloppy bookkeeping can spell tax and legal troubles.

“There are sales and use taxes that need to be tracked monthly for some companies. Don’t go years down the road as you’re building your business and get a knock on the door from a state tax authority asking for your records and tax payments for materials used. You’ll end up on a payment plan,” said Trimber.

Accurate bookkeeping and accounting also drive your business’ valuation — and lack of records means low or no value.

The bottom line: Early on in your business, set up a system to track revenue and expenses.

Not understanding state and federal pay regulations

Changes in pay regulations are “the single most important thing affecting small businesses right now,” said Trimber. Failure to understand them can endanger a small business’ survival, he warned.

For example, the Department of Labor is altering the rules for exempt (salaried) versus hourly employees.

“One major change is that the minimum annual salary is $50,440 for exempt employees. This more than doubles the current minimum salary of $23,600 annually. Small businesses will need to restructure compensation plans to comply and survive,” Trimber said.

Failure to pay minimum wage is another serious misstep, one that can result in major civil penalties. Minimum wage is different for each state, and companies must adhere to both federal and state rules. “A good attorney will know both and help structure the company’s compensation plans to comply with both — and in all states that the company operates,” Trimber said.

Tracking and paying overtime is also critical. If you don’t, the law is on the employee’s side in two ways, Trimber said. “First, the employer has to pay the employee’s legal fees in most cases. Second, the employee is entitled to treble damages, which means that your business pays the employee triple the amount he or she is owed.”

Corporate existence and licensing mistakes

Anyone can get on the Internet and create an entity in most, if not all, states, said Trimber. “However, one year later you will get a renewal for the entity. If you don’t file the renewal, the entity is cancelled, you now have no legal protections and can be found personally liable for business activities.”

Maintaining proper licensing and other registrations is also important. “A client of mine was fined $5000 per day for operating without a license. Small businesses need a system to maintain corporate and licensing requirements to legally operate.”

Poor structuring of partnerships

“Many times I’ve seen two friends start a business and become mortal enemies battling over the company,” Trimber said. Someone needs to be in control because a 50/50 situation leads to logjams and hurt feelings. “If the company was your idea, keep control and invite that person with a special skill to join.”

Have an attorney draft the bylaws or LLC operating agreement to include a formal process for what to do when you reach an impasse. The process should give the person in control the authority to act, Trimber said.

“These details should be addressed when you are not in an emotional state, when there is nothing to lose and you are still getting along. This may save your company later.”

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