Minimizing Risks of Operating a Small Business
1. Memorialize agreements in writing.
This one should go without saying. Just as you know that you should floss everyday but probably don’t, you’re likely well-aware that you should memorialize agreements in writing but you may not do it in every instance. After all, as a business-owner, you’re busy. You may be in the type of business that requires you to make small deals with vendors or clients on a very frequent basis. You may loathe the idea of making a trusted business associate sign a contract. For whatever reason, you finalize deals on a handshake. I cannot tell you how many lawsuits could have been avoided had the parties taken a moment to memorialize their agreement in writing. There is a reason why a contract requires a “meeting of the minds.” Often, the very act of putting your agreement down on paper can reveal that you had different understandings as to the terms of the agreement. While not ideal, it can be as simple as memorializing an oral agreement with a quick email confirming your conversation. A great amount of litigation is initiated because either (1) the parties truly had a different understandings as to the terms of the agreement or (2) one party seeks to take advantage of the fact that there was no written agreement. And even if, under scenario 2, you prevail and successfully defend against their claims, you’re going to spend a significant amount of money doing so. If you have an airtight contract, you make it much less likely that they’ll even find an attorney willing to take their case.
2. Conduct research on people or companies before doing business with them.
All too often, I find myself representing a client involved in a legal dispute that would have been foreseeable (and preventable) had the client done its due diligence before getting into bed with a bad-actor. I define the term bad-actor loosely to mean persons or companies that lack integrity, honesty, professionalism or competence. We’re talking about liars, cheats and idiots here. These types of people will not only do harm to you or your business, but they will likely also do harm to other parties with whom you do business, thus exposing you to liability from third parties. My advice prior to entering into an agreement to work with some one in any capacity (employee, independent contractor, partner, or any other business associate upon whom you will rely): take your time, ask around, have multiple frank conversations with them in different settings, run multiple Google searches and, perhaps most importantly, run a search of their name through legal databases to determine if they’ve been a party to any previous lawsuit. The best indicator of future behavior is past behavior, especially when it comes to the manner in which one conducts business.
3. Invest in legal advice.
While it’s true that I have a vested interest in telling you to hire an attorney, that does not make the advice any less valid. The majority of litigation in which my clients have been involved has dealt, in some respect, with the interpretation of a contract. More often than not, litigation could have been avoided or narrowed in scope had the contract been drafted or reviewed by an attorney. You may believe that you understand the implications of the terms of a contract that you drafted. It would take me an entire semester of contract law to explain to you all the ways that you might be wrong. Instead, I’ll say this: of all the contracts that I’ve reviewed in my capacity as a transactional attorney that were drafted by non-lawyers, nine out of ten were riddled with ambiguity that any good litigator could drive a truck through. 100% of layperson-drafted contracts that I’ve litigated caused the litigation to be more expensive as a result of the time it took to litigate ambiguities. Many lawsuits could have been avoided altogether had the parties sought the advice of legal counsel on the front-end.
It is also advisable to seek legal advice to make sure that your business is complying with applicable laws, to assist you in setting up your business’ operating structure and practices, and to deal with collections, among other things.
Legal advice can be expensive. But it does not have to be. In reality, the term “expensive” is a relative one. You may invest $1,000, $2,000, or more to have an attorney draft or review your contract and, in doing so, end up avoiding a $50,000 lawsuit. The peace of mind, alone, will make it worth your while. Additionally, when something goes wrong, and it will at some point, you will have a relationship with an attorney who will likely be willing to help you on short notice.
4. Insure your business.
I once heard it said that there are few problems that a million dollars can’t solve. The man who said that maintained a legal practice involving six and seven figure cases that were high-risk cases, or cases that were not slam-dunks and could be lost by an attorney who makes the smallest mistakes. He slept well at night, though, because he had an insurance policy of 1 million dollars. Even his $2 or $3 million dollar cases, if they were lost, and it was his fault, could likely be settled for a million.
Let’s face it, bad things happen to good people. You might do everything right and still get sued. You might even make a mistake from time to time. If you’re in business long enough, you will make mistakes. If that mistake lands you in a courtroom, the litigation expenses alone could bankrupt your company, and that’s before the case is won or lost. Many policies will cover the entirety of legal costs even if the ultimate judgment or settlement falls outside of the policy coverage.
I recommend using an insurance broker who can explain to you the different types of policies available to you, the different policy limits and can point you in the direction of the more reputable insurers.
5. Invest time planning your business structure.
Before you start selling your goods or providing your service, spend time thinking about what business structure will best suit your needs. Three of the biggest factors to consider are the tax implications, personal liability and flexibility of your chosen entity.
For example, sole proprietorships offer you a lot of flexibility, a simple pass-through tax structure, but no protection for your personal assets. An LLC will offer you better protection for your personal assets, a fair amount of flexibility and can be structured as a pass-through tax entity similar to that of a sole proprietorship. A corporation will similarly protect your personal assets but is more formal and inflexible than the other two entities. The tax implications of a corporation will be based on the type of corporation one chooses.
Second, give careful consideration to the designation of your workers as employees or independent contractors. At some point, you will likely have to terminate a worker. Frequently, terminated workers feel that their termination was wrongful and, even if it wasn’t, they will look for anything you might have done wrong that could give them an avenue to take legal action. You don’t want them coming after you for an alleged improper classification because not only will those allegations have tax implications but they could result in the violation of other federal, state and local laws.
There are several factors that go into the classification of a worker, and it’s looked at on a case by case basis by the IRS - there is no magic formula. Generally the classification will turn on the amount of control you exercise over your workers. If you tell them when to work, where to work, how to work and give them the tools for their work, they are probably an employee. If they work on their own time, in their own space, on their own equipment with an abundance of discretion as to how they perform that work, they are probably an independent contractor. The above present clearer examples of worker classification. Unfortunately, the facts are not normally that clear. There is a lot of gray area in this distinction.
If you have any doubt as to the proper classification for your workers, you can file an SS-8 IRS form to verify with the IRS that you’ve properly classified them.
*This article is for informational purposes only. It is not guaranteed to be a complete or thorough analysis of the issues discussed herein. It in no way shall serve to create an attorney-client relationship. The reader is advised to check for changes to current law and to consult with a qualified attorney on any legal issue.
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