18 Common Legal Mistakes Small Business Owners Make
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- 80% made it to the second year (2015);
- 70% made it to the third year (2016);
- 62% made it to the fourth year (2017);
- 56% made it to the fifth year (2018).
Given those numbers, more than half of all startups actually survive to their 4th year, while the startup failure rate at 4 years is about 44%.
Legal mistakes are one of the top causes of startup failure.
In the rush to start up their business, entrepreneurs mostly focus on everything except the legal considerations of operating their business. And, these are the same things that can knock them down in this cutthroat competition. Do not let this happen to you.
For startups, particularly in sectors such as payments, e-commerce, food or medical care, it becomes even more crucial to focus on the legal aspect. You do not want to make the same mistakes as someone else, but learn from it, right?
Here are some of the most common legal mistakes that are being made by startups:
1) Wrong legal entity
Choosing the right legal entity from the beginning is quite crucial for your startup. Some structures to choose from include LLP, a registered company (public / private limited), property and association. The most accepted is a registered firm, especially for any dealings with the foreign clients.
Go to a limited company or LLP if you do not want personal responsibility for the losses or responsibilities of your startup. Choose the correct form of legal entity to avoid any legal inconvenience and the payment of higher taxes.
2) Do not track expenses
Another common mistake commonly made by the startups is not keeping track of their expenses, small or large, throughout the year. Many startups try to collect all receipts only when tax returns must be filed! What is not documented is not deduced, hence, is like leaving money in the open.
There are many options available to manage and record expenses. Entities can also hire accountants in order to manage these records, if the volumes are quite high.
3) Lack of documentation
Each interaction, whether minutes of meeting or anything else, must be on the record. It is crucial to have all documents in proper order at all times. Legal due diligence can make or break a crucial deal of business.
4) Don’t have proper agreement of the founders
Each startup may or may not run or be essentially successful. Therefore, it is important to have a solid founders agreement, because it is worth thinking about how you and your co-founders could face failure. The agreement of founders must contain all the essential clauses, such as adjudication rights, property, and the functions and responsibilities of each founder, including conditions of employment and wages.
5) Mixing revenue and capital expenses
One of the main confusions for those who present business for the first time is about expenses. What expenses are considered capital / assets expenditures and what are called deductible income expenses in the P&L A / c. The most valuable items that will last significantly more than a year are known as capital / asset / equipment expenses. For instance, the expenses in the purchase of laptops are not deductible as income expenses in the P&L A/c, but only the amortization / depreciation in them is deductible over a period of time.
Things that are consumed over the year are included in the income expenses. If the capital or equipment items are deducted by accident as income expense, the tax department may evaluate that the expense has been characterized incorrectly and a deduction doesn’t apply. Therefore, be careful when you are accounting for all those expenses.
6) Mixing personal and business expenses
Money & time are the biggest investments in a startup, and often business and personal expenses become indistinguishable. This can be one of the major sources of confusion when taxes are filed and, in some cases, can lead to income authorities canceling various deductions on an ad hoc basis and, as a result, higher tax expenditures are levied. Therefore, startups must have a financial account at the beginning and separate records as well.
7) Not protecting intellectual property
(IP) is the most valuable asset of startup. Patents, trademarks, and copyrights are the three essential components of intellectual property. It is crucial to not let anyone claim a right to your IP. Strict non-disclosure agreements are a way of ensuring this. Startups often neglect the protection of intellectual property and suffer later.
8) Non-compliance with securities laws
The founders of new companies usually issue shares to angel investors, family and friends. However, shares issued without complying with the specific disclosure and presentation requirements under the securities law can lead to serious legal problems at a later stage.
9) Missing regular tax payments
Companies, whether sole proprietors or not, must pay taxes in advance. This means that they must determine their taxes for the year in advance and pay the prescribed fees. They can get in trouble for not paying taxes on stipulated time. Therefore, it is crucial to make a regular inventory of the profit and loss account in each quarter and pay the anticipated taxes.
10) Not ensuring professional help for tax-related issues
A startup must appoint a tax advisor in order to ensure that all regulations are complied with. This will also give you more time to concentrate on forming strategic relationships, building your company, and other things. It is crucial to ensure that all regulations are complied with until the tee. Taxes are also not something that a company should review only once per year.
11) Not Registering Your Name
If you intend to be a sole proprietor or a corporation, you must ensure that no one else is using the name you have selected for your firm. If you register a limited liability company (LLC) or a corporation, a name verification is needed, but make sure the name is available before making a logo, designing a web app, or printing business cards.
12) Not Choosing a Business Structure
While dreaming about the concept for your startup business, you are probably not focused on how you should structure your company. Establishing your company as an LLC or a corporation from the very beginning can save you money in taxes and can also help you clarify your structure of ownership.
Take some time to consider your options, which include partnership, unique property, LLC and corporations (S and C corporations) and choose the option that makes the most sense for starting your company. You should keep in mind that you’re planning for your startup to grow, so you will want to establish a structure that can facilitate your big plans. When starting a partnership or LLC, make sure you have established member or partner agreements so that role and participation of everyone are clearly designated.
13. Not Having a Standard Contract
When you start a business, you probably do not have many customers, but since you intend to see great growth, you must create a standard contract to use with all your clients. This will simplify things and ensure you protect yourself. Take a look at the contracts that your competitors use. Write a contract that’s easy to comprehend and is not too long. Talk to a lawyer in order to make sure you create a contract that is favorable to your business and fair to your clients.
14. Not Having a Nondisclosure Agreement
While exploring how to start a startup, you are probably talking to many people and sharing a lot of information about your startup idea while trying to hire people, get advice, get estimates and retain professionals. A confidentiality agreement, or non disclosure agreement, will help ensure that the information you share with others remains private.
15. Not Hiring Employees Correctly
Many startups are focused on finding the right employees than following the proper procedures for hiring the right employees. Hiring an ideal employees is a key part of your success when starting a business, and it is equally crucial that you have the proper documentation when you hire people. These include IRS Form W-4, USCIS Form I-9, offer letters, non-competitors, benefit forms and employee handbook, as well as standard operating procedures for jobs and tasks. Taking the time to create these documents when you start your company can save you cost & time later and provide important protections for your business.
16. Not Paying Attention to Securities Laws
When starting a company, it is tempting to want to distribute shares to your friends, family, and investors. After all, you are quite excited to start your own business and want to include them in your business plans. However, the issuance of shares is something that must be done quite carefully and in accordance with the laws of security board, therefore, control your enthusiasm and talk to a lawyer who can help you with the presentations, required disclosures, and forms. Talk to the lawyer before issuing actions, as it must be strategic to issue them. Making a mistake with the actions could result in expensive fines for your firm.
17. Not Having a Business Lawyer
There will be a wide gamut of situations in which you will have legal questionnaire, you will need the documents to be reviewed, you may have no idea what your rights are and you do not know how to protect your own interests. When you start your business, you should have a business lawyer to help you make important decisions and commit to legal agreements.
18) Infringing Another’s Trademarks
In technical terms, a registered trademark is a distinctive brand that clearly identifies the source of a service or product and distinguishes it from various other sources. A registered trademark can be a name, word, logo or design. A person receives rights to a brand simply by using it in the market and doesn’t have to register their trademark in order to enjoy brand protection. Some firms will start business with a name or brand that is already used.
After putting a lot of money and effort in order to build your brand around that brand, they discover that they don’t have enough rights, usually following a letter of withdrawal and termination of a lawyer.
Due diligence of the registered trademark is crucial for any company, maybe not today, maybe not tomorrow, but as soon as possible and for the rest of his life. The entrepreneur must conduct a search before deciding on a trademark of the firm in order to avoid using a trademark that is already owned by another. At a minimum, a normal web search is necessary, and a full search of the registered trademark is recommended.
Let’s Wrap Up:
Starting a new business is pretty exciting and challenging too, and your business has a plethora of growth potential, but there is also the possibility of making quite costly mistakes as you start. If you learn to avoid the most common mistakes made by startups, your startup can run smoothly from the beginning and your firm is better prepared to be successful and profitable in the long term.
: I am a Sr. Business Analyst, working for more 8+ years at Xicom Technologies
(Outsourcing Software Development Company).
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