Legal Traps for a Small Business

Starting your own business can be life-changing, but it has risks. The last thing an entrepreneur wants is to see their hard work go up in flames over something avoidable.

Starting your own business can be life-changing, but it has risks. The last thing an entrepreneur wants is to see their hard work go up in flames over something avoidable. Unfortunately, many business owners don’t fully understand some of the legal implications of their actions. Something that seems benign can quickly turn into a nightmare.

Today, we’ll review some disastrous legal traps small businesses fall into and how to avoid them.

Handshake Deals

No offense to your grandfather, but the handshake deal is dead. Look, I am an optimistic person. I even think most people are good and honest. Still, I cannot approve of handshake deals. I’ve seen too many of them turn into massive disasters.

It starts out something like this. The parties get to talking about a potential deal over dinner or drinks. They get hyped over the promise of the deal and hammer out some basic terms. They agree to “let the lawyers iron out the details” and decide to start the actual work ASAP. As “the lawyer” in this scenario, I know what happens next.

Things may start great, but then something happens. A shipment doesn’t go out in time, a payment gets missed, or the product specs are off. And that’s the first time the lawyer hears about the “agreement.”

This is why putting the agreement in writing is so important. A good contract is like a user manual for the deal. You can turn to the contract to determine the remedy when something goes wrong. The contract can describe product specifications, what to do in case a shipment is delayed, and how to dispute payments.

Don’t think of a contract as a sign of distrust. Instead, use it like a tool. The process doesn’t need to be adversarial, either. 99% of the time, my contract negotiations are pleasant and collaborative.

Using the Wrong Entity

Another legal trap to be aware of is using the wrong entity for your business.

I’ve talked before about the importance of choosing the right entity for a business. I understand that not every business has to be an LLC or a corporation. Plenty of small businesses operate as sole proprietorships without any significant issues. That said, it can open the owner up to liability concerns.

As a sole proprietor, you are your business. You might file for an assumed name (or d/b/a), but as far as the law is concerned, you are one and the same. This means that owners are also personally responsible for the debts and liabilities of their business.

So, for example, let’s say Calvin has a commercial cleaning business called “Calvin Clean.” One of Calvin’s employees accidentally scratches up a Brazilian Cherry wood floor, causing $50,000 in damages. Calvin and not the business will be on the hook for the $50,000. That means that the customer may even be able to go after Calvin’s personal assets and bank accounts.

Contrast this to an LLC or a corporation. In most cases, LLCs and corporations treated as being separate entities from their owners. Accordingly, these entities have limited liability. This means that, typically, the debts and liabilities of the LLC or corporation pass to the business and not the owners.

Let’s revisit that example. If Calvin Clean was an LLC, this scenario would be very different. Instead of suing Calvin individually, the customer must look to the company for the $50,000 in damages.

Note that there are circumstances where limited liability may not apply. These exceptions are limited to a handful of situations which I touch on more in the LLC vs. Corporation article.

Being a business owner sometimes means taking risks, but smart business owners also know how to mitigate risk. Using the right entity can help keep the risks of running a business minimized, so owners can focus on growing their enterprise.

Wrongful Termination

Sometimes an employee just isn’t a good fit. Terminating an employee is a difficult decision. It’s a decision that weighs heavily on the heart of a business owner, but sometimes it is the best option.

Terminations are typically made “for cause” or “without cause.” An employer may terminate an employee for any legal reason in an at-will employment state like Texas. So, if the owner finds the employee annoying, that is usually a good enough reason. The problems arise when the termination is due to age, gender, disability, or other protected categories.

At-will status does not give employers the right to act improperly. Unfortunately, some employers really will fire an employee for truly outrageous reasons. However, improper termination is often due to the owner’s lack of understanding of the law.

This is often the case with terminations due to disability. An employer may want to terminate a disabled employee because they think the employee can no longer perform their job duties. If the employer has 15 or more employees, however, they may be required to provide reasonable accommodations to the employee under the Americans with Disabilities Act (ADA).

Reasonable accommodations allow an employee with a disability to perform their job. Examples might include adding a wheelchair ramp or text-to-speech software. Most accommodations are not cost-prohibitive. An employer may still be able to terminate an employee if no reasonable accommodations can be made. This is also true if the accommodations would cause undue hardship to the employer. Typically, this means the cost or logistics would make it too difficult to implement.

The key takeaway is that even at-will employers should be careful about terminations. Most of the time, the employer is legally in the clear, but if handled incorrectly, they can fall into a costly legal trap.

Tax Troubles

One legal trap that can sneak up on business owners relates to taxes. Nobody likes paying taxes, but ignoring them is not a long-term solution. In addition to income taxes, a business may be required to pay sales, franchise, or property taxes, depending on the state.

One common mistake with taxes is when a business thinks it can write anything off as a business expense. A troubling trend I have seen on social media is that someone will claim you can write off vacations, luxury goods, and other things as a business expense. This may be true if there is a legitimate business purpose for buying these things, but the IRS may be very forgiving if you are just going to Hawaii to go to Hawaii.

Tax fraud is serious and can carry criminal implications. Even if you sincerely made a mistake, you could be subjected to stiff penalties for improper tax reporting. For this reason, it’s a good idea to talk to a CPA or accountant when in doubt. Even as an attorney, I usually defer to a CPA regarding tax questions.

Going it Alone

Finally, the last legal trap is one that I deal with all the time. Many business owners don’t ask for legal advice because they believe it costs too much. Most small businesses do not need a full-time attorney working as a general counsel. But talking to a business attorney about potential legal issues could prevent the business from losing thousands.

“Well of course you’d say that. You’re a lawyer!”

Look, fair enough. But, to be honest, my goal is not to milk clients for every penny. I like helping businesses. One of the ways I do that is by working with small businesses to ensure they are doing things the right way.

An attorney can help a business owner find the right entity. They can also help negotiate and draft contracts or assist with the termination of an employee. Getting help on the front end is usually much cheaper than paying legal fees for a major lawsuit later. As the saying goes: an ounce of prevention is worth a pound of cure.

As always, this article is meant to help people understand these concepts. It is not legal advice. If you have questions about these topics, please get in touch with an attorney.