Starting a new business? The U.S. Bureau of Labor Statistics indicates that 20% of new businesses fail in the first two years, and that 45% fail in the first five years. As daunting as those figures may seem, there are measures you can take to avoid having your new business become a negative statistic. Below are 11 reasons a business can be in trouble, often before even opening its doors.
Mistake #1: Operating as a Sole Proprietorship and Not Protecting Your Personal Assets
Although quick, easy and cheap, hanging out a shingle for your new business without considering a more formal statutory structure leaves your personal assets at risk as you are not separate from your business. A successful plaintiff may be able to attach your home and everything else you personally own to satisfy a judgment.
Best Practice: Structure and register your business as a corporation or limited liability company. Both structures provide immunity against personal liability in most situations. If you are using a fictitious name in your business rather than the formal registered name, make sure you register that as well. Using a non-registered fictitious name absent association with the company can also result in personal liability.
Mistake #2: Comingling Personal and Business Assets
Not separating your personal assets from those of your business can result in personal liability even if you have registered your business as a corporation or limited liability company under the doctrine of “piercing the veil.” If you fail to observe such formality, you are considered to be an “alter ego” of your business, exposing your personal assets to the reach of creditors.
Best Practice: Maintain separate bank accounts for your business and personal finances. Do not use company equipment for personal use. Document transfers of cash between you and your business through formal agreements. Additionally, you should sign all documents in the name of your company position, not in your individual capacity, else you find yourself liable for a business contract.
Mistake #3: Not Having Written Agreements With Business Partners
Forming a business with others can often result in disputes over the management and direction of the company. Not having an agreement or protocol on how to resolve disputes or expel a shareholder or member, or how you can withdraw, can result in a legal quagmire.
Best Practice: Corporations and limited liability companies generally control their operations and relationships with other shareholders or members through a formal written agreement. If you wish to have shareholders or members in your company, consider this agreement as your “pre-nuptial agreement” spelling out how the company can remove a shareholder or member or how she/he can withdraw.
Corollary: Read all of your organizing and governing documents, as well as contracts with financiers, vendors and customers. Ignorance is no excuse when it comes to compliance with your obligations.
Mistake #4: Infringing Another Company’s Name or Brand
Selecting the name of your company and designing your brand can be crucial to your business’s success. It can also be its demise if you fail to research your name and brand to assure it is not already in use for similar goods or services by another party. Using a name or brand that is likely to be confused with another already in use can result in claims for trademark and/or copyright infringement with significant monetary penalties.
Best Practice: Engage an attorney with expertise in intellectual property law to perform a search of your name and brand to assure there are no prior claims to a similar name or brand. Such a search would include reviewing records at the Secretary of State, the U.S. Patent and Trademark Office, and Copyright Office.
Mistake #5: Failure to Protect Your Company’s Brand, Intellectual Property and Trade Secret
Now that you have done your research and selected your name and brand, third parties can infringe them. Employees can walk away with confidential information related to your business such as customer data, secret manufacturing processes, company finances and other information you would not want a competitor to know. Your website developer may own the copyright in your website absent language in your contract assigning it to you.
Best Practice: Protect your name and brand with state or federal trademark registrations. Consider protecting articles of manufacture or business methods with patents. Protect your company’s confidential information and trade secrets with reasonable methods that will maintain their confidentiality such as non-disclosure agreements and non-compete agreements with employees. Review all contracts with website or other content developers to assure you own the necessary copyrights to your business content. If someone other than you developed a patentable invention, document all contributions to that development and establish ownership by the business, if necessary, through assignments or licensing agreements. Consider agreements with your employees requiring them to assign rights to all inventions developed during their employment with you.
Mistake #6: Confusing Independent Contractors With Employees
Although tempting to label a worker as an independent contractor and avoid the annoying task of withholding employment taxes, a worker that looks and acts as an employee will be considered by the U.S. Department of Labor and the IRS as an employee regardless of how you and the worker wish to label the relationship. That can result in significant financial penalties for the failure to maintain employment records, pay overtime or withhold taxes.
Best Practice: Analyze the factors used to by the DOL and IRS to determine whether the worker is an employee or independent contractor. DOL uses an economic realities test, and the IRS uses a right of control test. Engage an attorney experienced in employment law to review such relationships and draft an independent contractor agreement if appropriate. A best practice would be to have the independent contractor operate as a corporation or limited liability company and provide similar services to others.
Mistake #7: Misclassifying Employees
The federal Fair Labor Standards Act and state law require that employees be paid minimum wage for hourly work with additional compensation owed for hours worked over 40 in a pay period. Although the FLSA provides for some limited exemptions, such as for “white collar” positions, those exemptions must meet a tri-part test that includes a guaranteed salary, a minimum weekly wage and a duties requirement. Misclassifying an employee as exempt when she or he is not can result in significant financial penalties.
Best Practice: Review the tri-part test for each position you believe is exempt to assure that the employee meets the duties requirements, is paid at least the minimum weekly or annual salary, and that salary is guaranteed. The duties actually performed by the employee, not what is stated in the job description, will control the analysis.
Mistake #8: Not Withholding Employment Taxes
Cash crunches are common with new businesses, and it can be tempting to forego withholding employment taxes for one month hoping to make up for it the next month. Regardless of your company’s structure, a failure to withhold employment taxes will result in a personal penalty equal to the amount you failed to withhold.
Best Practice: Properly withhold and report all employment taxes on a timely basis.
Mistake #9: Not Having Sound Employment Practices
Even small businesses may be subject to state and federal laws that prohibit discrimination based on age, religion, national origin, race, gender, sexual orientation, disability and other protected characteristics. These include the federal Age Discrimination in Employment Act, the American with Disabilities Act, Title VI of the Civil Rights Act of 1964 and various state laws that mirror the federal counterparts.
Best Practice: Assure that in all employment actions, from hiring to compensation decisions to discipline to termination, you comply with these state and federal laws. Engage an employment attorney to periodically review your onboarding documents and employment policies to assure current compliance.
Mistake #10: Failing to Consider the Ohio Consumer Sales Practices Act
For businesses that cater to consumers, the Ohio Consumer Sales Practices Act prohibits unfair and deceptive as well as unconscionable sales practices. Those can involve “bait” advertising, treatment of deposits, provision of written estimates and home sales. Failure to comply can result in triple damages and reimbursement of attorney fees to the consumer.
Best Practice: Become familiar with the Ohio Consumer Sales Practices Act and its implementing rules.
Mistake #11: Failing to keep accurate records
Accurate records are required, not just necessary, for periodic financial review so you can measure your success, but also for filing correct taxes, meeting wage and hour requirements under the DOL and defining intellectual property ownership. Failure to maintain such records can result in financial penalties and even a loss of rights to assets of the business.
Best Practice: Maintain accurate financial records, maintain records related to the hours worked and compensation paid to all employees as required by the FLSA, and review and make sure that all intellectual property ownership is documented through internal records, assignments or licensing agreements.
Conclusion
In addition to the above tips, make sure you insure your business properly, including obtaining coverage for general liability, professional liability, directors’ and officers’ liability and employment practices liability insurance, as appropriate. As always, our partners in our Corporate and Labor and Employment practice groups are available to assist you with your new business and help it succeed.
For further questions and concerns, please contact KJK Partners, Maribeth Meluch (MM@kjk.com; 614.427.5747) or Steven Bersticker (SCB@kjk.com; 216.736.7219).