A Litigator’s Perspective
By Peter M. Storm
There is a wealth of information available to anyone considering starting their own business. A “Google” search for “business formation” delivers countless checklists and other resources that can be helpful to new business owners. At the bottom of this page, you will find links to my suggested reading list that includes information, guidelines and forms designed to help you discover what you can do, and how you can do it.
But what you won’t easily find are those things from a legal perspective that new business owners should avoid, or perhaps even more important, those things that in all cases, they should not fail to do. Identifying and planning for the matters most likely to subject them or their businesses to liability is key to staying out of court. As a prime example, business litigation arises often out of poorly drafted or “cookie-cutter” documents no one ever paid any attention to. While the following list is by no means exhaustive, our business litigation experience suggests these are among the top ten mistakes new business owners make.
1. A business plan is not necessary. Putting ideas into practice is a great idea, but no business, no matter how creative the idea, should be without a business plan. Clients often express the view that a business plan will be too costly or complicated and not really suited to their needs. However, according to the small business administration, nearly 45 % of new businesses will fail by their fourth year. Most experts agree that the failure to carefully address and plan for budgetary, financing, spending, marketing, location, control and expansion issues before the doors are opened is one of the chief reasons businesses fail. From a legal perspective, a business plan should carefully address any legal issues the new business might face. A good business plan doesn’t have to cost a lot, but failing to develop one might cost you everything.
2. I saved a lot of money with one of those “Do It Yourself Kits.” Many former business consultants, accountants and lawyers are now marketing “Do It Yourself Kits” for forming a corporation, or limited liability company to own and operate your business. They advertise “hundreds of dollars” in savings by purchasing and using their materials, rather than employing an accountant and/or a lawyer. There are certainly decent “kits” available, but we think even the best ones are not much different than the best “Build It Yourself” porch or garden pond kit. Some will be able to use them effectively and without much difficulty. But many others will overlook or be unaware of important details that could have a significant impact on their business later on. And virtually every client who has come to us to “straighten out” their mess, eventually concedes the money and time they spent on the kits was a total waste. Our advice: in order to make sure you have dotted all the “I’s” and crossed all the “t’s, and to avoid legal problems down the road, you should probably consult a professional.
3. My brother said I should form an LLC. Choosing the right firm for your business is extremely important. While the advice of family and friends may often be helpful, they can also steer you in a completely wrong direction. A limited liability company is a unique form of business because it combines the tax advantages of a partnership with the limitation on personal liability that a corporation provides. But just because your brother recommended you form a limited liability company does not mean that an LLC is the best choice for your business. For example, an LLC should not be formed without a comprehensive Operating Agreement specifically tailored to your particular business that also addresses any unique ownership issues between its members. Thus, formed correctly, an LLC may turn out to be a far more complicated and costly choice. And because the LLC form is often unfamiliar to those that your business may deal with, it could be threatened by such unintended things as withdrawals from company accounts without proper authorization or a failure to recognize a distinction between personal and LLC assets. Unlike corporate shareholder disputes, we have found that most judges have limited experience with litigation between LLC members, meaning that regardless of how carefully you have planned, you may still be in unchartered waters. In short, deciding to form an LLC is a choice that should be made after carefully considering all of the advantages and disadvantages of the various forms for your new business.
4. We will get our papers finished soon. A common thread in litigation disputes between partners or shareholders our firm has handled was the decision to open the doors before all the essential paperwork was complete. Trusting that your business partners will still sign the same deal after the fact, or will have the same “recollection” of the agreement that you do, is very risky. And entering into contracts with vendors and suppliers or a lease before your business is incorporated may subject you and your personal assets to liability. Resist the temptation to leave these important details to the last minute.
5. I don’t need to incorporate it. One of the chief reasons to form a corporation or a limited liability company is to insulate the business owners from individual liability if the business fails or is sued. You can lawfully operate most businesses without incorporating, but if the real reason for doing so is to avoid the costs you fear might be involved, you may later wish you had not tried to cut those corners. A decision not to incorporate should only be made with the help of a professional after carefully considering and weighing all of the factors.
6. I will take care of filing the annual reports. The protections a corporation or limited liability company provide rapidly diminish, however, when owners do not pay attention to keeping their books updated and filing the necessary annual reports. Often clients whose businesses have been sued have no idea where their corporate papers even are, let alone whether they are up to date. We have encountered clients who were completely unaware that their corporation was dissolved years ago by the Secretary of State because they did not file an annual report. Unless you are an unusually meticulous and detail-oriented owner, it is a good idea to have your accountant or lawyer keep the records, so they can be updated and the necessary reports filed.
7. I don’t need a shareholder agreement. One of the documents you won’t generally find in the avalanche of forms for new corporations is a shareholder’s agreement. Sometimes referred to as “buy-sell” or “buy-out” agreements, they are critical unless you want to leave to chance what will happen to your business if one shareholder dies, gets a divorce, or wants to sell his or her ownership interest. If your new corporation is going to have more than one shareholder, you should not fail to have every shareholder sign such an agreement.
8. I saved money with preprinted contracts. Nearly all of us have, at one time or another, seen or used a preprinted form or contract purchased from stationery or business supply store. And now you can find thousands of such forms online, for or at a modest cost. In certain situations, these forms are entirely suitable for many businesses, but using them without careful scrutiny or professional advice can have disastrous consequences. Often they are outdated or contain terms and provisions completely at odds with parties’ intentions. The courthouse is the wrong place to first test their suitability for your business.
9. Nobody’s going to steal my ideas or concepts. The odds that someone will claim to own or use the ideas and concepts that are integral to your business may be higher than you think. Lawsuits between businesses over the rights to a residential floor-plan or restaurant recipes are now common. The internet has created all sorts of opportunities for plagiarism and other misuses of proprietary information. New business owners should never assume that the names, concepts and ideas the new business is based upon are original or that they won’t be stolen. Registering marks and protecting names and concepts are crucial aspects of business formation that should never be taken for granted.
10. I don’t worry about what is on the website. Online newsletters, web logs and emails that are generated from your new business’ website are fertile ground for liability and litigation. The fast-paced world of the Internet produces written material that is published to the universe may contain all sorts of inaccuracies and poor word choices that can threaten your business before the owners even realize it has happened. And the ability of your competitors to misuse that information is limitless. The development and institution of careful controls and guidelines for the internet and your website is a crucial component of any new business formation.
© 2008 Peter M. Storm
Step By Step Guide To Starting A Business in Illinois
Small Business Administration – Manage Your Business from Start to Finish
Small Business Resources
Illinois Guide To Organizing Limited Liability Companies