Pantano
& Gupta has a soft spot for startups and small businesses and has been
serving the needs of these beloved clients since the firm’s inception. So, in
honor of our startup and small business friends, we are outlining common issues
you may encounter as a new venture. Most times, legal mishaps occur simply
because no one consulted an attorney. We hope that none of you will face these
legal problems. With the right legal assistance, you won’t.
If
It Happened to Them, It Can Happen to You…
Cautionary Horror Story. This story told by Nevada-based Bongiovi Law Firm highlights the
importance of creating agreements to manage cofounder disputes.[1]
Jack and Bill formed a two-member LLC and decided to hire this Nevada firm to
help them with preliminary legal work. Upon retaining Jack and Bill, the firm
promptly asked them to see the operating agreement governing their LLC. Jack
responded that they had obtained a generic operating agreement when they formed
the LLC and that was their only governing document. This, understandably,
troubled their new lawyers. Every few days for the next couple of months, the
firm attempted to obtain the generic operating agreement to update it to fit
the needs of Jack and Bill’s LLC – Jack and Bill were too concerned running the
business to find the document they thought they’d never need. One day, the firm
received a call from Jack in a panic – Bill was angry and leaving the company.
The firm’s first piece of advice was to remove Bill as a signer on the business
bank accounts. Jack went to the bank only to find that Bill was at another
branch at the same time…withdrawing $21,000 from the company’s checking
account. Because Bill was still a signer on the account, the bank could not
refuse to give him the money and because the generic operating agreement
did not restrict an LLC member’s ability to withdraw money from the company
bank account, Bill didn’t breach any agreement by doing so. Jack’s only
recourse at this point was to “file a lawsuit against Bill, hope he wins, and
then hope he can collect the money.” You can avoid situations like this if you plan
for the horrible.
Plan
for The Horrible
Operating Agreements. I know, you’re excited to start
your own company. In fact, you can’t wait and really don’t care to think about
any of the logistics before you do. But, part of planning for the horrible is
planning for the unpleasant possibility that your cofounder may not always be
the friend or business partner you expected him or her to be.[2]
It is an awkward situation to work with cofounders to plan for your potential
“falling out” – but, it’s worth it. To protect yourself and your business, it
is important that you create agreements during formation that clearly outline
what will happen if you or your cofounder decide to leave. These agreements
should include terms concerning who gets what when a cofounder leaves the
company and importantly – when money can be withdrawn from any bank accounts. It’s
a horrible situation to have a cofounder leave the business; it’s an even worse
situation not to have a plan when that happens.
Don’t Mix Business and Personal
Money. One thing
that every small business or startup wants to avoid is called “piercing of the
corporate veil.”[3]
Small companies often choose to form as a corporation or limited liability company
(LLC) to shield shareholders, officers, and directors of the company from personal
liability for business debts and obligations. However, in situations where it
seems that the corporation is simply an alter ego for the persons running it,
that shield or “veil” can be pierced making those persons liable for the debts
and obligations of the business. The fastest way to lose the corporate shield
is by mixing business and personal funds.[4]
DO NOT put business funds into your personal accounts or use them to cover
personal expenses and vice versa. Open business bank accounts and credit cards
and never use them for personal activities! EVER!
Put It In Writing. When a third party is important
to your business model, make sure to enter into a signed, written contract with
that party.[5]
As Jeff Yelton noted in his article on small business pitfalls, verbal
contracts “sealed with a handshake” are no longer sufficient to create a binding
obligation.[6] Although verbal contracts may be legally
sound, they are hard to prove and too easily altered. If you find a supplier,
client, or other business partner who offers to create a valuable relationship
– have that relationship recorded in a signed written contract. Include the
most important terms of that third party’s obligations. That way, if the third
party later decides they no longer want to perform their end of the deal, you
have a solid claim for breach of contract evidenced by a signed, written
agreement.
Protect
Your Intellectual Property Rights and
Don’t Violate Others’
Protect First, Use Later. Intellectual property protection
is not something you should think about after
you design a valuable creative project, brand logo, or useful invention.[7] Rather, there are preemptive types of
protection in almost every area of intellectual property that allow you to
protect first and use later. For example, to protect a logo you can file an
“intent-to-use” trademark application based on a bona fide intention to use
that logo in the future.[8]
In order to quickly protect an invention or procedure used by your business,
you can file a “provisional” patent application that requires much less
information and a much lower fee than a full patent application. Then, you can
take the time to determine your invention’s commercial potential before filing
the full application and investing the full fee amount, which you must usually do
within one year of filing of the provisional application.[9]
Remember also that copyright protection attaches to your creative image, song,
or video upon creation, so that you can register your copyright as soon as the
creative project is completed as long as it is in a fixed, tangible medium of
expression.[10]
Affordable Protection Does Exist.
Startups and
small business often believe it is too costly and time-consuming to protect
their intellectual property. While that may be true for certain types of
intellectual property, such as patents, there are other forms of protection
that are much more affordable. If you want to protect your brand, product
design, or product packaging, you can file trademark applications for
protection of all three. Trademark and copyright protection are much cheaper[11]
than patent protection and may be sufficient depending on the type of business
and the subject matter you’re seeking to protect.
License Others’ Intellectual
Property. The
internet provides a plethora of images, sounds, and videos that you may want to
use in promoting your business. However, just because something can be
downloaded online does not mean your company has the right to use it. In fact,
often times you don’t. Make sure that you have the license to use any
photographs, clipart, songs, sound clips or movies that you use on your company
brochure, business card, or website. Otherwise, you may find yourself being
sued for a hefty sum after several years of seemingly minor, but lengthy
infringement.
Avoid
Employment Lawsuits.
Have an Employee Termination
Procedure and Follow It. There
will likely be a time in the life of your company that you have to terminate an
employee. It is important to have a termination procedure in place before you
need to fire someone.[12]
It is also important to follow that termination procedure. If you do, you will
have strong evidence in your favor against an argument that the employee was
terminated for the wrong reasons. Point to the wrongdoings of the employee, as
documented according to your disciplinary and termination procedure, and you
have a defense. This relates to another important tip for employment issues –
keep a paper trail – meaning document EVERYTHING so that an employee attempting
to fudge the real facts of his or her termination cannot get away with it.[13]
Maintain an Internet and Security
Policy. There
are several reasons why you need an internet policy and a security policy for
your new business.[14]
An internet policy that specifically outlines acceptable online activities on
company computers can help keep employees productive and minimize the potential
for sexual harassment or other liability-creating behavior facilitated by
company technology. A security policy that delineates which employees can
access confidential information and trade secrets, how company files can be
transferred to third parties, and who has the authority to access client lists
will prevent leakage of valuable company information. These policies can be
included in an employee handbook or drafted as separate agreements.
[2] Mark Britton, Ten Legal Pitfalls Startups Should Avoid,
Fox News (July 12, 2011), http://smallbusiness.foxbusiness.com/legal-hr/2011/07/12/ten-legal-pitfalls-startups-should-avoid/ (last visited
on March 7, 2013).
[3] Glencap, How to Avoid Piercing the Corporate Veil and
Maintain Personal Asset Protection for Your LLC, http://glencap.hubpages.com/hub/avoidpiercingthecorpveil (last visited
on March 7, 2013).
[4] Suzanne Kearns,
5 Small Business Legal Nightmares – and
How to Avoid Them (Jan. 24, 2012), http://blog.intuit.com/money/5-small-business-legal-nightmares-—-and-how-to-avoid-them/ (last visited
March 7, 2013); See also Mark Britton, Ten
Legal Pitfalls Startups Should Avoid.
[5] Mark Britton, Ten Legal Pitfalls Startups Should Avoid;
See also Suzanne Kearns, 5 Small Business
Legal Nightmares – and How to Avoid Them; See also Eight Common Legal Mistakes That Startup Businesses Make, http://www.thesmallbusinessplaybook.com/common-legal-mistakes-startup-businesses-make/ (last visited
on March 7, 2013).
[6] Jeff Yelton, 5 Common Legal Pitfalls and How to Avoid
Them (Sept. 5, 2011), http://www.varsguide.com/5-common-legal-pitfalls-and-how-to-avoid-them/
(last visited March 7, 2013).
[7] Register it,
use it, and defend it – in that order. Barbara Findlay Schenck, Register, Protect and Defend (Jan. 3,
2011), http://www.entrepreneur.com/article/217800 (last visited
on March 7, 2013).
[8] See 15 USC
1051(b).
[9] See 35 USC
111(b); Provisional Application for Patent, http://www.uspto.gov/patents/resources/types/provapp.jsp; Provisionsal
Application Brochure, http://www.uspto.gov/patents/resources/types/provisional_app.pdf.
[10] See 17 USC
102(a).
[11] While the basic
fees for both somewhere between $300 and $400, there is much more preparation
work required for filing a patent that will result in greater attorneys’ fees.
See USPTO Website, http://www.uspto.gov/web/offices/ac/qs/ope/fee031913.htm (for patent and
trademark filing fees).
[12] Dana Schultz, Top Ten Legal Mistakes of Startup and Early
Stage Companies, LawPivot Blawg
(Oct. 11, 2011), http://blog.lawpivot.com/2011/10/top-ten-legal-mistakes-of-startup-and-early%C2%ADstage-companies/ (last visited
on March 4, 2013).
[13] Even when you
win an employment case, it can be a long and drawn-out process. Emails
documenting each step of the termination process will make this process easier.
See Adriana Gardella, Settling Is Not the
Only Way to Resolve an Employee Lawsuit, NY
Times (Feb. 20, 2013),
http://www.nytimes.com/2013/02/21/business/smallbusiness/tips-for-s…iness-owners-to-avoid-employee-lawsuits.html?ref=smallbusiness&_r=0
(last visited on March 7, 2013).
[14] Minara
El-Rahman, Current Legal Issues for Small
Business Owners (Jan. 25, 2010), http://blogs.findlaw.com/free_enterprise/2010/01/current-legal-issues-for-small-business-owners.html (last visited
on March 7, 2013); See also Karen E Klein, Four
Legal Pitfalls Loom in 2010, Businessweek
(Jan. 12, 2010), http://www.businessweek.com/smallbiz/content/jan2010/sb20100111_618606.htm (last visted on
Mar. 7, 2013).
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