There is more to business success than turning a profit. In the long term, the health of your company may depend as much on repelling legal threats as it does on meeting production and sales targets.
2. PRACTICE GOOD CORPORATE HYGIENE.
Simply generating your liability shield is not enough. Depending on which type of entity you select, various ongoing maintenance requirements keep that liability shield in place. If a plaintiff wins a significant judgment against your business, their attorney may try to convince a judge to “pierce the corporate veil,” which involves disregarding your liability shield and allowing the creditor to apply the judgment against your personal assets as well as the business’s.
Successfully defending against such gambits includes:
business and personal assets separate, i.e., not commingling personal and business monies, or paying personal expenses out of business accounts;
adequately capitalizing your business;
maintaining required formalities, such as creating an operating agreement for a limited liability company and bylaws and other necessary documentation for corporations;
maintaining ongoing business records, such as regular accounting of its assets; and
making it obvious to customers, clients, suppliers, and other parties to your agreements that they are dealing with your business entity and not you personally.
That final step is easily missed when partners, members or shareholders are first getting their business off the ground. If you execute a document and do not make it clear that you are signing in your capacity as a manager or officer of the entity, then you may be personally on the hook for an ensuing liability.
3. PAY ATTENTION TO YOUR GOVERNING DOCUMENTS.
Implementing bylaws, an operating agreement for an LLC, or a shareholder agreement between owners of the corporation can head off unnecessary litigation. While it may not seem urgent at the time of business formation, when enthusiasm and good will are at their peak, a well-planned operating agreement or shareholder’s agreement is the important rulebook that LLC members or corporate shareholders can reference if disputes arise. It should set forth everything about your business, from its purpose to how disputes are handled to how business interests are managed in the event of an ownership breakup.
It is imperative that those governing documents include a “business prenup” or succession plan that sufficiently outlines how business interests are handled at time of dissolution of the business, or the death, incapacity or divorce (among other things) of one of the owners. When drafted appropriately, the governing documents will smoothly guide members and shareholders through transition periods without the need for court intervention.
4. REQUIRE NONDISCLOSURE AND NON-COMPETE AGREEMENTS.
When dealing with a co-owner or key employee, it is important to protect your business’s relationships and other competitive assets. Often times, because a small business has a unique product or service or a limited area of influence, a removed owner or terminated employee can put your company’s interests at risk by immediately going into business against you.
Appropriately worded nondisclosure and non-compete agreements can help protect your business from such risks. However, to be enforceable, restrictive covenants must be reasonable as to time, location, and content. Consulting with a legal professional before drafting these agreements can help you produce an enforceable document that will survive legal challenges.
5. PROTECT YOUR INTELLECTUAL PROPERTY AND TRADE SECRETS.
Your company’s intellectual property and trade secrets need to be protected not only from dissociated owners and employees, but also from the greater market.
First, identify those assets, confirm that they are actually owned by you or your company, and determine the entire scope of your intellectual property rights.
Next, plan for the best way to protect identified intellectual property and consider formal and non-formal legal protections, such as patents and registered trademarks and copyrights.
Keep in mind that not all intellectual property is equal; in some cases, simple non-disclosure and non-use clauses signed by your employees might be the only action needed to protect your company’s intellectual property.
6. PROTECT YOUR ASSETS VIA SEPARATE LLCs.
While creating the right structure can protect you from personal liability, another angle to consider is the protection of various assets with separate LLCs. In this way, your business’s foundational assets can be protected from the liabilities accrued from the operational side of the business.
For instance, it is almost always a good idea to spin off the ownership and management of real estate into an entity that is separate from the entity that handles the day-to-day business operations. Another example is possibly creating one LLC to own valuable equipment and machinery, which then leases that equipment and machinery to the operating LLC. Then, if the operating entity is the target of a lawsuit, separate ownership of the equipment and machinery reduces their exposure.
7. COMMIT ALL BUSINESS TRANSACTIONS TO WRITING.
All agreements and transactions with vendors, suppliers and customers should be committed to writing. Failing to establish a written record of the transaction could result in lost business or assets, or raise uncertainty over what the actual transaction was supposed to be.
Always include all parties’ names, titles and contact information, the details of each party’s obligations, and, if applicable, payment terms. Be cautious in using contract templates downloaded from the internet, as they may not be sufficiently clear or applicable to the laws of your state.
Beyond formal agreements, it is important to document in writing what may seem like casual conversation. For example, when you are negotiating a contract with a potential customer or client, immediately confirm by email the terms discussed or agreed to, so that misunderstandings are minimized, your interests are protected, and momentum to a more formal agreement can be preserved.