cCommon Legal Mistakes Startups MakeCommon Legal Mistakes Startups Make

By Garrett Sutton, Esq.
In the shuffle of setting up your startup, ensuring all legal requirements are properly handled can seem like just another overwhelming chore, something to figure out later, or – worst of all – something that never gets done and you hope goes unnoticed.

Many new entrepreneurs focus on creating the product, providing services, attracting customers and hiring a good team. That can be a lot to handle by itself. Navigating the legal system is probably not how you’d like to spend a Sunday evening. Most entrepreneurs want their legal needs handled as quickly and efficiently as possible, so they can get back to the business of running the business.

So here’s a quick checklist for the first-time entrepreneur covering the most common legal mistakes you can easily avoid.

1. Waiting Until You’re in Trouble to Set Up Legal Protections

It is no secret that the United States is the most litigious society in the world. While many of these lawsuits are a necessary component of our legal system, a certain portion of these lawsuits are based on nothing more than an attempt by one party to generate a financial windfall from a targeted defendant. To help combat such legally permitted takings was born the concept of asset protection, the legal techniques of protecting one’s assets from judgment.

Asset protection is based on the principle that since assets held in your name (minus a few exceptions) can be seized by a judgment creditor, assets not held in your name (and subject to charging order protections) are better protected. If you don’t own valuable assets in your name and instead, they belong to a legal entity like a corporation or a limited liability company those assets will not be lost if you loose a lawsuit.

But, if you haven’t set up legal protections before you are sued, it can’t help you once you have been. That’s too late. Preventative care is the only treatment that works in this case. Denial won’t help you, but having a trusted legal advisor to answer questions and help you avoid potential issues can empower you and provide peace of mind. It’s smart to have a professional in your corner to answer legal questions, take many of those to-dos off your list, and ensure the paperwork is set up properly with full legal protection. If you have a business in the United States, Corporate Direct can help and advise you.

2. Not Setting Up a Legal Entity for Your Business or Property

An entity is a separate legal being, such as a corporation, limited liability company (LLC) or limited partnership (LP). All provide much greater asset protection when compared to a sole proprietorship or general partnership. It is the ‘separateness’ of an entity which protects you – the entity’s owner – from unlimited personal liability. Without that separation, if an angry customer sues you, any assets you own such as your house, car or bank account can all be taken should a judgment be found against you. An entity is a business organized according to state law to limit the liability of the owners.

An entity can’t protect you if it is not set up right at the start. Furthermore, it can’t protect you if you don’t properly maintain your entity over the long term.

3. Not Picking the Right Legal Entity

Choosing the correct entity is one of the most important decisions you can make. This one decision will dictate how you prepare your taxes, how you keep your books, how much of your business’s income you keep and how much you don’t. It will dictate your profits and losses, the financial security (and safety) of your family, maybe even your health and happiness.

Do not take the decision of which corporate entity you choose lightly. There is no part of your business that will not be affected by it.

Here are a few rules of thumb:

  • Don’t operate as Sole Proprietor: This leaves you vulnerable to unlimited personal liability. You’re also more likely to audited by the IRS.
  • Don’t Operate as a General Partnership: a general partnership is double the liabliabity risk without any reward.
  • Don’t use a C Corporation for Real Estate Investing: You’ll end up paying double the taxes. It simply doesn’t make sense.
  • Don’t Try to Save Money with a Series LLC: This newer and untested entity type isn’t available in all states and case law isn’t well established in the courts. This means the legal protections are not as established as other entity types.
  • Setting up a Single Member LLC is Risky: Courts are starting to deny sole owner LLCs the same protection as multiple member LLCs. The reason has to do with the charging order. Click here for more information.

For more information please see my book “Run Your Own Corporation.” If you’re looking to form an entity and unsure of what the best choice is for your situation, our incorporating specialists are here to help. For more information or assistance please call 1-800-600-1760.

4. Not Having a Registered Agent

Every corporation, LLC, or Limited Partnership must have a registered agent (also known as a “resident agent,” “statutory agent” or “agent of process”) in their state of formation and in any state the company qualifies to do business in. The registered agent ensures you receive all important legal documents such as service of process (meaning a notice of a lawsuit) and official governmental notices. You can be your own registered agent in some states, but some also require that you be open from 8 a.m. to 5 p.m. If you listed your house as the registered agent location, you might not always be home and that could be a violation.

In the case of a lawsuit, it is important to be notified as soon as possible since most states only allow you 30 days to answer the complaint. Without an answer, you will typically lose the case. It is important to deal with a professional, established company who will get notices to you promptly. We have been providing this critical service service for 27 years and helped more than 10,000 clients (see testimonials). For our globe trotting clients, we can email the important notifications to you, instead of waiting for the mail to catch up with you.

5. Forgetting about Trademark, Copyright or Patent Protection

Registering a trademark is an important step in any business venture – one that should not be overlooked. By protecting the name of your business, products or services, you ensure that others cannot use the trademarked words or designs.

If you fail to secure such protection, anyone can start using your ideas, and in some cases they may demand that you stop using what they now claim is their trademark.

When you have secured the rights to your trademark, it is an asset that increases in value and can be sold or licensed to others. Therefore, registering a federal trademark is an essential component to any business and wealth building strategist. Copyright and patent protection may also be relevant to you depending on your business and product. Copyright grants the creator of an original work exclusive rights for its use and distribution and tends to be for expressive works like books, screen plays, advertisements and similar works. A patents is a grant of protection for an invention. The owner of a patent has the right to stop someone else from making, using or selling the invention without their permission. However, certain things like recipes are considered trade secrets and are not available for such legal protections.

To learn how to win with trademarks, download our PDF.

Get Winning with Trademarks for Free

6. Failing to Meet Legal Requirements Resulting in Lost Legal Protections

This is a surprisingly common mistake. In fact, 50% of sued businesses and real estate ventures are not protected against the common legal attack of piercing the veil court cases — meaning the owners can lose their possessions. Learn the three steps to take to protect your business, your real estate & yourself.

The first, we’ve already mentioned, which is having a professional registered agent.

The second issue is caused by having incomplete paperwork for your entity. You will see the offers for a $99 (or less) corporation. This entails filing the Articles of Incorporation (for a corporation) or Articles of Organization (for an LLC) with the state. That’s all that is done in most cases.

Perhaps you are not told that you need bylaws, a registered agent, an operating agreement, minutes of the organizational meeting or the issuance of ownership certificates, among other requirements called corporate formalities.
And you think you are fine.

The problem is that by not following the corporate formalities you open yourself up to unlimited personal liability if your corporation or LLC gets sued. If you haven’t met all the corporate formalities, you can be held personally responsible for the corporation’s claim. That defeats the whole purpose of setting up your entity!

You need someone to make sure your business is following the law and that you’re filing the required paperwork every year. This is not intuitive to people who have not spent years in law school.

7. Having Poorly Drafted Operating Agreements

The LLC is now the most popular entity to use. The reasons are many. You can choose your taxation, so that you can be taxed as a partnership, S Corporation, C Corporation or disregarded entity. No other entity offers such flexibility. You have excellent asset protection via the charging order, especially in the states of Wyoming and Nevada. And the LLC allows for maximum flexibility in drafting the operating agreement (known as the Company Agreement in Texas), which is the entity’s roadmap for operations.

The problem is that many discount promoters ignore the importance and potential of the Operating Agreement (“OA”). As discussed in the section on Incomplete Paperwork, many of them don’t even provide this important document. Those that do offer only a skeleton version that will not completely protect you.

For example, some of the internet’s largest formation firms offer an OA that is extremely incomplete – just four to six pages long in some cases. (Ours is 30 pages.) A key failing of their very short OA is they allow for the free transfer ability of membership (ownership) interests within the LLC. This is contrary to one of the most important features of the LLC – the ability to keep unwanted potential owners out.

Here’s what all that might mean to you… Suppose you have an LLC with another friend and you are 50/50 members (owners). If your friend gets sued, you obviously want to keep the attacker out of your LLC. If the attacker wins a lawsuit and gains control of those shares, there will be all sorts of havoc wrought.

As a new 50% owner he can block any of your moves. He can try and force a sale of the company to get paid the money your friend owes him. Your LLC becomes a nightmare.

Don’t let any of these issues threaten to destroy your business or impoverish you. Take action to protect your startup.

Protect Yourself & Your Business

We have been creating and maintaining entities for our clients for well over 28 years. We have clients ranging from everyday people…to people worth hundreds of millions of dollars… to celebrities you would recognize.

One of those is Robert Kiyosaki, best-selling author of Rich Dad, Poor Dad. I am one of Robert’s Rich Dad Advisors and I have been helping protect his many corporations and LLCs for over 15 years.

The fact is, we’re an honest and trustworthy company that can help you decide what is best for you. All it takes is a simple email or call. Get in touch and see how we can help you using one of the following options:

  1. Call us at 1-800-600-1760.
  2. Email us at info@corporatedirect.com.
  3. Fill out the form on this page to get started.