(The following article was provided by Yevgeny Levin, a lawyer that concentrates in small business law. His firm’s website is www.ylevinlaw.com)
In today’s difficult economic times, many small business owners find themselves struggling in dire financial or legal situations, forcing their businesses to downsize or cease operation. Fortunately, many common legal mistakes may be avoided if the business owners pay careful attention to the formation and management of their businesses.
1. Selecting the Wrong Business Entity. The various types of legal entities differ in how they are taxed and how their liabilities are apportioned. For instance, a C corporation is taxed twice: at the corporate level and at the level of each individual shareholders’ tax rate once the dividends are paid. In contrast, an S corporation enjoys the benefits of singular “pass through” taxation. However, an S corporation is subject to restrictions concerning the number of shareholders and the issuance of stock. Finally, an LLC provides flexibility in membership, management, and the sharing of profits and losses but can be subject to certain publication requirements during its formation in some states, including New York.
2. Failing to Plan an “Exit Strategy”. Equally important as the formation of a business entity is planning for a business’ potential demise. The majority of the states have passes laws governing unincorporated entities, such as partnerships. In New York, for instance, a general partnership is dissolved as a matter of law upon the occurrence of any material change in the partnership, including the death or withdrawal of any partner.
3. Failure to Memorialize Contracts in Writing. Many small business owners are used to dealing with their customers and suppliers on a personal level and sometimes disregard using contracts in their business ventures. However, it is often crucial to put an agreement in writing because otherwise such an agreement may be deemed unenforceable, such as an agreement for the sale of goods valued at $500.00 or more. At other times in the absence of a written agreement, parties may not even realize that they are not in full agreement as to what is required of each other, even if both parties are acting in good faith. In such cases, the absence of the “meeting of the minds” prevents the formation of a valid contract.
4. Overreliance on Standard Forms. Small business owners should be very careful in using standard forms found on the Internet as such forms may not comply with local or state laws. Also, such contracts may have forum selection clauses which, if a dispute over the contract arises, may force the parties to litigate in a foreign jurisdiction. Also, liquidated and punitive damages clauses may pose problems for parties because many jurisdictions, such as New York, impose monetary limits or strict restriction on the enforceability of such clauses.
5. Not Reviewing Commercial Lease Carefully. Many commercial leases contain standard provisions restricting the permissible purpose for which the premises may be used. Such provisions may be amended to include incidental uses commonly associated with the stated business purpose to ensure that the lease is not terminated because the tenant is not strictly adhering to the designated purpose. In addition, many small business owners enter into percentage leases which require a tenant to pay “Base Rent” and, in addition to that amount, a percentage of monthly revenue of the business, if the gross revenue is above a certain amount. In such instances it is crucial to calculate what the actual rent would be and to make sure that the business remains profitable after the rent is paid each month.