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.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.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.”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.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.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. 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 afteryou design a valuable creative project, brand logo, or useful invention. 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.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.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.
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 cheaperthan 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.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.
Maintain an Internet and Security Policy. There are several reasons why you need an internet policy and a security policy for your new business.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.
 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).
 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).
 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.
 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).
 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).
 See 15 USC 1051(b).
 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.
 See 17 USC 102(a).
 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).
 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).
 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).
 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).