In Business Formation, Corporations, LLC, Startups

1) Choosing the Wrong Form of Business (or not choosing at all)

When it comes to deciding what form of business will work best for your company, it usually comes down to deciding between a partnership, limited liability company, or corporation. The most important considerations are liability protection and tax filings.

Partnerships come in a variety of forms: general partnerships, limited partnerships, and limited liability partnerships. Each offers flexibility in formation and management, but the level of liability protections varies greatly between them.

LLCs provide liability protection for the owner(s), multiple tax options, and flexible management opportunities. With an LLC, your business gets the flexibility of a partnership while gaining the liability protection of a corporation. Over the past decade, most companies in South Carolina have organized as an LLC.

If your company needs to attract a diverse group of outside investors or would benefit from a formal structure, a corporation may be the best fit.   Corporations have been around for a long time and are a great way to organize your business.

2) Poorly Drafted Partnership Agreements, Operating Agreements, and Bylaws

One of the biggest mistakes owners of a company make is failing to clearly define the terms of the agreement from the start. Whether you are running a partnership, LLC, or corporation, the agreement among the owners is essential to the long-term success of your company. It is easy to assume you understand one another and will be able to work out differences, but it is never as simple as it seems.

When partners set out to form a company, it is imperative for them to have a detailed conversation about many issues:

  • Who owns what percentage of the company?
  • How will the company raise new capital?
  • What happens if the company wants to add partners?
  • How does a partner cash out and what happens to his or he shares?
  • How will the company be managed?
  • How will the company be taxed?

The answers to these questions and many other questions are important. Discussing these questions and making tough decisions at the inception of the company is crucial because each of them can affect the success of the venture. Spending the time necessary to craft a good partnership agreement, operating agreement, or bylaws will help your business in the long run.

Sit down, have the talk, and put your agreement in writing.

3) Relying on Handshake Deals

Business contracts are as boring as it gets – at least until your money is on the line. If your company does not put “routine” agreements in writing, then you are asking for complications in your business dealings.

There are many reasons people fail to get the terms of an agreement down on paper. Some people think it slows the pace of business or they think it is unnecessary or they think it is insulting to imply the other party may not do what they say, but the truth is people make mistakes.

In Charleston, events are a huge part of the local economy. Every event requires a plethora of service contracts and vendor contracts, but too often companies fail to put these basic business contracts into writing and end up in trouble.

People misunderstand terms or think they have communicated well when they have not. Life happens, and having well documented terms of an agreement down on paper helps everyone understand what is expected.

4) Not Protecting Your Intellectual Property

Protecting copyrights, trademarks, trade secrets, and patents is vital to the long-term success of your company. Without trademark protection, for instance, many companies would not even exist today. Increasingly, a company’s assets are intellectual property. Imagine if Coca-Cola had not protected its famous recipe with trade secret protection?

The first thing to remember is: Don’t infringe on someone else’s intellectual property. Take the time to see if there are other companies using the name you want or who have claimed a trademark you want. The last thing you want is a cease and desist letter arriving in the mail the second week you are open for business or a letter arriving after you have spent two years developing your brand and building goodwill.

Intellectual property protection is not always as complicated as it seems. Depending on your circumstances, trademarking or copyrighting may be able to provide you adequate protection. In other situations, a nondisclosure agreement may be needed. Take the time to figure out what intellectual property you need to protect and develop a plan of action early.

5) Avoiding the Tax Talk

Taxes are not fun, but they are necessary and it is important to think about them. From the inception of our great county, Ben Franklin knew taxes were a necessary evil, remarking, “Nothing is certain except death and taxes.”

If you don’t have an accountant, get one. Not only is your business obligated to pay taxes, but a good accountant could save you money. An accountant provides advice on everything from how your company will be taxed to what filings are required and what deductions are allowed. Moreover, there are specific rules for issuing stock and raising capital that are important to understand, both for the investors in your company and the company itself. Developing a relationship with an accountant or CPA can pay big dividends in the long run.

6) Poorly Documenting Employee Files

Companies expose themselves to needless problems by failing to properly document employee files, even though it is one of the easiest mistakes to avoid. Most companies should keep at least three different files on employees.

The first file an employer should keep is a General Employee file, which includes any work related documentation for each employee. These files should include a signed job description, signed employee manual compliant with the at-will provision of S.C. Code 41-1-110, performance reviews, and any documentation of disciplinary action taken.

In addition, an employer should maintain a separate Health File for each employee. This file contains health insurance information, reports regarding a disability, and any other materials related to the health of the employee. The reason for a separate file is to make sure supervisors and managers do not inadvertently see sensitive health information.

Lastly, employers should keep I-9s on each employee together in one file. The form I-9 serves as identification verification and shows that the employee is eligible for employment in the United States. If a federal officer comes asking for I-9 forms, it is better to have them all together in one place without other sensitive information.

7) Drafting Bad Employment Handbooks

Employment Handbooks have many useful applications both practically and legally, but if it is poorly drafted, problems may quickly emerge.

The most import thing to keep in mind is that South Carolina is an at-will state. At-will means an employer can hire and fire employees for any reason as long as it is not for an illegal reason like firing someone based on gender, race, or religion.

A poorly written handbook that does not adhere to certain rules can erode employees’ at-will status and create contractual duties imposed on the employer. If the Employment Handbook fails to follow specific statutorily prescribed guidelines, then the employee may argue they had a contract and the only way to dismiss the employee is by adhering to the terms of the contract. In addition to failing to comply with the at-will provision of S.C. Code 41-1-110, companies also err when they include policies like progressive discipline, which may create an implied contract.

In short, having a good Employment Handbook will help your employees understand the company and what is expected of them, but make sure it is done the right way.

8) Confusing Independent Contactors and Employees

Employers have good reason to prefer independent contractors rather than employees: Because they can avoid employment taxes, workers’ compensation insurance, vicarious liability, maintaining employee files, and a number of other personnel issues. But just because a company calls someone an “independent contractor” does not make it true.

The South Carolina Supreme Court weighed in on the issue in Nelson v. Yellow Cab. Applying a four-point test, the Court stated the issue of whether or not a worker is an employee hinges on “a right to control the method and manner in which” a worker operates. Essentially, if an employer exercises the requisite degree of control over a worker, the worker is deemed an employee.

Despite the reluctance of many employers to classify workers as employees, there are numerous management advantages that are important to consider as well.

9) Slowly Reacting to Threatening Letters

When your company receives threatening letters in the mail, do not ignore them. From time to time every company overlooks something or tries a new approach, which sometimes leads to the company receiving a love note from a lawyer, the IRS, Immigration and Customs Enforcement (ICE), the city, or another company. Failing to respond is the worst course of action.

Most problems can be fixed by taking care of it before it becomes an issue. Waiting to address an issue makes things much worse. For instance, if your company is served with a lawsuit, it is important to contact a lawyer immediately because you may only have 30 days to respond before having a default judgment entered against you or your company. Or if the City sends you a letter, it could be as simple as mailing a check to renew your business license, but if your license expires you might have to reapply and pay more money. Companies also receive letters asking for payment, so why not call and make sure your account is clear instead of running the risk of a bill going to collections?

Do not let something manageable become a problem by ignoring the issue. If it was important enough for someone to send you a letter, it is not going away.

10) Poorly Hiring and Firing Employees

The adage “hire slow, fire fast” is popular for a reason. Making good choices about who to employ from the beginning is important and it all begins with a good job description.

Create a good job description for the position for which you are hiring. If the job description is good, then the employee knows what is expected and the employer has the ability to measure the employee’s performance. A poor job description that sets unrealistic goals or fails to define the job will create a problem if the company must dismiss an employee.

Firing an employee is not fun, but sometimes it may be the only alternative. Make sure you have a good job description, a fair employee review process, and a well-documented employee file, and be sure that the decision to let the employee go is based on the merits of the employee’s performance and your company’s needs. If you have to let an employee go, make sure you do it in a respectful way and do not embarrass him or her.

John Henderson is a business attorney with Henderson & Henderson. He focuses his Charleston, SC practice on business law and enjoys helping startups position for long-term success. For questions, contact John.

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