Four Common Mistakes Small Business Owners Make
This is a guest post by Northfield attorney Matthew Rich of Grundhoefer & Ludescher P.A.
Failing to enter into Non-Compete Agreements with Key Employees
The business is humming along, revenue is strong, costs are under control, and growth is all but assured. What could go wrong? The natural inclination is to stick with what works and have faith that the seed will continue to grow. Those who have been on this ride before know better. Virtually every business that operates with employees has at least one employee who is critical to the continued success of the business. Whether it’s sales connections, intellectual property, planning and growth strategy, or some specialized knowledge specific to the business, key employees are indispensable when employed, but a potential catastrophe for the business when the employment ends.
Without any contractual limitations in place, key employees, upon leaving the business, are free to take all of their accumulate knowledge, connections, and secrets with them wherever they end up, including potential competitors. It may not seem right, but key employees are even free to poach existing employees from the business they just left.
If a business wants to protect its customers, employees, and competitive edge, the burden is on the business to prevent the departing employee from wreaking havoc after separation. The best tool to accomplish that goal is a well-crafted Non-Compete and Confidentiality Agreement. Such an agreement can be used to prevent a departing key employee from stealing accounts, employees, and confidential information.
Failing to Put Business Assets in the Name of Company
When businesses first start, most of the assets are typically personal assets used by the business owner for business purposes. Even after the business gets running and a business entity designation is chosen, an often overlooked step is the transfer of the assets into name of the business entity. Even if assets are being used for business purposes, the assets aren’t owned by the business unless technically transferred to the business from the individual owner. This transfer can be very important for asset protection, tax purposes, and for the future sale of the business or assets.
Forgoing Limited Liability
The issue occurs most often with side businesses or projects that start to venture in the land of business opportunities. The project or idea is off the ground and starting to grow. The owners want to keep things loose and informal. They figure they’re being true to themselves and the organic process of entrepreneurism if they let nature take its course. Who can possibly be against that?
Those who value limited liability protection. If the business owners don’t take any steps to formalize the business structure to incorporate limited liability, the business owners will be personally liable for anything that goes wrong in the business, including outstanding debts and lawsuits related to the business. Limited liability can easily be obtained, and the business can still be run with a degree of informality and flexibility, so there’s really no good reason for a small business owner to risk personal exposure. Business owners should register the business as limited liability entity and use the designation (e.g., LLC, Inc., and LLP) on everything provided to clients and vendors. No exceptions.
Skirting Payroll Taxes by Calling Employees “Independent Contractors”
Here’s a classic scheme employed by business owners using the same ingenuity that allowed them to start and grow a small business. The problem they see with employees is that employees are expensive. Wages are only a fraction of the total cost to the business when you also include payroll taxes, income taxes, insurance, unemployment taxes, social security, and any other withholdings required of the particular employee. Businesses usually need to hire bookkeeping services to handle all of these payroll issues as well. Business owners sometimes think that the solution is to get rid of the “employee” designation and instead contract with “independent contractors” to do the same work. Independent contractors are responsible for their own payroll issues, so the business owners think that they’re getting the benefit of the work being performed without the burden of the administration.
This is almost always a terrible idea. Just because a business owner says that someone is an independent contractor does not make it so. Generally, the independent contractor must have their own clients. They usually have their own place of business, control their own work duties and schedule. They usually also have their own business name, registered location, business license, tax ID number, etc. The point is that it’s not an easy task to simply make someone an independent contractor.
There’s another critical, yet often overlooked, problem with making the independent contractor gamble—leverage. Calling an employee an independent contractor when it’s not clear that the independent contractor status is appropriate gives that employee a tremendous amount of leverage. Any signs that something is amiss will trigger an audit with the IRS. The audit will almost certainly cover every employee and every “contractor” the business has ever had. What’s worse is that the audit won’t be limited to just status designation issues. Wages, overtime, sick pay, and vacation issues will be thoroughly scrutinized. If the IRS is going to spend time and money to audit a business, the IRS is going to find something wrong and make the business pay. It’s not uncommon to see an imposed penalty of $10,000 per employee. The audit and possible financial ramifications can be the very definition of a business interruption. All it takes to trigger that process is one “independent contractor” who believes he or she wasn’t treated fairly by the business and calls in the state or federal government to make a complaint. That’s leverage, and a business cannot and should not be willing to provide that leverage to its employees.
For more information on Matthew Rich or Grundhoefer & Ludescher, PA, click here!