Legal Issues Affecting the Small Business

Presentation by

Nancy Fallon-Houle

West Suburban Women Entrepreneurs

Ashton Place, Willowbrook, IL

November 17, 2011 8:00 am

Legal Right to Start & Operate the Business?

Pre-existing Noncompete Agreement or Employee Manual: With current / former employer, vendor,

or customer Impede right to operate or sell business

or raise capital? To what degree? Prohibit altogether? Limit as to geographic scope? Time limit?

Duration? Prohibits contacting specific customers,

employees ?

Who Owns the Intellectual Property ?

Who Owns Intellectual Property Used to Start & Run The Business? IP Developed Where? While employed

elsewhere? Might employer have claim to it?

Co-developed with another party, who partially owns it? If so, are their legal rights all assigned to you? If not, it’s not yours to further develop.

Co-developed with current partner? Document Capital Contribution of both.

Protection of Intellectual Property of yours

Name Selection & Search, Tag Lines, Product Names, Logos

Name check before business formed or operated; before use of DBA, product name, logo, tag line or domain name

Common law: 1st to use name in industry is winner, even if they have not trademarked it or formed an entity.

Use of internet and websites, means you are doing business everywhere. Therefore, national, or global, name competition.

Can’t use same or similar name in the same industry. Even homonyms, same root words, or phrases if likelihood of confusion may result.

Name search at many levels: Federal trademark, Google, state trademark, state corporate, common law unincorporated, state tax roster, county DBAs, biz directories, domains. [Handout]

Like your name and don’t care if someone else is using it first? Beware of surveillance on the web by 1st Users looking for “infringers”!

Sole Prop vs Entity Personal Liability in sole prop, Separation of financial & tax matters, tax returns easier if

you are a corporation or LLC. Insurance Difficult to Obtain, Larger Companies require corps around business owners, Perception of customers, Easier to obtain a Loan if you look like a "real business", Due Diligence goes more professionally and easily if people

can conduct Due diligence on you on Sec of State site; If you will ever raise capital by issuing stock to investor or

employees, it can't be done with a sole prop; Must file DBA with IL SOS, and County and a Reg-1,

therefore much of the time consuming cost of forming a corporation must also be done for a sole prop, therefore there isn't a huge difference in cost

Filings Required if Sole Prop or Entity

Federal Tax ID and State Tax ID DBA Illinois Department of Professional

Regulation Business License in local jurisdiction Sales Tax Employer Payroll Tax Accounts Business Bank Account

Proper Entity Formation is Key Risks of a botched entity formation, by

online incorporation services, accountant, divorce lawyer, or Do-it-yourself)

Common Incorporation/LLC Formation mistakes: Name not fully searched and not available

under common law or outside of IL; Trademark Lawsuit Risk

Not Enough authorized shares, too low par value, wrong # of issued shares, thin capitalization;

Registered agent not biz owner = wrong county/state

Mistakes in board or managing members

Common Formation Mistakes (Cont.)

Wrong tax type, no accounting/tax advice Errors in, or Missing, “business purpose” (no name

protection then) Missing addendum to Articles (contains

restrictions, removes effect of unfavorable IL statutory or case law provisions)

No Stock Issued, no ownership % decided, no cap contributed

No Organizing Resolutions Adopted (Company does not legally operate until adopted, Agreements cannot be signed.)

No corporate formalities Using online service, accountant, or Do-it-yourself

does not save $: Botched entity formation clean-up costs $2,500-$3,000 to correct. (Filing amendments, re-documenting, correcting tax ID errors, name change)

Corporate Formalities After Starting

Operate the company like a business , not hobby. Its business, not friendship! (Customers &

Employees) Implement processes and documentation. Buy QuickBooks; Keep diligent accounting records Separate finances business & personal Follow Corporate Formalities to Avoid “Piercing the

Corporate Veil” (Handout). Keep up with Corporate Maintenance, legal, tax.

(Handout) File Annual Corporate Report Sales & Use Tax Reporting, Payroll tax Reporting Maintain Insurance Sign documents & contracts in business name. Separate actions, identity, contracts Two businesses? Use two business entities !

Partner & Shares Do’s & Don’ts;

Don’t make spouse partner unless they work substantially in the business. Use a Will, not shares, for Estate Planning

Don’t confuse Business Partner vs. Alliance Partner relationship;

Avoid temptation to give away equity as monopoly money when you don’t have real money;

Equity only to your closest partners inside the business.

Going into business with someone & no entity formed = Partnership by default. Partnership case law applies, not corporate or LLC case law

Two Businesses = Two Entities

For the same reason to form an entity around your business to separate liability, income expense: Form separate business entities around each differing business. Don’t try to smash together an IT consulting business with a real estate investment business or a retail store. In addition, confused business description, on corporate docs and on website, will confuse customers.

Shareholder Agreement Among Owners

The Business Pre-Nup between you & partners: Who invested What, How much, what

%? What percentage of ownership Percentage Vote to pass an Issue? Title, Role, Responsibilities Profit & Loss Allocation, Ownership

Allocation Buy Sell Provisions – Death or Disability Departure of a Shareholder?

Noncompete? Dissolution Provisions – How to Shut

Down

Fiduciary Duty & Conflicts of Interest

Fiduciary Duty to your company & to the other owners

Fiduciary Duty to all companies of which you are officer, director or control person.

Avoid Conflicts of Interest, disclose them to those who would be affected by them, would scrutinize them, or would later object to them when disclosed.

Avoid Conflicts of Interest in client relationships; Finders Fees, Referral Fees must be disclosed.

Classification of Employee vs Independent Contractor

Very Hot issue with IRS, IL Dept Rev, and IDES.

IRS presumption of being Employee (even part-time), several factor-test (Handout)

“IRS Audit Focus on Worker Classification - Employee or Contractor” and “Employee or Independent Contractor CCH”

Legal conclusion revolves mainly around who has control over the person: Sole employer, Location of work, whose equipment, hours dictated, other clients of the consultant.

Categorize most all contractors as employees, budget for payroll taxes.

Difficult for all early stage and small businesses

Worker Classification (cont.)

IRS going back and retroactively reclassifying “independent contractors” as employees; Retroactively imposing payroll tax, interest and penalties on all prior wages paid. No time limit!

Illinois employer laws possibly stricter than federal in the classifying contractors as employees, for unemployment tax, and UE claims, purposes. 10 hours/week = employee

Illinois Short Deadlines Legal issues arise from hiring

employees, such as Unemployment Liability (Be sure to terminate someone within 30 working days if they don’t work out, to avoid UE claim.) Even Part-Timers.

Illinois Directory of New Hires: Employers required to report all new employees, and their personal information within 20 days of their first day of work. Even Part-Timers

Federal & State Employment Laws

Harassment – Applies to all Discrimination Some laws apply to over 10

employees or over 20 employees Dangerous Work – requires attention

to other regs Document Problem Employees

Protection of Intellectual Property

Is protection of your IP Possible? Patented? Business Process Patent? Copyright? (Software, writings, art)

Trade-markable? Don’t blow IP protection by putting your

ideas in public domain before protecting! Tradeshow, conference, website

You don’t own the business idea until you own the IP !

Impose NDA’s & Noncompetes on your Employees. Must be reasonable in scope and duration

Websites & LinksWebsite Developers Don’t Always Know: If your website links to a site outside of

yours, don’t imply or state a connection or relationship between the 2 sites, unless there is one.

You may be responsible to your readers for accuracy of info on the other site.

Don’t post someone else’s trademark on your site, nor as a link on your site, without permission. Don’t use a trademark that is “confusingly similar” to another trademark.

Credit the writer

Websites & Social Media You must own the intellectual property on

your site, or instead must have permission to use it. (Jury still out about using content of others, or links to their content)

Statements on your site about your company must be true! – If not, its fraud. Ditto for FB and LinkedIn, YouTube, Twitter. Can’t put water back in the damn once it has spilled out via social media & passed around the globe.

Privacy Policy may be required on website Consider privacy of clients before using FB,

LinkedIn, Twitter posts about your work Know rules for allowing kids under 13:

COPPA http://www.ftc.gov/privacy/coppafaqs.shtm

Website Legal Notices & Disclaimers

Importance depends on nature of the business and info on the website.

States terms & conditions of Use of the site, including disclaimers for: Warranties for website information, Responsibility for information on other linked websites, Endorsement of the products/info offered on other

websites, Liability for damages resulting from use of website or info

contained on the site, or any other site to which it links.

Prohibited activities (posting offensive or illegal content)

Monitoring rights of the website owner, Allowing kids to use site, and Intellectual property notices.

Email & Internet Advertising RulesThe CAN-SPAM Act establishes requirements for e-mailed commercial messages. Penalties for violations.  Summary of the rules: Don't use false or misleading header information.

Your "From," "To," "Reply-To," and routing information - including the originating domain name and email address - must be accurate. Must identify the message sender or initiator.

Don't use deceptive subject lines. The subject line must accurately reflect the content of the message.

Tell recipients where you're located. Your message must include your current street address or a post office.

It’s illegal to spam people who don’t want advertising emails, even your newsletters! Ask permission of recipient first.

Tell recipients how to opt out of receiving future email from you. Your message must include a clear explanation of opt out procedure, or provide working “unsubscribe” link.

Honor opt-out requests promptly.

Ducks in Row, Due Dilly, Conflicts

Business Ducks in Row – Industry Research

Due Diligence Conflicts and Fiduciary Duties

Business Contracts Must be In writing to be enforceable (But! An

email can be a writing) - Capacity, Offer, Acceptance, Consideration Exchanged, Legal Purpose, Meeting of minds, mutual assent.

Expensive to retroactively paper oral agreements, so paper them when they are agreed to.

Sometimes documenting an oral discussion brings up deal-killing discussion points. Best to know before you act under contract.

Read, and understand, every word. It is the section or word you skip that will come back to bite you. No Such things as “boiler plate”

“Reps & Warranties”: Make sure your “reps” are true & can be done (for example insurance requirement)

Contracts (Continued) Breach & Indemnification Get Insurance to cover Indemnification

Clause Many Items are Business Points, not Legal Think Through What could go wrong from a

business standpoint Business person makes business bullet

points for lawyer to draft into agreement Plain English Writing Realistic Expectations as to Cost & Timing When to involve counsel Services Contract: Assignable if biz sold (if

stated in agreement)

Due Diligence Others Conduct on You

Your Clean Background is Key: Principals: Shareholders/Owners, Directors,

Officers The entity itself, and Prior business (you can run, but you can’t hide,

by forming new entity) Due Diligence will be conducted by: Lenders,

Vendors, Industry Partners, Investors Background checks, criminal, regulatory,

licensures, tax liens, bankruptcy (business & personal), Facebook & LinkedIn

Often a credit check as well Legal history (litigation, regulatory issues,

licenses) Business Reputation like Virginity, once its gone,

can’t get it back

Due Diligence You Conduct on

Others Conduct Due Diligence on Clients, Co-Owners,

Alliance Partners, Suppliers, Lenders, Investors:

You are judged by the Company You keep Bad people often prey on small

businesses, new businesses, woman-owned or minority-owned businesses. Beware of crooks, scammers, deadbeats, toxic clients. If THEY found YOU, instead of YOU finding THEM, be especially careful. If too good to be true, it is.

Avoid the Toxic Client/Customer: High Maintenance, Doesn’t Pay, In a Rush, unprepared, energy-sucking

Trust your gut, take off the money blinders.

Changes in Ownership

Adding Partners Removing Partners Corporate Split Up

Selling Your Business (or Buying)

Plan years in advance to sell your business by keeping ducks in a row: Corporate Records, Legal, Accounting, Processes Documented, Good Management so you can leave, not too much debt.

Sellers (especially) & Buyers: Must have realistic expectations as to selling price and timing. Obtain valuation in advance.

Caution about using business brokers, use only reputable ones. They receive a fee, usually worth it if good quality firm.

Selling Your Business Use lawyer & accountant, after discussion, but

before sealing the deal or the price. Valuation Done in Advance Allow significant time for Buyer to complete Due

Diligence. Financing from Lender? or Seller? Noncompete – Restricts Seller from competing in

industry after sale. Duration, Scope, Coverage Seller’s Job after Closing - Consulting Period Stay-

On Asset Purchase vs. Stock Purchase

Securities Laws Apply if You Have Investors

Issuing any equity interest in your company, in exchange for cash, property, or services, or a vendor/supplier contract, is a securities issuance. Even selling stock to your mother, your employees, board members, advisors, is a securities sale.

Key to find exemptions from registration, but there are no disclosure exemptions.

Complex laws apply. See Outline Items 20, 21, 22. NFH can email further detailed handouts

Borrowing Debt vs Raising Investor Equity

Compare Debt (loan) to Equity (money from investors). See Outline Item 20.

Investor Money more expensive, deal must be larger to make it worth it. Debt is faster and cheaper.

Investors share fully in losses and profits, while lenders receive payments no matter what. Several other points in outline.

Venture Capital

Venture Capital and Private Equity

Real Estate Investment Deals

Securities Law and Corporate Law Issues Arising in a Real Estate Transaction in which Investor Money is collected

Investors vs General Partners More on securities disclosure and

exemptions

Business Points Use Technology to Operate Your Business

Efficiency of tech will make you better Never acceptable to say “I don’t use email”

or “I’m not good with computers”, or perhaps “I’m out of the office”.

Don’t use AOL or Hotmail email address for business – smacks of cheapness or lack of experience

Never have a live website stating “under construction”. At least put up a 1 page “Name, Address, Location, Phone, Email, & “what we do””

Use Email-able brochures, so colleagues can easily refer you to others. Paper is dead, other than biz cards.