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Small Business Center

Don’t Avoid the Legal Side of Starting a Small Business Just Because It’s Dry

July 24, 2023

Few things have more potential to shake up your business than a lawsuit. According to an U.S. Chamber of Commerce Institute for Legal Reform poll, 43% of small business owners have been threatened with or involved in a civil lawsuit.

While many aspiring business owners focus on products, services and marketing, it’s crucial that they not overlook the legal aspects that come with running a business, said Todd Masuda, a Cleveland-based lawyer specializing in helping small businesses. Understanding and complying with the laws and regulations and mitigating the risk of lawsuits down the line ensure the smooth operation and long-term success of your business.

When planning for your small business, Masuda said, there are three major areas of legal compliance and risk management to think about:

  1. the integrity of the entity itself, meaning: Are you a properly formed, legal business, able to operate in the U.S.?
  2. making sure your internal relationship structure — your policies regarding personnel like employees and supervisors — provides clear guidelines for roles and responsibilities. ensuring that the contracts and policies you have with the “outside world” — i.e., customers, landlords and vendors — are fair and transparent.

Here are Masuda’s tips for navigating the legal landscape and minimizing risk in your small business journey.


Decide the Structure of Your Business

A business can be structured as a:

  • sole proprietorship: a single-owner venture 
  • partnership: a multi-owner enterprise 
  • limited liability company, or LLC: a business structure that offers limited liability protection to its owners, shielding their personal assets from business liabilities.  
  • corporation: a shareholder-owned company

The structure you choose impacts your potential liability, taxes, management and growth potential. “If you have a weak entity or poorly organized entity, as the owner, you can undermine the strength of your liability protection,” said Masuda.

Spend time really considering the most advantageous structure of your business because it provides a roadmap for how to handle company matters if something unexpected comes up like a dispute between owners or the death of an owner, said Masuda. In Ohio, where Masuda practices, “the easiest entity to form is an LLC. That doesn’t mean it’s right for every particular company, he advised. 

Apply For an Employer Identification Number, or EIN

If you plan to hire employees or operate as anything other than a sole proprietorship, obtain an Employer Identification Number, or EIN, from the tax authorities, Masuda said. This number is used for tax purposes and to identify your business.

Even if you are registered as a sole proprietor, “on the legal side, lawyers tend to recommend getting a separate EIN for the company because it’s evidence of greater legal separation between the company and the individual, which is meaningful for liability shield purposes,” Masuda said.

Establish Good Governance Documents

From the get-go, put in place written policies, procedures, guidelines and other formal documents that outline the governance framework of your small business. This helps ensure transparency, accountability and proper decisionmaking down the line. Make sure you have “a document that thinks through the financial rights of all the owners and is clear about their roles and accommodates change in the business,” Masuda said.

For instance: What happens when owners disagree? When owners die? In other exit scenarios?

“You’re not going to foresee every single thing that’s going to happen during the life of the company,” he said, but the more things are written down up front, there is less of a chance of a lawsuit from family members later on.

Get the Right Experts Onboard Early

“Your team as you start up is very important,” Masuda said. That team includes a lawyer, who can identify legal risks, and an accountant, who Masuda explained is “the most important person.” That’s because “you need to know what’s going on with the money — i.e., who among the owners are going to pay for what when you need money and who’s going to get what money — and that all involves good record-keeping.”

Also have a good, trustworthy insurance agent. “A lot of what lawyers do is identify things that can go wrong,” Masuda said. “We can write a lot of documents that say: ‘If this happens, here’s what you should happen,’ but your insurance policy is your first line of defense against a lot of stuff.”

ALSO FROM THE ICSC SMALL BUSINESS CENTER: 7 Tips for Buying Commercial Insurance

Internal Structures

Familiarize Yourself with Employment Law

Before you start hiring, make sure you’re on top of employment laws and regulations, including minimum wage requirements, overtime pay, anti-discrimination laws and employee benefits, Masuda said. Then when hiring and managing employees, make sure these rules are followed to a T. If someone is being noncompliant, Masuda advised, get rid of them quickly. “There’s a reason there’s a popular HR maxim to hire slow and fire fast,” Masuda said.

Avoid discrimination liability, and avoid violating wage and hour and pay rules. That’s because, Masuda said, “hey’re both very large liabilities that companies incur.”  

Create an Employee Handbook

Mitigate the risk of something happening in the future by putting an employee handbook in place from the beginning. “A lot of times, people will hire two or three employees and everything’s going fine because they’re your friends from high school or they’re your kids’ friends, but at a certain point, small businesses get to a certain number of employees and they can’t just manage it by their personality,” said Masuda. Employee handbooks set expectations, ensure legal compliance and provide clarity to both employers and employees.

Relationships with Third Parties

Read Over Vendor Contracts Carefully

When negotiating contracts with vendors, think about what you need from the exchange, Masuda said. “There’s no such thing as a standard contract. What vendors will often offer you is their standard contract, and if there are 60 terms in contract, 40 of them will be colored slightly away from you.”

Another rule of thumb with contracts, he said, is “to pay as little up front as possible. “You want your payments to keep track with your level of risk.”

If you have a contract that a vendor will deliver 10,000 pairs of pants that you need to have by Thanksgiving, the ideal situation would be for you to pay when you get the pants, Masuda said. “If you’re paying 50% in June and expect to pay another 50% on Thanksgiving and they never shipped, that’s bad.” And it could throw off all your sales for the year.

Consult with Professionals Before Signing Your Lease

There are a lot of potential pitfalls in the language of leases, Masuda said. The typical tiers of a shopping center lease are:

  • base rent: your fixed lease payment 
  • net costs: the additional financial obligations beyond the base rent that are associated with occupying and maintaining a leased property and that are borne by the tenant, including property taxes, utilities and maintenance 
  • common area maintenance: the costs of upkeep and operations of shared facilities like hallways, parking lots and common amenities. Tenants sometimes contribute.
  • percentage rent: an uncommon lease provision in which the tenant pays a base rent, plus an additional percentage of its gross sales or revenue

Small business owners must understand all these pieces before signing anything, Masuda said.

ALSO FROM THE ICSC SMALL BUSINESS CENTER: 3 Tips for Drafting a Small Business Lease

In addition to those financial pieces, also understand the fine print about what happens if your business goes south. Landlords have become more flexible in recent years, but some leases “are almost like a mortgage,” Masuda said. “If you have a 10-year lease and something happens in Year One, [generally] you don’t just get to just pay out your month’s rent; they keep your security deposit and you [may] have to pay out all 10 years of rent. That’s shocking to some tenants who haven’t done that before.”

Also keep an eye out for lease requirements about what times and days you have to be open. And try to include in the lease the right to assign the lease should you sell your business.

Ultimately, Masuda advised that leases are something you should “lawyer up for.” Leases, he said, represent the core of your business, and lawyers “can negotiate key terms in your favor or at least terms that are more acceptable to you and manage the risk that’s represented by that contract,” Masuda said.

A Note About Lawyers

While lawyers can be great support systems for pointing out risks and how technical terms work, “business lawyers are not consultants,” he said, adding that whether to accept a certain risk is “always going to be up to the individual.”

And the bar is different for everyone. “It’s not a lawyer’s job to say: ‘Everything will be fine.’ It’s our job to say: ‘Here’s a landscape of potential risks that have legal risks, and here are the different things we can do to mitigate those risks. Let’s see what the cost of doing that is.’” Everyone, he said, has a different appetite for risk.

By Rebecca Meiser

Contributor, Commerce + Communities Today and Small Business Center

Small Business Center

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