Entrepreneurs face a host of risks and pitfalls as they try to make their new businesses successful. These include dangers such as unrelenting competition, downturned markets, the risk of financial ruin, as well as the hazards of a changing political landscape and a fluctuating economy.
Given the things that can go wrong over which a business owner has no control, it’s wise to focus on avoiding the miscues that can spell disaster which can be avoided. This article will look at two of the Seven Deadly Legal Mistakes every entrepreneur must avoid.
Legal Mistake Number 1: Failing to create your legal entity before you start your business
Forming Your Business
Depending on the type of business entity you wish to form, New York requires specific filings to be completed with the state. For example, if you plan on operating a for-profit business as a sole proprietorship or general partnership under any name other than your own, you must file a Business Certificate (also called a Certificate of Assumed Name) in the office of the County Clerk in the county your business is located. A Limited Liability Company (“LLC”) needs Articles of Organization, and a Business Corporation requires a Certificate of Incorporation.
In addition, New York business owners must identify and obtain the licenses and permits needed for their businesses.
Failing to Form an Entity
You must complete all the steps in forming your business entity. For instance, if you don’t publish and file the certificate of publication for your LLC in the required timeframe, your ability to conduct business in New York will be automatically suspended.
If you go ahead and begin doing business without registering, the state will consider you to be a sole proprietorship. It is important to note that this is not a legal entity; it merely refers to an individual who owns the business and is personally responsible for its debts.
As a result, you’ll have to use your personal social security number and your personal legal name to conduct business (unless you file a DBA). While there’s nothing wrong with doing business as a sole proprietorship, you will assume unlimited legal responsibility for everything concerning your business. For example, if your company is sued, you are personally liable for any settlement or judgment and all your assets are at risk.
Research shows that almost half (43%) of small business owners have been threatened with or have been a party to litigation. Think about this: if something happens to your business—a contract dispute, an accident in your retail space, or a lawsuit over trademark infringement—you will personally have to satisfy any adverse judgment. And if you don’t have the money, you may be forced to sell home, vehicles, and other personal assets to pay off the debt. This is why we never recommend sole proprietorships or general partnerships to our clients. (See here and here)
Don’t make this Deadly Legal Mistake and fail to create a legal entity before you start your own business.
Legal Mistake Number 2: Starting a competitive business while employed, or violating a non-solicitation/non-compete agreement
New York common law protects businesses against the “faithless” employee. This is one who while continuing to accept wages from the employer, sets up, participates or solicits business for a rival company. New York courts recognize that this is simply not fair to the employer. Thus, if you want to compete against your current employer, you need to leave before you begin doing so.
In addition, it’s common for an employer to add a term to an employment agreement, offer letter, or other document, that restricts an employee who leaves from starting a competing business under certain conditions.
A non-competition agreement can be a standalone contract or a term in an agreement that prohibits an employee from working for a competitor or participating as an owner in a competing business. A “non-compete” is usually for a certain duration after an employee leaves a job and has a geographic limitation. A non-compete can be signed before or after employment begins.
In New York State, a non-compete is only permitted and enforceable if:
- It’s necessary to protect the employer’s legitimate interests;
- It doesn’t impose an undue hardship on the employee;
- It doesn’t harm the public; and
- It’s for a reasonable time period and geographic scope.
New York courts are often reluctant to enforce non-competes, and therefore they need to be carefully crafted. (More on that here.)
A critical question in examining a non-compete you may be subject to is determining what constitutes “competition.” A non-compete, to be enforceable, must describe the employer’s business or industry and what it seeks to prohibit; however, it can hard to ascertain whether your proposed business meets the definition of a competitor. One way to get a better sense of this is to consider the following:
- Whether your startup in a similar business or industry to your former employer’s business;
- Whether your new business will target the same customers; and
- Whether your new business will employ similar knowledge or technology.
If you signed a non-compete and are considering launching a business in the same field or industry, it is always best to consult with a New York business attorney to learn if your new company might violate the terms of your employment contract.
Similar to a non-compete, a non-solicitation agreement is a contract in which an employee agrees not to solicit a company's customers after leaving the company if he or she starts his or her own business. In addition, a non-solicitation agreement can include a term that the employee can’t solicit other employees to leave when he or she leaves the company.
A non-solicitation agreement is designed to protect an employer. Thus, an employee who decides to strike out on his or her own is prohibited from recruiting half the company and then selling a similar product or service to their former employers’ customers. In effect, you can’t steal customers, and you can’t steal co-workers.
New York courts are much more prone to enforce non-solicits as each business needs to stand and fall on its own merits, and not by taking the customers and employees of another.
Intellectual Property Contracts
In addition to employees and clients, you can’t steal intellectual property when you start your own business.
A third type of employment agreement you might have signed with your former employer is one that assigns all intellectual property that you created to the company during the course of your employment and keeps what you learned at your prior company confidential.
This provides protection for your former employer’s trade secrets and confidential information, as well as preventing workers from using them in their own business.
How you begin your business counts. The top two Deadly Legal Mistakes are all about forming an entity and starting it properly. Check back for Parts 2 and 3!