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Avoiding Legal Problems When You Run a Small Business


Copyright 1990 Nolo Press

Define Your Risks

With a bow to the old saying "an ounce of prevention is worth a pound of cure," let's focus on the obvious: the best way to deal with legal problems is to avoid them in the first place. Here are a few suggestions.

Define Your Risks

Start with a list of the aspects of your business where legal trouble is likely. Every business faces potential legal hassles regarding taxes, hiring and firing employees, collecting overdue accounts and, of course, how best to organize the business--as a corporation, partnership or sole proprietorship.

Add to this list your particular concerns. Consider carefully what your potential liabilities are if someone is injured or suffers an economic loss if your product is defective or your service substandard. For example, suppose you operate a copy shop in leased premises with ten employees. You have a heavy walk-in trade, and you also make deliveries to important customers. Potential legal risks of your business include:

To be sure your list is complete, talk to other small business owners, especially those who operate the same type of business.

Next, consider the following ways to limit your risk.

Buy Insurance

Insurance can protect your business from some types of legal jeopardy at a reasonable cost. For example, the risk that someone will fall down in your store and sue for a bundle can be dealt with by a liability policy.

Identify the risk areas on your list that can be covered by cost-effective insurance. For the copy shop, the risk of vehicle accidents, a customer or visitor being hurt on the premises, and the risk that equipment or inventory will be stolen or destroyed all fit.

Buy insurance from a local broker or agent who specializes in business insurance. It's not enough to just send your insurance company a check. To keep rates down and run a better business, you want to avoid problems. To this end, ask the insurance company for a free safety check. The company should be willing to send a knowledgeable person to your business to help you take sensible steps to improve safety and reduce risk. If it is slow to respond to your request, ask your broker to speed things up or find you a more responsive insurer.

Avoid Legal Risks

In this era of huge court judgments, many businesses can't afford the kind of amount of insurance coverage they need. For example, a small software publisher whose programs can cause substantial harm if they crash or if bugs surface at a critical time is likely to find that insurance protecting it from the consequences of its errors and omissions is prohibitively expensive. Obviously, it makes no sense to buy insurance if its cost sinks your business.

If you're in a similar situation and you decide to operate anyway ("go bare") you obviously have a great incentive to minimize your risk by seeing that your products or services do not fail. Do this by adopting extra-good business practices. If you are in the software business, this means you test our product, you hire outsiders to test it, and then you test it again and again.

And if you run a copy shop, you should insist on super-safe storage of chemicals and take the precautions necessary to limit access to your trade secrets to people who have signed a non-disclosure agreement.

Stress Safety

It used to be that business tolerated a certain level of unsafe practices. The assumption was that there was no such thing as a 100% safe, mistake-free operation. No more. Fixing problems and coping with the legal claims they engender costs so much that well-run businesses aim for no injuries--one good result, at least, from our lawsuit-crazy society.

Again, start by identifying your risks, and then take steps to eliminate them. There are loads of sources of information on how to run a safe business. For example, if you are starting a small warehouse operation which includes a forklift, you can likely get help from the forklift sales company, books and trade publications on warehouse safety and your insurance company. Don't overlook the fact that lots of small businesses in your area undoubtedly use forklifts; they face many of the same problems you do and are a great source of hands-on help.

Above all, consult your own employees. No one has a bigger stake in on-the-job safety. More important, your employees are also likely to have nitty-gritty information that you don't have. Returning again to the copy shop example, employees may alert you to problems of chemical fumes released when copy machines are serviced, bad lighting in the storage area, paper supplies that are stacked too high in the warehouse and slippery tile on the front steps. Every one of these conditions is a lawsuit waiting to happen. Fixing them is the cheapest preventive law you'll ever do.

Consider Incorporation

Many small business owners worry that if the business is sued, a huge court judgment could wipe out both the business and their personal savings. A well-run business is not likely to experience a problem of this magnitude, but you can never be sure.

The cheapest way to prevent a business disaster from turning into a personal one is to incorporate your business. When you incorporate a sole proprietorship or partnership, you and your business become separate legal entities. You're no longer personally liable for the debts, judgments and other legal obligations of the business unless you volunteer to assume them--as is the case when you pledge your personal credit to get a bank loan.

And the nice thing about incorporation is that it's relatively cheap, easy and safe to do yourself, without a lawyer. Once you file your company's Articles of Incorporation with your state and a put a good set of bylaws (corporate operating rules) in your corporate records book, you'll find that operating as a small corporation makes little difference to your business on a day-to-day basis.


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