CHAPTER V
Common Mistakes
Don’t Be That Guy or Gal: Ten Common Mistakes
STARTING AND GROWING A BUSINESS draws on practically all your resources. If your background hasn’t exposed you to entrepreneurial thinking, you’ll have lots to learn. One piece of advice comes out again and again when you ask entrepreneurs for some of their favorite tips: Know what you don’t know. And as you’ll see below, if you are short on that wisdom, you may make serious mistakes with the best of intentions. So here are ten common mistakes you can avoid just by knowing about them!
Not being self-disciplined. Self-discipline is essential. Don’t think running your own business means going home early whenever you want. Or not sticking to budgets and spending limits, paying random bonuses with extra money rather than saving it. Or treating employees inconsistently. Or blurring the lines of employer/employee roles.
Not using contracts, or not reading them if they are used. Likewise, inconsistent record keeping, especially in accounting. If you cook your own books to make the business look profitable, you are only cheating yourself.
Not consulting with a lawyer for key issues or important business document review. Don’t make this mistake, because the consequences are potentially huge. All businesses start the same way: as ideas and paperwork. If you’re going to invest your life, time and money in a business, don’t you think it’s worth starting it out the right way and ensuring that paperwork experts get a chance to look at it? It won’t cost that much, because they are efficient. After all, they study business paperwork for a living. Their highly trained eyes and years of thinking about the best interests of their clients will always catch something that would take you hours or days to catch, if you catch it at all. Putting it a different way, if you hesitate because of costs, consider the price of undoing your do-it-yourself lawyering if you get things wrong.
Not incorporating, or choosing the wrong corporate structure. You attorney can guide you based on your vision and plans. The easiest way to start a small business is with a sole proprietorship. The taxes are easily manageable and there is very little paperwork. Unfortunately, if someone accidentally injures herself using your product, she could end up owning your house, all your stuff, and all your money via a lawsuit. Incorporation means protection for the business owner(s). Protect yourself and your immediate family by incorporating. If you know you will never eventually take your company public, a limited liability company (LLC) is likely your best bet, due to the ease of incorporation and lower taxes than with full incorporation (LLCs cannot go public). Not limiting your liability by forming an LLC or corporation is asking for trouble.
Failing to patent, trademark, or copyright material. Earlier we discussed the hand-made jewelry designer who found out the hard way that she wasn’t the only one with a creative eye and a great idea. This can happen with slogans, songs, images, logos, icons, products, procedures, or a million other things related to building a business and brand. Don’t try to do the research yourself; I guarantee that you won’t know all the places to look. There are corporate attorneys who specialize in patenting, trademarking and copyrighting. In fact, in many cases, that’s all they do. Think of it like this: Do you really want to build an entire business around something, only to find out the hard way that you’re not the first to do it, and the person who was first did protect themselves and their idea with a patent, trademark or copyright? That, my friends, is a bad day to be a business owner.
Not having a formal agreement between owners. Owner agreements don’t have to be long. In fact, I think ours is only a couple pages. Mike O’Keefe was my college roommate and the best man at my wedding, but despite our history, when we started Expert Business Advice, LLC together, even we had a formal operating and ownership agreement. It basically just puts in writing who the owners are, how much we each own, what our responsibilities are, what happens if one of us dies or elects to leave the company, how major business decisions will be handled, etc. Also, we are not 50/50 (equal) owners. This can sometimes cause issues for a group of friends who all want to own equal shares, but you must find some way to make it unequal, or you’ll suffer death by stalemate. If two people own a business together and want to be as equal as possible, I recommend a 51/49 percent ownership split. The money is practically equal, but when decisions must be made, they can always be enacted. If you cannot decide who will be the majority owner, use the oldest tipping mechanism in the book—flip a coin!
Starting a business with a large loan, but not understanding the terms of the loan or how to manage it. Just because you get a hefty business loan doesn’t mean you can start throwing money around. As we have seen, you really need to read the fine print to ensure you don’t have to start paying that loan back right away. And if you do get a huge loan, don’t start hiring all your friends to work at your business. It takes careful analysis to determine how many employees a business requires to run optimally. You friends may think you are wicked awesome for hiring them, but the test of your friendship might come when your loan is spent. I hope for your sake at least one of them has a comfortable sofa.
Working on your new business idea at your old job. Say you design and build widgets. You’ve worked at your job for ten years and just love it. Now you’ve developed a completely revolutionary widget design on your own, in spare moments at work. It will transform the widget industry. You don’t have a non-compete agreement with your employer, so you decide to start your own widget business based on your new design. On your last day at your old job, you print out the designs for your new widget and take the schematics home.
Unfortunately, some time later, you get a letter from your old company’s attorney, claiming that they own your new widget design! I hate to be the bearer of bad news, but I’m afraid most courts would find that your old company does own your new widget. Here’s why: You created your new widget on their time, using their equipment, while they were paying you to design and build widgets for them. You even printed off the schematics on their printer. Oh yeah, they own your widget.
If this scenario rings any bells in your head, meet with an experienced business lawyer and check out your situation. It would be better to figure out how to develop prototypes of your new company’s product under conditions that guarantee the new products are yours, than to have them swept up in costly lawsuits and heartbreak.
Thinking you know enough. Lack of continuing education or continuing improvement can trip you up at any time. Just because you made it through the first year does not mean you kick back and rest on your accomplishments.
Not keeping records and documents in perfect order. Do yourself a favor and make your paperwork a model of organized efficiency.
There you have it. Steer clear of these mistakes and you’ll up your odds of success!
S.G. and M.R.M.
Isn’t a Tort Made of Chocolate?
YOU’VE PROBABLY HEARD THE WORD TORT at some point or another. Simply put, a tort is wrongdoing committed by or against people or businesses. Common types of torts involving businesses include fraud, embezzlement, unfair competition, misrepresentation, breach of fiduciary duty (in a corporation, when a director acts against shareholders’ interests), embezzlement, equity-stripping or minority owner squeeze-outs, product liability, malpractice, negligence, etc. These are the things that high-drama novels and movies are made of!
Torts can occur when a business is solely responsible for wrong (e.g., product liability), but can also involve responsibility for a wrong by the business, its owners, its employees and other individuals involved with it, in any combination. (e.g., negligence or misrepresentation). Torts can also include wrongs against the business, its owners, its employees or other individuals involved with it (e.g., civil theft or fraud).
What to do if accused
Valid or not, accusations of torts can be catastrophic to your business. Businesses can be accused of interfering with the operation of another business; or of acting in an oppressive, harmful, unscrupulous or oppressive manner to their customers; or a host of other things.
If your business is accused of some kind of wrongdoing, do not respond directly. Bring your business attorney in on the situation. Typically, if you are getting sued by someone or another business, it’s too late to stop legal action. If it turns out your business is in the wrong, either accidentally or deliberately, your business attorney can often negotiate with the plaintiff and secure a more favorable verdict, a dismissal or a settlement that is less damaging to your business’s operations and reputation.
Let’s look at two common types of torts committed by and against businesses, so as a new or prospective business owner, you can keep yourself protected.
Misrepresentation
Remember when you wrote that business plan in hopes of taking it to a bank to secure your start-up or expansion loan? Hopefully all your numbers were true and accurate. If you padded or inflated them, you may have been committing a very serious, and regrettably common business tort: misrepresentation. Depending on the circumstances and the results of the misrepresentation, it could carry serious consequences. Many entities are very good at detecting misrepresentations and aggressively pursuing their rights. The wronged parties will not think twice about going after an individual or entity that has misrepresented material facts, which could lead to additional risks.
There are three types of misrepresentation, in ascending order of liability risk:
• Innocent Just what it sounds like: It’s an honest, good faith and unintentional mistake made without the intention to harm. This has a very low liability risk.
• Negligent An unintentional mistake made due to the failure to follow established or reasonable standards of care. So while you are not intentionally misrepresenting a fact, you are not making a good-faith attempt to provide the truth. This carries significant liability risk.
• Fraudulent An intentional misrepresentation of a material fact. Needless to say, this act risks extreme liability.
Small businesses are most often the victims of these types of torts. To help you recognize the most serious version, fraudulent misrepresentation, take a look at the actions that define it:
• A false statement (or concealment) was made.
• It was a statement of a “material fact”, i.e., its content would be important in decision making, vs. trivial content.
• The person making the statement knew it to be false or had reckless disregard about its truth.
• The misrepresentation was made with the intention of getting the other party to act.
• The other party did rely on the statement.
• Due to this reliance on the false statement, the other party suffered damages.
Examples are the classic bait-and-switch maneuver you might encounter when selling a business or buying goods or services. You as the business owner are shown and told one thing, but then the product or service that is actually delivered is vastly different. In that case you could be the victim of a tort.
Tortious or intentional interference with contractual relations
Most business between people and entities will not (and should not) occur without a contract. Remember, contracts are not only the lengthy agreements with signatures and amendments we picture. Invoices, purchase orders, employment agreements, owner agreements, and letters of intent can be contracts too. Even a check exchanged can be considered as a constructive contract in the right circumstances. It is a document that you sign and deliver that indicates that you agree to pay another party the amount written in, for the purpose annotated on it, that can be accepted by the other party. Hence the rationale for serious penalties behind forgery, mail or check fraud.
In the realm of torts affecting contractual relations, even petty behavior can lead to big trouble. Suppose a competitor spreads an untrue rumor about a you or your business to one of his suppliers, and the supplier decides not to renew her contract with you. That’s a tort. When you find out, your competitor, called a “tortfeasor”, could be facing multiple suits.
To be liable for tortious or intentional interference with contractual relations, generally the following requirements apply:
• A valid contract or contractual relationships existed between the two parties.
• The third party (the tortfeasor, i.e., liable party, violator and generally bad person) had knowledge of the contract or contractual relationship.
• The third party intended to convince or induce one of the parties to the contract to commit a breach.
• The third party was not privileged or authorized in any way to induce the breach.
• The contract was in fact breached.
• The non-breaching party suffered some sort of measurable damages.
Negligence
Negligence is basically the failure to do what you reasonably should have done. It is one of the most common types of torts, either by itself or as an element of other torts (as for example in negligent misrepresentation). It is very important to note that negligence arises out of careless behavior, and not intentional actions.
Generally, to be liable for negligence, the following requirements apply (and incidentally, this case is a version of a law school example):
• Duty The liable party had a reasonable duty to the other party (a shopkeeper has a duty not to place hidden, cobra-filled snake pits in her shop).
• Breach The liable party breached that duty (the shopkeeper does in fact place a hidden snake pit in the shop, complete with cobras).
• Causation The breach by the liable party either actually or legally causes harm to the other party (a shopper enters the shop, falls in snake pit, is bitten by a snake and dies).
• Damages As a result of this harm, the other party has incurred monetary damages that require compensation (the shopper, now dead, is no longer able to earn income and provide for her family, so the shopper’s family therefore requires monetary compensation).
There are many specific types of negligence and negligence-related torts in each jurisdiction (including criminal negligence, gross negligence, comparative negligence, contributory negligence, vicarious liability or negligence per se). Some of the most common types of negligence torts in relation to businesses are property liability (slips and falls or injuries in a business); product liability (defective products); accidents (vehicle or industrial accidents); or malpractice (errors, omissions or medical malpractice). As an entrepreneur, you need to review and follow the reasonable standards of care expected in your industry and take steps to mitigate risk (via insurance, safety standards and equipment, signage, etc.). It would be wise to ask your attorney to help you identify risk exposures and address your need for prevention and protection accordingly.
Owning and running a business means that you will be executing transactions depending on the honesty, fair dealing and responsible behavior of many individuals and entities. Sometimes bad things happen, sometimes people act badly, sometimes you will not be able to resolve the situation and sometimes you may be forced into the legal system. If you use common sense, make ethical and morally sound decisions and understand the standards you are held too, you will steer clear of liability for torts. As we’ve said, if you suspect or you are the victim of a wrong by another party, a tort has most likely occurred. Take it very seriously and contact your attorney.
Finally, torts are not cheese or wine. They do not get better with age, regardless of which side you are on. As I advise my clients, “Go ugly early.” Get out in front of any incident: Address it as soon as possible and be pro-active. It will really help you and your business in any damage control if the victim feels like this event is a priority to you. You will also establish your business reputation as one not to be messed with by those seeking to take advantage.
S.G. and M.R.M.
Product Liability
WE ALL LIKE TO THINK that when we buy something, it will do what it’s supposed to do without causing harm. Yet we’ve all had experiences or heard of cases in which bad things happened: the super-duper gadget with a jagged handle which cut your hand, the faulty design of a tool that caused accidents and injuries, the cosmetic that burned your skin because the instructions didn’t say to wash it off after one minute.
If your company is a manufacturer, distributor, supplier, retailer or other entity involved in the process of making products available to the public, you may be obliged to compensate for injury caused by defective merchandise you have been involved with. Generally, only tangible products are the focus here—things you can touch. We cannot give you hard and fast advice here, because product liability standards vary by product, industry and jurisdiction. In this aspect of business, you really must consult an attorney with expertise in the topic.
The sorts of complaints that are brought in a product liability suit include negligence, breach of warranty and what is called strict liability. Let’s take a quick look at them.
• Negligence Exactly what it sounds like. There was a duty owed, then a breach of that duty. The breach caused an injury and there are quantifiable damages suffered from the injury. For example, a taxi driver fails to obey traffic laws, the taxi is at fault in an accident, and passengers are injured as a result.
• Breach of warranty The seller specifically states that a product can do something, but the product is unable to fulfill that representation. For example, a consumer purchases a product labeled as a DVD player, but the product will not play DVDs. This can also fall under misrepresentation.
• Strict Liability This sets a much higher standard for the regular manufacturers and sellers, and it provides significantly more protection for the consumers. The injured party must only prove that the product was defective and dangerous when sold, and that the defect caused the injury. There is no requirement to prove fault or negligence against the seller. This may seem like lawyers have pushed the law too far, but the rules are designed to protect individuals from large companies. The law makes it easier for ordinary consumers to prove liability against large businesses, something that otherwise might be impossible, given the businesses’ massive and well-funded legal teams.
Here’s a who-what-when-where-how-why rundown of basics.
Who?
All businesses that produce, handle or affect a product before it reaches the final consumer can be liable. Yes, that means you, even if you are only reselling items on eBay (though you’d have to be selling things regularly to bear liability; single, or infrequent sales are not affected). While many businesses, especially service-based businesses, may not have tangible products, they may still be liable under similar service-related laws. As we’ll see in the next section, other variations of this liability apply to them: malpractice for a doctor or lawyer, errors or omissions for financial or real estate professionals, premises liability for hotels or social event locations.
What?
You and/or the business can be liable and/or responsible (i.e., made to pay or even face criminal charges in extreme cases) if someone is injured (i.e., damaged, harmed either physically, mentally, or financially) because of your product. The ways products are found to be defective are:
• A manufacturing defect Perhaps you put the product together wrongly or put some bad parts in. Examples are most recalls, where only certain cars, phones or other products are recalled due to faulty sub-components, such as a particular model of car sold with a particular brand of tires that had a tendency to explode and cause the vehicle to roll over.
• A design defect There could be a design defect (you designed a product that does really bad things). For example, your car design put the gas tank in the rear, but if the car is rear-ended, it explodes. Or the product’s formulation has unintended side effects: This pill will make some of your pain go away, but it will also likely stop your heart (so take two and call us in the morning?).
• Or failure to warn Perhaps you forgot to mention that your product did SOMETHING ELSE too. Examples: we forgot to advise that tobacco products also cause cancer, or we forgot to mention that coffee was extremely hot.
When
Liability can arise at any time throughout the normal operation or use of your product. For example, a car manufacturer would be liable if its car burst into flames during routine driving, but not if it burst into flames when a driver was trying to jump it across the Grand Canyon. There are specific limits of when, defined by product, industry and jurisdiction. These limits will also define time in the form of a statute of limitations. They say that after a certain time, you are no longer liable for damages related to this product.
Where
Liability is confined to use within the course of normal operation. If you burn out your dog’s hair clipper motor while trying to trim the hedge, don’t bother filing for damages. These things are usually defined on a case-by-case basis.
How
Liability cases are brought as demands against a business, claims to insurance policies or lawsuits. Remember, a case can be brought against anyone in the supply chain. As a general rule, when filing a claim (from the injured person’s side), the strategy is to go after everyone and then focus on the easy targets and the deep pockets (i.e., parties with the ability to pay). From the perspective of the injured person, the goal is compensation for injury (medical bills, loss of income, pain and suffering, etc.). The person does not care much where the compensation comes from. So be prepared: As a business owner it is not a question of IF you will face a claim, but WHEN you will have to.
Why
Why do product liability laws exist? The answer’s simple: consumer protection. Yes, this area of law has spawned ambulance-chasing lawyers and others who can give the profession an extremely bad rap, based on outrageous cases (e.g., a fortune awarded for not telling that consumer the coffee was hot). And it’s too bad that almost every quality-driven business will face a claim at some point. But the public policy behind the way the law is written is to create financial incentives for businesses to do the right thing and to produce safe products. As a whole the system works: It is because of this system that tobacco products now carry warning labels and are not marketed to children, our buildings are no longer built with “fire resistant” asbestos and our homes are no longer painted with the cheaper lead-based paint, all of which were proven to be extremely harmful to the consumers.
At this point, I imagine you are ready to return to the Insurance section of this book, and perhaps the phonebook, to make sure your product liability coverage is adequate. And that, plus your continued vigilance over your company’s delivery of safe experiences with your products, is your best strategy.
M.R.M.
Other Forms of Liability
NOT ALL LIABILITY IS PRODUCT LIABILITY. There are a number of other forms of responsibility and liability you should be aware of. These types of liability relate to intangible products (things you cannot physically touch), and to services.
Malpractice or Professional Liability Generally, this affects regulated professionals who fail to meet their profession’s standards of practice. Most professionals are required to carry the related insurance. Examples are doctors, lawyers and accountants.
Errors and Omissions This is very similar to malpractice liability, primarily related to transactional businesses in industries with more paperwork than products. You may or may not be required to carry this type of insurance. Examples include financial services, real estate brokers and bookkeepers.
Premises and Property This applies to any brick and mortar business and covers the slips and falls in the store, the freak accidents, etc. If you are in this field, you absolutely must insure against this risk. In certain jurisdictions, it is the single largest risk to businesses. Accidents happen, and, yes, there are con men and scam artists out there that prey on small businesses by staging accidents.
Further, this liability has been extended in some jurisdictions to include areas immediately surrounding your business, such as a parking lot. For example, if you know that more than one person has been assaulted in your parking lot and you fail to warn customers, properly light the area after dark or even possibly fail to hire appropriate security, your business could be found to be liable, if another customer were to be assaulted.
Data and Confidential Information This risk affects any business that keeps or has access to confidential information. It could be specifically protected business information related to the operations or practices of one of your suppliers, or it could be clients’ sensitive information like credit card account numbers. As you know, this is a fast-growing risk area for businesses, with criminals targeting some of the largest and most well-funded businesses all over the world. Consider insuring against data theft and planning for recovery from it when designing your operations.
Workers’ Compensation Any business with employees has to address this. Each jurisdiction has unique laws or rules related to your duties and responsibilities. Basically, you have to keep your employees safe at work and compensate them if they are injured in the course of normal business operations.
Vehicles If your employees drive motor vehicles as part of their job duties, this affects you. Each jurisdiction will have specific laws and rules related to vehicle accident liability. This is an area that is very often overlooked until it is too late.
The most common example is small brick-and-mortar retail or service business, say an ice cream shop or doctor’s office. They run out of spoons or printer paper, so the business sends an employee to the store. On the way to the store the employee has an accident and is at fault. The business now shares liability/responsibility (i.e., can be sued and made to pay) for the accident, because the employee was driving within the course of his employment. This common example is an especially big deal in that most businesses would not have any insurance to cover this situation, thinking their employees do not drive as part of their regular job. So why should you pay the high cost of the additional insurance to cover vehicle accidents by employees? The damage payments could be a game changer for a small business. Note: This is also why so many small businesses (including mine) pay a premium for the delivery of supplies directly to the office.
Time to take a deep breath. Yes, you face a lot of liability out there as a business owner. Remember, these sections were written by an attorney who deals with these situations every day. So go back and reread the section on business insurance, then make an appointment to sit down with your insurance agent. (Note: Insure your risks, and make sure they are covered. But be aware that the insurance agent works for the insurance company. And the insurance company is in business to make a profit…).