The Early Years of a Business, Part 5: Mitigating Your Business’ Risks

This is the last post in a five-part series about the early years of a business formation.  To catch up, click here.

After you’ve selected your business entity, capitalized your business, purchased insurance for your business, and maybe even taken on some new employees, you will want to get into the mindset of identifying legal risks present in your business.  Often, your business risks can be minimized at little to no cost to you.

To begin the process of assessing your business risks, you will want to conduct an internal audit to help you identify those risks.  Many hear the word “audit” and believe it to be daunting and time-consuming; even so, an audit will be worth your time now in order to minimize risks and prioritize your business goals.

During an audit, here are the questions you are likely to come across in the process that will prompt the biggest red-flags:

  1. Is there a document for succession of ownership in the case of my death?
  2. Are my key employees prevented from using my business methodology against me in the future?
  3. Do I have an employee handbook that only contains provisions for the size of my business?
  4. Are the terms of my sales/services recorded in a written agreement with my customer that sufficiently limits my liability?
  5. Do I have written agreements for all installment purchases, financial leases, letters of credit, or other similar transactions?
  6. Do I have appropriate insurance coverage and limits for my business?
  7. Do I have legal counsel on all pending or threatened litigation, including claims brought by the business as well as against the business?

Business owners should put into place a system to help them identify their risks now and during future growth.  Knowledge of these risks can provide a great sense of comfort to the business owner. The business owner can either adopt a plan for mitigation of these risks, increase their business model to protect cash flows in the event of a risk, or simply accept the risk and carry on with their business.  Note: Any findings from your internal audits are protected by attorney-client privilege.

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The Early Years of a Business, Part 4: Documenting New Hires

This post is the fourth in our series about the early years of a business formation.  Read more in parts One, Two, and Three.

Another step most small business owners take in the first few years is hiring employees or staffing with independent contractors.  All of these professional relationships should be documented through the following agreements, forms, and letters:

  • Employment Contract or Employment Offer Letter. This document should include information such as the job title, scheduled work days/hours, term (or length) of employment, compensation details, responsibilities, and termination conditions.
  • Required Employment Forms/Filings. Some of these forms are likely ones that you are familiar with: the W-4 form for employees (W-9 for contractors), I-9 Employment Eligibility Verification form, State Tax withholding form, and direct deposit form.  You can also run the candidate through E-Verify, a system that checks employment eligibility in the U.S.
  • Necessary Agreements and Policies. When staffing your business, you can begin protecting your business from the get-go by having your staff sign the following agreements: non-competition agreement, non-disclosure agreement, employee invention form, employee handbook with an acknowledgement form, drug and alcohol testing consent forms, job analysis forms (this may encompass responsibilities, goals, and performance evaluation criteria), employee equipment inventory list, confidentiality and security agreements.  Depending on your business type, this list may vary or lengthen to suit your needs.
  • Employee Benefits Documentation. If you offer benefits to your employees, you may need documentation of the following: health/life insurance, mobile phone plan, company vehicle lease, stock options, retirement plan, disability insurance, paid time off or vacation policies (this would also include paid holidays), sick leave, employee wellness perks (such as gym memberships), and tuition reimbursement for continuing education.
  • Personal Data Collection. You also need to gather your staff’s personal data and keep it updated with the following: emergency contacts, brief medical history or relevant impairments, and any food allergies or preferences if there is a company-funded lunch or related event.

Employees are the small business owner’s greatest asset, but they do not come without risks.  Start your employer-employee relationship out the right way through proper documentation.  It will mitigate your risk, and it will also help you get to know your staff and keep you on the same page.

The Early Years of a Business, Part 3: Insuring Your Business

This post is the third in a series we are bringing to you about the early years of a business formation.  If you are getting caught up, here is Part 1 and Part 2.

Since every small business has different needs, there is no longer a one-size-fits-all coverage out there; as such, you are sure to find a plan that truly suits your business’ unique needs.  Here are the categories and types of insurance that, depending on your business, would be invaluable for you to invest in:

  • Property Insurance. This would cover any physical damage or loss your business may suffer, from the building to the supplies and equipment you use.
  • Business Interruption Coverage. This would protect your business’ earnings in the event that you have to close your doors due to an incident. (Note: if you operate your business out of your home, do not assume that your homeowners insurance would cover this loss; check with your provider first.)
  • Commercial Vehicle Insurance. If your business uses vehicles regularly to operate (whether you own them or rent them), this is important coverage to have.
  • Life Insurance. If you work with one or more business partners, life insurance will cover the finances that need to be handled after the death of a partner.
  • Liability Insurance. There are three types of liability insurance, each suited for different business types:
  1. General Liability: covers injury, property damage, medical expenses, and lawsuits.
  2. Product Liability: covers safety issues related to the malfunctioning of a product.
  3. Professional Liability: covers small business owners who provide a service, in the event of malpractice or error.
  • Workers Compensation Insurance. It is possible that, if your business has employees, you have a legal obligation to purchase workers compensation and unemployment insurance; this is the case for any business in the state of Illinois.  You may also be required to have disability insurance to cover an employee’s sickness or injury outside of work.

Remember: Insurance is not just about protecting your business as it exists today, but also to protect your business in the future when it comes time for you to pass your business on to a successor.  As we pointed out in last week’s post: You should always be planning for growth and succession!

The Early Years of a Business, Part 2: Capitalizing Your Business

This post is Part II in a five-part series on our blog about the early years of a business.  Click here to read Part 1.

One requirement to preserve your business structure and limit your personal liability is to adequately capitalize your business entity.  But what exactly is considered “capital” in your company?  Capital can be any asset, whether tangible or intangible, that is held in your company for the sake of long-term investment.

Small business capital can come from three different sources:

  1. Investors.  For business start-ups, the investor is typically you.  However, it is common for outside investors to provide capital in small businesses as well. When you invest money as capital into your company, you typically won’t receive that capital investment back until you sell your business.  This often scares small business entrepreneurs from investing any of their personal cash or savings as capital in the first place.  You will often find that outside investors hold the same hesitancy when investing in a small business; so, many investors prefer a loan structure over a capital-contribution structure.
  2. Retained Earnings.  Retained earnings are the earnings of the business that are not otherwise distributed to you or your investors as salaries, bonuses, dividends, etc. and are thus retained by the business.  These earnings are reported on your balance sheet and they evidence that (a) your business operated at a profit, and (b) you, as the owner, had the discipline to leave this capital in the business instead of distributing it.  For business start-ups, this type of capital is often very hard to attain, and is thus the least common structure for capital investment.
  3. Borrowed Money.  Loans are, by far, the most popular form of capital investment in a small business.  Loans don’t have to just come from a bank; loans can come from family members, friends, investment groups, private equity firms, or private investors.  When borrowing money as capital, remember two things: (1) the interest, and most often the principal, must be repaid systematically in the form of established, regular payments, and (2) your business must have sufficient cash flow in order to make those regular payments.

So, how do you know if you are adequately capitalizing your business?

Begin by asking yourself “Am I able to pall all of the expenses, including the payment of debt, that are necessary to operate my business?”  Project your sales, estimate how long it would take for you to collect your receivables, represent the capital needed and when you would need it.  This gives you your operating cash.  If you are unsure of how to work with these numbers, find an accountant to help you adequately assess your capital needs.

Not only should you plan for short-term capital needs, but long-term needs as well.  I tell all of my clients to plan for growth; in the future of your business, will you be making any large capital purchases?  Hiring employees?  Requiring the research and development of any new products?  Avoid using the operating cash you come up with from earlier to make large capital purchases.  Instead connect with a commercial banker to get an equipment loan with a low interest rate and fixed terms.  You will want to use your own retained earnings for growth and future needs; this may feel like a lofty goal, but sufficient planning and baby steps will get you there!  Remember: It takes more capital to stay in business and grow it successfully than to start it in the first place.  Always be planning for growth!

The Early Years of a Business, Part 1: Selecting a Business Entity

The foundational step in protecting your personal assets from your business risks is by forming a business entity.  Here are several forms of popular business entities that you can choose from:

Corporation

  • Articles of Incorporation are required to be filed with the Secretary of State in order to form the entity.
  • A corporation is a legal entity separate from its owners, who own shares of stock in the company. They are called the shareholders.
  • Corporations can be created for profit or nonprofit purposes.
  • A special structure called a Professional Corporation may be used when the corporation provides a certain professional service (i.e. law).
  • Profits are taxed both at the corporate level and again when distributed to shareholders. This is referred to as “double taxation.”
  • Shareholders are not personally liable for corporate obligations unless corporate formalities have not been observed; such formalities provide evidence that the corporation is a separate legal entity from its shareholders. Failure to do so may open the shareholders to liability of the corporation’s debts. Corporate formalities include: issuing stock certificates, holding annual meetings, recording the minutes of the meetings, and electing directors or ratifying the status of existing directors.
  • The shareholder’s interested are managed by an elected group, the Board of Directors. The Board of Directors is responsible for election of the officers that run the day-to-day business of the corporation.
  • The shareholders and/or Board of Directors may adopt Bylaws setting for the management and the affairs of the corporation.
  • Shareholders may adopt a Shareholder Agreement which sets the rules for how the shareholders interact.

Subchapter S Corporations

  • Identical to the Corporation, except a tax election is made that enables the shareholder(s) to treat the profits as distributions and have them pass through to their personal tax return. This avoids “double taxation.”
  • A shareholder that works for the corporation must pay him/herself reasonable wages.

Limited Liability Company (LLC)

  • Articles of Organization are required to be filed with the Secretary of State in order to form the entity.
  • The LLC is generally considered advantageous for small businesses because it combines the limited personal liability feature of a corporation with the tax advantages of a partnership and sole proprietorship.
  • Profits and losses can be passed through the company to its members or the LLC can elect to be taxed like a corporation.
  • LLCs do not have stock and are not required to observe corporate formalities.
  • Owners are called members, and the LLC is managed by these members or by appointed managers.

Series LLC

  • Illinois is one of the few states that recognize the Series LLC.
  • Identical to LLC, except that the debts, liabilities and obligations incurred, contracted for or otherwise existing with respect to a particular series shall be enforceable against the assets of such series only, and not against the assets of the limited liability company generally or any other series of the LLC.

If you aren’t sure which entity is right for you, reach out to a small business attorney’s office, like Sparks Law Office, P.C., to get your business rolling in the right direction.

Employee Handbooks: What They Are and What They Aren’t

It is not uncommon for small business owners to believe that they have their company policies in writing for their employees, when what they really have are various agreements, or even just “procedure manuals,” which do not replace the need for Employee Handbooks.

At the beginning of this month, we shared the basics of Employee Handbooks, and explained that they are a lengthy agreement that protects both you and your employees by making legally-compliant policies very clear in writing.  Like most of your internal documents, this document has the ability to change and grow over time as your business grows.

You may, however, have other documents circulating around your business that do not fit the profile of an “Employee Handbook,” but are important nonetheless.  These documents might be …

  1. Procedure Manuals. A procedure manual is a document that instructs your employees, contractors, and even management on how operations are to be done in your business day-to-day. For example, if your business has a particular way of handling customer service, then a procedure manual is a great place to document the step-by-step process of taking care of a customer. This document is unlike an Employee Handbook, in that not just “employees” will follow these procedures, but even your independent contractors can be required to agree to the procedures you have put in place in order to achieve some continuity in your business operations.  You may even have separate procedure manuals for different departments such as Accounting Procedures, OSHA Safety Procedures, etc. Procedure manuals establish consistency in your business operations, protect you and your employees, and they are a great tool for training as you hire or bring on more team members in the future.
  2. Independent Contractor Agreements. Sometimes agreements are necessary because the service provider is not an employee at all, but rather an Independent Contractor.  Independent Contractor Agreements will include clauses for policies such as Non-Disclosure, Intellectual or Tangible Property Ownership, etc.  In this case, your Employee Handbook, by definition, does not cover your independent contractors, so they need their own agreements with similar policies to your Employee Handbook, such as Confidentiality, Standards of Conduct, Compensation, etc.  Remember, these Independent Contractor Agreements are to be signed by both the contractor and yourself.
  3. Employee Offer Letter / Terms of Employment. This document is an introductory document for your employees.  It is just a 2 to 3 page document detailing the most basic, specific information needed for the person to whom you are offering employment to make an informed decision.  This document informs a specific employee of their job title and description, pay rate, term of employment, any benefits offered, a non-disclosure clause, etc. Employee offer letters are a necessity when bringing on a new employee, but they are not as comprehensive as an Employee Handbook.
  4. Various Policy Agreements. You may also have certain policies written as separate agreements for your employees to sign. This may include vehicle use policies, confidentiality policies, and more.  Stand-alone agreements can be much more comprehensive and exhaustive than what your Employee Handbook would contain; plus, your Employee Handbook has the ability to point to or reference your stand-alone policies as presiding documents in the event that the policy in the Employee Handbook is brief.  You can also utilize stand-alone policy agreements to specify which employees have certain responsibilities.  For example, if you have 14 employees but only two of them drive company cars, then it may not be necessary to include the entire length of a Vehicle Use Policy in your handbook.  Instead, those two employees may simply be required to sign a Vehicle Use Policy Agreement, and the handbook may simply make mention of that policy as the “governing” document for Vehicle Use.

Employee Handbooks are, in fact, their own type of document with a specific purpose.  If you are utilizing internal agreements with your workers, always have an attorney look over your documents to vet them for legal compliance and efficiency for your business.  If trouble ever were to arise with a worker, it is important to know if and where they have signed specific agreements with you as the representative of your company.

Check out our other posts about Employee Handbooks here and here.

Employee Handbooks: When You Have More than 15 Employees

Last week, you read about the basics of Employee Handbooks.  The list you saw in that post was a list of standard policies for fewer than 15 employees. If you have 15 or more employees, you are required by law to begin implementing more policies with broader protections.  Some of these laws are dictated by the state, and some are statutes held at the federal level.  (Note: the information contained in this blog post is written with Illinois state law considered.  Other states may have varied requirements; always seek a licensed attorney in your state to help you with your business’ Employee Handbook.)

Additional Policies for 15-49 Employees

If you have 15 or more employees, but still fewer than fifty, your Employee Handbook will include all the policies you saw in last week’s post, plus…

  1. Equal Employment Opportunity Policy
  2. Internal Complaint Procedure
  3. Sexual and Discriminatory Harassment Policies
  4. Retaliation Policy
  5. Reasonable Accommodation Policy
  6. Family Military Leave (may vary from State to State)

Additional Policies for 50 or more Employees

If you have 50 or more employees, your Employee Handbook will include all of the policies for 49 or fewer employees, plus…

  1. School Visitation Leave / Small Necessities Law
  2. Blood Donation Leave
  3. Family and Medical Leave
  4. Victims of Domestic Violence Accommodation Policy

In summary, the key to protecting yourself and your employees as your business grows is staying up-to-date with your company policies in your Employee Handbook.  If you are just starting out on your small business journey, it is important to always have legal compliance in mind as you bring more employees on board.  The need for more employees is, of course, a great sign of your business’ growth and success; however, growth rarely comes without risks.  Your small business attorney is there to help you mitigate those risks, and keep your company policies both functional and compliant.