By Joshua Massingill, Esq.

As a transactional business attorney, I have helped establish hundreds of businesses and have advised thousands of business owners regarding liability protection, regulatory compliance, corporate structure, and related issues. As you can imagine, I’ve seen my fair share of business disasters. Here’s what I’ve learned: legal problems rarely appear out of thin air, and most are easily avoidable.

It’s heartbreaking to watch a client wrestle with a $100,000 problem that could have been avoided with $500 in proactive legal assistance or a little common sense. Here are the top 5 legal mistakes I’ve seen business owners make that can drive a business to the brink of destruction:

1.) Not using written contracts.

This is a no-brainer. Handshake deals are for losers. Legitimate businesses use written contracts. Verbal contracts are (almost always) useless. Written agreements are necessary to permit legal enforcement of their terms. And even simple contracts between honest, well-intentioned people occasionally give rise to disputes. Memories fade. Sometimes what you said differs from what the other party heard. Written agreements prevent misunderstandings and reduce the likelihood you’ll end up in court arguing with third parties.

2.) Not keeping copies of contracts you have signed.

You’re an honest person who honors your obligations, right? Of course you are. But the only way to know you’re doing the things you’ve promised to do is by keeping a record of the promises you’ve made! It is vitally important that you keep copies of every written agreement you sign. This will allow you to ensure you are complying with their terms and that other parties are meeting their obligations to you and your business. If you sign your name on it, keep a copy of it.

3.) Signing contracts in your personal name.

Suppose John Doe is president of a large manufacturing company, ABC Manufacturing LLC. One day, he signs a million-dollar contract with a supplier and signs the agreement as simply “John Doe.” Who is legally bound in contract? A court might presume that John Doe meant to personally guarantee the contract because he signed in his individual capacity. That could be very, very bad news for John. Instead, John should have signed the contract as “ABC Manufacturing LLC, by John Doe, President” or “John Doe, President of ABC Manufacturing LLC.” That would have made it clear he was binding the company (not himself) in contract. Whenever you sign an agreement, ask yourself the following question: If an alien came to Earth with no knowledge of my business or the circumstances surrounding this contract and only had the document itself as a reference, who would they presume the parties to the contract to be? It must always be 100% clear that your business is the contractual party – not you personally.

4.) Misclassifying employees as independent contractors.

In general, your company’s workers can be compensated as employees or paid as independent contractors. Employees receive a W-2, whereas independent contractors receive a 1099. Most business owners understand this concept but fail to realize that the ultimate determination of whether a worker qualifies as an independent contractor is made by the Internal Revenue Service (IRS), not the business owner. If the IRS determines that you have misclassified employees as independent contractors (and therefore failed to withhold and pay the appropriate taxes) it will impose harsh penalties. Many businesses have been driven into bankruptcy by an unfavorable IRS determination regarding misclassified employees. If your business uses independent contractor labor, you should consult with an attorney to determine whether they meet the IRS requirements. 

5.) Commingling business and personal funds.

There are many reasons business owners form legal entities, but the most compelling is this: to protect their personal assets from their business liabilities. Forming a business entity (such as a corporation or limited liability company) enables the business owner to take risks and conduct business without the fear of putting their personal assets in jeopardy. However, certain legal mistakes can unravel this protection and allow litigants to “pierce the corporate veil” and hold business owners personally liable for the entity’s obligations. One such mistake is commingling business and personal funds. For example, paying your mortgage payment directly from a business bank account (instead of paying yourself a personal distribution, then paying the mortgage company using your own personal funds). A pattern of such behavior might lead a court to conclude that the business entity does not deserve its status as a separate legal “person” and instead hold that it is merely the business owner’s “alter ego” – in which case the owner would be personally liable for the entity’s obligations. In summary, commingling business and personal funds is what we attorneys call “a very bad idea.”

Joshua Massingill is a business attorney in Austin, Texas.