For small businesses, lawsuits can be a death knell. Already strapped for time, money, and resources, entrepreneurs simply can’t afford the financial and emotional stress that comes with legal wrangling.
And while any business is susceptible to lawsuits on a number of fronts, there are a few key areas to watch out for:
Choose the right business entity: Many new entrepreneurs choose sole proprietorship because it’s easy to set up, yet it offers little protection from lawsuits. On the other hand, a corporation-type structure usually shields an owner’s personal assets from lawsuits. Damon G. Tyner, an associate at Fox, Rothschild, O’Brien & Frankel in Atlantic City, New Jersey, says the limited liability company (L.L.C.) is a hybrid of the two that’s popular because it operates like a corporation but is taxed as a partnership or a sole proprietorship.
Keep tight reins on receivables: Cash flow problems can put a small business under very quickly. For example, Tyner’s firm recently worked with a facilities services business (janitorial, landscaping, snow removal, and metal refinishing) that was bringing in 70% of its annual sales from a single contract. When that customer stopped paying due to bankruptcy, the facilities company couldn’t pay its own bills and became vulnerable to suits by its vendors and employees. When litigation was settled, the small business wound up with about 10 cents on the dollar for the money owed. Tyner adds that prevention in this case required a hard look at the small business internal operations, less complacency with a single client and a more diversified client base.
Develop employment policies: Although their human resources components may be more casual than those of larger firms, small businesses cannot be lax when it comes to their employees. Noncompete agreements, confidentiality agreements, severance agreements, and non-solicitation agreements should all be areas of concern for small companies, says Toya Cirica Cook Haley, attorney with Winstead Sechrest & Minick P.C., in Dallas.
Estrellita J. Doolin, corporate counsel at Golfsmith International, a multi-channel seller of golf equipment, components, and accessories in Austin, Texas, says her firm has avoided lawsuits simply by addressing potential employment disputes before they happen. “That includes making sure that hiring practices are fair, that agreements are clear, and that a policy is in place to deal with complaints — in the event that a dispute does arise,” says Doolin, who works closely with an outside attorney to review and evaluate all of Golfsmith’s employment-related documents.
One good preventative step, says Haley, is to develop and maintain effective employee policies and procedures in a written, published document (i.e. an employee handbook) that every employee must read and sign.
Consult with knowledgeable experts: Lawsuits can sometimes be avoided through preliminary consultation with outside legal experts. Fees can range from about $10,000 to $25,000.
Of course, most small business owners realize that legal advice doesn’t come cheaply. Tyner, for example, requests a retainer of $1,500 to $2,500 (depending on the individual business and the matter at hand) and charges $205 an hour. To all small business owners he offers these