Ten common legal mistakes made by small businesses

Posted by Christine Jackson on February 7 2017 in Commercial transactions

In 2014 it was reported that over 580,000 new businesses were registered at Companies House, reflecting the continued popularity of bringing new ideas to the market. Being your own boss, avoiding corporate bureaucracy, freedom to make your decisions about your product - whatever your reasons, it’s an exciting time. Caught up in the enthusiasm of starting a business it is easy to overlook some critical actions:

The wrong legal structure

Failing to choose the best legal structure for your business may mean that you become personally liable if it makes a loss or if you find yourself facing a claim (although that is an insurable risk). Deciding which structure to adopt will depend on the nature of your business. The most common structures are: a self-employed sole trader, a limited company (more legal responsibilities but the company’s finances are separate from your own), or a partnership (which can be a limited liability) where you share any risk with one or more other people.

Lack of shareholder / partnership agreement

Failing to have a properly drafted shareholder or partnership agreement can be an expensive mistake in the event of a future dispute. An agreement should take into account all eventualities: death, incapacity, retirement, divorce (leading to a need to extract assets) or wanting to exit the business. It is also a good opportunity to review any tax planning advantages that the partnership might bring.  

Not incorporating terms and conditions

Regardless of the perceived level of trust with your customers and suppliers, protect yourself and your business from an expensive legal dispute by putting all agreements in writing.  Invest in specially prepared terms and conditions, or a bespoke agreement for signature, and incorporate them into your contracts by, as a minimum, referring to them in your pre-contract correspondence (and on the back of invoices for good measure).  A recent court case highlighted the importance of properly incorporated terms and conditions by ruling that neither party’s terms and conditions applied because neither had expressly stated their intention to use them. If you don’t win the “battle of the forms” your customer's terms and conditions will prevail which may mean your financial liability is not limited. Insurers may even refuse to insure the business if you approach the contracting in this way. 

No proper contracts of employment or workplace policies

Don’t think formal employment arrangements are unnecessary because you have a small or part-time team made up of family and friends. If something goes wrong you could find yourself facing a substantial claim. All your employment contracts should be in writing and include basic details such as pay; working hours; holiday entitlements; and notice periods. Make sure you have policies reflecting any minimum statutory requirements (such as flexible working and maternity/ paternity/adoption leave) and outline your disciplinary / dismissal and grievance procedures.

Missing deadlines

Check the paperwork you need to complete for HMRC and Companies House. Sole traders must complete a Self-Assessment tax return, paying Income Tax and National Insurance. A small limited company, benefiting from the audit exemption, must file a copy of the balance sheet (or an abbreviated version) with the Registrar of Companies plus a note that the balance sheet has been prepared according to the small companies’ special provisions regime.

Know your regulatory obligations

Cafes and coffee shops are popular small businesses and they operate in one of the most tightly regulated environments in the UK for good reason. Cosmetics, waste disposal and logistics are also highly regulated so you must understand the regulatory environment in which you operate to avoid heavy penalties from non-compliance. Ignorance is no defence.

Not protecting your IP

Don’t overlook the commercial value of your business’ intellectual property (IP), something which is often under-exploited and/or poorly protected. A recent report by the Federation of Small Businesses revealed 25% of those surveyed indicated their IP rights had been violated in the past five years. There are three things you must do: understand the extent of the IP within the business; register it (if applicable); and protect it in agreements with third parties. An IP audit is a good investment and a good starting point. Make sure all IP rights in any bespoke websites and software are assigned to you in writing. Simply paying the supplier does not transfer IP rights’ ownership to you.

Overlooking on-line selling regulations

If you are selling online, be aware of four key points: (i) all information relating to the product, the seller’s identity and contact details, the cancellation and returns policy, and pricing, must be unambiguous; (ii) terms and conditions must be fair and written in good, clear English; (iii) the eight Data Protection Principles must be followed; and (iv) any retailer collecting data for online marketing must obey the law around consent and ‘opting-in’ or ‘opting out’.

Not protecting customer data

Failure to store and/or handle employees’ and customers’ personal data in accordance with the Data Protection Act risks a fine of anything up to £500,000. Most of the requirements can be satisfied by following the eight Data Protection Principles. Data Protection laws are changing and the proposed EU regulations impose stricter obligations on business to protect their customers’ personal data and stricter penalties for breach. Review your Data Protection policies when the new regulations come into effect. 

Failing to negotiate property lease terms

Do not assume the terms of a lease or licence (the latter is more short-term and flexible) are standard and non-negotiable. You may need flexibility, so ensure that you understand the length of the term; whether or not there is a break clause (enabling you to leave the premises early); who is responsible for maintenance and whether you can afford the running costs (including rent, service charges, utilities and insurance).