Is Your Company in Position to Succeed? 11 Considerations from a Business Lawyer
When we meet a new business client, we analyze whether the company is positioned to succeed legally. Not unlike a doctor’s visit, these are the focal points during that assessment:
- Corporate records – An Ohio corporation is required to keep certain corporate records and hold certain meetings. No one goes to prison for ignoring these requirements, but there are potential consequences—particularly if the owner has wealth outside of the business assets. If a company is sued, a plaintiff may seek to “pierce the corporate veil” to reach the shareholder’s assets by determining (among other things) “whether corporate formalities were observed and whether corporate records were kept.” Denny v. Breawick, LLC, 3rd Dist. No. 5-18-12, 2019-Ohio-2066, 137 N.E.3d 578, ¶ 17. Once the veil is pierced, the company’s liabilities are your personal liabilities, and creditors could attach your own residence. It comes as a great relief when we find out that, although a client is getting sued, at least it has good corporate records. If a new client’s corporate records are not in order, we make that a priority.
- State-law structure – A business comes in many forms, as far as state law is concerned. Everyone knows what they are: the corporation, LLC, general partnership, sole proprietorship, and limited partnership. With a few exceptions, LLCs are the optimal structure (https://www.cavitch.com/blog/2023/04/five-reasons-not-to-form-a-corporation-and-one-reason-to-ignore-those-five/), and a conversion to an LLC is often a simple, common-sense plan to reduce annual compliance costs and reduce risk of liability to creditors.
- Federal tax classification – Every business needs a strong tax adviser—not just an accountant. Often, I find that a business has never been adequately advised on the ideal tax classification. As you may know, a business can be taxed as a sole proprietorship, partnership, S-corporation, or C-corporation. An analysis of this decision exceeds the scope of this article, but we are certain to confirm that a strong CPA has thought it through. Another consideration is whether affiliated taxpayers can be merged or combined to alleviate the cost of unnecessary tax returns.
- Contracts – Some entrepreneurs claim to “do business on a handshake.” More often than not, it’s not a position based on principle but on lack of inertia. The reality is, your lack of good contracts only benefits the party suing you. Specifically, I’m talking about contracts with customers (i.e., Ts & Cs), vendors, employment contracts, and NDAs. Something you grabbed online does not qualify as a “good contract.” They need to be crafted so that they are suited to your current practices and provide seller-friendly terms (or buyer-friendly terms, as the case may be).
- Trade Names and IP – Most companies do not conduct business in their exact formal name. There’s nothing illegal about this as long as that commercial name is registered, either as a trade name or a fictitious name. A related question: Does your business have all of the trademarks it needs to protect the goodwill of its goods and services from unfair competition?
- Confidentiality – There are good business reasons to keep your information secret. That much is obvious. But businesspeople are not always aware of how important it is to have an air-tight set of procedures for your trade secrets if there is ever a legal dispute. You should be able to demonstrate that any person who can access your customer list, formulae, etc., is bound by confidentiality protections within a contract, and that those trade secrets are only available to the limited number of people who need to know them. This includes vendors and employees as a starting point. Without careful attention to this topic, you shouldn’t put much faith in the value of a company’s goodwill.
- Dissolving dormant entities – Entrepreneurs often have a pile of unused corporations and LLCs resulting from abandoned ventures. It has always been a “best practice” to dissolve these entities, but now the stakes are higher. Beginning in January 2025, all entities must either register with the Financial Crimes Enforcement Network (FinCEN) or find an exemption under the Corporate Transparency Act (https://www.cavitch.com/blog/2023/04/what-you-need-to-know-about-the-corporate-transparency-act/). Penalties are quite high, so dissolving the entity now makes sense and will save hassle.
- Insurance – Can you answer with confidence as to whether any of these events would be covered: frozen pipe bursts and you lose two weeks of revenue, a manager sexually harasses an employee and sues your business, an employee has too much to drink at a company party and causes an accident? There are just too many potential threats out there, so be sure to buy insurance policies that are designed by someone who is carefully considering your business’s needs. If it hasn’t been done already, we suggest the new client talk to a sharp broker who can help close as many gaps as possible.
- Employee handbook – An employee handbook has the force of a contract and will help keep your company out of court. It should be the first thing on your list if you don’t have one or haven’t updated it recently.
- Succession plan – Do you know who will own and manage the business when you’re retired, disabled, or deceased? Do you have a game plan for buying out any business partners who may experience such an event? These are critical questions for determining the ongoing value of an enterprise for your heirs. Even if you have a buy-sell agreement from many years ago, it should be re-examined regularly based on insurance not being maintained or valuations and outlooks have changed.
- Critical Dates and Deliveries – Important contractual relationships come with important deadlines. Leases and loan agreements are most noteworthy. A lawyer should review the contractual relationships that are most indispensable and ensure that all dates are calendared, and the deliverables are being delivered. This is particularly important for businesses that are too small to have an in-house lawyer taking care of that task regularly.
These considerations are important from a day-to-day perspective, but they’re also related to the considerations for a business owner who is planning an exit.