Legal Landmines Savvy Entrepreneurs Can Dodge

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In this episode of In Process Podcast: Conversations about Business in the 21st Century, Trusted Counsel’s John Monahon talks with Trusted Counsel colleagues Allen Bradley and Valerie Barton about some of the most common legal landmines often encountered by clients and their thoughts on how to sidestep them. In Monahon’s view, entrepreneurs are usually so busy focusing on building a business, sometimes they overlook basic legal coverage which enhances the value of the company. For example, not putting restrictive covenants on employees of your organization, or not protecting your intellectual property. We recorded this podcast episode to help you understand the ways in which the law is a tool that can help you capture value and prevent costly problems (such as additional legal or litigation fees) down the road.

#1. Put restrictive covenants in employment contracts
Simply put, a restrictive covenant is a clause in an employment contract which prohibits the employee from competing with the company, or from solicitation of customers or employees for a specified period upon termination.

#2. Get intellectual property transfer/assignments from independent contractors
Under the law, an independent contractor owns what he or she develops, writes or makes. So when working with independent contractors, it’s important to have him or her transfer the work over to you, the owner of the business. The transfer assignment occurs through a signed contract that the independent contractor signs, ideally at the start of the project.

#3. Identify and protect copyrights, patents and trademarks
Failing to trademark the company name could cost millions of dollars for future protection or could mean losing the rights should another party “steal” the name, or copy the product. The legal process of trademarking exists to send out a formal notice that a business is declaring exclusive rights to the name. Hence, trademarking the company name and product name is smart and proactive.

#4. Issue equity in a timely manner
It’s important to issue stock at the time of grant because procrastination could result in larger legal and tax fees down the road. For example, if equity is promised when the company is at the start-up stage and has a low value, postponing issuance translates into paying taxes based on “phantom income” as the company moves to the next stage which creates a higher value.

#5. Review letters of intent with legal counsel
Savvy entrepreneurs see the importance of involving legal counsel during the initial letter of intent review. Barton states, “oftentimes I’ll receive a letter of intent that has been fully executed and I think to myself, oh my gosh, I could have provided invaluable suggestions prior to mutual execution including an asset purchase as opposed to a stock purchase. Sometimes, clients do not know which purchase is better for their business, and as legal counsel, I am fully equipped to explain the difference and why I would recommend one versus the other.”

#6. Be aware of tax landmines like phantom income problems
Property such as stock can create income when there is no cash to pay the tax.

#7. Equity rollovers are often not tax free
Typically, rollover equity is taxable because the IRS takes the position that rollover equity is income. But there are various exceptions to the general rule, and there are ways to document it so that the rollover equity is tax free so that no tax is paid on the phantom income, the value of the rollover equity.

#8. Take advantage of Research & Development (R&D) Tax Credits
The R&D Tax Credit remains one of the best opportunities for businesses to reduce their tax liability. The R&D Tax Credit is for businesses of all sizes. Industries which may qualify for the R&D Tax Credit include but are not limited to Manufacturing & Fabrication, Software Development, Engineering, Food Science, and Chemical & Formula.

#9. Tax law changes: stay up to date
Taxes should be reviewed periodically as they frequently change which could result in structural adjustment. Another benefit of a periodic tax review is staying abreast on growth of the company. Most likely, the current tax election will no longer be applicable if the company has grown to a multimillion-dollar business.

#10. Put a limited liability company operating agreement or shareholder agreement in place!
The state of formation dictates requirements for entering into an operating agreement. In the world of corporations, the operating agreement is called the shareholder agreement. One of the primary reasons an operating or shareholder agreement is important is to agree upon and document rights, obligations and procedures, should disputes arise. Documented agreements will address and help resolve disputes.

During the podcast CEOs, business owners, and C-level executives will learn:

  • Legal landmines to avoid

  • A few ways to avoid paying large tax fees

  • Commonly confused legal terms

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