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7 Common Legal Pitfalls for Small Businesses

By: SmallBizClub


a law gavel and a dollar bill emphasizing the financial burdens of lawsuits

Legal issues can be distracting and expensive for business owners. Typically, legal pitfalls put most entrepreneurs in an awkward position, especially when you have zero legal background.

If you make a mistake, it can have legal consequences for your business and possibly lead to financial losses. It’s important to understand some of the potential legal pitfalls and protect your business.

1. Failing to Pay Employees on Time

Most startups have an insufficient understanding of their legal obligation to pay employees on time. In addition, small businesses may fail to pay workers due to adverse effects of economic downturns. While the issues are financial, they can cause severe disruptions in business operations or even overwhelming legal ramifications.

Different states have varying timeframes that guide employee salaries. However, the timeframes are based on factors like company policies and circumstances surrounding worker termination.

If you employ people in multiple states, various jurisdictions have varying legal requirements regarding remunerations. For instance, it’s essential to understand whether the states qualify employee fringe payments as wages.

2. Employee Misclassification

Most small businesses prefer independent contractors to employees. However, employers may still misclassify to avoid payroll obligations. In a traditional employment relationship, the employer has the duty to provide minimum wage and overtime pay. However, employee misclassification can lead to severe liabilities, including wage backdating and other penalties.

Most importantly, worker misclassification can haunt top-level managers responsible for tax withholding. Depending on the circumstances, the law may hold the officers personally liable for lost tax. Small business owners should create clear job descriptions for different workers.

3. Securing the Necessary Business Licenses

Most businesses are required to secure one or more licenses depending on your industry. If you launch a business and fail to acquire the licenses, the authorities may shut down your business and impose hefty fines or penalties.

Most small business owners often ignore permits and licenses necessary for legal operations. Others secure some permits but fail to acquire some vital licenses. Regardless, regulators will come for you despite your lack of knowledge of mandatory permits.

Every small business owner has to seek all the necessary permits and apply. Otherwise, missing or expired licenses can attract a variety of legal pitfalls. If you are unsure about the exact permits essential in your jurisdiction or business industry, consulting an expert can be your best bet to avoid business disruptions.

4. Agreement and Contract Breaches


Employers constantly deal with service contracts, employment contracts, and contractor agreements. Regardless of your industry, you probably use different contracts in your business. This means you are committed to various parties, which may increase the risk of violation.

Contract violation can either be a minor breach or a material breach. Typically, the scale of the breach determines the legal consequences. A material breach can lead to contract cancellation or financial penalties.

Small business owners should examine contracts before signing to avoid expensive violations. On the other hand, global transactions should be guided by amicable agreements that abide by industry regulations. Regardless, you should establish a regular review process to ensure all your agreements are accurate and executable.

5. Intellectual Property Infringement

While it may go unnoticed, intellectual property violation is a common legal pitfall that may affect your business. Intellectual property includes any intangible asset that is part of your core products or services.

Intellectual property infringement lawsuits involve patents, copyrights, and trademarks. These legal proceedings can be expensive since they last several years. It’s critical to conduct a sufficient background search when designing and naming products. Ideally, you should check for filed trademarks and patents in your industry. Similarly, you should avoid copyright violations when using written copy, videos, and images.

Intellectual property enforcement may be rare in your business headquarters, but as you expand, it’s prudent to consider potential violations. However, intellectual property lawsuits are more frequent in some countries like the U.S., but other jurisdictions may be friendlier.

6. Wrongful Termination

While wrongful termination falls under employment law violations, legal battles related to worker termination are more common. In addition, wrongful termination often attracts hefty penalties that may affect your cash flow. Regardless of designation, employee terminations require careful handling to ensure dismissals are based on valid reasons. Also, you must observe the necessary notification timeframes.

While the grounds for worker termination and procedure vary in different jurisdictions, employers are required to provide timely notification. This means you’ll have to deliver a termination letter denoting legally valid reasons for dismissal. Depending on the worker’s designation, the law requires you to provide a relevant severance pay.

As with most legal pitfalls regarding complex employment law, an attorney can help you navigate employee dismissal in compliance with relevant laws. If you’re facing an employment lawsuit, consulting an expert in Case Management for Workers’ Comp Legacy Claims can be prudent. Most importantly, ensure your human resources department understands the current employment regulations that may cause problems.

7. Business Structure

Choosing the perfect business structure for your startup can be overwhelming. Whether you prefer a sole proprietorship, LLS, partnership, or trust, each category has unique legal and tax implications.

With time, the environment and circumstances affecting your business can change. For instance, it’s common to start a sole proprietorship and change the structure as your business expands. Sole traders can run the business with lots of freedom, but this means you are responsible for any financial or legal obligations. However, sole traders fall under the personal tax bracket, which can get too expensive as your revenue rises.

On the contrary, companies are considered separate legal entities, and the directors are not personally liable for business debts and some violations. Most importantly, companies enjoy a lower tax rate than sole proprietorships. If you’re in a business with a high growth potential, it’s essential to consider your business structure and determine if it offers optimal benefits.


There are numerous legal considerations when launching or expanding your small business. However, some legal pitfalls can be lethal and are best addressed early. Typically, employment law issues can be far-reaching and should be addressed early. But the good news is that you can avoid unnecessary legal cases and penalties by ensuring compliance with small but potentially dangerous regulations.

Published: November 22, 2023

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SmallBizClub.com is dedicated to providing small businesses and entrepreneurs the information and resources they need to start, run, and grow their businesses. The publication was founded by successful entrepreneur and NFL Hall of Fame QB Fran Tarkenton. We bring you the most insightful thinking from industry leaders, veteran business owners, and fellow entrepreneurs. Follow us on Facebook, Twitter, and LinkedIn.

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