5 Legal Mistakes That Sink New Small Businesses (and How to Avoid Them)

Starting a business is exciting, but skipping over key legal steps can cost you big down the road. As a small business firm based in Englewood, Colorado, we've worked with plenty of entrepreneurs who unknowingly exposed themselves to lawsuits, tax headaches, and operational issues simply because they didn’t get the right legal foundation in place.

Here are five of the most common legal mistakes small business owners make, and how you can avoid them from day one.

1. Not Forming a Legal Entity (or Choosing the Wrong One)

Too many entrepreneurs start their business as a sole proprietorship or general partnership without realizing they’re exposing their personal assets. In Colorado, if you don’t register an LLC, corporation, or other entity with the Secretary of State, you are by default a sole proprietor or general partnership—and that means if your business is sued, your personal home, car, and cash could be on the line.

One way to avoid personal liability is to form a limited liability company (LLC) or corporation. LLCs are especially popular for small business owners in Colorado due to their flexibility and ease of maintenance. You can file online with the Colorado Secretary of State and get setup quickly—but make sure your operating agreement is tailored to your business. A proper operating agreement isn’t just a formality—it defines roles, responsibilities, voting rights, and financial arrangements. If you skip it, you’re asking for disputes down the road. Additionally, it's one more piece of evidence that your LLC is being treated as a separate and distinct legal entity, should a third party seek to hold you individually liable for something.

Also, consider your long-term goals when deciding on which entity to us. If you plan to raise outside capital, a corporation might make more sense. Speak to a lawyer or CPA early so you don’t have to backtrack later. While changes can be made, they can be more time and cost-intensive after an organization has already experienced growth.

2. Failing to Put Agreements in Writing

A handshake deal might work when you’re mowing a neighbor’s lawn. It doesn’t cut it when you're starting a business. Verbal agreements are hard to prove and often lead to costly misunderstandings.

Whether it’s with a partner, a contractor, or a key vendor, failing to document agreements can lead to major disputes.

As much as possible, get everything in writing. If you’re going into business with a partner, you need a written partnership agreement or an LLC operating agreement. If you're hiring someone, use a contractor agreement. If you're bringing on investors, document their ownership and rights. Even basic templates can prevent misunderstandings and protect your position in a dispute. If you're making a sale, have a sales contract.

Also, revisit and update agreements as your business grows. A contract that worked when you were a two-person shop might not be sufficient once you have employees, investors, or new product lines.

3. Ignoring Employment and Contractor Laws

Hiring help is a milestone—but if you misclassify a worker or skip required steps, it can blow back in a big way. The IRS and Colorado Department of Labor can be aggressive when it comes to worker misclassification. Just because someone signs a contractor agreement doesn’t mean they qualify as an independent contractor under the law.

In Colorado and elsewhere, the penalties for misclassifying employees as independent contractors can include back taxes, fines, and liability for unpaid wages. Onboarding a W-2 employee? You're responsible for tax withholding, workers' comp, and adhering to labor laws. You’re also required to comply with Colorado’s Equal Pay for Equal Work Act and other state-specific rules.

Make sure you understand the difference between an independent contractor and an employee. Use written agreements with contractors. If you're hiring employees, register for a state wage withholding account and unemployment insurance. Make sure you're posting required labor law notices and following wage rules. Consult a lawyer if you're unsure—missteps here can be expensive.

It’s also wise to implement an employee handbook or at least basic HR policies to ensure consistent practices and mitigate risk. If you ever face a wage or harassment claim, those documents can help prove you took your obligations seriously.

4. Not Protecting Intellectual Property (IP)

Brand names, logos, product designs, and trade secrets can be a business’s most valuable assets—but many founders never take steps to protect them.

That cool business name you’ve printed on 1,000 T-shirts? If someone else has a federal trademark, you could be forced to rebrand (and pay for past infringements). Your website copy or original content? Someone else might copy it unless you assert your rights. If you’re developing software, you need to make sure your developers assign their IP rights to your business—or you might not even own your product.

The solutions to this depend on the type of intellectual property, but a few evergreen points: Run a trademark search before naming your business. Register your trademark with the USPTO if it’s key to your brand. Consider copyright registration for original content. Use NDAs when discussing confidential info with contractors, freelancers, or potential partners. In short, protect the ideas that make your business stand out.

In Colorado, state trademark registration is also available and may be useful for local businesses not yet ready for federal filings. You should also consider domain name protection and checking for social media handle availability as part of your IP strategy.

5. Skipping Compliance Requirements

Starting an LLC or corporation is a good first step, but it's not set-it-and-forget-it. Colorado requires annual reports and good standing maintenance. Local jurisdictions (like the City of Englewood or Arapahoe County) may require business licenses or zoning permits. Failure to keep up with these can lead to late fees or administrative dissolution.

Many small businesses are shocked to learn they were involuntarily dissolved due to missed filings—and now have to scramble to restore their status. In some cases, this lapse can nullify contracts or expose owners to liability.

It's wise to keep a compliance calendar. File your Colorado periodic report annually. Check with your city and county about local requirements. If you collect sales tax, register with the Colorado Department of Revenue. And make sure you're maintaining records of key decisions (like major purchases or changes in ownership) to protect your liability shield.

Also, if you’re operating in multiple states or selling across state lines, you may have additional compliance obligations such as foreign entity registration or sales tax nexus rules. As your business expands, revisit these issues.

Final Thoughts: Build a Strong Legal Foundation Now, Not Later

Legal issues don’t always show up right away. Often, the problem hits months or years later—when you're growing, bringing on partners, raising money, or being sued. That’s when your early legal shortcuts can come back to haunt you.

Taking the time to structure your business properly, get written agreements, stay compliant, and protect your brand isn’t just busywork—it’s a strategic investment in your long-term success. You don’t have to do everything at once, but ignoring these fundamentals is risky.

Working with a local business lawyer early can save you thousands (or more) in future litigation, tax penalties, and lost opportunities. And in many cases, getting things right upfront is far cheaper than fixing problems later.