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MANY SMALL-BUSINESS OWNERS relish the informal workplace, where rules are bendable, office politics are nil, and staff members are treated like family. Corporate America be damned, right?

Not exactly. When it comes to managing employees, many business owners take too lax of an approach, failing to educate their work force on harassment or discrimination policies and forgetting to document performance problems. Unfortunately, that "one-big-happy-family" attitude — so common in small businesses — can turn out to be highly dysfunctional.

"I tell my clients all the time — if you think you are not going to get sued because you and your subordinates are like family, remember this: Families sue each other all the time," says Gary M. Gansle, an attorney in Wilson Sonsini Goodrich & Rosati's labor and employment law practice in New York.

Entrepreneurs might be surprised to learn that they're vulnerable to the same worker complaints that plague larger corporations. The hottest area, currently, is wage-and-hour litigation, in which employees claim they weren't paid for overtime or provided meal or rest breaks. In the past year, giants such as Wal-Mart Stores (WMT) and Morgan Stanley (MS) have been forced to pay millions of dollars to resolve wage-and-hour suits. Small businesses are feeling the pain, too, with this type of litigation — brought under the Fair Labor Standards Act — now surpassing discrimination and harassment claims as the worker lawsuit du jour, legal experts say.

Small-business owners often unwittingly violate federal and state employment laws, because they don't have in-house counsel or even a human-resources department to advise them on best practices. The results can be disastrous, says Jennifer L. Goldberg, a labor and employment lawyer with Thelen Reid & Priest in Los Angeles.

"The risks for small-business owners are so great, because one lawsuit can make such a huge dent in your overall financial picture," she says. While small-business owners like to eschew corporate rigidity, "you still have to deal with a certain amount of sophistication, with having some written policies, following posting laws, and taking necessary steps to prevent anything from blowing up."

Here are some ways small-business owners can protect themselves throughout an employee's lifecycle, from hiring to termination:

Don't hire the walking lawsuit
Be savvy enough to read between the lines of someone's well-crafted resume, says Goldberg. Ask previous employers if the person is eligible for re-hire, and make sure you check references. Have a formal in-house application on hand that the employee completes and signs. Background and credit checks are also a good idea, though you must have written authorization from the potential employee.

Make sure employees are classified properly
Employees must be labeled "exempt" or "nonexempt" under federal labor laws. Employees are exempt from overtime based on their duties and salaries; the general hallmark is the ability to work with a certain amount of discretion. Categories include executive, professional and administrative. Nonexempt employees, on the other hand, receive hourly wages, which means they are eligible for overtime and provided meal and rest breaks. For more information, check the Department of Labor's web site.

Maintain a clear discrimination policy
This means outlining clearly what constitutes unlawful harassment or discrimination based on age, gender, race, religion or disability. Have the policy in writing, and make sure employees receive and sign a copy when they are hired. Display the policy on workplace bulletin boards or the company's intranet.

Address problems when they arise
Have a procedure for handling employee complaints. Train supervisors and managers on responding to unacceptable behavior. And be proactive, as there's an obligation on the part of the employer. You can be sued for failing to prevent harassment, for instance.

Implement an evaluation process
Do performance reviews — and make sure they are honest. A big mistake made by small-business managers working in a close environment is patting someone on the back for hard — but insufficient — work. "It's what we call the 'halo' effect," says Keith Rosenblatt, a lawyer specializing in employment litigation with Littler Mendelson in Newark, N.J. "They sugarcoat bad performance. They don't want to hurt employees' feelings."

Document, document, document
Whether it's unacceptable workplace behavior or extended absences or poor performance, keep a written record. "Do so keeping in mind that those documents could be Exhibit A to a jury," says Goldberg. It's harder to prove that an employee was warned or disciplined if there's no documentation. Remember the saying: If it's not in writing, it didn't happen.

Be careful when handling a termination
Take a step back, especially if the reason for firing an employee is bad performance. Make sure you've put the employee on notice, and given them an opportunity to improve. "The big message I give to small-business clients is: The employee who is more surprised by his termination is more likely to sue," says Gansle, of Wilson Sonsini. "So clear warnings that your conduct is putting you at risk of losing your job are key."