Entrepreneurship Chapter 7

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Questions and Answers

What is a founders' agreement also known as?

Shareholders' agreement

What is the purpose of a code of conduct in an organization?

To provide intellectual property rights

To lead by example (correct)

To handle legal disputes

To establish business licenses and permits

A founder's agreement includes details on the division of ownership among founders.

True

A ____________ agreement binds an employee to not disclose a company's trade secrets.

nondisclosure Signup and view all the answers

Match the form of business ownership with its description:

Sole Proprietorship = A business involving one person responsible for all liabilities. Partnership = Organized as either general or limited liability partnership. Corporation = A separate legal entity where owner maintains control. Limited Liability Company = Offers liability protection with flexible management structure. Signup and view all the answers

What is a general partnership?

A form of business organization where two or more people pool their skills, abilities, and resources to run a business. Signup and view all the answers

What is the primary disadvantage of a general partnership?

All partners are liable for all the partnership's debts and obligations Signup and view all the answers

What is a limited partnership?

A modified form of general partnership that includes two classes of owners: general partners and limited partners. Signup and view all the answers

What is the advantage of a general partnership in terms of raising funds?

Having more than one owner may make it easier to raise funds Signup and view all the answers

What is a corporation?

A separate legal entity organized under the authority of a state. Signup and view all the answers

What is the disadvantage of a C corporation in terms of taxation?

Income is subject to double taxation Signup and view all the answers

What is a subchapter S corporation?

A corporation that combines the advantages of a partnership and a C corporation, with income not subject to double taxation. Signup and view all the answers

What is a requirement for a business to qualify as a subchapter S corporation?

The shareholders must be U.S. citizens Signup and view all the answers

What is a limited liability company (LLC)?

A form of business ownership that combines the limited liability advantage of a corporation with the tax advantages of a partnership. Signup and view all the answers

What is an advantage of a limited liability company (LLC)?

Members are liable for the debts and obligations of the business only up to the amount of their investment Signup and view all the answers

Study Notes

Preparing a Proper Ethical and Legal Foundation

Founders can establish a strong ethical culture in their entrepreneurial ventures by:
- Leading by example
- Drafting a code of conduct
- Implementing an ethics training program
A code of conduct (or code of ethics) is a formal statement of an organization's values on certain ethical and social issues.
Ethics training programs teach business ethics to help employees deal with ethical dilemmas and improve their overall ethical conduct.

Choosing an Attorney for a Firm

Select an attorney early, familiar with start-up issues
Consider intellectual property issues and use an attorney who specializes in this field
Tips for selecting an attorney:
- Contact the local bar association for a list of attorneys who specialize in start-ups in your area
- Interview several attorneys
- Select an attorney who can assist you in raising money for your new venture
- Check for track record of completing work on time and discuss fees
- Ensure the attorney understands your business
- Learn about the process of starting a business yourself

Drafting a Founders' Agreement

A founders' agreement (or shareholders' agreement) deals with issues such as:
- Relative split of equity among founders
- Compensation for cash or "sweat equity" invested in the firm
- Vesting period for share ownership
Items to include in a founders' agreement:
- Nature of the prospective business
- Identity and proposed titles of the founders
- Legal form of business ownership
- Apportionment of stock (or division of ownership)
- Consideration paid for stock or ownership share
- Description of how founders will be compensated and how profits will be divided
- Provisions for resolving disputes
- Buyback clause

Avoiding Legal Disputes

Most legal disputes result from misunderstandings, sloppiness, or lack of knowledge of the law
Steps to avoid legal disputes:
- Meet all contractual obligations
- Avoid undercapitalization
- Get everything in writing
- Set standards
Written agreements help to avoid misunderstandings and legal disputes

Nondisclosure and Noncompete Agreements

Nondisclosure agreements bind employees or other parties to not disclose a company's trade secrets
Noncompete agreements prevent individuals from competing against a former employer for a specific period of time

Obtaining Business Licenses and Permits

Businesses may need local, state, and/or federal licenses and permits to operate
Examples of businesses that require federal licenses and/or permits:
- Selling or providing services related to alcohol, tobacco, firearms, animal transport, commercial fisheries, or radio and television broadcasting
State licenses and permits:
- Business registration requirements
- Sales tax permits
- Professional and occupational licenses and permits
Local licenses and permits:
- Operation of certain types of businesses
- Permits for engaging in certain activities (e.g., building, health, signage)

Choosing a Form of Business Ownership

Common legal entities:
- Sole proprietorship
- Partnership
- Corporation
- Limited liability company
Issues to consider when choosing a form of business ownership:
- Liability
- Control
- Finances
- Growth and exit strategies
- Other factors (e.g., taxes, complexity, flexibility)

Sole Proprietorship

Simplest form of business entity
Owner and business are essentially the same
Advantages:
- Easy and inexpensive to create
- Owner maintains complete control and retains all profits
- Business losses can be deducted against other income
- Not subject to double taxation
- Easy to dissolve
Disadvantages:
- Unlimited liability
- Relying on single owner's skills and abilities
- Raising capital can be difficult
- Business ends with owner's death or loss of interest
- Liquidity of owner's investment is low

Partnerships

Form of business organization where two or more people pool their skills, abilities, and resources
Types of partnerships:
- General partnership
- Limited partnership
General partnership:
- Primary disadvantage is unlimited liability
- Skills and abilities of multiple owners are available
- Raising capital may be easier
- Business losses can be deducted against partners' other income
- Not subject to double taxation
Limited partnership:
- Modified form of general partnership
- Includes two classes of owners: general partners and limited partners
- General partners are liable for partnership debts and obligations
- Limited partners are only liable up to their investment

Corporations

Separate legal entity, organized under state authority
Types of corporations:
- C corporation
- Subchapter S corporation
C corporation:
- Owners are liable only for their investment
- Easier to raise capital
- No restrictions on number of shareholders
- Stock is liquid if traded on a major stock exchange
- Ability to share stock with employees as motivation
- Double taxation of income
Subchapter S corporation:
- Combines advantages of partnership and C corporation
- Income not subject to double taxation
- Owners not personally liable for business debts or behavior
- Strict standards to qualify as a subchapter S corporation

Limited Liability Company

Form of business ownership that combines advantages of partnership and corporation
Owners (members) are not personally liable for business debts or behavior
Income is not subject to double taxation
More flexible than corporations, with fewer restrictions on ownership and management### Limited Liability Company (LLC)
Combines the limited liability advantage of a corporation with the tax advantages of a partnership
Does not pay taxes; profits and losses are passed through to the tax returns of the owners

Advantages of a Limited Liability Company

Members are liable for debts and obligations only up to the amount of their investment
Unlimited number of shareholders
Can elect to be taxed as a sole proprietor, partnership, S corporation, or corporation, providing flexibility
No double taxation, as profits are taxed only at the shareholder level

Disadvantages of a Limited Liability Company

Setting up and maintaining an LLC is more difficult and expensive
Tax accounting can be complicated
Regulations governing LLCs vary by state
Limited legal precedent for owners to anticipate how legal disputes might affect their business
Some states levy a franchise tax on LLCs, essentially a fee for the benefit of limited liability