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Copyright 2012 Pearson Education
Chapter 7
Preparing a Proper
Ethical and Legal
FoundationBruce R. Barringer
R. Duane Ireland
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Chapter Objectives1 of 3
1. Describe how to create a strong ethical culture in anentrepreneurial venture.
. !"plain the i#portance of $leading b% e"a#ple& in
ter#s of establishing a strong ethical culture in afir#.
3. !"plain the i#portance of having a code of conductand an ethics training progra#.
'. !"plain the criteria i#portant to selecting anattorne% for a new fir#.
(. Discuss the i#portance of a founders) agree#ent.
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Chapter Objectives of 3
*. +rovide several suggestions for how entrepreneurial
fir#s can avoid litigation.
7. Discuss the i#portance of nondisclosure and
nonco#pete agree#ents.,. +rovide an overview of the business licenses and
business per#its that a start-up #ust obtain before it
starts conducting business.
. Discuss the differences a#ong sole proprietorships/
partnerships/ corporations/ and li#ited liabilit%
co#panies.
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Chapter Objectives3 of 3
10. !"plain wh% #ost fast-growth entrepreneurial
ventures organie as corporations or li#ited
liabilit% co#panies rather than sole proprietorships
or partnerships.
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Initial !thical and 2egal Issues acing a
4ew ir#
!stablishing a strong
ethical culture
Choosing an attorne%
5voiding legal
disputes
Obtaining business
licenses and per#its
Choosing a for# of
business organiation
Drafting a founder)s
agree#ent
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!stablishing a 6trong !thical Culture1 of
2ead b% !"a#ple
8 9he #ost i#portant thing that an% entrepreneur/ or tea# of
entrepreneurs/ can do to build a strong ethical culture in
their organiation is to lead b% e"a#ple. !stablish a Code of Conduct
8 5 code of conduct :or code of ethics; is a for#al state#ent
of an organiation)s values on certain ethical and social
issues.
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!stablishing a 6trong !thical Culture of
I#ple#ent an !thics 9raining +rogra#
8 !thics training progra#s teach business ethics to help
e#plo%ees deal with ethical dile##as and i#prove their
overall ethical conduct.8 5n ethical dile##a is a situation that involves doing
so#ething that is beneficial to oneself or the organiation/
but #a% be unethical.
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+otential +a%offs for !stablishing a 6trong
!thical Culture
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Choosing an 5ttorne% for a ir#
6elect an 5ttorne% !arl%
8 It is i#portant for an entrepreneur to select an attorne% as
earl% as possible when developing a business venture.
8 It is criticall% i#portant that the attorne% be fa#iliar withstart-up issues.
Intellectual +ropert%
8 or issues dealing with intellectual propert% :patents/
trade#ar
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=ow to 6elect an 5ttorne%
Contact the local bar association and as< for a list of attorne%s who
specialie in start-ups in %our area.
Interview several attorne%s.
6elect an attorne% who is fa#iliar with the start-up process.
6elect an attorne% who can assist %ou in raising #one% for %our new
venture.
>a
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Drafting a ounders) 5gree#ent
ounders) 5gree#ent
8 5 founders) agree#ent :or shareholders) agree#ent; is a
written docu#ent that deals with issues such as the relative
split of the e?uit% a#ong the founders of the fir#/ howindividual founders will be co#pensated for the cash or the
$sweat e?uit%& the% put into the fir#/ and how long the
founders will have to re#ain with the fir# for their shares
to full% vest.
8 9he ite#s to include in the founders) agree#ent are shown
on the following slide.
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Ite#s to Include in a ounders) 5gree#ent
4ature of the prospective business.
Identit% and proposed titles of the founders.
2egal for# of business ownership.
5pportion#ent of stoc< :or division of ownership;.
Consideration paid for stoc< or ownership share of each of the founders.
Identification of an% intellectual propert% signed over to the business.
Description of the initial operating capital.
Bu%bac< clause.
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5voiding 2egal Disputes1 of
5voiding 2egal Disputes
8 >ost legal disputes are the result of #isunderstandings/
sloppiness/ or a si#ple lac< of
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5voiding 2egal Disputes of
5lthough it)s te#pting to tr%
to show people %ou trust
the# b% not insisting on
written agree#ents/ it)s not a
good practice.
One of the si#plest wa%s to
avoid #isunderstandings
and ulti#atel% legal disputes is to get ever%thing in
writing.
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Obtaining Business 2icenses and +er#its1 of
Business 2icenses
8 In #ost co##unities/ a business needs a license to operate.
8 If the business will be run out of the founder)s ho#e/ a
separate ho#e occupation business license is oftenre?uired.
8 If a business has e#plo%ees/ or is a corporation/ li#ited
liabilit% co#pan%/ or li#ited partnership/ it will usuall%
need a state business license in addition to its local one.8 5 narrow group of co#panies are re?uired to have a federal
business license/ including invest#ent advising/ drug
#anufacturing/ and interstate truc
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Obtaining Business 2icenses and +er#its of
Business +er#its
8 5long with obtaining the appropriate licenses/ so#e
businesses #a% need to obtain one or #ore per#its.
8 9he need to obtain a per#it depends on the nature andlocation of the business.
If %ou plan to sell food/ %ou)ll need a cit% or count% health per#it.
If %our business is open to the public/ %ou #a% need a fire per#it.
6o#e co##unities re?uire businesses to obtain a license to put up
a sign.
5ll businesses that plan to use a fictitious na#e need a fictitious
business na#e per#it.
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Copyright 2012 Pearson Education
Choosing a or# of Business Ownership
hen a business is launched/ a for# of legal entit% #ust bechosen. 9he #ost co##on legal entities are
6ole +roprietorship +artnership
Corporation2i#ited 2iabilit%
Co#pan%
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Issues to Consider in Choosing a 2egal
or# of Business Ownership
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6ole +roprietorship
6ole +roprietorship
8 9he si#plest for# of business entit% is the sole
proprietorship.
8 5 sole proprietorship is a for# of business organiationinvolving one person/ and the person and the business are
essentiall% the sa#e.
8 5 sole proprietorship is not a separate legal entit%. 9he
sole proprietor is responsible for all the liabilities of thebusiness/ and this is a significant drawbac
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5dvantages and Disadvantages of a
6ole +roprietorship1 of
5dvantages of a 6ole +roprietorship
Creating one is eas% and ine"pensive.
9he owner #aintains co#plete control of the business and retains all of the
profits.Business losses can be deducted against the sole proprietor)s other sources of
inco#e.
It is not subject to double ta"ation :e"plained later;.
9he business is eas% to dissolve.
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5dvantages and Disadvantages of a
6ole +roprietorship of
Disadvantages of a 6ole +roprietorship
2iabilit% on the owner)s part is unli#ited.
9he business relies on the s
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+artnerships1 of 3
+artnerships
8 If two or #ore people start a business/ the% #ust organie
as a partnership/ corporation/ or li#ited liabilit% co#pan%.
8 +artnerships are organied as either general or li#itedliabilit% partnerships.
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+artnerships of 3
@eneral +artnership
5 for# of business organiation
where two or #ore people pool
their s
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+artnerships3 of 3
2i#ited +artnership
5 #odified for# of general
partnership.
9he #ajor difference between
the two is that a li#ited
partnership includes two classes of ownersA general partners and
li#ited partners.
9he general partners are liable
for the debts and obligations of the partnership/ but the li#ited
partners are onl% liable up to
the a#ount of their invest#ent.
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5dvantages and Disadvantages of a
@eneral +artnership1 of
5dvantages of a @eneral +artnership
Creating one is relativel% eas% and ine"pensive co#pared to a corporation or
li#ited liabilit% co#pan%.
9he s
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5dvantages and Disadvantages of a
@eneral +artnership of
Disadvantages of a +artnership
2iabilit% on the part of each general partner is unli#ited.
9he business relies on the s
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Corporations
Corporations8 5 corporation is a separate legal entit% organied under the
authorit% of a state.
8 Corporations are organied as either C corporations orsubchapter 6 corporations.
8 C corporations are what #ost people thin< of when the%hear the word $corporation.& =owever/ business startupsare often organied as subchapter 6 corporations.
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C Corporation1 of
C Corporation
Is a separate legal entit% that/ in the
e%es of the law/ is separate fro# its
owners.
In #ost cases a corporation shields
its owners/ who are called shareholders/ fro# personal liabilit% for the debts of
the corporation.
5 corporation is governed b% a board
of directors/ which is elected b% the shareholders.
5 corporation is for#ed b% filing
articles of incorporation.
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Copyright 2012 Pearson Education
C Corporation of
C Corporation
5 corporation is ta"ed as a separate
legal entit%.
5 disadvantage of a C corporation is
that it is subject to double ta"ation.
9his #eans that a corporation is ta"ed on its net inco#e/ and when the sa#e
inco#e is distributed to shareholders
in the for# of dividends/ the inco#e is
ta"ed again on the shareholders)personal ta" returns.
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5dvantages and Disadvantages of a
C Corporation1 of
5dvantages of a C Corporation
Owners are liable onl% for the debts and obligations of the corporation up to
the a#ount of their invest#ent.
9he #echanics of raising capital is easier.4o restrictions e"ist on the nu#ber of shareholders/ which differs fro#
subchapter 6 corporations.
6toc< is li?uid if traded on a #ajor stoc< e"change.
9he abilit% to share stoc< with e#plo%ees through stoc< options or other
incentive plans can be a powerful for# of e#plo%ee #otivation.
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5dvantages and Disadvantages of a
C Corporation of
Disadvantages of a C Corporation
6etting up and #aintaining one is #ore difficult than for a sole proprietorship
or a partnership.
Business losses cannot be deducted against the shareholder)s other sources of inco#e.
Inco#e is subject to double ta"ation/ #eaning that it is ta"ed at the corporate
and the shareholder levels.
6#all shareholders t%picall% have little voice in the #anage#ent of the fir#.
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Copyright 2012 Pearson Education
6ubchapter 6 Corporation1 of
6ubchapter 6
Corporation
Co#bines the advantages of a
partnership and a C corporation.
Is si#ilar to a partnership in that the
inco#e of the business is not subject
to double ta"ation.Is si#ilar to a corporation in that the
owners are not subject to personal
liabilit% for the debts or behavior of
the business.5 6ubchapter 6 Corporation does not
pa% ta"es. +rofits and losses are passed
through to the ta" returns of the owners.
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6ubchapter 6 Corporation of
9he business cannot be a subsidiar% of another corporation.
9he shareholders #ust be .6. citiens. +artnerships and C corporations #a%
not own shares in a subchapter 6 corporation. Certain t%pes of trusts and
estates are eligible to own shares in a subchapter 6 corporation.
It can onl% have one class of stoc< issued and outstanding :either preferred
stoc< or co##on stoc
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2i#ited 2iabilit% Co#pan%
2i#ited 2iabilit%
Co#pan%
Is a for# of business ownership that
is rapidl% gaining popularit% in the
.6.
5long with the 6ubchapter 6/ it is a
popular choice for start-up fir#s.9he li#ited liabilit% co#pan% co#bines
the li#ited liabilit% advantage of the
corporation with the ta" advantages of
a partnership.5 li#ited liabilit% co#pan% does not
pa% ta"es. +rofits and losses are passed
through to the ta" returns of the owners.
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5dvantages and Disadvantages of a
2i#ited 2iabilit% Co#pan%1 of
5dvantages of a 2i#ited 2iabilit% Co#pan%
>e#bers are liable for the debts and obligations of the business onl% up tothe
a#ount of their invest#ent.
9he nu#ber of shareholders is unli#ited.
5n 22C can elect to be ta"ed as a sole proprietor/ partnership/ 6 corporation/
or corporation/ providing #uch fle"ibilit%.
Because profits are ta"ed onl% at the shareholder level/ there is no double
ta"ation.
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5dvantages and Disadvantages of a
2i#ited 2iabilit% Co#pan% of
Disadvantages of a 2i#ited 2iabilit% Co#pan%
6etting up and #aintaining one is #ore difficult and e"pensive.
9a" accounting can be co#plicated.
6o#e of the regulations governing 22Cs var% b% state.Because 22Cs are a relativel% new t%pe of business entit%/ there is not as
#uch legal precedent available for owners to anticipate how legal disputes
#ight affect their business.
6o#e states lev% a franchise ta" on 22CsEwhich is essentiall% a fee the 22C pa%s the state for the benefit of li#ited liabilit%.
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C i ht 2012 P Ed ti
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,tates o& !(erica$
Copyright 2012 Pearson Education
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