Entrepreneurship:

Successfully Launching
New Ventures, 1/e
Bruce R. Barringer
R. Duane Ireland

Chapter 8

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 Chapter Objectives
(1 of 2)

1. Identify the two most important issues to consider

when leaving an employer.
2. Discuss the importance of nondisclosure and
noncompete agreements.
3. Explain the criteria important in selecting an
attorney for a new firm.
4. Discuss the importance of a founders’ agreement.
5. Provide several suggestions for how new firms can
avoid litigation.
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 Chapter Objectives
(2 of 2)

1. Discuss techniques entrepreneurs use to promote high

standards of business ethics in their firms.
2. Discuss the differences between sole proprietorships,
partnerships, corporations, and limited liability
companies.
3. Explain why most fast-growth entrepreneurial firms
organize as corporations or limited liability companies
rather than sole proprietorships or partnerships.
4. Explain double taxation.
5. Explain the importance of the Electronic Signatures in
Global and International Commerce Act.
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 Initial Ethical and Legal Issues Facing a
New Firm

Ethically departing a
Choosing a lawyer
former employer

Drafting a founders’ Choosing a form of

Avoiding litigation business ownership
agreement

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 Ethically Departing a Former Employer
(1 of 2)

• Ethically Departing from an Employer

– Behave in a Professional Manner
• First, it is important that an employee give proper notice of an
intention to quit and that the employee perform all assigned duties
until the day of departure.
• If an employee is leaving a job to start a firm in the same industry,
it is vital that he or she not take information that belongs to the
current employer.
– Honor all Employment Agreements
• Honor all nondisclosure and noncompete agreements entered into
at the time of employment. (see next slide)

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Ethically Departing a Former Employer
(2 of 2)

Nondisclosure Agreement Noncompete Agreement

Is a promise made by an Prevents an individual

employee or another from competing against
party to not disclose the a former employer for a
company’s trade secrets specified period of time

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 Drafting a Founders’ Agreement
(1 of 1)

• Founders’ Agreement
– A founders’ agreement (or shareholders’ agreement) is a
written document that deals with issues such as the relative
split of the equity among the founders of the firm, how
individual founders will be compensated for the cash or the
“sweat equity” they put into the firm, and how long the
founders will have to remain with the firm for their shares
to fully vest.
– The items to include in the founders agreement are shown
on the following slide.

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 Avoiding Legal Disputes

• Avoiding Legal Disputes

– Most legal disputes are the result of misunderstandings,
sloppiness, or a simple lack of knowledge of the law.
Getting bogged down in legal disputes is something an
entrepreneur should work hard to avoid.
– There are several steps that an entrepreneur can take to
avoid legal disputes:
• Meet all contractual obligations
• Avoid undercapitalization
• Get everything in writing
• Promote business ethics

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 Promoting Business Ethics
(1 of 3)

• Promoting Business Ethics in a New Venture

– Code of Ethics
• A code of ethics describes the firm’s general value system, moral
principles, and specific ethical rules that apply.
• The advantage of having a code of ethics is that it provides specific
guidance to managers and employees regarding what is expected of
them in terms of ethical behavior.
– Ethics Training Programs
• Many organizations have formal ethics training programs that teach
employees how to respond to the types of ethical dilemmas that
might arise on their jobs.

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 Promoting Business Ethics
(2 of 3)
Most common types of ethical problems to guard against

Type of ethical problem Description

These problems relate to the equitable and just

Human resource treatment of current and prospective employees.
ethical problems Unethical behavior here can range from asking an
inappropriate question in a job interview to treating
people unfairly because of their gender, ethnic
background, religion, and so on.

These problems relate to situations that divide the

loyalty of employees. For example, it would be
Conflicts of interest inappropriate for an employee of a company to award
a business contract to a friend or family member
because of their personal relationship rather than for
legitimate business reasons.

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 Promoting Business Ethics
(3 of 3)
Most common types of ethical problems to guard against (continued)

Type of ethical problem Description

Problems in this area flare up when a company

behaves in a way that shows a lack of respect for
Customer confidence customers or a lack of concern with public safety.
Examples include misleading advertising and the sale
of a product that a company knows is unsafe.

Problems in this area typically arise when a employees

uses corporate resources for personal gain beyond
Inappropriate use of what is customary and reasonable. For example, an
corporate resources employees who spends two hours of every eight-hour
workday surfing the Internet is guilty of excessive or
inappropriate use of corporate resources.

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Choosing a Form of Business Ownership
When a business is launched, a form of legal entity must be chosen.
The most common legal entities are…

Sole Proprietorship Partnership

Limited Liability
Corporation
Company

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 Issues to Consider in Choosing a Legal
Form of Business Ownership
• The cost of setting up and maintaining the legal form
of ownership.
• The extent to which an entrepreneur can shield his or
her personal assets from the liabilities of the business.
• Tax considerations
• The ease of raising capital

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 Sole Proprietorship
(1 of 2)

• Sole Proprietorship
– The simplest form of business entity is the sole
proprietorship.
– A sole proprietorship is a form of business organization
involving one person, and the person and the business are
essentially the same.
– A sole proprietorship is not a separate legal entity. The
sole proprietor is responsible for all the liabilities of the
business, and this is a significant drawback.

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 Sole Proprietorship
(2 of 2)

Advantages and disadvantages of sole proprietorship

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 Partnerships
(1 of 2)

• Partnerships
– If two or more people start a business, they must organize as a
partnership, corporation, or limited liability company.
– Partnerships are organized as either general or limited partnerships.
• A general partnership is a form of business organization where two or
more people pool their skills, abilities, and resources to run a business.
• A limited partnership is a modified form of general partnership. The major
difference between the two is that a limited partnership includes two
classes of owners: general partners and limited partners. The general
partners are liable for the debts and obligations of the partnership, but the
limited partners are liable only up to the amount of their investment.

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 Partnerships
(2 of 2)

Advantages and disadvantages of a general partnership

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 Corporations
(1 of 5)

• Corporations
– A corporation is a separate legal entity organized under the
authority of a state.
– Corporations are organized as either C corporations or
subchapter S corporations.
• C Corporations
– A C corporation is a separate legal entity that, in the eyes
of the law, is separate from its owners.
– In most cases the corporation shields its owners, who are
called shareholders, from personal liability for the debts of
the corporation.

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 Corporations
(2 of 5)

• C Corporations (continued)
– A corporation is governed by a board of directors, which is
elected by the shareholders.
– A corporation is formed by filing articles of incorporation
with the secretary of state’s office in the state of
incorporation.
– A corporation is taxed as a separate legal entity.
• A disadvantage of corporations is that they are subject to double-
taxation, which means that a corporation is taxed on its net income
and, when the same income is distributed to shareholders in the
form of dividends, is taxed again on shareholders’ personal tax
returns.
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 Corporations
(3 of 5)

Advantages and disadvantages of a C Corporation

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 Corporations
(4 of 5)

• Subchapter S Corporation
– A subchapter S corporation combines the advantages of a
partnership and a C corporation. It is similar to a
partnership in that the profits and losses of the business are
not subject to double taxation.
– The subchapter S corporation does not pay taxes; instead,
the profits or losses of the business are passed through to
the individual tax returns of the owners.
– It is similar to a corporation in that the owners are not
subject to personal liability for the behavior of the
business.
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 Corporations
(5 of 5)

There are strict standards that a business must meet to qualify for status as a
subchapter S corporation. The standards are shown below:

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 Limited Liability Company
(1 of 2)

• Limited Liability Company

– The limited liability company (LLC) is a form of business
organization that is rapidly gaining popularity in the U.S.
– Along with the subchapter S corporation, it is a popular
choice for start-up firms.
• As with partnerships and corporations, the profits of an LLC flow
through to the tax returns of the owners and are not subject to
double taxation.
• The main advantage of the LLC is that all partners enjoy limited
liability.
– The LLC combines the limited liability advantage of the
corporation with the tax advantages of the partnership.
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 Limited Liability Company
(2 of 2)

Advantages and disadvantages of a Limited Liability Company

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 The Legal Environment of the Internet

• Legal Environment of the Internet

– Most new businesses will utilize the Internet in their
business operations.
– When the Internet was introduced in the early 1990s, many
businesses approached it with an “anything goes” attitude,
believing it was alright to do almost anything online.
– As time goes on, however, the legal system is getting a
better grip on the Internet, and more laws and regulations
are being passed.

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 The World Wide Web
(1 of 3)
Three Types of Web Sites
Type of Web Site Description
This type of Web site
Shop-Window
Web Site provides information
about a company and its
products but encourages
very little interaction.
©2006 Prentice Hall
Primary Legal Issues Involved
• All content placed on the Web site
should be original, unless permission
has been obtained.
• Pricing information should be updated
frequently.
• Misleading product descriptions can
cause repercussions.
• Misleading advertising should be
avoided.
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 The World Wide Web
(2 of 3)

Three Types of Web Sites (continued)

Type of Web Site Description Primary Legal Issues Involved

Contributed Web sites that The most common problem in this area
Content Web encourage visitors to arises when sites encourage visitors to
Sites interact are exposed to interact by making discussion boards
several additional or chat rooms available. Reasonable
forms of legal risks. measures should be taken to control
the material that appears on the Web
site. These measures need to be
addressed in a Web site’s “terms and
conditions” so that anyone viewing the
Web site is aware of the steps taken to
prevent problems from occurring.

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 The World Wide Web
(3 of 3)

Three Types of Web Sites (continued)

Type of Web Site Description Primary Legal Issues Involved

Full E-Commerce Full E-Commerce Web New businesses that plan to sell
Web Site sites sell goods and products or services via the Web
services via the Web. should consult with an attorney to be
sure they know all the current laws
and regulations that apply. An
important caveat of selling online is to
make sure to form a legally binding
contract with the purchaser. To do
this, many sites require their
customers to scroll through a list of
terms and conditions and click on an
“I accept” button before a purchase
can be completed.

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 Trademarks and Domain Names
(1 of 3)

• Trademarks
– The emergence of the Internet has led to a variety of issues
in trademark law and practice.
– Because it is so easy to find a company with the same name
as your company’s name on the Internet, trademark
disputes often arise.
• For example, in the past, a consulting firm in Michigan operating
under the name Ivey Consulting may have never known that a
similar firm in California operated under the same name. Now, its
easy for the firms to stumble across one another surfing the
Internet, which could result in a trademark infringement suit by the
company that first registered the name.

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 Trademarks and Domain Names
(2 of 3)

• Domain Names
– A domain name is a company’s Internet address (e.g.,
www.intel.com).
– Most companies want their domain name to be the same as
their company’s name.
– It is easy to register a domain name through an online
registration service (www.networksolutions.com).
• Until recently, some people, called cybersquatters, registered the
domain names of companies and people for the sole purpose of
trying to resell the names (for a substantial profit) to those
companies or individuals. (Next slide)

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 Trademarks and Domain Names
(3 of 3)

• Domain Names
– To stop the practice of cybersquatting, Congress passed the
Anticybersquatting Consumer Protection Act in 1999.
• Probably the most famous domain name dispute in the history of
the Internet involved the actress Julia Roberts. In June 2000, an
international arbitration panel ruled that an accused cybersquatter
who registered the domain name (www.juliaroberts.com) had no
legitimate interest in the name and registered it in bad faith. The
panel awarded the name to Julia Roberts. In finding bad-faith
intent, the arbitration panel cited evidence that the defendant had
registered the names of several famous movie and sports figures
and even tried to auction off the name Julia Robert’s domain name
on eBay’s Web site.

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Electronic Contracts and Digital Signatures

• Legally Binding Contracts Online

– As a result of the Electronic Signatures in Global and
International Commerce Act, contracts negotiated online
have the same legal standing as traditional legal contracts
signed in ink.
– Online contracts are often signed with digital signatures.
• A digital signature is a computer-generated block of text that
accurately identifies both the signer and the content, helping to
ensure the authenticity and integrity of electronic documents.

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