Entrepreneurial Mind

Chap. 7. Legal Challenges to

Entrepreneurial Venture
 Chapter Objectives
1. To introduce the importance of legal issues to
entrepreneurs
2. To examine patent protection, including
definitions and preparation
3. To review copyrights and their relevance to
entrepreneurs
4. To study trademarks and their impact on new
ventures
5. To examine the legal forms of organization—sole
proprietorship, partnership,
1–2 and corporation
 Chapter Objectives
6. To illustrate the advantages and disadvantages
of each of these three legal forms
7. To explain the nature of the limited partnership
and limited liability partnerships (LLPs)
8. To examine how an S corporation works
9. To define the additional classifications of
corporations, including limited liability companies
(LLCs)
10. To present the major segments of the
bankruptcy law that apply
1–3 to entrepreneurs
 Legal Challenges for
the Entrepreneurial Venture

Inception of the The Ongoing

Venture Venture

Legal
Concepts

Growth and
Continuity of the
Venture
 Major Legal Concepts and
Entrepreneurial Ventures
I. Inception of an Entrepreneurial Venture
n A. Laws governing intellectual property

• 1. Patents
• 2. Copyrights
• 3. Trademarks
n B. Forms of business organization

• 1. Sole proprietorship
• 2. Partnership
• 3. Corporation
• 4. Franchise
n C. Tax considerations

n D. Capital formation

n E. Liability questions
 Major Legal Concepts and
Entrepreneurial Ventures
II. Ongoing Venture: Business
Development and Transactions
n A. Personnel Law
• 1. Hiring and firing policies
• 2. Equal Employment Opportunity Commission
• 3. Collective bargaining
n B. Contract Law
• 1. Legal contracts
• 2. Sales contracts
• 3. Leases
 Major Legal Concepts and
Entrepreneurial Ventures
III. Growth and Continuity of an Entrepreneurial
Venture
n A. Tax considerations
• 1. Federal, state, and local
• 2. Payroll
• 3. Incentives
n B. Governmental regulations
• 1. Zoning (property)
• 2. Administrative agencies (regulatory)
• 3. Consumer law
n C. Continuity of ownership rights
• 1. Property laws and ownership
• 2. Wills, trusts, and ownership
• 3. Bankruptcy
 Intellectual Property
Protection: Patents
n Patent
n Provides the owner with exclusive rights to hold,
transfer, and license the production and sale of
the product or process as an intellectual property
right.
n Design patents last for 14 years; all others last
for 20 years.
n What Items Qualify for Patent Protection?
n Processes, machines, products, plants,
compositions of elements (chemical
compounds), and improvements on already
existing items.
 Securing a Patent
n Rule 1:Pursue patents that are broad, are
commercially significant, and offer a
strong position.
n Rule 2:Prepare a patent plan in detail.
n Rule 3:Have your actions relate to your original
patent plan.
n Rule 4:Establish an infringement budget.
n Rule 5:Evaluate the patent plan strategically.
 Intellectual Property
Protection: Patents
Patent Application
1. Specification: the text of a patent and may include any
accompanying illustrations.
a. An introduction explaining why the invention will be useful.
b. A description of prior art considered similar to the invention.
c. A summary of the essence of the technology/invention, its
differences from prior art and requisite features.
d. A description of the invention, including anything remotely
relevant, reference to variations, and number bounds.
e. Examples and/or experimental results, in full detail.
2. Claims: a series of short paragraphs, each of which
identifies a particular feature or combination of features
that is protected by the patent.
Figure 7.1: The Patent Process: From
Application to Allowance and Issue
 Figure 7.1: The Patent Process: From
Application to Allowance and Issue (cont’d)
 Figure 7.1: The Patent Process: From
Application to Allowance and Issue (cont’d)
 Intellectual Property
Protection: Copyrights
n Copyright
n Provides exclusive rights to creative individuals for the
protection of their literary or artistic productions.
n Duration: life of the author plus 70 years.
n The copyright owner has the rights to:
n Reproduce the work
n Prepare derivative works based on it
n Distribute copies of the work by sale or otherwise
n Perform the work publicly
n Display the work publicly
n Sell or transfer individual rights
 Intellectual Property
Protection: Copyrights
n Copyright Protection
n The material must be in a tangible form
so it can be communicated or
reproduced.
n It also must be the author’s own work and
thus the product of his or her skill or
judgment.
n Formal registration of a copyright is with
the Copyright Office of the Library of
Congress.
 Copyrights (cont’d)

n Fair Use Doctrine

n Reproduction of a copyright work for purposes such as
criticism, comment, news reporting, teaching (including
multiple copies for classroom use), scholarship, or
research is not an infringement of copyright.
n Protected Ideas?
n The Copyright Act specifically excludes copyright
protection for any “idea, procedure, process, system,
method of operation, concept, principle, or discovery,
regardless of the form in which it is described,
explained, illustrated, or embodied.”
 Intellectual Property
Protection: Trademarks
n Trademark
n A distinctive name, mark, symbol, or motto
identified with a company’s product(s) and
registered at the Patent and Trademark Office
n Advantages of Trademark Registration
n Nationwide constructive notice of the owner’s
right to use the mark
n Bureau of Customs protection against importers
using the mark
n Incontestability of the mark after five years
 Intellectual Property
Protection: Trademarks
n Trademark Duration
n Current registrations are good for 10 years with
the possibility for continuous renewal every 10
years.
n A trademark may be invalidated in four specific
ways:
• Cancellation proceedings
• Cleaning-out procedure
• Abandonment
• Generic meaning
 Trademarks (cont’d)
n Avoiding the Trademark Pitfalls
n Rule 1: Never select a corporate name or a mark without first
doing a trademark search.
n Rule 2: If your attorney says you have a potential problem with a
mark, trust his or her judgment.
n Rule 3: Seek a coined or a fanciful name or mark before you
settle for a descriptive or a highly suggestive one.
n Rule 4: Whenever marketing or other considerations dictate the
use of a name or a mark that is highly suggestive of the
product, select a distinctive logotype for the descriptive or
suggestive words.
n Rule 5: Avoid abbreviations and acronyms wherever possible,
and when no alternative is acceptable, select a distinctive
logotype in which the abbreviation or acronym appears.
 Trade Secrets
n Trade Secret
n Business processes and information that cannot be
patented, copyrighted, or trademarked but makes an
individual company unique and has value to a
competitor could be a trade secret.
n Information Is Considered a Trade Secret:
n If it is not known by the competition.
n If the business would lose its advantage if the
competition were to obtain it.
n If the owner has taken reasonable steps to protect the
secret from disclosure.
 Trade Secrets
n Examples of Trade Secrets:
n Customer lists
n Strategic plans

n Research and development

n Pricing information

n Marketing techniques

n Production techniques
 Trademark Protection
on the Internet
n Cyberlaw
n The emerging body of law governing
cyberspace.
n Domain Names (Internet Addresses)
n The principles of trademark law apply to
domain names (Cybersquatters).
n Unauthorized use of another’s mark in a
domain name may constitute trademark
infringement.
 Identifying Legal Structures
n A legal structure that will best suits the
demands of the venture addresses:
n Changing tax laws
n Liability situations

n The availability of capital

n The complexity of business formation.

n Three primary legal forms of organization

n Sole proprietorship
n Partnership
n Corporation
 Sole Proprietorships

n Sole Proprietorship
nA business that is owned and
operated by one person. The
enterprise has no existence apart
from its owner.
n To establish a sole proprietorship, a
person merely needs to obtain
whatever local and state licenses are
necessary to begin operations.
 Sole Proprietorships (cont’d)
nAdvantages nDisadvantages
n Ease of formation n Unlimited liability
n Sole ownership of
n Lack of continuity
profits
n Decision making and n Less available capital
control vested in one n Relative difficulty
owner obtaining long-term
n Flexibility
financing
n Relative freedom from
governmental control n Relatively limited
n Freedom from corporate viewpoint and experience
business taxes
 Partnerships
n Partnership
n An association of two or more persons acting
as co-owners of a business for profit.
n The Revised Uniform Partnership Act (RUPA)
acts the guide for legal requirements in forming
partnerships.
n Articles of Partnership
n Clearly outline the financial and managerial
contributions of the partners and carefully
delineate the roles in the partnership
relationship.
 Articles of Partnership Items
n Name, purpose, domicile n Separate debts
n Duration of agreement n Authority (individual partner’s
n Character of partners (general or authority on business conduct)
limited, active or silent) n Books, records, and method of
n Contributions by partners (at accounting
inception, at later date) n Sale of partnership interest
n Division of profits and losses n Arbitration
n Draws or salaries n Settlement of disputes
n Rights of continuing partner(s) n Additions, alterations, or
n Death of a partner (dissolution modifications of partnership
and windup) n Required and prohibited acts
n Release of debts n Absence and disability
n Business expenses (method of n Employee management
handling)
 Partnerships (cont’d)
n Advantages n Disadvantages
n Ease of formation n Unlimited liability of at
n Direct rewards least one partner
n Growth and performance n Lack of continuity
facilitated n Relative difficulty
n Flexibility obtaining large sums of
capital
n Relative freedom from
governmental control and n Bound by the acts of
regulation just one partner
n Possible tax advantage n Difficulty of disposing
of partnership interest
 Corporations
n Corporation
n “An artificial being, invisible, intangible, and existing
only in contemplation of the law”.
–Supreme Court Justice John Marshall
n As such, a corporation is a separate legal entity apart
from the individuals who own it.
n Forming a Corporation
n Subscriptions for capital stock must be taken and a
tentative organization created.
n Approval (a charter) must be obtained from the
secretary of state in the state in which the corporation
is to be formed.
 Corporations (cont’d)
n Advantages n Disadvantages
n Limited liability n Activity restrictions
n Transfer of n Lack of
ownership representation
n Unlimited life n Regulation
n Relative ease of n Organizing
securing capital in expenses
large amounts n Double taxation
n Increased ability
and expertise
 Table 7.3: General Characteristics of
Forms of Business
Sole Limited Liability
Proprietorshi Limited Liability Limited Limited Limited Liability
p Partnership Partnership Partnership Partnership Corporation S Corporation Company
Formation When one By agreement of By agreement of By agreement of By agreement of By agreement of By agreement of By agreement of
person owns owners or by owners; must owners; must owners; must owners; must owners; must owners; must
a business default when two comply with comply with comply with comply with comply with comply with
without or more owners limited liability limited limited liability corporation corporation limited liability
forming a conduct partnership partnership limited statute state; must elect company statute
corporation business statute statute partnership S Corporation
or LLC together without statute status under
forming a limited Subchapter S of
partnership, an Internal Revenue
LLC or a Code
corporation

Duration Terminates Usually Unaffected by Unaffected by Unaffected by Unaffected by Unaffected by Usually

on death or unaffected by death or death or death or death or death or unaffected by
withdrawal of death or withdrawal of withdrawal of withdrawal of withdrawal of withdrawal of death or
sole withdrawal of partner partner, unless partner, unless shareholder shareholder withdrawal of
proprietor partner sole general sole general member
partner partner
dissociates dissociates
Management By sole By partners By partners By general By general By board of By board of By managers or
proprietor partners partners directors directors members

Owner Unlimited Unlimited Mostly limited to Unlimited for Limited to capital Limited to capital Limited to capital Limited to capital
Liability capital general partners; contribution contribution contribution contribution
contribution limited to capital
contribution for
limited partners

Transferability None None None None, unless None, unless Freely Freely None, unless
of Owners’ agreed otherwise agreed otherwise transferable, transferable, agreed otherwise
Interest although although
shareholders shareholders
 Table 7.3: General Characteristics of
Forms of Business

Limited
Limited
Sole Limited Liability S Limited
Partnershi Liability Corporatio
Propriet Partnershi Limited Corporatio Liability
p Partnershi n
orship p Partnershi n Company
p
p

Usually Usually Usually Usually

only only only Corporatio only
partners partners partners n taxed; members
Only taxed; taxed; taxed; sharehold taxed;
Federal Only Only
sole may elect may elect may elect ers taxed may elect
Income partners sharehold
propriet to be to be to be on to be
Taxation taxed ers taxed
or taxed taxed like taxed like taxed like dividends taxed like
a a a (double a
corporatio corporatio corporatio tax) corporatio
n n n n
Specific Forms of Partnerships
and Corporations (cont’d)
nS Corporation
n Takes its name from Subchapter S of the
Internal Revenue Code.
n Is commonly known as a “tax option
corporation”— it is taxed similarly to a
partnership.
n Avoids the imposition of income taxes at
the corporate level yet retain the benefits
of a corporate form (especially the limited
liability).
 Guidelines for S Corporations
n The corporation must be a domestic corporation.
n The corporation must not be a member of an affiliated
group of corporations.
n The shareholders of the corporation must be individuals,
estates, or certain trusts.
n Corporations, partnerships, and non-qualifying trusts
cannot be shareholders.
n The corporation must have 100 or fewer shareholders.
n Only one class of stock, although not all shareholders may
have the same voting rights.
n No shareholder may be a nonresident alien.
Specific Forms of Partnerships
and Corporations
n Limited Partnerships
n Have two or more partners without
responsibility for management and without
liability for losses beyond their investment with
the right to share in the profits.
• Formed under The Uniform Limited Partnership Act
(ULPA).
n Limited Liability Partnership (LLP)
n Allows professionals the tax benefits of a
partnership while avoiding personal liability for
the malpractice of other partners.
Specific Forms of Partnerships
and Corporations (cont’d)
n Limited Liability Limited Partnership (LLLP)
n has elected limited liability status for all of its
partners, including general partners.
n Limited Liability Company (LLC)
n A hybrid form of business enterprise that offers
the limited liability of a corporation but the tax
advantages of a partnership.
n Disadvantage is that LLC statutes differ from
state to state, and thus any firm engaged in
multi-state operations may face difficulties.
 Table 7.4: Principal Characteristics
of Limited Partnerships and LLLPs
1. A limited partnership or LLLP may be created only in
accordance with a statute.
2. A limited partnership or LLLP has two types of partners: general
partners and limited partners. It must have one or more of each
type.
3. All partners, limited and general, share the profits of the
business.
4. Each limited partner has liability limited to his capital contribution
to the business. Each general partner of a limited partnership
has unlimited liability for the obligations of the business. A
general partner in an LLLP, however, has liability limited to his
capital contribution.
 Table 7.4: Principal Characteristics
of Limited Partnerships and LLLPs
5. Each general partner has a right to manage the business, and she is
an agent of the limited partnership or LLLP. A limited partner has no
right to manage the business or to act as its agent, but he does have
the right to vote on fundamental matters. A limited partner they
manage the business, yet retain limited liability for partnership
obligations.
6. General partners, as agents, are fiduciaries of the business. Limited
partners are not fiduciaries.
7. A partner’s rights in a limited partnership or LLLP are not freely
transferable. A transferee of a general or limited partnership interest
in not a partner, but is entitled only to the transferring partner’s share
of capital and profits.
8. The death or other withdrawal of a partner does not dissolve a limited
partnership or LLLP, unless there is no surviving general partner.
9. Usually, a limited partnership or LLLP is taxed like a partnership.
 Understanding Bankruptcy
n Bankruptcy
n When a venture’s financial obligations are greater than
its assets and it is unable to meet its obligations.
n The Bankruptcy Act
nA federal law that provides for specific procedures for
handling insolvent debtors—those who are unable to
pay debts as they become due.
• Ensures that the property of the debtor is distributed fairly to
the creditors.
• Protects creditors from having debtors unreasonably diminish
their assets.
• Protects debtors from extreme demands by creditors.
 Bankruptcy (cont’d)
n Chapter 7: Straight Bankruptcy
n Sometimes referred to as “liquidation.”
n Requires the debtor to surrender all property to
a trustee appointed by the court.
n Chapter 11: Reorganization
n The most common form of bankruptcy.
n Under this format, a debtor attempts to
formulate a plan to pay a portion of the debts,
have the remaining sum discharged, and
continue to stay in operation.
 Bankruptcy (cont’d)
n Chapter 13: Adjustment of Debts
n Individuals or sole proprietors with unsecured
debts of less than $100,000 or secured debts of
less than $350,000 are eligible to file under a
Chapter 13 procedure.
n In the petition the debtor declares an inability to
pay his or her debts and requests some form of
extension through future earnings (a longer
period of time to pay) or a composition of debt
(a reduction in the amount owed).
 Table 7.5: Bankruptcy: A Comparison of
Chapters 7, 11, and 13

Chapter 7 Chapter 11 Chapter 13

PURPOSE Liquidation Reorganization Adjustment
WHO CAN Debtor (voluntary) or creditors Debtor (voluntary) or creditors Debtor (voluntary) only
PETITION (involuntary) (involuntary)

WHO CAN BE Any “person” (including Any debtor eligible for Chapter 7 Any individual (not partnerships or
A DEBTOR partnerships and corporations) relief; railroads are also eligible. corporations) with regular income
except railroads, insurance who owes fixed unsecured debt of
companies, banks, savings and less than $290,525 or secured
loan institutions, and credit unions. debt of less than $871,550.
Farmers and charitable institutions
cannot be involuntarily petitioned.

PROCEDURE Nonexempt property is sold with A plan is submitted and, if it is A plan is submitted (must be
LEADING TO proceeds to be distributed (in approved and followed, debts are approved if debtor turns over
DISCHARGE order) to priority groups. discharged. disposable income for three year
Dischargeable debts are period) and, if it is approved and
terminated. followed, debts are discharged.

ADVANTAGES On liquidation and distribution, The debtor continues in business. The debtor continues in business
most debts are discharged, and Creditors can accept the plan, or it or keeps possession of assets. If
the debtor has an opportunity for a can be “crammed down” on them. the plan is approved, most debts
fresh start. The plan allows for a are discharged after a three year
reorganization and liquidation of period.
debts over the plan period.
 Keeping Legal Expenses Down
n Establish the fee structure with an attorney beforehand.
n Establish clear written agreements on all critical matters that affect
business operations.
n Always attempt to settle any dispute rather than litigate.
n Have your attorney share forms in electronic format.
n Use a less expensive attorney for small collections.
n Suggest cost-savings to your attorney for business matters.
n Always check with your attorney during normal business hours.
n Consult with your lawyer on several matters at one time.
n Keep abreast of legal developments in your field.
n Handle some matters yourself.
n Involve attorneys early when it is feasible
 Key Terms and Concepts
n abandonment n limited liability partnership (LLP)
n bankruptcy n limited partnership
n Bankruptcy Act n liquidation
n cancellation proceedings n partnership
n claims n patent
n cleaning-out procedure n Patent and Trademark Office
n copyright n Revised Uniform Limited
n corporation Partnership Act (RULPA)
n debtor-in-possession n S corporation
n fair use doctrine n sole proprietorship
n generic meaning n specification
n infringement budget n trademark
n intellectual property right n trade secrets
n limited liability company (LLC) n unlimited liability
n limited liability limited
partnership (LLLP)