1. Establishing the Legal Foundation
Chapter Seven
Establishing the Legal Foundation

2. 7-2
Learning Outcomes
7.1 Discuss the various legal forms of business in order to determine the best design for a proposed new business 7.2 Explain the basics of contracts 7.3 Define the role of leases in the legal formation of a new business 7.4 List how laws, rules, and regulations benefit new businesses
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3. 7-3
Learning Outcomes
7.5 Explain the importance of copyrights/trademarks/patents to small businesses 7.6 Define the role that insurance plays in the risk portfolio of the new business 7.7 Discuss how to develop an effective Board of Advisors and Board of Directors
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4. 7-4
Forms of Business
Sole Proprietorship-the simplest form of business to establish, characterized by the fact that the person who owns the business and the business itself are treated as the same entity and is popular among individuals who:
Are unsure about their business idea
Have a small business where the limitations of the founder will keep the business from growing.
Have a small business where the costs of equipment are low
See Learning Outcome 7.1: Discuss the various legal forms of business in order to determine the best design for a proposed new business
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Sole Proprietorship
Filling out a simple form and paying a small fee is usually all that is required to establish a sole proprietorship.
All business income and losses are treated as part of the individual’s overall income and are reported on Schedule C of the 1040 tax form.
Benefits-easy to form and easy to dissolve. There is no separation between the founder and the business. There are strict rules to record-keeping.
Drawbacks- are numerous
A business that has more than one founder cannot be a sole proprietorship unless 100% of the authority is placed with a single individual
The law does not recognize other equity investors and therefore the equity incentives to attract top employees/executives are not possible
All liabilities are the direct responsibilities of the owner of the business
Because this type of business is so easy to dissolve, suppliers typically require personal guarantees for debts

5. 7-5
Forms of Business
Partnerships-a type of business formed between individuals directly
General Partnership
A draw is a distribution of funds from the business.
Limited Partnership
In a Limited Liability Partnership (LLP), the General Partner has unlimited liability for any debts or judgments against the firm.
See Learning Outcome 7.1: Discuss the various legal forms of business in order to determine the best design for a proposed new business
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General Partnership-similar to a sole proprietorship, it requires an extra step: a partnership agreement. These agreements generally specify who is involved; what each party is expected to contribute to the founding of the firm; and how profits, losses, and draws by the partners are to be treated.
Benefits-partnerships require little in the way of formal paperwork and dissolution can be quite easy. It is also a bit easier to bring in new equity investment.
Drawbacks-are similar to that of a sole proprietorship, except that a Partnership is more complicated when it comes to liability. Partners are generally held to be jointly liable for all debts incurred by the partnership. Each partner is assumed to be involved with all decisions, which translates into a fiduciary relationship between the partners.
Limited Partnership-there are still at least two individuals involved, however there are two classes of partners.
General Partner-This individual is considered to be the manager of the firm and as such has unlimited liability for any debts or judgments against the firm.
Passive (Limited) Investor-These individuals’ liability is limited to their investment in the business. They can work for the firm, but must not be active in the management of the organization.

6. 7-6
Forms of Business
Corporation-treated as a separate entity, it limits the investment of investors to their initial investment. There are many types, we consider:
Subchapter S Corporation
Subchapter C Corporation
Limited Liability Corporation
See Learning Outcome 7.1: Discuss the various legal forms of business in order to determine the best design for a proposed new business
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Subchapter S Corporation-
A summary of benefits include
Limited liability
The potential to consolidate financial statements for the tax benefits of the owner(s)
Relatively easy formation compared with a “C” corporation
Legitimacy in the market as a more established form of business (the ability to put “Inc.” after the corporation’s name)
Drawbacks include:
Can be cumbersome and expensive to form
Has a numerical limit to the number of shareholders (currently 100)
Subchapter C Corporation
Also has limited liability for the owner(s), but the corporation pays an income tax. Therefore, the profits are taxed and any potential dividends paid to the owner(s) have to be claimed as income by the owners (double taxation). A way around this is to pay all of the profits to the owner(s) as salaries or bonuses and/or dividends are retained by the corporation for future expansion.
Limited Liability Corporation
Similar to an “S” corporation, but allows the new venture to have more than 100 investors and it allows other corporations to hold stock in the company (a feature not available to an “S” corporation). The owner(s) are allowed to flow the profits through to their personal returns to avoid the double taxation.

7. 7-7
Contracts
A contract is an agreement between two parties to perform certain activities for some consideration.
See Learning Outcome 7.2: Explain the basics of contracts
A contract should include the following:
Who the parties are in the contract
What each party agrees to do and for what consideration
When the transaction is to take place
The timing of payment, if other than immediately
When the activity is to take place and how long the contract is in place
Warranties
How the contract can be terminated and any damages
Whether the contract can be transferred
If the firms are in different states, which state’s laws apply.

8. 7-8
Leases
One of the most significant contracts that a new business is initially involved in is the lease where the business will operate. Consider:
What exactly is the new business owner leasing?
Is there an ability to renew the lease?
Who is responsible for improvements?
Who has responsibility for maintenance and other facilities issues?
See Learning Outcome 7.3: Define the role of leases in the legal formation of a new business
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9. Leases Who has to carry the liability insurance and at what level?
7-9
Leases
Who has to carry the liability insurance and at what level?
Can your landlord enter your place of business?
If there are problems, what are the procedures for resolving them?
See Learning Outcome 7.3: Define the role of leases in the legal formation of a new business
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A lease is multi-dimensional and should be carefully crafted before signing.

10. 7-10
Regulations
Regulation-related issues must be extensively considered when the new business is developed including:
The industry where the business will operate
Employer Identification Number
Payroll requirements
Locale regulations
The Americans with Disabilities Act
See Learning Outcome 7.4: List how laws, rules, and regulations benefit new businesses
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The industry where the business will operate-some industries are highly-regulated regardless of size
Employer Identification Number-required if a business has employees
Payroll requirements-payroll requirements are specific and well-developed
Locale regulations-specific cities may have unique sets of regulations
The Americans with Disabilities Act-applies to any firm with more than 15 employees

11. 7-11
Licensing
A license can be as simple as a business license or it may be specifically related to the fundamental operations of the business. Examples include:
Alcoholic Beverage Control License
Occupancy permits
Federal liquor license
Business license
Sign permits
OSHA permit for food handling
Fire safety permit
See Learning Outcome 7.4: List how laws, rules, and regulations benefit new businesses
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At a minimum, most businesses must acquire a license to do business in the county/city in which they will be operating.

12. Copyrights, Trademarks, and Patents
7-12
Copyrights, Trademarks, and Patents
Copyright-the legal means to protect intellectual property.
Trademark-a claim of intellectual property that is associated with a specific business
Patent-a claim of intellectual property that covers a specific innovation.
See Learning Outcome 7.5: Explain the importance of copyrights/trademarks/patents to small businesses
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Copyright-can be claimed on creative materials generated, such as books magazines, advertising copy, music, artwork, or virtually any creative product, whether published or unpublished
Trademark-is legal protection of the intellectual property that is associated with a specific business
Patent-a patent is good for 20 years and must be filed and accepted by the United States Patent and Trademark Office for it to be valid.

13. 7-13
Insurance
One means to limit liability concerns is through the effective application of insurance, including:
Property
Liability
Employee Bonding
Workers’ Compensation
See Learning Outcome 7.6: Define the role that insurance plays in the risk portfolio of the new business
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Property-includes the building, fixtures, and inventory in all of the buildings in which the business has a function
Liability-covers lawsuit judgments
Employee Bonding-bonding is a type of insurance in which the business is covered in case the workers cause any damage in the performance of their duties
Workers’ Compensation-covers liability for workers that are injured on the job

14. Board of Advisors and/or Board of Directors
7-14
Board of Advisors and/or Board of Directors
Board of Directors-individuals who have a fiduciary responsibility to the shareholders of the organization
Board of Advisors-a group formed at the discretion of the founders and composed of individuals outside the small business that advise the firm.
See Learning Outcome 7.7: Discuss how to develop an effective board of advisors and board of directors
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Board of Directors-a business that chooses to form a corporation must have a Board of Directors. In a new corporation, the shareholders and Board of Directors are often the same individuals.
Board of Advisors-may be formed at the discretion of the founders (regardless of the legal form chosen) and is composed of individuals outside the new business that advise the firm.

15. Summary This chapter covered: The legal form the business will take
7-15
Summary
This chapter covered:
The legal form the business will take
Regulations
Licenses
Contracts
Leases
Insurance
Boards
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