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Chapter 9: Establishing a Legal Foundation

by: Sarah Oglesby

Chapter 9: Establishing a Legal Foundation MGT 386-005

Marketplace > University of Alabama - Tuscaloosa > Business > MGT 386-005 > Chapter 9 Establishing a Legal Foundation
Sarah Oglesby
GPA 3.2

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About this Document

discusses legal forms of businesses the new owners may implement based on the needs and goals of the new business
Foundations of Entrepreneurship
Dr. Jeffrey A. Martin
Class Notes
Legal, foundation, Corporation, LLC
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This 9 page Class Notes was uploaded by Sarah Oglesby on Tuesday October 11, 2016. The Class Notes belongs to MGT 386-005 at University of Alabama - Tuscaloosa taught by Dr. Jeffrey A. Martin in Summer 2015. Since its upload, it has received 35 views. For similar materials see Foundations of Entrepreneurship in Business at University of Alabama - Tuscaloosa.

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Date Created: 10/11/16
MGT 386 TEST Friday, October 14 Chapter 9: Establishing the Legal Foundation Realities of Legal Issues in Business • legal issues may coincide with other events or issues relating to the business and, as a result, may impact financial decisions • mature economies are based on laws, therefore legal structures in society are critical for businesses • the entrepreneur has the ability to use the court system for a legal remedy that is bound by precedent and the Uniform Commercial Code • several legal issues impact the founding of a new business: - forms of business - contracts - leases - regulations and licensing - copyrights, trademarks, patents - insurance - board of directors I. Various Legal Forms of Business • three basic types of legal business organization: sole proprietorship, partnership, and corporation A. Sole Proprietorship - the simplest form of business to establish, as the person who owns it and the business itself are treated as the same entity, it essentially allows an individual to legally transact business - communities generally encourage the development of new business as it is good for the local economy, as a result many communities have made the process of obtaining a sole proprietorship license relatively simple and quick - all business income and losses are treated as part of the individual’s overall income and are reported on the regular tax form 1 MGT 386 TEST Friday, October 14 - Drawbacks: 1. a business that involves more than a single founder cannot be a sole proprietorship, this means the business may not have any other equity investors which can stunt growth and limit outside investments in the company 2. all of the liabilities of the sole proprietorship are the direct responsibility of the owner, this limits the risk that the entrepreneur can take in making business decisions to expand 3. given that this form is easily dissolvable, a firm may struggle with issues of legitimacy with suppliers and customers, the result is that the value of the business is limited since it is so tightly tied to the founder B. Partnerships - a type of business formed between individuals directly, it includes both general and limited varieties 1. General Partnership: if two or more people are involved in the founding of an organization, they can form a partnership in a relatively simple manner - formation requires a partnership agreement which generally specifies who is involved; expected contributions from each party, how profits, losses, and draws by the partners are to be treated; how one partner can buy out the other(s) if that individual decides to leave; how new partners are brought in; and how disputes are settled - draw: a distribution of funds from the business, usually in the form of a cash dispersion in advance of salary, bonus, expected year- end distribution and the like - partnership agreements should be developed early to establish clear and legally binding dimensions of the partnership - if a partnership is not developed and signed, the partnership will be governed by either the Uniform Partnership Act or the Revised Uniform Partnership Act 2 MGT 386 TEST Friday, October 14 - like in a sole proprietorship, owners report their shares of losses or profits on their own personal income returns in proportion to their interest in the firm - each partner is assumed to be involved with all decisions, which translates into a fiduciary relationship between partners - new partners may be brought in by essentially “buying out” a portion of the existing partners’ equity in the firm 2. Limited Liability Partnership (LLP): still has at least two individuals who are partners in a venture, however, there are two classes of partner - the general partner is considered the manager of the firm and has unlimited liability for any debts or judgements against the firm - limited partners are considered to be passive investors and their liability is limited to their investment in the business; these partners may work for the firm, but may not be active in management of the organization - LLPs require that there be at least one general partner C. Corporations - a form of business that addresses the personal liability issues that can hurt founders of sole proprietorship or partnerships - it views the business not as synonymous with the individual but as a separate entity; if the corporation suffers substantial losses, the founder(s) will lose only his investment in the business 1. Subchapter S Corporation: an organizational form that treats the firm as an entity separate from the individuals, this allows the owners to treat the income as they would if the firm were a sole proprietorship or a partnership, it has limitations in the number and type of shareholders - benefits include: limited liability for owners, tax benefits for owners by consolidating business and personal financial statements, easier formation than Subchapter C, legitimacy in the market as more established 3 MGT 386 TEST Friday, October 14 - negatives include: formation is cumbersome and expensive in comparison with partnerships or sole proprietorships, limits the number of shareholders to a maximum of 75 2. Subchapter C Corporation: an organizational form that treats the firm as a unique entity responsible for its own taxes, there are no limitations to shareholder participation and the “owners” are protected beyond their equity investment - the corporation pays a tax on its profits after which the profits are distributed as dividends to owners which are then taxed again on personal income causing double taxation - double taxation costs may be mitigated by paying out business profits as employee bonuses and salaries (owners are also considered employees of C corps.) which allows very little profits to be reported by the business which means little corporate income tax is owed - fringe benefits are not treated as income for employees, therefore these costs can be expensed as costs of business - there are no limits to the number of shareholders, there is a limit to the number of authorized and distributed shares at “par” value (shareholder equity = par value x number of shares distributed) - with either a subchapter S or C must have: a corporate name; headquarters location; general nature of business; founder and initial investor names, addresses, and titles; time horizon for the firm’s existence; authorized stock and capital; and by-laws of the corporation 3. Limited Liability Corporation (LLC): an organizational form that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation - allows the new venture to have more investors as well as allowing other corporations to hold stock in the company - may have as few as one individual listed as an officer of the company, referred to as a “member” 4 MGT 386 TEST Friday, October 14 - substantial flexibility regarding the amount of income that is designated for each individual, does not have to be in proportion to that owner’s holdings - cost of formation is relatively low, most states require simple paperwork to be submitted to the government before beginning operations II. Basics of Contracts • contract: an agreement between two parties to perform certain activities for some consideration should be a formal, written agreement created with the supervision and guidance of • an attorney • items that should be included: - who the parties are - what each party agrees to do and for what consideration (ie. payment, compensation) - when the transaction will take place - timing of the payment - when the activity is to take place and how long the contract is in place - warranties - how the contract can be terminated, including damages - whether the contract may be transferred - if the firms are in different states, which laws apply III. Leases a significant type of contract that a new business is involved in that negotiates • where the business will operate • lease contracts may be of any term length that is agreeable between parties • things that must be considered: - what exactly is the business owner leasing? (physical space and address - what about parking, external premises, etc.) 5 MGT 386 TEST Friday, October 14 - can the business owner renew the lease? the lease should specify how long it is in effect and if there is the opportunity to renew the lease. - who is responsible for improvements? who has the responsibility and authority for physical plan improvements? a lease that includes the responsibility for making improvements to the facility should be accompanied by a lower lease payment. - who has the responsibility for maintenance and other facility issues? - who has to carry the liability insurance and at what level? - can your landlord enter your place of business? most leases give the landlord some rights to enter your business and inspect it. - if there are problems, what are the procedures for addressing and resolving them? if you have unused space, is subleasing permitted? • a lease is multidimensional and should be carefully crafted before signing IV. Laws, Rules, and Regulations A. Regulations new businesses generally deal with fewer regulations than do established • larger businesses • many regulations enacted by the federal government do not apply to businesses with fewer than 50 employees • some industries are highly regulated regardless of size due to the sensitivity of the business activities (ie. medical, military, alcohol, national security, environmental, etc.) • all businesses must have an Employer Identification Number for tax purposes • a business with employees will be required to calculate and deduct various taxes for federal, state, and, in some cases, local authorities • specific cities may have unique sets of special regulations • Americans with Disabilities Act (ADA): specifies protections in business for those with disabilities (prohibits discrimination in hiring, management, or dismissal, also requires businesses to be accessible to those with disabilities) B. Licensing 6 MGT 386 TEST Friday, October 14 • examples of licenses and permits include: - business license - local ABC (booze) - occupancy permits - federal liquor license - local business license - sign permits - OSHA permits (food handling) - fire safety permit • at a minimum, most businesses must acquire a license to do business in the county or city in which they will be operating • license is simple to acquire: fill out a form, pay a set fee, and agree to report basic information about the business’s performance on a set schedule • the business will also be requires to pay a license tax each year (often based on company sales) V. Importance of Copyrights, Trademarks, and Patents to a New Business • copyright: the legal means to protect intellectual property; it grants ownership on creative materials generated, such as books, magazines, advertising copy, music, artwork, or any other creative product, whether published or unpublished • trademark: claim of intellectual property that is associated with a specific business; this may be the name of the firm, a symbol representing the firm, or the names of its products patent: claim of intellectual property that covers a specific innovation • - utility patent: for a new process, machine, article of manufacture, or composition of matter, or any new and useful improvement of those - design patent: for a new, original, and ornamental design for an article of manufacture - plant patent: for someone who invents or discovers and asexually reproduces any distinct and new variety of plant 7 MGT 386 TEST Friday, October 14 - patents can be significant barriers to entry VI. Role of Insurance • the new business chooses the level of liability it is willing to risk • effective application of insurance can limit liability • property insurance covers the building, fixtures, and inventory in all of the buildings in which the business has a function - important to distinguish whether the insurance covers replacement cost or only current value greater insurance = greater cost, the firm must balance risk and cost • • other types of insurance: - liability insurance: helps to protect the business against lawsuit judgments - does not cover intentional acts of malice, but does cover accidents - bonding: covers the business in the case that workers cause any damage in the performance of their work - worker’s compensation: covers liability for workers who are injured on the job (required in many states) VII.Board of Advisors and Board of Directors • composed of people who have both insight and experience with which to advise founders • corporations must have a board of directors - these individuals have a fiduciary responsibility to the organization’s shareholders - in new corporations, the shareholders and board of directors are often the same board of advisors: a group formed at the discretion of the founders (regardless of • the legal form chosen) and composed of individuals outside the business who advise the founders • individuals on the advisory board should have experience in: - licensing requirements for the industry - regulations for your specific industry 8 MGT 386 TEST Friday, October 14 - new start-up experience and success - financial and accounting background with new start-ups - human resources experience • the board can meet formally or informally 9


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