Chapter 7: Preparing the Proper Legal and Ethical Foundation

Teach business ethics to help employees deal with ethical dilemmas and improve their overall ethical conduct.

Implement an Ethics Training Program

A situation that involves doing something beneficial to oneself or the organization but may be unethical

Ethical dilemma

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 “sweat equity” they put in a firm, and how long the founders will have to remain with the firm for their shares to fully vest.

Drafting a Founder’s Agreement

• Description of how the firm will operate and each person’s responsibilities

• Description of the outside business activities in which founders may not participate

• Provisions for resolving disputes (include stipulation that founders will use mediation or arbitration rather than courts to resolve disputes)

• Buyback clause which explains the disbursement process of a founder’s shares if the person dies, wants to sell, or is selling because of a court order to do so

Items included in a founder’s agreement

• Meet all contractual obligations

• Avoid undercapitalization

• Get everything in writing

• Set Standards

Avoid Legal Disputes

A legal agreement that binds an employee or other party (such as a supplier) to not disclose company trade secrets

NDA (Nondisclosure agreement)

A legal agreement that prevents an individual from competing against a former employer for a specific period of time

Noncompete agreement

• Alcohol

• Firearms

• Commercial Fisheries

• Animal Transport Across state lines

• Preparation of meat products

• Radio & Television Broadcasting

Business that requires federal license to operate

• Plumbers

• Daycare centers

• Trucking companies

• Insurance agencies

Businesses that are required to pass a state exam and maintain a professional license to conduct business

The simplest form of a business entity involving one person and the person and the business are essentially the same (legally)

Sole Proprietorship

Advantages

• Creating one is easy and inexpensive

• Owner maintains complete control of the business and retains all profits

• Not subject to taxation

Disadvantages

• Unlimited liability on the owner’s part

• Raising capital can be difficult

• Business relies on skills and abilities of a single owner to be successful

• Business ends at owner’s death or loss of interest

• Low liquidity of owner’s investment

Advantages/Disadvantages of Sole Proprietorship

Occurs when two or more people start a business. Entity is organized as either general or limited liability company

Partnerships

Advantages

• Creating one is easy and inexpensive

• Firm has access to skills and abilities of multiple individuals

• Having more than one owner makes raising funds easier

• not subjected to double taxation

Disadvantages

• Each partner is subject to general partnerships

• Raising capital can be difficult

• Disagreements among partners can occur

• Business ends with death or withdrawal of one partner unless otherwise stated in partnership agreement

• Low liquidity of each partner’s investment is low

Advantages/Disadvantages of a Partnerships

A separate legal entity organized under the authority of a state. Organized as either C corporations or subchapter S corporations.

Corporation

Advantages

• Raising capital is easier

• No restrictions exist on the number of shareholders

• Stock is liquid if traded on a major stock exchange

Disadvantages

• Subject to double taxation (one on corporation’s net income & a shareholder’s personal tax returns)

• Set up and maintaining a corporation is more difficult

• Shareholders cannot deduct business losses against other sources of income

Advantages/Disadvantages of C Corporations

A form of business ownership that is rapidly gaining popularity in the US. Popular choice amongst startup firms and does not pay taxes and losses are passed through the tax returns of the owners.

LLC (Limited Liability Company)

Advantages

• Number of shareholders is unlimited

• An LLC can elect to be taxed as a sole proprietor, partnership, S corporation, Corporation, providing flexibility

• No double taxation

Disadvantages

• Set up and maintaining one is more difficult and expensive

• Tax accounting can be complicated

• Some of the regulations governing LLCs vary by state

• Possible fees the LLC pays the state for the benefit of limited liability

Advantages/Disadvantages of LLCs