Business Law Notes: Chapter Introduction, Sole Proprietorships, and Franchises

Chapter Introduction: Entrepreneurship and Business Organization

  • Entrepreneur: An individual who initiates and assumes the financial risk of a new business enterprise, undertaking to provide or control its management.
  • Many major corporations (e.g., Apple, Alphabet/Google, Amazon) started as small companies by entrepreneurs.
    • Examples: Jeff Bezos (Amazon) and Steve Jobs (Apple) began their companies in garages.
  • One of the initial decisions for an entrepreneur is selecting the most appropriate form of business organization.

Factors in Selecting an Organizational Form

Entrepreneurs consider several factors when choosing a business form:

  1. Ease of creation.
  2. Liability of the owners.
  3. Tax considerations.
  4. Ability to raise capital.
  • The primary motive of an entrepreneur is to make profits.
  • Traditionally, three major business forms have been used: sole proprietorship, partnership, and corporation.
  • This chapter examines sole proprietorships and franchises. While a franchise is not strictly an organizational form, it is a significant business arrangement.

Evolution of Business Forms

  • Initially, a sole proprietorship may be sufficient.
  • As a business grows, a more formal organization may be needed, especially to limit personal liability.
  • Examples of formal organizations that limit owner's personal liability:
    • Limited Partnership (LP)
    • Limited Liability Partnership (LLP)
    • Limited Liability Company (LLC)
    • Corporation
  • Limited liability is generally necessary for those seeking to raise outside capital.

General Legal Requirements for All Business Forms

Any business, regardless of its form, must meet various legal requirements, including:

  1. Business name registration.
  2. Occupational licensing.
  3. State tax registration: For permits related to collecting and remitting sales taxes.
  4. Health and environmental permits.
  5. Zoning and building codes.
  6. Import/export regulations.
  • If a business has employees, the owner must also comply with numerous workplace laws.

Protecting Intellectual Property

Protecting intellectual property (IP) is crucial for many small businesses.

Copyrights and Patents

  • Software companies and app developers rely on copyrights and patents to protect their R&D investments.
  • Without IP protection, competitors or customers could easily copy software or apps.

Trademarks

  • Choosing and protecting a trademark or service mark is vital for a new business's success.
  • The business name itself might also function as a trademark.
  • General Rule: A trademark cannot be the same as, or confusingly similar to, another's mark.
  • U.S. Patent and Trademark Office (PTO) Registration: Provides the most protection.
    • Federally registered marks can use the symbol ®\text{\textregistered}.
    • Unregistered marks can use the symbol TM\text{TM}.
    • Registration renewal is required 55 years after initial registration, and then every 1010 years thereafter.

Trade Secrets

  • Much of a small business's value can be in its trade secrets (e.g., product development info, production processes, techniques, customer lists).
  • Requirement for Legal Protection: Maintaining the secrecy of the information.
  • Risk: Trade secrets must often be divulged to key employees, posing a risk of disclosure to competitors or employees starting competing businesses.
  • Protection Mechanisms:
    • Employment Contracts: Requiring employees with access to trade secrets to agree not to divulge them.
    • Covenant Not to Compete: A non-compete clause in employment contracts to prevent key employees from working for a competitor or starting a competing business.

Obtaining Business Loans

Raising capital is crucial for growth.

Bank Loans

  • Benefit: Allows the owner to retain full ownership and control.
  • Caveats: Banks may place restrictions on future business decisions as a loan condition.
  • Challenges: Banks are often reluctant to lend significant sums to unestablished businesses.
    • They may require personal guarantee contracts from the owner, putting personal assets at risk.

U.S. Small Business Administration (SBA) Microloans

  • Availability: Desirable terms may be available through the SBA.
  • Amount: Offers microloans up to \50,000.Theaveragemicroloanisabout. The average microloan is about\13,00013,000.
  • Providers: Available through non-profit, community-based organizations experienced in lending.
  • Requirement: SBA often requires business owners to put some of their own funds at risk.

State Grants

  • Many states offer small business grants to individuals starting a business.

Sole Proprietorships

  • Definition: The simplest form of business where the owner is the business. Anyone doing business without creating a separate organization has a sole proprietorship.
  • Default Form: The law presumes new, single-owner businesses are sole proprietorships unless another form is affirmatively adopted.
  • Prevalence: More than 23\frac{2}{3} (approximately 66.7%66.7\%) of all U.S. businesses are sole proprietorships.
  • Scope: Can range from informal home offices to large restaurants or construction firms.
  • Size: Most are small enterprises; about 99%99\% have revenues less than \1millionperyear.</li></ul><h4id="advantagesofthesoleproprietorship">AdvantagesoftheSoleProprietorship</h4><ol><li><strong>Proprietorownstheentirebusinessandreceivesallprofits</strong>,duetoassumingallrisk.</li><li><strong>EaseofCreation</strong>:Easierandlesscostlytostartthanotherbusinesstypes;fewlegalformalitiesrequired.<ul><li>Generally,nodocumentsneedfilingwiththegovernmenttostart.</li></ul></li><li><strong>Taxes</strong>:Soleproprietorpaysonly<em>personal</em>incometaxesonbusinessprofits.<ul><li>Profitsarereportedaspersonalincomeontheproprietor′spersonalincometaxreturn.</li><li>Thebusinessitselfdoesnotfileaseparateincometaxreturn.</li><li>Soleproprietorscanestablishtax−exemptretirementaccountsuntilfundsarewithdrawn.</li></ul></li><li><strong>Flexibility</strong>:Offersmoreflexibilitythanpartnershipsorcorporations.<ul><li>Ownerisfreetomakeallbusinessdecisions(e.g.,businesstype,hiring,vacation).</li><li>Ownercansellortransferallorpartofthebusinessanytimewithoutapproval(unlikepartnershipsorcorporations).</li></ul></li></ol><h4id="disadvantagesofthesoleproprietorship">DisadvantagesoftheSoleProprietorship</h4><ol><li><strong>UnlimitedLiabilityandPersonalAssetsatRisk</strong>:Theproprietoralonebearstheburdenofanybusinesslossesorliabilities.<ul><li>Anylawsuitagainstthebusinessoremployeescanleadtounlimitedpersonalliabilityfortheowner.</li><li>Creditorscanpursuetheowner′spersonalassetstosatisfybusinessdebts.</li><li>Insurancemayhelp,butliabilitycaneasilyexceedpolicylimits.</li><li><strong>Example16.1(SheilaFowler′sGolfShop)</strong>:Ifanemployee′snegligenceinjuresacustomer,Sheila′spersonalliabilitycouldexceedinsurancelimits,potentiallycostingherbusiness,house,car,andotherpersonalassets.</li></ul></li><li><strong>LackofContinuity</strong>:Thebusinessautomaticallydissolvesuponthedeathoftheproprietor.</li><li><strong>LimitedAbilitytoRaiseCapital</strong>:Proprietorsarelimitedtopersonalfundsandloanstheycanobtain.<ul><li>Lendersmaybeunwillingtoloantosoleproprietorships,especiallystartups,duetounlimitedpersonalliabilityandpotentialinabilitytopay.</li></ul></li></ol><h4id="case161portorchardairportincvwagnercourtofappealsofwashingtondd2020dd">Case16.1:PortOrchardAirport,Inc.V.Wagner(CourtofAppealsofWashington,million per year.</li> </ul> <h4 id="advantagesofthesoleproprietorship">Advantages of the Sole Proprietorship</h4> <ol> <li><strong>Proprietor owns the entire business and receives all profits</strong>, due to assuming all risk.</li> <li><strong>Ease of Creation</strong>: Easier and less costly to start than other business types; few legal formalities required.<ul> <li>Generally, no documents need filing with the government to start.</li></ul></li> <li><strong>Taxes</strong>: Sole proprietor pays only <em>personal</em> income taxes on business profits.<ul> <li>Profits are reported as personal income on the proprietor's personal income tax return.</li> <li>The business itself does not file a separate income tax return.</li> <li>Sole proprietors can establish tax-exempt retirement accounts until funds are withdrawn.</li></ul></li> <li><strong>Flexibility</strong>: Offers more flexibility than partnerships or corporations.<ul> <li>Owner is free to make all business decisions (e.g., business type, hiring, vacation).</li> <li>Owner can sell or transfer all or part of the business anytime without approval (unlike partnerships or corporations).</li></ul></li> </ol> <h4 id="disadvantagesofthesoleproprietorship">Disadvantages of the Sole Proprietorship</h4> <ol> <li><strong>Unlimited Liability and Personal Assets at Risk</strong>: The proprietor alone bears the burden of any business losses or liabilities.<ul> <li>Any lawsuit against the business or employees can lead to unlimited personal liability for the owner.</li> <li>Creditors can pursue the owner's personal assets to satisfy business debts.</li> <li>Insurance may help, but liability can easily exceed policy limits.</li> <li><strong>Example 16.1 (Sheila Fowler's Golf Shop)</strong>: If an employee's negligence injures a customer, Sheila's personal liability could exceed insurance limits, potentially costing her business, house, car, and other personal assets.</li></ul></li> <li><strong>Lack of Continuity</strong>: The business automatically dissolves upon the death of the proprietor.</li> <li><strong>Limited Ability to Raise Capital</strong>: Proprietors are limited to personal funds and loans they can obtain.<ul> <li>Lenders may be unwilling to loan to sole proprietorships, especially startups, due to unlimited personal liability and potential inability to pay.</li></ul></li> </ol> <h4 id="case161portorchardairportincvwagnercourtofappealsofwashingtondd2020dd">Case 16.1: Port Orchard Airport, Inc. V. Wagner (Court of Appeals of Washington,2020$$)
    • Background: Shannon Wagner owned Northwest Cabinets and Furniture (a sole proprietorship) and sold its assets to Claire Messina. Wagner continued working for the business and later married Messina. Wagner then filed a breach of contract claim against Port Orchard Airport for work done after the sale and marriage.
    • Trial Court Decision: A jury awarded damages, but the court dismissed the claim, finding Wagner lacked standing as he was no longer the owner.
    • Wagner's Appeal (Montana Supreme Court):
      • Issue: Did Wagner, as a former sole proprietor, have standing to sue for breach of contract related to work performed by the business after its sale to his wife?
      • Court's Reasoning (Sutton, J.):
        • Every action must be prosecuted by the real party in interest, possessing a present substantial interest, not a mere expectancy.
        • The trial court erred in deeming the business Messina's separate property.
        • Key Principle: