Chapter 7 Preparing the Proper Ethical and Legal Foundation Entrepreneurship: Successfully Launching New Ventures Some Sections Modified from Barringer and Ireland (2008)

5 Initial Ethical and Legal Issues Facing a New Firm Ethically departing a former employer Choosing an attorney Drafting a founders’ agreement Avoiding litigation Choosing form of business ownership

Issue 1: Ethically Departing a Former Employer Ethical Guidelines How to Behave in a Professional Manner Give proper notice of an intention to quit Must perform all assigned duties until the day of departure If leaving to start firm in same industry, must not take information that belongs to the current employer Be sure to Honor all Employment Agreements Honor all nondisclosure and non-compete agreements entered into at the time of employment Nondisclosure Agreement: is a promise made by an employee or another party to not disclose the company’s trade secrets Non-compete Agreement: prevents an individual from competing against a former employer for a specified period of time

Issue 2: Choosing and Attorney for the New Firm Considerations when Choosing and Attorney Entrepreneurs should select an attorney as soon as possible The attorney should be familiar with start-up issues and should have experience To manage the finances, they will often work out payment plans with entrepreneurs Criteria to consider: Contact local bar and ask for a list of start-up specialized attorneys Interview several attorneys Select an attorney who can assist in raising money for the firm Double-check the attorney’s track record

Issue 3: Drafting a Founders’ Agreement (AKA shareholders’ agreement) What is a founders’ agreement? Written document dealing with issues like: Relative split of equity among founders of the firm How individual founders compensated for cash or “sweat equity” put into the firm How long founders have to remain with firm for shares to fully vest Items to include in a founders’ agreement: Nature of prospective business Brief business plan Identity and proposed titles of founders Legal form of business Division of stock or ownership share for each founder ID of any IP signed over to business by any founder(s) Description of initial operating capital Buyback clause

Issue 4: Avoiding Legal Disputes Most disputes result from misunderstandings, sloppiness, or lack of legal knowledge Steps an entrepreneur can take to avoid legal disputes: Meet all contractual obligations Avoid undercapitalization Get everything in writing Promote business ethics via codes of ethics and ethics training

A Note on Promoting Business Ethics Promoting Business Ethics in a New Venture Code of Ethics: describes firm’s general value system, moral principles, and specific ethical rules Ethics Training Programs: formal programs teaching employees to respond to ethical dilemmas that might arise Most common ethical problems Human resource ethical problems Example: job interviews; applications; resume “padding” Conflicts of interest Example: hiring/contracting with family members not qualified Customer confidence Example: Labor practices; handling recalls; resume verification; misrepresenting competitors Inappropriate use of corporate resources Example: taking paper and pens home from work

A Note on Customer Confidence Issues dealing with appropriate labor practices Nike and Kathie Lee and sweatshops Handling issues requiring recalls Tylenol Lead in children’s toys Tainted food Employer responsibilities to customers in hiring employees The Washington Post George O’Leary Misrepresenting competitors Amway vs. Proctor and Gamble Janet Cooke awarded the Pulitzer on April 13, 1981. When the editors of the Toledo Blade, where Cooke had worked, read biographical notes, noticed discrepancies. Investigation revealed that Cooke's credentials were false. Pressured by the editors of the Post, Cooke confessed her guilt. Two days after the prize had been awarded Post held press conference admitted that the story was fraudulent. Next day's paper offered a public apology. Assistant Managing Editor Bob Woodward said at the time: "I believed it, we published it. Official questions had been raised, but we stood by the story and her. Internal questions had been raised, but none about her other work. The reports were about the story not sounding right, being based on anonymous sources, and primarily about purported lies [about] her personal life -- [told by three reporters], two she had dated and one who felt in close competition with her. I think that the decision to nominate the story for a Pulitzer is of minimal consequence. I also think that it won is of little consequence. It is a brilliant story -- fake and fraud that it is. It would be absurd for me or any other editor to review the authenticity or accuracy of stories that are nominated for prizes."

A Note on the Inappropriate use of Corporate Resources $40 billion is stolen annually from US businesses via employee theft. Around 75% of all employees steal from their employers. Employee theft has been cited as the reason why between 30-75% of businesses fail. Employee theft includes: Embezzling cash, taking office supplies/equipment, photocopies, phone calls, taking extended lunch breaks/personal time, etc. Preventing Employee Theft Pre-screen people Use interviews, trust tests, psychological tests, as appropriate and legal Effective prescreening has been found to reduce firm losses by as much as 70% Utilize prevention and detection methods to combat existing employee theft Surveillance cameras, financial controls, anonymous 800 numbers, informer drop boxes, etc. Handle all employees consistently Engage in ethics training 80% of employees admitting to stealing regularly, do not believe they are doing anything wrong Suggests misunderstandings of what constitutes ethical behavior Monitor ethics programs on a regular basis

Issue 5: Choosing the Legal Form of Business Sole Proprietorship: involves one person; the person and business are the same; not a separate legal entity Partnerships: when two or more people start a business General Partnership: two or more (general partners) pool their skills, abilities, and resources to run a business Limited Partnership: same as general but includes two classes of owners—general partners and limited partners Corporations: separate legal entity organized under the authority of a state C-Corporation: separate legal entity that, in the eyes of the law, is separate from its owners S-Corporation: subchapter S corporation combines the advantages of a partnership and a C corporation. Must meet certain standards to become S-Corp. Limited Liability Company: LLC combines the limited liability advantage of the corporation with the tax advantages of the partnership

4 Issues to Consider When Choosing Legal Form of Business Ownership The cost of setting up and maintaining the legal form of ownership. The extent to which an entrepreneur can shield his or her personal assets from the liabilities of the business. Tax considerations The ease of raising capital

Summary of Advantages/Disadvantages Associated with Forms of Business Ownership Green = positives; Red = drawbacks Sole Proprietorship General Partnership Limited Partnership C Corp. S Corp. Limited Liability Co. Cost of setting up & running Easy and Inexpensive More expensive and time intensive Liability Issues Unlimited liability to owner Unlimited liability to partners Limited partners liability limited to investment General partners liability unlimited Liability limited to investment Tax Issues Not subject to double taxation Subject to double taxation Ease of raising capital Difficult Easy (if business model is strong) Moderately difficult Other Issues Liquidity of investment low Relies on Skills of a single owner Skills and abilities of > 1 owner Stock can be liquid Ability to share stock via options can motivate employees Must meet certain standards to qualify Tax accounting complicated Governing regulations vary by state