1. ORGANIZING AND FINANCING A NEW VENTURE
ENTREPRENEURIAL FINANCE
Leach & Melicher
Chapter 3
ORGANIZING AND FINANCING A NEW VENTURE
© 2003 South-Western College Publishing

2. Chapter 3: Learning Objectives
Describe the proprietorship, partnership, & corporate forms of business
Identify a limited liability company (LLC)
Describe the benefits, risks, & basic tax aspects of various organizational forms
Discuss the use of patents & trade secrets to protect intellectual property

3. Chapter 3: Learning Objectives (continued)
Discuss the use of trademarks & copyrights to protect intellectual property
Describe how confidential disclosure agreements & employment contracts are used to protect intellectual property rights
Explain how financing is obtained via financial bootstrapping & through business angels

4. Forms of Business Organization
Proprietorships
Partnerships >General >Limited
Corporations >C corporations >S (or Subchapter S) corporations
Limited Liability Companies (LLCs)

5. Proprietorships
Proprietorship >business venture owned by an individual who is personally liable for the venture’s liabilities
Unlimited liability >personal obligation to pay a venture’s liabilities not covered by the venture’s assets

6. Partnerships
Partnership >business venture owned by two or more individuals who are jointly and personally liable for the venture’s liabilities
Joint Liability >legal action treats all partners equally as a group in a general partnership

7. Partnerships (continued)
Joint and Several Liability >allows subsets of partners to be the object of legal action related to the partnership
Limited Partnership >limits limited partner liabilities in a partnership to the amount of their equity capital contribution to the partnership

8. Corporations
Corporation >a legal entity that separates personal assets of the owners (shareholders) from the firm’s assets
Limited Liability >creditors can seize the corporation’s assets but have no recourse against the shareholders’ personal assets

9. Corporations (continued)
Corporate Charter >legal document that establishes the corporation
S Corporation >provides limited liability for shareholders plus corporate income is taxed as personal income to the shareholders

10. Limited Liability Companies (LLCs)
Limited Liability Company (LLC) >a business organization owned by “members” (shareholders) with limited liability
Major Incentive for Organizing as an LLC >its earnings are taxed at the personal income tax rates of the members

11. Bases for Comparing Various Business Organizational Forms
Number of Owner’s & Ease of Startup
Investor Liability
Equity Capital Sources
Firm life & Liquidity of Ownership
Taxation

12. Number of Owners & Ease of Startup
Proprietorship >one; low time & legal costs
Partnership (general) >two or more; moderate time & legal costs
Limited Partnership >one or more general & one or more limited partners; moderate time & legal costs

13. Number of Owners & Ease of Startup (continued)
Corporation (C) >one or more, with no limit; high time & legal costs
S (Subchapter S) Corporation >less than 75 owners; high time & legal costs
Limited Liability Company (LLC) >one or more, with no limit; high time & legal costs

14. Investor Liability Proprietorship >unlimited
Partnership (general) >unlimited (joint & several liability)
Limited Partnership >limited partners’ liability limited to their investments

15. Investor Liability (continued)
Corporation (C) >limited to shareholders’ investments
S (Subchapter S) Corporation >limited to shareholders’ investments
Limited Liability Company (LLC) >limited to owners’ investments

16. Equity Capital Sources
Proprietorship >owner, family, & friends
Partnership (general) >partners, families, & friends
Limited Partnership >general and limited partners

17. Equity Capital Sources (continued)
Corporation (C) >venture investors & common shareholders
S (Subchapter S) Corporation >venture investors & Subchapter S investors
Limited Liability Company (LLC) >venture investors & equity offerings to owners

18. Firm Life & Liquidity of Ownership
Partnership >life determined by owner; often difficult to transfer ownership
Partnership (general) >life determined by partners; often difficult to transfer ownership
Limited Partnership >life determined by general partner; often difficult to transfer ownership

19. Firm Life & Liquidity of Ownership (continued)
Corporation (C) >unlimited life; usually easy to transfer ownership
S (Subchapter S) Corporation >unlimited life; often difficult to transfer ownership
Limited Liability Company (LLC) >life set by owners; often difficult to transfer ownership

20. Taxation Proprietorship >personal tax rate
Partnership (general) >personal tax rates
Limited Partnership >personal tax rates

21. Taxation (continued)
Corporation (C) >corporate taxation; dividends subject to personal tax rates
S (Subchapter S) Corporation >income flows to shareholders; taxed at personal tax rates
Limited Liability Company (LLC) >income flows to owners; taxed at personal tax rates

22. What is Intellectual Property?
Intellectual Property >a venture’s intangible assets and human capital and includes inventions and innovations that can be protected from being freely used or copied by others

23. Protecting Valuable Intangible Assets
There are Four Forms of Protection:
Patents
Trade Secrets
Trademarks
Copyrights

24. Intellectual Property Protection Methods: Basic Definitions
Patents >intellectual property rights granted for inventions that are useful, novel, and non-obvious
Trade Secrets >intellectual property rights in the form of inventions and information not generally known to others that convey economic advantages to the holders

25. Intellectual Property Protection Methods: Basic Definitions (cont’d)
Trademarks >intellectual property rights that allow firms to differentiate their products & services through the use of unique marks
Copyrights >intellectual property rights to writings in written and electronically stored forms

26. Patent Basics
Intellectual property rights granted for inventions that are “useful,” “novel,” and “non-obvious.”
Patents are granted by the U.S. Patent and Trademark Office
Patent law is very complex (you need to hire a patent applications specialist lawyer)

27. Three Kinds of Patents:
1. Utility Patents
>cover mechanical or general inventions, chemical inventions, & electrical inventions

28. Three Kinds of Patents (cont’d):
2. Design Patents
>cover the “appearance” of items (e.g.,
sports uniforms, electronic products, & autos)
3. Plant Patents
>protect discoveries of asexual reproduction methods of new plant varieties

29. Utility Patents: Basic Information
A new idea by itself cannot be patented
The idea must be part of an invention that has a “physical form” such as a product
The physical form also can exist as a sequence of steps contained in a process or the delivery of a service

30. Utility Patents: Application Process
Develop or conceive an Invention
Prepare (you, or a registered patent attorney on your behalf) a patent application
File the application in U.S. Patent & Trademark Office
If successful, the utility patent life will be 20 years (prior to mid-1995 the life was 17 years)

31. Utility Patents: Provisional Patent Application
Beginning in mid-1995, inventors were permitted to file a provisional application
Filing dates can be established more quickly & at lower costs, & small entities are charged lower filing fees
Allows the inventor to use the term “patent pending” on the invention
However, patent rights & protection occur only when a patent is issued

32. Provisional Patent Application Requirements & Conditions
An invention title, the inventor’s name, residence, & address for correspondence
Clearly written description and “drawings”
A person skilled in the art of the invention’s area should be able to use or practice the invention
Has a life of 12 months & will be abandoned unless a regular patent application is filed

33. Regular Patent Application Requirements
A detailed written description of the invention & detailed drawings of how the invention works
One or more claims justifying why the invention should be patented
Inventor must indicate the “best use” or method of practicing or carrying out the invention

34. Why Might Your Patent Application be Rejected?
1. For a patent application to be accepted, the invention must be:
Useful
>the invention cannot just “do nothing”
Novel
>the invention was not previously produced, described in a publication, or patented

35. Why Might Your Patent Application be Rejected (cont’d)?
Non-Obvious >invention should be “non-obvious” to a person with ordinary skills in the art of the invention’s area or subject
2. Timing of filing the application >must be filed within one year of first introduction to the public >in the future, it may be necessary to file prior to any public disclosure or use

36. What Does Having a Patent do for the Inventor?
The government does not enforce your rights
The burden of enforcing the patent lies with the inventor and enforcement can be costly
Records indicate that over one-half of patent infringement suits taken to court are not upheld on behalf of the inventor

37. Other Methods
Trade Secrets
What are Trade Secrets? >intellectual property rights in the form of inventions & information (e.g., formulas, processes, customer lists, etc.) >trade secrets are not generally known to others & convey economic advantages to the holders

38. Trade Secrets (continued)
Other Methods
Trade Secrets (continued)
Why Consider Protection as a Trade Secret instead of as a Patent? >trade secret law can sometimes protect inventions that did not qualify for patents >some inventors want to avoid the detailed disclosure required by the U.S. Patent and Trademark Office >there are no time restrictions on trade secrets (in contrast to patents)

39. Trade Secrets (continued)
Other Methods
Trade Secrets (continued)
What are Drawbacks of Seeking Protection under Trade Secrets Law? >there is no formal procedure for obtaining protection as a trade secret >protection is established by the secret’s characteristics & efforts to protect it >holders do not have exclusive “rights” to what comprises the secret (someone could independently replicate the secret)

40. Trademarks
What are Trademarks? >Intellectual property rights that allow firms or others to differentiate their products & services through the use of unique “marks”
Marks allow consumers to easily identify the source & quality of products/services

41. Trademarks (continued)
Most trademarks take the form of names, words, or graphic designs
Trademarks also can be on the shape of packages, colors, odors, & sounds
Trademarks are the most valuable form of intellectual property for many firms
A trademark should be suggestive of (but not describe) a product or product line

42. Trademarks (continued)
How do You Obtain or Disclose a Trademark (or ™)? >no formal government procedure exists for establishing a trademark >ownership is established by being first to use the mark on products >a trademark can be lost if the mark becomes a generic term or label (e.g., “aspirin” or “cellophane”)

43. Trademarks (continued)
How do You Register a Trademark? >a trademark can be registered in individual states or with the U.S. Patent and Trademark Office >a federal registration should be used if a product is sold in more than one state >products with federally registered trademarks show the trademark accompanied by ®

44. Copyrights
Intellectual property rights to “writings” in written and electronically-stored forms
Protects the “form of expression of an idea” and not just words themselves
Traditional way to establish a copyright is to “publish” your book or other work accompanied by a copyright notice using the word “Copyright” or the symbol ©

45. Other Methods for Protecting Intellectual Property Rights
Confidential Disclosure Agreements >documents used to protect an idea or other forms of intellectual property when disclosure must be made to another individual or organization

46. Other Methods for Protecting Intellectual Property Rights
Employment Contracts
>agreements between an employer and employee whereby the employer employs the employee in exchange for the employee agreeing to keep confidential information secret and to assign ideas and inventions to the employer

47. Seed & Startup Financing
Financial Bootstrapping
>minimizing need for financial capital & finding unique ways of financing a new venture
Business Angel Funding
>wealthy individuals who invest money in fledgling ventures in exchange for the excitement of launching a business & a share in any financial rewards