Chapter #3 – Financing and Organizing a New VentureOrganization

­ An entrepreneur is usually unable to perform all business functions by himself/herself

­ If more than one person is involved in an enterprise, this constitutes an organization

o a social group which distributes tasks for a collective goal.

­ Organizations operate according to known principles (take an organization theory class)

­ This lecture is about setting up a new business organization

Forms of Business Organization­ Sole Proprietorships­ Partnerships

o Generalo Limited

­ Corporationso C corporationso S (or Subchapter S) corporations

­ Limited Liability Companies (LLCs)EXAMPLE: Phil Young, founder of the Pedal Pushers Company, has developed several prototypes of a pedal replacement for children’s bicycles. The Pedal Pusher will replace existing bicycle pedals with an easy release stirrup to help smaller children hold their feet on the pedals. The Pedal Pusher will glow in the dark and will provide a musical sound as the bicycle is pedaled.Solution:

• Capital intensity of production: low • Required investment: not much• If Phil wants easy set up: sole proprietorship• If Phil wants to limit liability: S corporation

Proprietorships­ Proprietorship: business venture owned by an individual who is personally liable for the venture’s liabilities­ The primary advantage of a proprietorship is that it allows an entrepreneur to conduct the full range of business

activities with almost no additional expense to the organization­ Unlimited liability: personal obligation to pay a venture’s liabilities not covered by the venture’s assets which is a

drawback­ the only source of equity capital is owner’s funds­ the proprietor of a failed venture with outstanding obligations may be forced into personal bankruptcy to protect

personal assets from the venture’s creditors**Partnerships

­ Partnership: business venture owned by two or more individuals who are jointly and personally liable for the venture’s liabilities

­ partnership agreement: spells out how business decisions are to be made and how profits and losses will be shared

­ If the partnership agreement does not state otherwise, each general partner has complete managerial discretion over the conduct of business

­ Equity capital sources for general partnerships are restricted to funds supplied by partners­ The costs associated with forming a general partnership are usually moderate in terms of time and legal fees­ A general partner’s personal financial liability for the venture’s obligations mirrors that of the sole proprietor—

unlimited­ Joint Liability: legal action treats all partners equally as a group

­ Joint and Several Liability: allows subsets of partners to be the object of legal action related to the partnership­ The body of law normally governing partnerships is the Uniform Partnership Act (UPA)­ In cases where the partnership agreement is silent, the UPA provides the precedence in general partnership law

­ Limited Partnership: limits limited partner liabilities in a partnership to the amount of their equity capital contribution to the partnership

**Corporations­ Corporation: a legal entity that separates personal assets of the owners (shareholders) from the assets of the

business­ Limited Liability: creditors can seize the corporation’s assets but have no recourse against the shareholders’

personal assets­ Corporate Charter: legal document that establishes the corporation­ S Corporation: provides limited liability for shareholders; plus, corporate income is taxed like personal income to the

shareholders **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

o Earnings can be taxed at the personal income tax rates of the membersBases for Comparing Various Business Organizational Forms

­ Number of Owners and Ease of Startup­ Investor Liability­ Equity Capital Sources­ Firm Life and Liquidity of Ownership­ Taxation

Intellectual Property­ Intellectual Property: a venture’s intangible assets and human capital, including inventions that can be protected

from being freely used or copied by others (knowledge in particular)­ Protecting Valuable Intangible Assets

o There are Four Forms of Protection:

Patents

Trade Secrets

Trademarks

CopyrightsIntellectual Property Protection Methods

­ Patents: intellectual property rights granted for inventions that are useful, novel, and non-obviouso Intellectual property rights granted for inventions that are “useful,” “novel,” and “non-obvious.”o Patents are granted by the U.S. Patent and Trademark Officeo Patent law is very complex (you most likely need to hire a patent applications specialist lawyer)o Four Kinds of Patents:

Utility Patents: cover mechanical or general inventions, chemical inventions, and electrical inventions

Design Patents: cover the “appearance” of items (e.g., sports uniforms, electronic products, and autos)

Plant Patents: protect discoveries of asexual reproduction methods of new plant varieties

Business Method Patents: protect specific ways of doing business and the underlying computer codes and technology

o 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

o 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 and Trademark Office

If successful, the utility patent life will be 20 years (prior to mid-1995 the life was 17 years)o 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, and small entities are charged lower filing fees

Allows the inventor to use the term “patent pending” on the invention

However, patent rights and protection occur only when a patent is issued o Provisional Patent Application Requirements & Conditions

An invention title, the inventor’s name, residence, and 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 and will be abandoned unless a regular patent application is filedo Regular Patent Application Requirements

A detailed written description of the invention and 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 inventiono Why Might Your Patent Application be Rejected?

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

• Non-Obvious - Invention should be “non-obvious” to a person with ordinary skills in the art of the invention’s area or subject

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 useo 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

­ Trade Secrets: intellectual property rights in the form of inventions and information, not generally known to others, that convey economic advantages to the holders

o intellectual property rights in the form of inventions & information (e.g., formulas, processes, customer lists, etc.)

o Trade secrets are not generally known to others & convey economic advantages to the holderso 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) o 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 and efforts to protect it

holders do not have exclusive “rights” to what comprises the secret (someone could independently replicate the secret)

­ Trademarks: intellectual property rights that allow firms to differentiate their products & services through the use of unique marks

o Marks allow consumers to easily identify the source and quality of products/serviceso Most trademarks take the form of names, words, or graphic designso Trademarks also can be on the shape of packages, colors, odors, and soundso Trademarks are the most valuable form of intellectual property for many firmso A trademark should be suggestive of (but not describe) a product or product line o 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”)o 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 ®­ Copyrights: intellectual property rights to writings in printed and electronically stored forms

o Protects the “form of expression of an idea” and not just words themselveso 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 ©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

­ 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

Seed & Startup Financing­ Seed and startup financing: financing sources available during the development and startup stages of a venture’s

life cycle. Included are the entrepreneur’s physical and financial assets, family and friends, and business angels­ Financial Bootstrapping: minimizing need for financial capital and finding unique ways of financing a new venture­ Business Angels: wealthy individuals who invest money in fledgling ventures in exchange for the excitement of

launching a business and a share in any financial rewardsSummary

­ The nature of an entrepreneurial idea and scope of business will determine the appropriate type of business organization

­ One key aspect in organizing a new venture is protecting the idea and associated intellectual property­ At the seed and startup stages financing sources are limited