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Chapter Nine: Establishing the Legal Foundation
Table of Contents
Brief Chapter Outline...............................................................................................2
Chapter Outline and Lecture notes..........................................................................4
Key Terms.............................................................................................................. 14
Suggested Text Responses
…………………………………………………………………………16
Class Activities and Sample Assignments.............................................................19
Discussion Questions for Online/Hybrid classes....................................................21
Lecture Links......................................................................................................... 25
Lecture Link 9.1: Commercial Law for the New Entrepreneur............................25
Lecture Link 9.2: New Small Business and the IRS.............................................26
Lecture Link 9.3: The United States Patent and Trademark O&ce (USPTO).......27
Bonus Internet Exercises.......................................................................................28
Bonus Internet Exercise 9.1: State Rules on Partnerships and the New
Entrepreneur...................................................................................................... 28
Bonus Internet Exercise 9.2: Business/ Gov’s “Permit Me Tool”.........................29
Bonus Internet Exercise 9.3: Workers’ Compensation and the New Business....30
Critical Thinking Exercises..................................................................................... 31
Critical Thinking Exercise 9.1: Copyright, Trademark, and Patents....................31
Critical Thinking Exercise 9.2: Contracts and the Sole Proprietor......................33
Critical Thinking Exercise 9.3: Entrepreneurs Evaluate Lease Speci5cations.....35
Bonus Cases.......................................................................................................... 37
Bonus Case 9.1: Workers’ Compensation Claims Increase.................................37
Bonus Case 9.2: Board of Directors or Board of Advisors?.................................38
Bonus Case 9.3: Regulatory Requirements and the New Small Business Owner
........................................................................................................................... 40
Endnotes............................................................................................................... 41
Brief Chapter Outline
I. Learning Objectives (text page 162)
.
IM 9-1
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
Discuss the various legal forms of business to determine the best design for a
proposed new business.
Explain the basics of contracts.
Define the role of leases in the legal formation of the new business.
List how laws, rules, and regulations benefit new businesses.
Explain the importance of copyrights, trademarks, patents to a new business.
Define the role that insurance plays in the risk portfolio of the new business.
Discuss how to develop an effective board of advisors and board of directors.
II. Various Legal Forms of Business to Determine the Best Design for a Proposed
New Business (text pages 166 through 173)
Learning Objective 9-1: Discuss the various legal forms of business to determine
the best design for a proposed new business.
III. Basics of Contracts (text pages 173 and 174)
Learning Objective 9-2: Explain the basics of contracts.
IV. Role of Leases in the Legal Formation of the New Business (text pages 174 and
175)
Learning Objective 9-3: Define the role of leases in the legal formation of the new
business.
V. How Laws, Rules, and Regulations Benefit New Businesses (text pages 176 and
177)
Learning Objective 9-4: List how laws, rules, and regulations benefit new
businesses.
VI. Importance of Copyrights, Trademarks, and Patents to a New Business (text
pages 177 and 178)
Learning Objective 9-5: Explain the importance of copyrights, trademarks, and
patents to a new business.
VII. Role That Insurance Plays in the Risk Portfolio of the New Business (text pages
178 through 180)
Learning Objective 9-6: Define the role that insurance plays in the risk portfolio of
the new business.
VIII. How to Develop an Effective Board of Advisors and Board of Directors (text
pages 180 and 181)
IM 9-2
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
Learning Objective 9–7: Discuss how to develop an effective board of advisors or
board of directors.
IX. For Review (text page 181)
Chapter Outline and Lecture notes
1. Learning Objectives (text page 162)
Discuss the various legal forms of business to determine the best design for a
proposed new business.
Explain the basics of contracts.
Define the role of leases in the legal formation of the new business.
List how laws, rules, and regulations benefit new businesses.
Explain the importance of copyrights, trademarks, and patents to a new
business.
Define the role that insurance plays in the risk portfolio of the new business.
Discuss how to develop an effective board of advisors or board of directors.
2. Various Legal Forms of Business to Determine the Best Design for a Proposed
New Business
Learning Objective 9-1:Discuss the various legal forms of business to determine
the best design for a proposed new business
A. Sole Proprietorship (text pages 166 through 168)
i. The simplest form of business organization, characterized by the
fact that the person who owns the business and the business itself
are treated as the same entity
ii. A key benefit of a sole proprietorship is they are easily formed and
easily dissolved
iii. There are strict record-keeping rules
iv. Business expenses and personal expenses must be kept separate
v. Disadvantages:
1. Limited to one business owner
2. Limited growth potential
3. No equity investors
4. Liability is the responsibility of the business owner
5. Business debt is the owner’s debt
IM 9-3
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
6. Legitimacy of the business is tied to the owner with
customers and suppliers
vi. Two growth options for sole proprietors:
1. Obtain funds as personal debts
2. Change the legal form of the business
vii. A popular form of business for the following individuals:
1. A speculative business idea or opportunity
2. Time constraints of the owner prevent the business from
substantial growth
3. A low-cost small business that does not require significant
investment or capital
B. Partnerships (text pages 168 through 170)
i. A type of business formed between individuals directly. It includes
both general and limited varieties
1. Two types of partnerships are general partnerships and
limited partnerships
ii. General partnership
1. In an LLP, the individual considered the manager of the firm,
who, as such, has unlimited liability for any debts or
judgements against the firm
2. A general partnership is easily formed with a partnership
agreement and a specific business direction stated in the
partnership agreement
3. Attorney or accountant prepares agreement
4. If there is no viable partnership agreement, the partnership is
governed by the Uniform Partnership Act or the Revised
Uniform Partnership Act. These are governed by the state
where the partnership is located
5. Specifies the individuals in the general partnership and their
individual contribution to the business
6. Describes the draw which is a distribution of funds from the
business.
7. Contains buyout stipulations and new partnership
opportunities
8. Owners report their profits or losses on personal tax returns
in proportion to the percentage of the business owned by
each owner
9. Disadvantage is that partners are jointly liable for all
business debts
10. Each partner is assumed to be involved in all decisions
IM 9-4
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
11. Relationship between partners is fiduciary
iii. Limited Liability Partnership (LLP)
1. Common for at least two individuals or when one individual
owns the LLP and has declared a full pass-through of all
income on the owner’s federal income taxes
2. Two classes of partners include general partners and limited
partners
a. The general partner is the manager of the business with
unlimited liability for debts incurred from the business
b. The limited partners are passive investors with liability of
the business limited to their investment in the business
c. Limited partners work for the firm but they may not be
active managers
d. If a limited partner becomes an active manager, the
business becomes a general partnership and not a LLP
C. Corporations
i. The business, or corporation, is a separate entity
ii. The owner or president is not personally liable for the debt of a
corporation but is liable for the amount of investment that person
made
iii. The three corporations are Subchapter S Corporation, Subchapter
C Corporation, and Limited Liability Company
iv. A subchapter S Corporation is an organizational form that treats the
firm as an entity separate from the individuals. This allows the
owner to treat the income as they would if the firm were a sole
proprietorship or a partnership. It has limitations in the number and
type of shareholders.
1. Limited liability for the owner
2. Financial statements are combined with personal income for
a tax benefit to the owners
3. Simpler formation compared to a Subchapter C corporation
4. A legitimate form of business since “inc” is included in
company’s name
5. Increased expenses when compared to a sole proprietorship
or partnership because of additional paperwork required
6. Lawyer or accountant is needed to prepare formation
paperwork
7. Limited to a maximum of 75 shareholders
8. Disadvantageous for a growth-focused company that will go
public in the foreseeable future
IM 9-5
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written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
v. A subchapter C Corporation is an organizational form that treats the
firm as a unique entity responsible for its own taxes. There are no
limitations to shareholder participation and the “owners” are
protected beyond their equity investment
1. Limited liability for the owners
2. Double taxation on both corporation and owners
3. Corporation pays income tax on profits
4. Owners pay income taxes on their personal tax returns for
the dividends of the corporation
5. Profits after taxes can be paid as dividends to the owners
6. Income tax is mitigated because the owners are employees
who are paid salaries and bonuses
7. Cost of salaries are costs to the business
8. Owners can pay themselves all the profits, reducing the
corporation’s taxable profit and limiting the corporate tax
owed.
9. Health insurance and other fringe benefits can paid by the C
corporation and not expensed as income to the employees
because they are a business expense charged to the
corporation
10.There is no limit to the number of shareholders
11. Only the number of authorized and distributed shares in the
company are limited
a. The corporation’s Floor value equals the par value
times the number of shares distributed and equals to
the shareholder equity in the firm
b. The par value should be offered at a very low price in
order to increase the number of shares sold
c. A detailed corporate charter can be using a software
package
12.The characteristics of a C corporation include:
a. The corporate name is patented or trademarked
b. The location of a corporate headquarters is
established
c. The general nature of the business is defined for filing
purposes
d. The names, addresses, and titles of each corporate
officer and each initial investor is required
e. The time horizon anticipated for the firm is identified
f. The number of authorized stock and capital
g. By-laws of the organization are established.
IM 9-6
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written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
vi. Limited Liability Corporation (LLC) (text page 172)
1. One of the most popular form of incorporation for new
businesses
1. Liability to the owner(s) is limited to the amount invested
2. Unlimited number of investors
3. Other corporations can hold stock in the company
4. Owners flow profits through to their personal taxes to avoid
double taxation
5. Income may not be in proportion to the owner’s holdings.
6. Formed by submitting paperwork to the state government to
issue a charter
7. Formation requirements are established by individual
states
8. States may require the business establishment to be
published in the newspaper
9. Some states prohibit certain professionals from establishing
the business
10.An attorney or other professional should be consulted prior
to the establishment of the LLC
3. Contracts (text pages 173 and 174)
Learning Objective 9-2: Explain the basics of contracts
A. Contract (text pages 173 and 174)
i. An agreement between two parties to perform certain activities for
some consideration
1. A written agreement is preferred; however, some contracts
can be stated or implied
ii. It is strongly recommended that the entrepreneur use an attorney
and a formal written contract
iii. The contract should state the name of the parties involved and the
scope of the transaction
iv. A specific action each party agrees to do and for what
consideration should be stated
v. The timing of a payment if it will not be immediately upon
agreement or acceptance should be stated
vi. The time that the agreed upon transaction or event will occur and
any optional expiration date should be stated
vii. Warranties need to be spelled out should be stated
IM 9-7
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
viii. Termination agreements, breach of contract penalties, damages,
or restitution agreements should be stated
ix. Whether contract can be transferred should be stated
x. The state law(s) applicable to and specified in the agreement
should be stated
4. Role of Leases in the Legal Formation of the New Business (text pages 174 and
175
Learning objective 9-3: Define the role of leases in the legal formation of the new
business
A. Lease Contract
i. A new business uses lease contracts to secure a building or space
for its operations (text pages 174 and 175)
1. It specifies what the business owner is leasing
2. It describes the length of the lease, the purpose, and
renewable options in the lease agreement
3. It states the authorized party(s) responsible for making
improvements
a. Lower lease payments are included in leases that
include the responsibility for making facility
improvements
4. It describes maintenance and other facility responsibilities
a. Janitorial costs
b. Landscaping
c. Trash removal
d. Utilities
5. It identifies the party responsible for liability insurance
a. It specifies whether or not the owner or tenant is
responsible for insurance
b. The tenant could be liable for landlord liability in
addition to tenant liability
6. It stipulates the landlord’s right of entry
7. It contains procedures that address other issues
a. It addresses the right to cancel the lease
i. Actions taken in case of bankruptcy
b. Problems and disagreements
i. Arbitration agreements
ii. Mediation options
iii. Withholding rent stipulations
c. Subletting may be an option
IM 9-8
Copyright © McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
5. How Laws, Rules, and Regulations Benefit New Businesses (text pages 176 and
177)
Learning Objective 9-4: List how laws, rules, and regulations benefit new
businesses
A. Laws, Rules and Regulations
i. Small businesses have fewer regulations than a larger business
ii. Some industries are regulated by the business type regardless of
their size
iii. A business that has employees is required to have Employer
Identification Numbers (EIN)
iv. A business with employees is required to pay federal, state, and
perhaps other taxes
v. Some states and some cities may have specific regulations
1. i.e. New York restaurants
vi. There are sources for regulatory requirements
1. Small Business Assistance Centers (SBAC) sponsored by the
Small Business Administration (SBA)
2. Economic Development Centers in various states
3. Chambers of Commerce
4. Americans with Disabilities Act (ADA) (text page 176)
a. This law pertains to a business with more than 15
employees in order to prevent discrimination in the
hiring, management, or dismissal of an employee with
disabilities
vii. Businesses are required to make reasonable accommodations for
individuals with disabilities
viii. Businesses are required to make their facilities accessible to
individuals with disabilities
ix. Requirements can change so the law must be constantly monitored
B. Licensing (text page 177)
i. The businesses may be required to purchase a business license
from its city or county in order to operate a legal establishment in
the community
ii. To obtain a business license
1. A business license application or other required form can be
obtained from the courthouse or other designated agency
2. A nominal fee to purchase business license may be charged
by the city or county
IM 9-9
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written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
3. The business must agree to report earnings quarterly or at
other designated time intervals if required
iii. An entrepreneur should consult with an attorney if a challenging l
license is required for the new business
iv. Certain types of businesses are required to obtain specific licenses
or permits
1. Local ABC (Alcohol Beverage Control) requires a liquor
license
2. Occupancy permits
3. Federal liquor licenses
4. Local business licenses
5. Sign permits
6. OSHA
7. Fire safety permits
6. Importance of Copyrights, Trademarks, and Patents to a New Business
Learning Objective 9-5: Explain the importance of copyrights, trademarks,
patents to a new business
A. Copyright
i. It is the legal means to protect intellectual property. It grants
ownership on creative materials generated, such as books,
magazines, advertising copy, music, artwork, or virtually any other
creative product, whether published or unpublished.
ii. It is filed with the US Government
iii. It is valid for the life of the author plus 70 years
B. Trademark
i. This is a claim of intellectual property that is associated with a
specific business. It may be the name of the firm, a symbol that
represents it or the names of its products or services.
ii. Entrepreneurs are required to renew their trademarks every 10
years
C. Patent
i. This is a claim of intellectual property that covers a specific
innovation
ii. Patents are expensive and they last for 20 years
iii. An entrepreneurs file their patent application with the United States
Patent and Trademark Office
iv. Entrepreneur obtains a competitive advantage in an industry
because it prevents direct imitation of products for a period of time
v. There are types of patents
IM 9-10
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written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
a. Utility – a patent for a new process, machine, article
of manufacture or composition of matter, or any new
and useful improvement to those.
b. Design – a patent for a new, original, and ornamental
design associated with an article of manufacture
c. Plant – a patent for someone who invents or
discovers or asexually reproduces any distinct and
new variety of plant.
vi. A patent provides a strong barrier to prevent direct imitation for the
time period of the patent.
vii. Copyrights, trademarks and patents filed in the US only apply in
the United states
7. Role That Insurance Plays in the Risk Portfolio of the New Business (text pages
178 and 179)
Learning objective 9–6: Define the role that insurance plays in the risk portfolio
of the new business
A. Insurance limits the liability concerns associated with the business
B. There are different types of insurance based on the needs of the firm.
An entrepreneur must evaluate if the insurance covers replacement
costs or current value
8. How to Develop an Effective Board of Advisors and Board of Directors (text
pages180 and 181)
Learning Objective 9-7: Discuss how to develop an effective board of advisors or
board of directors
A. Board of Directors
i. A group formed as a legal requirement for a corporation and
composed of individuals outside the business who advise the
business owner
B. Board of Advisors
i. A group formed at the discretion of the founders (regardless of the
legal form chosen) and composed of individuals outside the
business who advise the founders
C. The experience of the board members enhance the new small business’s
initiatives
i. Knowledge of the industrial licensing required in the location of the
new small business
ii. Knowledge of regulations of the specific industry
iii. Having success in another new start-up business
iv. Having financial and accounting background
v. Having human resource experience
D. Preferred boards consist of approximately five individuals or less
IM 9-11
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written consent of McGraw-Hill Education.
Chapter Nine: Establishing the Legal Foundation
i. A boards meets when appropriate
ii. A boards typically meets three times per year
9. Review (text page 181)
IM 9-12
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