Chapter 3ORGANIZING AND FINANCING A NEW VENTURE1ENTREPRENE.docx

Chapter 3
ORGANIZING AND FINANCING A NEW VENTURE
1
ENTREPRENEURIAL FINANCE
Leach & Melicher
© 2015 South-Western Cengage Learning
FIFTH Edition
FIFTH Edition
Entrepreneurial Finance: Leach & Melicher
Describe the proprietorship, partnership, and corporate forms of
business
Identify the differentiating characteristics of a limited liability
company (LLC)
Describe the benefits, risks, and basic tax aspects of various
organizational forms
Discuss the use of patents and trade secrets to protect
intellectual property
Discuss the use of trademarks and copyrights to protect
intellectual property
Describe how confidential disclosure agreements and
employment contracts are used to protect intellectual property
rights
Explain how financing is obtained via financial bootstrapping
and through business angels
Describe first-round financing sources

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Chapter 3: Learning Objectives
FIFTH Edition
Forms of Business Organization
Sole Proprietorships
Partnerships
General
Limited
Corporations
C corporations
S (or Subchapter S) corporations
Limited Liability Companies (LLCs)
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FIFTH Edition
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
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FIFTH Edition

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
5
FIFTH Edition
Partnerships (cont’d)
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
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FIFTH Edition
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
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FIFTH Edition
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
earnings can be taxed at the personal income tax rates of the
members
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FIFTH Edition
Bases for Comparing Business Organizational Forms
Number of Owners and Ease of Startup
Investor Liability
Equity Capital Sources
Firm Life and Liquidity of Ownership
Taxation
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FIFTH Edition
Number of Owners & Ease of Startup
Proprietorship
one; low time and legal costs
Partnership (general)
two or more; moderate time and legal costs
Limited Partnership
one or more general and one or more limited partners; moderate
time and legal costs
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FIFTH Edition
Number of Owners & Ease of Startup (cont’D)
Corporation (C)
one or more, with no limit; high time and legal costs
S (Subchapter S) Corporation
less than 100 owners (since 2005); high time and legal costs
Limited Liability Company (LLC)
one or more, with no limit; high time and legal costs
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FIFTH Edition
Investor Liability
Proprietorship
unlimited

unlimited (joint and several liability)
Limited Partnership
limited partners’ liability limited to their investments
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FIFTH Edition
Investor Liability (cont’d)
Corporation (C)
limited to shareholders’ investments
limited to shareholders’ investments
limited to owners’ investments
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FIFTH Edition
Equity Capital Sources
Proprietorship
owner
partners, families, and friends
Limited Partnership
general and limited partners
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FIFTH Edition

Equity Capital Sources (cont’d)
Corporation (C)
venture investors and common shareholders
venture investors and Subchapter S investors
venture investors and equity offerings to owners
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FIFTH Edition
Firm Life & Liquidity of Ownership
Proprietorship
life determined by owner; often difficult to transfer ownership
life determined by partners; often difficult to transfer ownership
Limited Partnership
life determined by general partner; often difficult to transfer
ownership
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FIFTH Edition
Firm Life & Liquidity of Ownership (cont’d)
Corporation (C)
unlimited life; usually easy to transfer ownership

unlimited life; often difficult to transfer ownership
life set by owners; often difficult to transfer ownership
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FIFTH Edition
Taxation
Proprietorship
personal tax rate
personal tax rates
Limited Partnership
personal tax rates
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FIFTH Edition
Taxation (cont’d)
Corporation (C)
corporate taxation; dividends subject to personal tax rates
income flows to shareholders; taxed at personal tax rates
income flows to owners; taxed at personal tax rates
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FIFTH Edition
What is Intellectual Property?
Intellectual Property (IP):
a venture’s intangible assets and human capital, including
inventions that can be protected from being freely used or
copied by others
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FIFTH Edition
Protecting Valuable Intangible Assets
There are Four Forms of Protection:
Patents
Trade Secrets
Trademarks
Copyrights
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FIFTH Edition
IP 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

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FIFTH Edition
IP 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 printed and
electronically stored forms
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FIFTH Edition
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 most likely need to hire a
patent applications specialist lawyer)
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FIFTH Edition
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
25
FIFTH Edition
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
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FIFTH Edition
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)
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FIFTH Edition
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
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FIFTH Edition
Prov. Patent Application Requirements
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 filed
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FIFTH Edition
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 invention
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FIFTH Edition
Why Might Your 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
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FIFTH Edition

Why Might Your Application be Rejected (cont’d)?
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
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FIFTH Edition
What Does 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
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FIFTH Edition
Trade Secrets
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
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FIFTH Edition
Trade Secrets (cont’d)
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)
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FIFTH Edition
Trade Secrets (cont’d)
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)
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FIFTH Edition

Trademarks
What are Trademarks?
Intellectual property rights that allow firms or others to
differentiate their products and services through the use of
unique “marks”
Marks allow consumers to easily identify the source and quality
of products/services
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FIFTH Edition
Trademarks (cont’d)
Most trademarks take the form of names, words, or graphic
designs
Trademarks also can be on the shape of packages, colors, odors,
and 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
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FIFTH Edition
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”)
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FIFTH Edition
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 ®
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FIFTH Edition
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 ©
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FIFTH Edition
Other Methods for Protecting IP
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
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FIFTH Edition
Seed & Startup Financing
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 rewards
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FIFTH Edition

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