1.

2. The Organizational Plan McGraw-Hill/Irwin Entrepreneurship, 7/e Copyright 2008The McGraw-Hill Companies, Inc. All rights reserved. Chapter 9 3. Developing the Management Team

The management team is expected:

• To not operate the business as a sideline or part-time venture.

• To operate the business full time and at a modest salary.

4. Legal Forms of Business

Three basic legal forms of business:

• Proprietorship: single owner, unlimited liability, controls all decisions, and receives all profits.

• Partnership: two or more individuals, unlimited liability who have pooled resources to own a business.

• Corporation (C corporation): most common form of corporation, regulated by statute, and treated as a separate legal entity for liability and tax purposes.

New forms of business formations:

• Limited liability company (LLC).

• Limited liability partnership (LLP).

• S corporation.

5. Ownership(1 of 2)

Proprietorship:

• Owner is the individual who starts the business.

• Has full responsibility for the operations.

Partnership:

• General partnership owners and limited partnership owners.

Limited liability partnerships (LLP):

• Partnership is treated as a legal entity.

6. Ownership(2 of 2)

Corporation:

• Ownership is reflected by ownership of shares of stock.

• No limit to the number of shareholders.

S corporation:

• Maximum number of shareholders is 100.

7. Liability of Owners

Sole proprietorship:

• Individual is liable for business liabilities.

Partnership-general:

• Liable for all aspects of the business.

• Amount of personal liability is shared equally.

Partnership-limited:

• Limited partners liable for amount of capital contribution.

Corporation:

• Owners liable only for the amount of their investment.

8. Costs of Starting a Business

Sole proprietorship:

• Filing for a business or trade name.

Partnership-general:

• Partnership agreement, legal costs, trade name filing fees.

Partnership-limited:

• More complex than a general partnership.

Corporation:

• Created by statute, articles of incorporation, filing fees, taxes, fees for states in which corporation registers to do business

9. Continuity of Business

Sole proprietorship

• Death of owner results in the termination of the business.

Partnership-general:

• Death or withdrawal of one of the partners results in partnership termination, unless stipulated otherwise.

Partnership-limited:

• Death or withdrawal has no effect on continuity of business.

Corporation:

• Death or withdrawal has no impact on continuation of business.

10. Transferability of Interest(1 of 2)

Sole proprietorship:

• Entrepreneur has the right to sell or transfer any assets in the business.

Partnership-general:

• Cannot sell their interest without first refusal from the remaining general partners.

Partnership-limited:

• Can sell their interest at any time without consent of the general partners.

11. Transferability of Interest(2 of 2)

Corporation:

• Shareholders may transfer their shares at any time without consent from the other shareholders.

• Disadvantage: It can affect the ownership control

S Corporation:

• Transfer of interest can occur only as long as the buyer is an individual.

12. Capital Requirements

Sole proprietorship:

• From loans or by additional personal contributions by the entrepreneur.

Partnership:

• Loans can be obtained from banks but may require change in partnership agreement.

Corporation:

• Stock may be sold as either voting or nonvoting.

13. Management Control(1 of 2)

Sole proprietorship:

• Entrepreneur is responsible for and has sole authority over all business decisions.

Partnership-general:

• Can present problems if partnership agreement is not concise.

• Usually majority rules unless agreement states otherwise.

14. Management Control(2 of 2)

Partnership-limited

• Separation of ownership and control.

• Limited partners have no control over business decisions.

• Rights of all partners are clearly defined in the agreement.

Corporation:

• Management has control over day-to-day business

• Majority stockholders control major long-term decisions through vote.

• Stockholders can indirectly affect operation by electing someone to the board of directors.

15. Distribution of Profits and Losses(1 of 2)

Sole proprietorship:

• Receive all distributions of profits from the business.

• Personally responsible for all losses.

Partnership-general:

• Distribution of profits and losses depends on the agreement.

• Sharing of profits and losses likely to be a function of the partners investments.

16. Distribution of Profits and Losses(2 of 2)

Partnership-limited

• Protect limited partners against personal liability.

• May reduce share in any profits.

Corporation:

• Distribute profits through dividends to stockholders.

• Losses will often result in no dividends.

17. Attractiveness for Raising Capital

Sole proprietorship

• Limited to capability of owner and success of the business.

• Least attractive for raising capital.

Partnership-general:

• Depends on capability of partners and success of business.

Corporation:

• Most attractive for raising capital.

• Shares of stock, bonds, and/or debt are all opportunities for raising capital with limited liability.

18. Tax Attributes of Forms of Business(1 of 2)

Sole proprietorship:

• IRS treats business as the individual owner.

• All income appears on owners return as personal income.

• Tax advantages:

• • No double tax when profits are distributed to owner.

• • No capital stock tax or penalty for retained earnings.

Partnership-general:

• Tax advantages and disadvantages similar sole proprietorship.

19. Tax Attributes of Forms of Business(2 of 2)

Partnership-limited:

• Has the advantage of limited liability.

• Treated the same as the LLC for tax purposes.

Corporation:

• Can take many deductions and expenses not available to proprietorship or partnership.

• Distribution of dividends is taxed twice.

• Double taxation can be avoided if income is distributed to entrepreneur(s) in the form of salary.

20. Limited Liability Company Vs S Corporation

Venture capitalists prefer LLCs as a form of business entity.

• Popularity has resulted from finalization of the new regulation.

• LLC can be automatically taxed as a partnership, unless the entrepreneur actively makes another choice.

Growth rate of the formation of S corporations has leveled off primarily because of the wide acceptance of LLCs.

21. S Corporation

Combines the tax advantages of the partnership and the corporation.

Passage of the 1996 law loosened some of the restrictions.

In 2004, Congress responded to criticisms of the restrictions on S corporations as compared to LLCs.

• Intent was to make the S corporation as advantageous as the LLC.

22. S Corporation- Advantages

Gains/losses = Personal income/loss.

Limited Liability Protection.

No minimum tax.

Stock transferable.

Stock = Voting or non-voting.

Cash method of accounting.

Long-term capital gains/losses deductible to shareholders.

23. S Corporation- Disadvantages

Some restrictions for qualification.

Potential tax disadvantages.

Most fringe benefits not deductible for shareholders.

Must have calendar tax year.

One class of stock.

Net loss limited to shareholders stock plus loans to business.

No more than 75 shareholders.

24. Limited Liability Company

Partnership/corporation hybrid, laws differ from state to state.

Has members.

No shares issued, each member owns according to articles of incorporation.

Liability = Members capital contribution.

Transfer requires unanimous consent.

Taxed as partnership.

Standard term = 30 years, continuity restricted.

25. Advantages of LLC

LLC liabilities added to partnership interest.

Most States do not tax LLCs.

Ownership not limited to individuals.

Members share income, profit, expense, etc., among themselves.

26. Designing the Organization

This is the entrepreneurs formal and explicit indication to the members of the organization as to what is expected of them.

• Organization structure.

• Planning, measurement, and evaluation schemes.

• Rewards.

• Selection criteria.

• Training.

27. Stages in Organizational Design

28. Building the Management Team and a Successful Organization Culture(1 of 2)

A management team must be able to accomplish three functions:

• Execute the business plan.

• Identify fundamental changes in the business as they occur.

• Make adjustments to the plan based on changes in the environment and market that will maintain profitability.

29. Building the Management Team and a Successful Organization Culture(2 of 2)

Factors to establish an effective team, and in turn a successful organization culture:

• Desired culture must match business strategy outlined in the business plan.

• The workplace must encourage communication from the bottom up.

• Entrepreneur should be flexible enough to try different things.

• Entrepreneur needs to spend extra time in the hiring process.

• Core values and appropriate tools must be provided for employees to effectively complete their jobs.

30. Board of Directors(1 of 2)

Functions of the board of directors:

• Reviewing operating and capital budgets.

• Developing longer-term strategic plans for growth and expansion.

• Supporting day-to-day activities.

• Resolving conflicts among owners or shareholders.

• Ensuring the proper use of assets.

• Developing a network of information sources for the entrepreneurs.

31. Board of Directors(2 of 2)

They must be chosen to meet the requirements of the Sarbanes-Oxley Act and the following criteria:

• Individuals who can work with a diverse group and will commit to the ventures mission.

• Candidates who understand the market environment.

• Candidates who can contribute important skills to the new ventures achievement of planning goals.

• Candidates who will show good judgment in business decision making.

32. Board of Advisors

More loosely tied to the organization.

Serve the venture only in an advisory capacity.

Has no legal status, unlike the board of directors.

Likely to meet less frequently or depending on the need to discuss important venture decisions.

Useful in a family business.

Selection process for advisors can be similar to the process for selecting a board of directors.

33. Organization and Use of Advisors

Usually used on an as-needed basis.

Can also become an important part of the organization.

Need to be managed just like any other permanent part of the new venture.

Even after hiring advisors, the entrepreneur should question their advice.

34. 35. Intellectual Property and Other Legal Issues for the Entrepreneur McGraw-Hill/Irwin Entrepreneurship, 7/e Copyright 2008The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6 36. Intellectual Property

Includes:

• Patents.

• Trademarks.

• Copyrights.

• Trade secrets.

Represents important assets to the entrepreneur.

Should be understood even before engaging the services of an attorney.

37. Selecting a Lawyer

Lawyer may work on a:

• Retainer basis.

• One-time fee.

A good working relationship with a lawyer:

• Eases some of the risk in starting a new business.

• Gives the entrepreneur necessary confidence.

Entrepreneur can offer lawyer stock in exchange for the services.

38. Types of Patents

Patent: grants holder protection from others making, using, or selling similar idea; issued by the PTO.

• Utility patent: grants owner protection from anyone else making, using, and/or selling the identified invention.

• Design patent: provide inventor with a negative right excluding others from making, using, or selling an article having the ornamental appearance given in the drawings included in the patent.

• Plant patent: given for new varieties of plants, represent a limited area of interest.

39. International Patents

The Patent Cooperation Treaty (PCT) was established to provide firms protection in global markets.

• Has over 100 participants.

• Facilitates patent filings in multiple countries in one office.

• Administered by the World Intellectual Property Organization (WIPO) in Geneva, Switzerland.

• Provides a preliminary search that assesses whether filing firm will face infringements in any country.

Significant differences may exists in patent laws in each of these countries.

40. The Disclosure Document

Statement to U.S. Patent and Trademark Office by inventor disclosing intent to patent idea.

• Establish a date of conception of the invention.

• Important when two entrepreneurs file patents on similar inventions.

• Relevant when foreign companies are involved.

To file a disclosure document:

• Prepare a clear and concise description of the invention.

• Include photographs.

• Include a cover letter and a duplicate with the description.

41. The Patent Application(1 of 2)

Introduction

• Background.

• Advantages of the invention and the nature of problems that it overcomes.

• States how the invention differs from existing offerings.

Description of invention

• Description of the drawings that accompany it.

• Detailed description of the invention.

42. The Patent Application(2 of 2)

Claims

• Serve to specify what the entrepreneur is trying to patent.

• Essential parts of the invention should be described in broad terms

• • Claims must not be too general either.

Application should contain a declaration or oath signed by the inventor or inventors.

43. Patent Infringement

Many businesses, inventions, or innovations are results of improvements on, or modifications of, existing products.

Copying and improving on a product:

• May be perfectly legal

• A good business strategy.

Products can be licensed from the patent holder.

Advisable to hire a patent attorney to ensure no possibility of patent infringement.

44. Business Method Patents

Growth of Internet use and software development has given rise to use of business method patents.

• E.g. Amazon.com.

Firms that hold these patents use them to assault competitors.

• Subsequently provide a steady stream of income from royalties or licensing fees.

45. Trademarks

A distinguishing word, name, or symbol used to identify a product.

• Can last indefinitely.

• Can be filed solely on intent to use the trademark in interstate or foreign commerce.

• Can also be filed with intent to use in the future.

Categories:

• Coined marks.

• Arbitrary marks.

• Suggestive marks.

• Descriptive marks.

46. Registering the Trademark(1 of 2)

Federal registration of trademarks PTO.

Filing must meet four requirements:

• Completion of the written form.

• A drawing of the mark.

• Five specimens showing actual use of the mark.

• The fee.

Initial determination of suitability takes 3 months.

• Objections must be raise within six months, or application is considered abandoned.

• Right to appeal in case of refusal.

47. Registering the Trademark(2 of 2)

Once accepted, trademark is published in the Trademark Official Gazette to allow any party:

• 30 days to oppose.

• Request an extension to oppose.

• Registration issued if no opposition is filed.

• Procedure takes about 13 months from initial filing.

48. Copyrights

Right given to prevent others from printing, copying, or publishing any original works of authorship

• Issues surrounding access to material on the Internet have led to major legal battles for the entertainment industry.

• Example: Napster.

Copyrights are registered with the Library of Congress

• Usually do not require an attorney.

• Term of the copyright is the life of the author plus 70 years.

49. Trade Secrets

Protection against others revealing or disclosing information that could be damaging to business.

• Have a life as long as the idea or process remains a secret.

• Not covered by any federal law but is recognized under a governing body of common laws in each state.

Entrepreneur needs to take proper precautions.

Legal action can be taken only after the secret has been revealed.

50. Licensing(1 of 2)

Contractual agreement giving rights to others to use intellectual property in return for a royalty or fee. Type of licensing:

• Patent license agreement: specifies how the licensee would have access to the patent.

• Trademark: involves a franchising agreement.

• Copyrights.

Licensing has become a revenue boom for many Fortune 500 companies.

51. Licensing(2 of 2)

Question to be considered by an entrepreneur:

• Will customers recognize licensed property?

• How well does the licensed property complement my products or services?

• How much experience do I have with the licensed property?

• What is the long-term outlook for the licensed property?

• What kind of protection does the licensing agreement provide?

• What commitment do I have in terms of payment of royalties, sales quotas, and so on?

• Are renewal options possible and under what terms?

52. Product Safety and Liability(1 of 2)

Responsibility of a company to meet any legal specifications regarding a new product covered by the Consumer Product Safety Act.

• First passed in 1972.

• Created a five-member commission with:

• • Power to prescribe safety standards.

• • Responsibility and power to identify substantial hazards and bar products it considers unsafe.

Act was amended and signed into law in 1990.

• Establishes stricter guidelines for reporting product defects and any injury or death resulting from such defects.

53. Product Safety and Liability(2 of 2)

Claims regarding product liability usually fall under one of the following categories:

• Negligence.

• Warranty.

• Strict liability.

• Misrepresentation.

Best protection against product liability is to:

• Produce safe products.

• Warn consumers of any potential hazards.

54. Insurance

Provides a means of managing risk in the new business.

Entrepreneurs usually have limited resources in the beginning.

• Some insurances are required by law and cannot be avoided.

• Other insurances are not required but may be necessary to protect the financial net worth of the venture.

55. Types of Insurance and Possible Coverage

56. Sarbanes-Oxley Act(1 of 3)

Congress passed the Act in 2002.

• Has provided a mechanism for greater control over the financial activities of public companies.

• Has created some difficulties for start-ups and smaller companies.

Under this law:

• CEOs need to vouch for financial statements through a series of internal control mechanisms and reports.

• Directors must meet background, length of service, and responsibilities requirements regarding internal auditing and control.

57. Sarbanes-Oxley Act(2 of 3)

Attempt to influence the auditor or impede the internal auditing process is considered a criminal act.

• Law covers bank fraud.

Passage of this lawhas been of some concern due to:

• Interpretation of this law.

• Subsequent directors liability.

Foreign companies that trade on U.S. stock exchanges often delist.

58. Sarbanes-Oxley Act(3 of 3)

Though private companies are not included, they are subject to control if:

• They consult with a public company.

• Influence that public company in any wrongdoing established by the Sarbanes-Oxley Act.

Entrepreneurs can set up a board of advisors instead of an extended board of directors.

59. Contracts(1 of 2)

A legally binding agreement between two parties.

Business deals are concluded with a handshake, but in case of disagreements, entrepreneurs:

• May find that there is no deal.

• May be liable for something never intended.

Rule is to not to rely on a handshake if deal cannot be completed within one year.

Courts insist on a written contract for all transactions over $500.

60. Contracts(2 of 2)

Four essential items in an agreement to provide the best legal protection:

• All parties involved should be named and specific roles in the transaction specified.

• Transaction should be described in detail.

• Exact value of the transaction should be specified.

• Signature(s) of the person(s) involved in the deal should be obtained.

61. 62. TheFinancialPlan McGraw-Hill/Irwin Entrepreneurship, 7/e Copyright 2008The McGraw-Hill Companies, Inc. All rights reserved. Chapter 10 63. Operating and Capital Budgets(1 of 2)

Developed before the pro forma income statement.

Sales budget: estimate of the expected volume of sales by month.

• Cost of sales can be determined from the sales forecasts.

• In manufacturing ventures: costs of internal production or subcontracting are compared.

• Includes estimated ending inventory required as a buffer.

64. Example of a Manufacturing Budget

65. Operating and Capital Budgets(2 of 2)

Operating costs:

• List of fixed expenses incurred regardless of sales volume.

• Variable expenses must be linked to strategy in the business plan.

Capital budgets provide a basis for evaluating expenditures that will impact the business for more than one year.

66. Example of an Operating Budget

67. Pro Forma Income Statements(1 of 2)

Pro forma income: projected net profit calculated from projected revenue minus projected costs and expenses.

Sales by month is calculated first.

• Basis of the figures: marketing research, industry sales, and some trial experience.

• Forecasting techniques may be used.

New ventures take time to build up sales.

Projections of all operating expenses for each of the months during the first year should be made.

68. Pro Forma Income Statements(2 of 2)

Increasing selling expenses as sales increase should be taken into account.

Changes in expenses during the first year can necessitate month-by-month illustration.

Increase in individual expenses need to be reflected in the first years pro forma income statement.

Projections should be made for years 2 and 3 as well.

69. Example of a Pro Forma Income Statement

70. Pro Forma Cash Flow(1 of 2)

Projected cash available calculated from projected cash accumulations minus projected cash disbursements.

• Not the same as profit.

• Sales may not be regarded as cash.

• Cash flow is a major problem faced by new ventures.

• Use of profit as a measure of success for a new venture may be deceiving.

Two standard methods used to project cash flow:

• Indirect method.

• Direct method.

71. Statement of Cash Flows: The Indirect Method

72. Pro Forma Cash Flow(2 of 2)

Entrepreneurs must make monthly projections of cash.

Difficulty with projecting cash flows is determining the exact monthly receipts and disbursements.

Cash flow statement is based on best estimates.

73. Example of a Pro Forma Cash Flow

74. Pro Forma Balance Sheet

Pro forma balance sheet: summarizes the projected assets, liabilities, and net worth of the new venture.

• A picture of the business at a certain moment in time.

• Does not cover a period of time.

Consists of:

• Assets: items that are owned or available to be used in the venture operations.

• Liabilities: money that is owed to creditors.

• Owners equity: amount owners have invested and/or retained from the venture operations.

75. Example of a Balance Sheet

76. Break-Even Analysis

Break-even: volume of sales where the venture neither makes a profit nor incurs a loss.

Break-even sales point indicates the volume of sales needed to cover total variable and fixed expenses.

Major weakness in calculating the breakeven lies in determining if a cost is a fixed or variable.

77. Graphic Illustration of Breakeven

78. Pro Forma Sources and Applications of Funds

Sources

• Operations.

• New investments.

• Long-term borrowing.

• Sale of assets.

Uses/ Applications:

• Increase assets.

• Retire long-term liabilities.

• Reduce owner or stockholders equity.

• Pay dividends.

79. Example for Sources and Applications of Funds

80. Software Packages

A spreadsheet program (Microsoft Excel) is most suitable for completing pro forma statements.

• Helps present different scenarios and assess their impact on the pro forma statements.

• A simple and easy to use software is useful in the start-up stage.

Software packages vary in price and complexity.