Navigating Legal and IP Issues Entrepreneurship: The Practice and the. Learning Objectives. Notable Quote. Useful Online Legal Sources

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1 Navigating Legal and IP Issues Entrepreneurship: The Practice and the Mindset by Heidi M. Neck, Christopher P. Neck and Emma L. Murray Learning Objectives Discuss how legal considera1ons can add value to entrepreneurial ventures. Explain the most common types of legal structures available to startups Outline the most common legal errors made by startups. Define IP and how it affects entrepreneurs. Assess the global impact of IP theb. Iden1fy the common IP traps experienced by entrepreneurs. Explain the legal requirements of hiring employees. Notable Quote If you desire informa1on on some point of law, you are not likely to ponder over the ponderous tomes of legal writers in order to obtain the knowledge you seek, by your own unaided efforts. -Felix Adler, Professor of Poli1cal and Social Ethics. Useful Online Legal Sources Business.gov IRS.gov Securi1es and Exchange Commission (sec.gov) Department of Labor (dol.gov) NOLO Press (nolo.com) Entrepreneurship.org Critical Thinking Questions Laws differ from state to state. How would you go about ensuring your startup was legally set up? What steps would you take to protect your product/service from being copied by compe1tors? Types of Legal Structures

2 Sole Proprietorship General Partnership C Corpora1on (C-Corp) S Corpora1on (S-Corp) Limited Liability Company (LLC) Limited Partnership and Limited Liability Partnership (LP and LLP) Sole Proprietorship One owner Unlimited liability Simple to start A sole proprietorship refers to a person who owns a business but has not formed a separate en1ty to run it. This is the simplest and most inexpensive form of legal structure for startups, but it is rarely the correct choice. It means the business is completely managed and controlled by you, the owner, and that you are en1tled to all the profits your business makes. However, it also means you are personally exposed to all the risks and legal responsibili1es or liabili1es of the business. The main reason why sole proprietorship is the most common choice of business structures is simply that many entrepreneurs are not well versed in the legali1es. But many large organiza1ons began as sole proprietorships; for example, ebay was a sole proprietorship owned by founder Pierre Omidyar for three years before he joined with other partners. Successful Entrepreneurs Who Started Out as Sole Proprietors Gaebler.com h]p:// retrieved on August 2, 2015 General Partnership Two or more partners Unlimited and joint liability A general partnership involves two or more people who have made a decision to manage and share in the profits and losses of a business. Like a sole proprietorship, sebng up a general partnership is rela1vely low-cost and straighcorward. As each partner reports profits and losses on individual tax returns rather than the corporate level, a process called pass-through taxa1on, taxes are also paid at your personal income tax rates.

3 For example, say you and your business partner decide to open a café. To qualify for general partnership legal status, you and your partner must be involved in the business, and contribute towards sebng up and paying the costs of running the café. You and your partner will split the profits and losses between you. C Corporation Stockholders, Directors, and Officers Limited liability Taxable en1ty Poten1al double tax on dividends A C corpora0on (some1mes known as a C-corp ) is a separate legal en1ty created by the state government and owned by an unlimited number of shareholders. This means that the corpora1on, not the shareholders, is legally liable for its ac1ons. The most money that shareholders can lose is their personal investment the value of their stock. Another advantage to the c-corpora1on is transferable ownership, which means it can issue shares of stock to investors in exchange for capital. In addi1on, because the corpora1on is a separate en1ty, it benefits from con1nuous existence, which means that it will s1ll survive aber the demise of its owners. This allows the corpora1on to plan for the future. S Corporation Stockholders, Directors, and Officers Limited liability Subject to eligibility requirements An S corpora0on (some1mes known as an S-Corp ) is a corpora1on whose stockholders elect special treatment for income tax purposes. For all other purposes, it is iden1cal to a C corpora1on. In order to qualify as an S-Corp, the corpora1on must be a US domes1c corpora1on, and have no more than 100 shareholders who in most cases must be individual US ci1zens or legal immigrants (not corpora1ons, partnerships or trusts) and all of whom must own only one class of common stock (ordinary shares). Unlike the C-corp, the S-corp does not have to deal with double taxa1on, as there is only one level of tax to pay. Similar to a partnership, the income and losses are passed through to the company s shareholders tax returns and taxed at the individual rates. This is especially a]rac1ve for corpora1ons expec1ng to lose money in the short term as such losses will offset other income earned by shareholders, ac1ng as a so-called tax shelter. S-

4 Corps oben consider a later switch to C-Corp status because their growth may be limited by the restricted number and types of shareholders permi]ed. Another reason for switching to C-Corp status is the fact that an S-Corp s future retained earnings would be taxed to stockholders as so-called phantom income earnings are taxed but not received by the individual. Limited Liability Company Members and board of managers (op1onal) Limited liability May elect to become taxable en1ty A limited liability company is business structure which combines the pass-through taxa1on aspects of a partnership with the limited liability benefits of a corpora1on without being subject to the eligibility requirements of an S corpora1on. This means that profits and losses are reported on individual tax returns, therefore double taxa1on does not apply and there is poten1al tax sheltering from losses while personal assets are protected. Modern limited liability company statutes allow LLCs to have con1nuous existence similar to corpora1ons. And just as with partnerships and corpora1ons, it is advisable for the LLC s owners (called members ) to enter into ownership agreements, oben contained within an opera1ng agreement which serves the combined purposes of bylaws and stockholder agreements in corpora1ons. LLCs are rapidly replacing S corpora1ons as the en1ty of choice for many startup businesses. Flexground, featured in Entrepreneurship in Ac5on, is made up of four different companies, three of which are LLCs (FlexGround LLC and FlexGround Products LLC in Arizona and FlexGround Nevada in Nevada). Limited Partnership General partners and Limited partners Unlimited liability for general partners Limited liability for limited partners Pass- through taxa1on Limited partners prohibited from management There are a variety of other forms of business en1ty which may be used in certain circumstances. One example is the limited partnership, a pass-through tax en1ty made up of two kinds of partners: general partners, who manage the business but have personal

5 exposure for its liabili1es; and limited partners, who are essen1ally silent investors but are protected from liabili1es. Recently, however, the limited partnership has been largely replaced by the limited liability company. It acts as a pass-through en1ty, grants limited liability to all members, and does not prohibit any member from gebng involved in management. Limited Liability Partnership Two or more partners Limited liability with some restric1ons Typically professional prac1ces Another example is the limited liability partnership. This is essen1ally a general partnership which, in exchange for registering with the state and paying an annual fee, gets a form of limited liability for its partners. However, the partners are s1ll not protected from the consequences of wrongful acts commi]ed by themselves and in some cases by their employees. This form is popular generally only among firms of licensed professionals, such as lawyers and accountants, who want to avoid classifying their partners as employees of the business. This means that these employers do not have to comply with employment laws and regula1ons (such as mandatory or enforced re1rement). BeneDit Corporation Stockholders, Directors, and Officers Limited liability Either C-Corp or S-Corp Charter sets social purpose In Chapter 1, we men1oned a benefit corpora0on (or B corpora1on) as a form of organiza1on cer1fied by the nonprofit B Lab, which ensures that strict standards of social and environmental performance, accountability, and transparency are met. B Lab cer1fica1on ensures that the for-profit company fulfils its social mission. It is available to businesses opera1ng as any one of the business en11es men1oned above (not just corpora1ons). In addi1on to the B Lab cer1fica1on, many states have enacted statutes crea1ng a new form of business en1ty also called a B or Benefit corpora1on which is not subject to the fiduciary obliga1ons of other business corpora1ons. A B corpora1on must jus1fy all their ac1ons as contribu1ng ul1mately to increased shareholder wealth.

6 See e.g., California Corpora1ons Code Sec1ons 2500 et seq. and Massachuse]s General Laws Ch. 156E. Most Common Legal Mistakes Choosing the correct business structure Accep1ng free advice from family and friends Unclear or missing wri]en agreements Ves1ng schedule Richard Harroch, 10 Big Legal Mistakes Made by Startups, Forbes (October 3, 2013) h]p:// retrieved on August 4, 2015 Four Types of Intellectual Property (IP) Copyright Trademark (and service mark) Trade secret Patent Critical Thinking Questions How would you protect your startup against patent trolls? 2. Do you think individuals or firms have the right to hold patents without producing any useful products of their own? Why or why not? 3. What are the effects of patent trolls on startups? Resources for IP Information US Patent and Trademark Office US Copyright Office Invent Now Google Patents Pat2PDF Inventors Digest Patent Wizard Patent Pro

7 Adapted from Jonathan Blum, How to Protect Your Intellectual Property Rights Entrepreneur (July 26, 2011) h]p:// retrieved on August 2, Common IP Traps Publicly disclosing innova1ons Failure to protect product and processes Inability to determine originality Failure to assign ownership Failure to protect IP in global markets Legal Requirements for Hiring Employees Equal Employment Opportunity Employer Iden1fica1on Number (EIN) Unemployment and Workers Compensa1on Withholding Taxes Employee Forms Benefits Workplace Posters Safety Measures Critical Thinking Questions Why is it important to protect intellectual property? 2. Whose responsibility is it to protect intellectual property? 3. When is the best 1me to apply for intellectual property protec1on? Resources for Hiring Employees Types of Workers Employees Contractors Unpaid Interns

8 Volunteers The thought of receiving the services of enthusias1c young interns looking for work experience rather than financial compensa1on can be very a]rac1ve to the resourceconstrained startup. However, bear in mind that such arrangements are generally illegal. The Fair Labor Standards Act provides a minimum wage, over1me pay and other protec1ons to most workers. Pubng an intern to work in your business normally requires compliance with these requirements. The Department of Labor has directly addressed the issue of unpaid interns and published a 6-part test to determine its legality. In summary, the internship must be solely for the benefit of the intern s educa1on, the services provided must be of a kind which do not displace other employees, and the employer must not benefit from the arrangement. Many companies demand that the intern receive academic credit from an educa1onal ins1tu1on as a way of complying with regula1ons, but even in that case the intern s services must not benefit the company or replace du1es which could be provided by paid employees. United States Department of Labor Wage and Hour Division Fact Sheet #71: Internship Programs Under the Fair Labor Standards Act Hire a Contractor or an Employee, US Small Business Associa1on h]ps:// content/hire-contractor-or-employee retrieved on August 2, 2015.