Aspects of Entrepreneurship
Professor Stephen Goodman
Starting a New Business
Preliminary Considerations for Entrepreneur
Whether it is financially, professionally and personally worthwhile to start a business.
o Joint Ventures – No statutory requirements for formation. Usually include active participation by all involved. Very flexible in form, can be contractual or as a complex partnership.
o Sole Proprietor – the basic non-corporate form that an individual may use to operate a business.
§ Simple to start or finish but poses difficulty in transfer of business and in estate planning. Limited income tax savings and no personal liability protection. Not a separate legal entity from the entrepreneur.
o Employment – Seek employment at a business entity.
§ Send business plan or executive summary – enough information to evaluate the needs of the client
§ Will initially help determine appropriate form for the entity and sets it up.
§ Once the entity is formed the attorney should request clear guidance on who the client is; entrepreneur or the corporate entity.
§ Engagement agreements and conflicts of interest check
o Accountant – Can aid in determining business structure from a tax, investment and employment perspective.
Initial Client Interview
Entrepreneur can describe ideas, goals and prospects / Attorney can assess them.
Consider prior experience of entrepreneur, the industry focus, and should review the relevant business and legal information
Attorney may want to prepare a checklist of information to discuss.
Should the entrepreneur launch the business alone or as a joint venture? Experience.
Planning for Management and Control
Control Structure – How financial and control elements of business will be constructed.
o Allocation of Financial Interests
§ Founders usually purchase equity in the business for cash or contributions of assets or services, may also allocate financial interest as debt.
§ Must determine how additional financial interests will be allocated.
§ Allocating financial interests as equity allows raising of capital and offers an ownership interest. Disadvantage is that owners are diluted by subsequent issuances of equity.
§ Ultimately decided by client.
o Allocation of Control
§ In the absence of some type of contractual arrangement, the shareholders control the corporation; Or the general partner in a partnership; or all the partners in an LLC partnership
§ Control measures may be supplemented via shareholder agreements such as voting agreements, voting trusts or similar arrangements.
o Retaining Control
§ Control may be managed by restricting how a shareholder or note holder disposes the interest acquired.
§ In the case of debt→ Corp can make the promissory note non-transferable to another lender.
§ In the case of equity→ Contractual arrangements that allow shareholder to only transfer their interests in limited circumstances.
§ Essential to have a strong and competent management team → provides face to investors and clients.
§ Not all entrepreneurs make good managers – may have to cede control.
Arrangements Prior to Forming Business Entity
Formation expenses may be substantial – usually repaid to entrepreneur or compensated via an ownership interest.
o Any repayment should be well documented by directors.
Pre-Formation subscription agreements – formation of an agreement to subscribe for an ownership interest in the proposed entity before formation.
o Not usually necessary, may be needed if an investors commitment is suspect.
o Subject to corporate securities laws.
Pre-formation transactions by entrepreneurs – Organizers enter into a contract or commitment that will be required of the business entity before it is formed.
o Business entity may be liable for the goods and services if it ratifies the contracts or commitments (express or implied).
o Promoters may remain personally liable, should seek indemnification from the business entity for pre-formation commitments made on its behalf.
I. Exiting current employment arrangement
Potential showstopper. Need to find out if there is an employment agreement. Is there a non-compete or non-solicitation of employment? Confidentiality? Disclosures? Inventions?
With an at-will employment contract there are generally no notice requirements before termination.
Common Law Duties and Obligations:
o Employer may have cause of action for breach of common law duties of loyalty. Duty not to do something to intentionally harm the employer (stealing information, time from employer).
o Give employer your full time and attention, fulfill obligation to employer.
o If using company email, computer, etc, this is company hardware and software that employer paid for and can search.
o Employer will need to show specific harm such as losing customers or employees to bring breach of duty of loyalty claim.
o Determined on case by case basis
Assignment of inventions and original works
Non-competition and non-solicitation
o Elements in deciding to enforce covenant not to compete:
§ Reasonableness–Clause or contract must be reasonable in a number of components:
§ Protectable interest in preventing employee from going to the next job – determined on a case-by-case basis. Needs to be some similarity to new job.
§ In scope of agreement – geography/territory; time; scope of business; product line.
o Should be detailed about the nature of the business.
§ If overbroad, court may void it but usually will “blue-pencil” (revise) it.
o Courts most likely to intervene if solicitation of customers against non-solicitation agreement. May allow going to work for competitor but not allowed to go near certain customers.
Solicitation can be potentially inducing breach of contract by other employees who have covenant not to compete. This is a tort.
Potential business disparagement claims if say bad things about employer to other employees.
Remedy? Likely to be an injunction. Employer does not want to create precedent.
o Show irreparable harm
o Employer cannot sit on its rights. Doctrine of laches. The longer employer waits to try to enforce rights, the stronger the argument for the defendant because if this would cause irreparable harm, then employer should have tried to get injunction right away.
II. Introduction to Intellectual Property Issues; “Freedom to Operate”
Need to be sure there is freedom to operate and not infringing on another’s rights. Have to make sure that technology you will use is free from impediments and obstacles. Need to get technology free of current employer, make sure you can establish ownership, select the right way to protect it and how to mark it. Need to establish that you own and is free of other’s intellectual property.
Ø Patent: grant of property right to inventor issued by PTO. Term of new patent is 20 years.
o Confers right to exclude others from making, using, offering for sale, or selling the invention.
o Must disclose to the public what you are protecting – disclose how to make and use your invention; in return, if it is patentable you get “limited monopoly”
o Scope of protection: right to exclude others from making, using or selling a product which covers the invention, as defined by the claim. No right to make, use or sell the invention.
o Finite duration; currently 20 years from filing date.
o Utility *of greatest concern to us*: Term: 20 Years from filing; Scope Requirement: New and useful process (including business methods and software), machine (traditional machines and computer systems), manufacture (electronic components, any non-machine) or composition of matter (chemical compositions, genes, modified organisms), or any improvement thereof.
· Useful – very low bar
· Must be within statutory subject matter (process, machine, manufacture or composition of matter).
· New (novelty) – different from what is known in the field. Not new if ALL of the invention’s elements are present in a SINGLE prior art reference.
· Non-Obvious – from the perspective of a person of ordinary skill in the art (POSITA). Obvious if ALL elements are present or suggested in the prior art (need not be in a single source) and there is a suggestion to combine into one invention.
o Design: Term: 14 Years from date of issue; Scope: new, original, ornamental designs for articles of manufacture
§ Protects ONLY the appearance, not functionality.
§ Requirements: New, Original, Ornamental (purely decorative) and Non-obvious
o Plant: Term: 20 Years from filing; Scope: distinct, asexually reproducing varieties of new plants; Requirements: New, Useful and Non-obvious
Ø Trademark: used to indicate the source of goods and to distinguish them from the goods of others. Used to prevent others from using same or similar mark, but not to prevent others from making or seling the same goods under a clearly different mark. Thinks generic drugs.
Ø Copyright: form of protection provided to authors of “original works of authorship.” Protects the form of expression rather than the subject matter of the writing. Exam
y to valuation
o Copies of patents and applications owned by or licensed to the target company
o Copies of patentability searches/opinions relevant to target company’s patents
o Copies of freedom to operate searches and opinions
o Copies of material IP agreements (licenses) or other technology transfer agreements
o Access to technical and legal personnel involved with the target company
Ø Benefits of Freedom to Operate and Patent Due Diligence
o Adds tremendous value to an entity
o Identify possible vulnerabilities and possible solutions to solidify patent position
o Use intelligence gathered during due diligence to add value to target company post closing of funding or other transaction
o Confirm patent strategy
Ø Identify competitor
III. Entity formation
Note: Delaware is choice jurisdiction for formation.
SEE COMPARISON CHART OF BUSINESS ENTITIES!
(1) Management and Control
a. Corporation – central management; BOD serves monitoring function; officers run business day-to-day; stockholders vote to elect board and for major corporate events; mtings, minutes and resolutions are required on a regular basis
i. useful if business will be conducted in multiple jurisdictions or if more than one type of biz will be conducted; may make sense if biz is expected to continue beyond the initial principals; benefits, however, may be outweighed by the formalities, admin and legal requirements to be followed, and double taxation
b. Partnership – all partners have equal right to manage partnership; partnership agreement may narrow scope of business; each partner has right to terminate partnership upon disagreement w/ any other partner
c. Limited Partnership – managed by one or more general partners (GP’s); limited partners (LP’s) cannot participate in management w/o incurring liability
d. LLC – highly flexible, easy from admin standpoint; can be either member managed (functions like P’ship) or manager managed (functions like Corp.); operating agreement can narrow scope of business and limit rights of member; but, lack of case law and precedent, so may be less desirably if you want certainty wrt legal and tax ramifications of LLC transactions
a. Corporation – limited liability
b. Partnership – unlimited liability; joint and several
c. Limited Partnership – limited liability for LPs, unless they take part in mgnt
d. LLC – limited liability
i. The most protective types of biz entities are LLCs and Corps
*LP’s, Director/Officers, members, however, may be personally liable for tortious conduct or breaching duties
(3) Transferability of Interest
Not generally a significant factor in determining choice of entity
a. Corporation – most transferable interest; especially if stock traded on a public exchange; provides the most flexibility in allowing varying control and types of stocholders’ equity in the corp;
b. Partnership – least transferable interest; bc of unlimited liability, transfer of full interest requires unanimous consent of other partners; however, economic rights to P’ship distribution are transferable; transfer of interest may have adverse tax consequences in the form of a “stepped up” basis of the partnership’s assets
c. Limited Partnership – economic interest is transferable; voting right not transferable unless provided in agreement; need at least 1 LP and 1 GP; attractive to income-seeking investors who do not want to manage the biz
d. LLC – economic interest transferable; voting right not transferable unless provided in charter