Chapter 7

Preparing a Proper
Ethical and Legal
Foundation
Bruce R. Barringer
R. Duane Ireland

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 Chapter Objectives
1 of 3

1. Describe how to create a strong ethical culture in an

entrepreneurial venture.
2. Explain the importance of “leading by example” in
terms of establishing a strong ethical culture in a
firm.
3. Explain the importance of having a code of conduct
and an ethics training program.
4. Explain the criteria important to selecting an
attorney for a new firm.
5. Discuss the importance of a founders’ agreement.

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 Chapter Objectives
2 of 3

6. Provide several suggestions for how entrepreneurial

firms can avoid litigation.
7. Discuss the importance of nondisclosure and
noncompete agreements.
8. Provide an overview of the business licenses and
business permits that a start-up must obtain before
it starts conducting business.
9. Discuss the differences among sole proprietorships,
partnerships, corporations, and limited liability
companies.

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 Chapter Objectives
3 of 3

10. Explain why most fast-growth entrepreneurial

ventures organize as corporations or limited liability
companies rather than sole proprietorships or
partnerships.

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 Initial Ethical and Legal Issues Facing a New
Firm

Establishing a strong Drafting a founder’s

Choosing an attorney
ethical culture agreement

Avoiding legal Obtaining business Choosing a form of

disputes licenses and permits business organization

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 Establishing a Strong Ethical Culture
1 of 2

• Lead by Example
– The most important thing that any entrepreneur, or team of
entrepreneurs, can do to build a strong ethical culture in
their organization is to lead by example.
• Establish a Code of Conduct
– A code of conduct (or code of ethics) is a formal statement
of an organization’s values on certain ethical and social
issues.

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 Establishing a Strong Ethical Culture
2 of 2

• Implement an Ethics Training Program

– Ethics training programs teach business ethics to help
employees deal with ethical dilemmas and improve their
overall ethical conduct.
– An ethical dilemma is a situation that involves doing
something that is beneficial to oneself or the organization,
but may be unethical.

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Potential Payoffs for Establishing a Strong
Ethical Culture

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• What are the ethicals values of your startup?

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 Video Title: Red Frog Events: Non-Conventional Organizational Structure
Link: http://media.pearsoncmg.com/ph/streaming/bp/2013/MGMT/Entrep/Entrep2012_RedFrog_OrgStructure.html

• 1. Describe the organizational culture of Red Frog Events.

• Red Frog Events has a very nontraditional organizational culture.

CEO and founder, Joe Reynolds, has designed an organization to
attract young, talented employees and provide them with a
collaborative environment that encourages teamwork and
creativity. The office space includes a slide, a rock climbing wall,
two tree houses, and a zip line.
• Reynolds also has an open door policy so that employees feel free
to share new ideas and discuss any problems with him directly.
• Currently the organization is still small enough to accommodate this
structure, but as it grows this will become more difficult, if not
impossible, to maintain.

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• 2. In your opinion, how does Joe Reynolds’ management style
influence the ethical culture of Red Frog Events?
•
• Joe Reynolds has a unique management style. The organization is
designed to exclude all traditional forms of organizational structure
even traditional job titles.
• Reynolds discusses his opinion of how traditional job titles create
barriers between employee cooperation which he wishes to
encourage. The organizational culture of Red Frog Events
emphasizes personal responsibility.
• Alex Yount, Foreman of Festivities, discusses how he was given
significant responsibility for an event from the first day he started
work at Red Frog. So, although there is not a traditional structure,
Joe’s leadership style encourages personal responsibility by his
delegation of authority and decision-making

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 Choosing an Attorney for a Firm

• Select an Attorney Early

– It is important for an entrepreneur to select an attorney as
early as possible when developing a business venture.
– It is critically important that the attorney be familiar with
start-up issues.
• Intellectual Property
– For issues dealing with intellectual property (patents,
trademarks, copyrights, and trade secrets) it is essential to
use an attorney who specializes in this field.

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 How to Select an Attorney
• Contact the local bar association and ask for a list of attorneys who
specialize in start-ups in your area.
• Interview several attorneys.
• Select an attorney who is familiar with the start-up process.
• Select an attorney who can assist you in raising money for your new
venture.
• Make sure your attorney has a track record of completing his or her work
on time.
• Talk about fees.
• Select an attorney that you think understands your business.
• Learn as much about the process of starting a business yourself as
possible.
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 Drafting a Founders’ Agreement

• Founders’ Agreement
– A founders’ agreement (or shareholders’ agreement) is a
written document that deals with issues such as the relative
split of the equity among the founders of the firm, how
individual founders will be compensated for the cash or the
“sweat equity” they put into the firm, and how long the
founders will have to remain with the firm for their shares
to fully vest.

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 What is Sweat Equity?
• DEFINITION of 'Sweat Equity'
• Contribution to a project or enterprise in the form of effort
and toil. Sweat equity is the ownership interest, or increase in
value, that is created as a direct result of hard work by the
owner(s).
• It is the preferred mode of building equity for cash-strapped
entrepreneurs in their start-up ventures, since they may be
unable to contribute much financial capital to their enterprise.
• The term is probably derived from the fact that such equity is
considered to be generated from the "sweat of one's brow.“
• http://www.investopedia.com/terms/s/sweatequity.asp

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 What is Sweat Equity?
• Exemple:
• Consider an entrepreneur who has invested TND 100,000 in her
start-up.
• After a year of developing the business and getting it off the ground,
she sells a 25% stake to an angel investor for TND 500,000.
– What is the new valuation of the startup?
• The business new valuation is TND 2 million (i.e. $500,000/0.25).
– How much is the sweat equity built by the entrepreneur?
• The entrepreneur's share is TND 1.5 million. Subtracting her initial
investment of TND 100,000, the sweat equity she has built up is TND
1.4 million.
• http://www.investopedia.com/terms/s/sweatequity.asp

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Items to Include in a Founders’ Agreement

• Nature of the prospective business.

• Identity and proposed titles of the founders.
• Legal form of business ownership.
• Apportionment of stock (or division of ownership).
• Consideration paid for stock or ownership share of each of the founders.
• Identification of any intellectual property signed over to the business.
• Description of the initial operating capital.
• Buyback clause.

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 Obtaining Business Licenses and Permits
1 of 2

• Business Licenses
– In most communities, a business needs a license to operate.
• Business Permits
– Along with obtaining the appropriate licenses, some
businesses may need to obtain one or more permits.
– The need to obtain a permit depends on the nature and
location of the business.
• If you plan to sell food, you’ll need a city or county health permit.
• If your business is open to the public, you may need a fire permit.

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Choosing a Form of Business Ownership
When a business is launched, a form of legal entity must be
chosen. The most common legal entities are…

Sole Proprietorship Partnership

Limited Liability
Corporation
Company

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