PA R T 3 Moving from an Idea to an Entrepreneurial Firm CHAPTER 7 Preparing the Proper Ethical and Legal Foundation CHAPTER 8 Assessing a New Venture’s Financial Strength and Viability CHAPTER 9 Building a New-Venture Team CHAPTER 10 Getting Financing or Funding 211 Getting Personal with XPLOSAFE Founder: SHOAIB SHAIKH MBA, Spears School of Business, Oklahoma State University, 2009 Dialogue with Shoaib Shaikh FAVORITE PERSON I FOLLOW ON TWITTER Guy Kawasaki WHAT I DO WHEN I’M NOT WORKING Hang out with friends, meet new people, put in a decent workout MY BIGGEST WORRY AS AN ENTREPRENEUR Complacency is not an entrepreneur’s virtue. It is highly recommended to acknowledge and celebrate every milestone or setback but one must pay special attention to not dwell in past successes or failures. MY FAVORITE SMARTPHONE APP Pandora MY ADVICE FOR NEW ENTREPRENEURS Entrepreneurship is all about working as much as you can towards the goals you establish for the venture. It is not about working 8 hours a day for 5 days a week, it is about operating to meet the goals irrespective of the days or the schedule.
CURRENTLY IN MY SMARTPHONE The Black Keys, The Rolling Stones, Beatles, Led Zeppelin, The Who, Pink Floyd, Jimi Hendrix, Warren Zevon, Jay-Z, Eminem, Lil Wayne CHAPTER 7 Preparing the Proper Ethical and Legal Foundation OPENING PROFILE XPLOSAFE Proceeding on a Firm Legal Foundation Web: www.com Twitter: XploSafe Facebook: XploSafe, LLC LEARNING OBJECTIVES I magine the following scenario. You’re next in line to walk through After studying this chapter you should be the metal detector at airport security. Shortly after you walk ready to: through, you observe an interesting scene at the security line next to you. A backpack that passed through the scanning device for 1.
Describe how to create a strong ethical culture in an entrepreneurial venture. carry-on luggage has raised concern. A TSA agent identifies the 2. Explain the importance of “leading by owner of the backpack and pulls the owner along with the back- example” in terms of establishing a pack aside.
The backpack is searched and a bottle of water is strong ethical culture in a firm. Instead of asking the backpack’s owner to throw the 3. Explain the importance of having a code bottle of water away, the TSA agent removes a small bottle from his of conduct and an ethics training program. shirt pocket, opens the bottle, and places two drops of an ink-like substance in the water.
The ink is initially dark blue and starts to 4. Explain the criteria important to selecting an attorney for a new firm. change to pale yellow. The TSA agent immediately alerts a 5.
Discuss the importance of a founders’ uniformed police officer who is nearby. The police officer asks the agreement. owner of the bag to “step aside” and they start moving away. Provide several suggestions for how seconds, you see several other TSA agents and another uniformed entrepreneurial firms can avoid litigation.
police officer gather around the owner of the backpack. Discuss the importance of nondisclosure This scenario may someday happen as a result of work being and noncompete agreements. done by XploSafe, an explosives detection start-up. The ink-like 8.
Provide an overview of the business licenses and business permits that a substance in the product described previously, called XploSens KT, start-up must obtain before it starts contains metal-oxide particles. When the particles come in contact conducting business. with peroxide-based explosives, which are a favorite of terrorists, they 9. Discuss the differences among sole change color alerting authorities to the presence of an explosive.
proprietorships, partnerships, corporations, and limited liability XploSafe now sells a full line of explosive-detection devices, including companies. a spray version of the product described previously, which can be 10. Explain why most fast-growth sprayed on suspicious packages or objects to detect explosives. entrepreneurial ventures organize as The manner in which XploSafe was started, and the work that corporations or limited liability was done to place it on a firm legal foundation, is an interesting companies rather than sole proprietorships or partnerships.
XploSafe was started by Shoaib Shaikh, Jessie Loeffler, and Liviu Pavel, three MBA students at Oklahoma State University. 213 214 PART 3 䊏 MOVING FROM AN IDEA TO AN ENTREPRENEURIAL FIRM The three were part of an honors class and were matched with two scientists who were working on explosive-detection technologies. The students’ task was to write a business plan to commercialize the technology. The three completed the plan in the fall of 2008, which they found fascinating, and in early 2009 entered it into Venture Challenge, a business plan competition hosted by San Diego State University.
While they didn’t advance to the finals, they received positive feedback and encouragement from the judges. Shortly after returning from San Diego, the three met with Dr. Michael Morris, the head of the School of Entrepreneurship at Oklahoma State. Morris encouraged the team and pledged the school’s support, and the three decided to commit to XploSafe and make it a reality.
The two scientists behind the explosive detection technologies are Dr. Allen Apblett and Dr. Nick Materer, both chemistry professors and active researchers at Oklahoma State. At this point, the XploSafe team consisted of the three students, Shaikh, Loeffler, and Pavel, and the two scientists.
All three students graduated in spring 2009. Although the team was eager to move forward with developing products, one thing they realized is that XploSafe needed to be on a firm legal foundation. Here are the steps they took, led by Shaikh, who was emerging as the leader of the group, to establish a firm legal foundation: 䊏 Obtained a Federal Tax ID Number. 䊏 Registered XploSafe as a Limited Liability Company.
䊏 Obtained a business license. 䊏 Obtained an exclusive option to license the technologies underlying XploSafe’s potential products from Oklahoma State University. 䊏 Drafted and executed an operating agreement, between the five cofounders, that laid out how XploSafe would be structured, how it would operate, the equity split between the cofounders, and similar details. 䊏 Obtained the appropriate Internet domain name(s).
䊏 Established a pattern for the type of distribution agreements that would be executed with distributors of XploSafe’s products. 䊏 Drafted prospective nondisclosure agreements. 䊏 Opened a bank account. Shaikh did not take on these tasks on his own.
Part of the process involved finding an attorney who was a good fit for the firm and could help with the items identified previously. XploSafe was based in Stillwater, Oklahoma, the home of Oklahoma State University. Shaikh and his team interviewed four attorneys, one in Stillwater, one in Tulsa, and two in Oklahoma City. They picked the attorney in Tulsa for two reasons.
First, he had the most experience working with start-ups. Second, he agreed to alter his fee structure to charge less at the beginning and more as XploSafe grew and became profitable. With these legal steps completed, XploSafe moved forward. It wasn’t long before the operating agreement, in particular, was needed.
One of the co-founders, Jessie Loeffler, decided to pursue a full-time job and left XploSafe before the operating agreement was signed. The second student cofounder, Liviu Pavel, left shortly after the agreement was signed. His departure was handled consistent with the operating agreement, which he had signed. Fortunately, the operating agreement had clauses in it that addressed how a cofounder’s “exit” would be handled in regard to equity distri- bution and other issues.
Pavel’s exit from XploSafe was handled smoothly and wasn’t a distraction. CHAPTER 7 䊏 PREPARING THE PROPER ETHICAL AND LEGAL FOUNDATION 215 XploSafe is now moving forward on sound legal footing. It routinely utilizes legal documents in everyday business dealings including nondisclosure agreements, mutual confidentiality agreements, and formal agreements with distributors. When needed, the documents are run by an attorney for approval or advice.
It’s also progressing as a business. It’s generating sales, has been awarded a Small Business Innovation Research grant, and has secured sales from customers across the world including NASA, the Department of Energy, and multiple pharmaceutical companies. It is also hoping to play an ever expanding role in the fight against harmful explosives.1 T his chapter begins by discussing the most important initial ethical and legal issues facing a new firm, including establishing a strong ethical organizational culture, choosing a lawyer, drafting a founders’ agreement, and avoiding litigation. Next, we discuss the different forms of business organi- zation, including sole proprietorships, partnerships, corporations, and limited liability companies.
Chapter 12 discusses the protection of intellectual property through patents, trademarks, copyrights, and trade secrets. This topic, which is also a legal issue, is becoming increasingly important as entrepreneurs rely more on intellectual property rather than physical property as a source of a competitive advantage. Chapter 15 discusses legal issues pertaining to franchising. The chapter next discusses the licenses and permits that may be needed to launch a business, along with the different forms of business organization, including sole propri- etorships, partnerships, corporations, and limited liability companies.
INITIAL ETHICAL AND LEGAL ISSUES FACING A NEW FIRM As the opening case about XploSafe suggests, new ventures must deal with important ethical and legal issues at the time of their launching. Ethical and legal errors made early on can be extremely costly for a new venture down the road. And there is a tendency for entrepreneurs to overestimate their know- ledge of the law. In fact, in one study 254 small retailers and service company owners were asked to judge the legality of several business practices.2 A sam- ple of the practices included in the survey is shown next.
Which practices do you think are legal and which ones do you think aren’t legal? 䊏 Avoiding Social Security payments for independent contractors 䊏 Hiring only experienced help 䊏 Preempting potential competition with prices below costs 䊏 Agreeing to divide a market with rivals The first two practices are legal, while the second two are illegal. How did you do? For comparison purposes, you might want to know that the partici- pants in the survey were wrong 35 percent of the time about these four prac- tices. The study doesn’t imply that entrepreneurs break the law intentionally or that they do not have ethical intentions. What the study does suggest is that entrepreneurs tend to overestimate their knowledge of the legal complexities involved with launching and running a business.
As a company grows, the legal environment becomes even more complex. A reevaluation of a company’s ownership structure usually takes place when investors become involved. In addition, companies that go public are required to comply with a host of Securities and Exchange Commission (SEC) regulations, 216 PART 3 䊏 MOVING FROM AN IDEA TO AN ENTREPRENEURIAL FIRM including regulations spawned by the Sarbanes-Oxley Act of 2002. We provide more information about the Sarbanes-Oxley Act in Chapter 10.
Against this backdrop, the following sections discuss several of the most important ethical and legal issues facing the founders of new firms. Establishing a Strong Ethical Culture for a Firm One of the most important things the founders of an entrepreneurial venture LEARNING OBJECTIVE can do is establish a strong ethical culture for their firms. The data regarding 1. Describe how to create a business ethics are both encouraging and discouraging.
The most recent strong ethical culture in version of the National Business Ethics Survey was published in 2009. This an entrepreneurial survey is the only longitudinal study that tracks the experiences of employees venture. within organizations regarding business ethics. According to the survey, 49 percent of the 2,852 employees surveyed reported that they had observed misconduct or unethical behavior in the past year.
Of the employees who observed misconduct, 63 percent reported their observation to a supervisor or another authority in their firm.3 The 10 most common types of misconduct or unethical behavior observed by the employees surveyed are shown in Table 7. While the percentage of employees who have observed misconduct or unethical behavior (49 percent) is discouraging, it’s encouraging that 63 percent of employees reported the behavior.