Chapter 13 Legal and regulatory challenges for entrepreneurial ventures Objectives 1. To introduce the importance of legal and regulatory issues to entrepreneurs 2. To review the regulatory environments of the Asia-Pacific within which a new venture must exist 3. To examine intellectual property protection, including copyright, patents, trademarks and domain names 4. To recognise the important international protection regimes for intellectual property 5. To critically examine the IP practices of AsiaPacific countries Objectives 6. To compare the common legal forms of business organisation in the Asia-Pacific, such as sole proprietorship, partnership and corporation 7. To examine the trend for environmental regulations that will affect business entrepreneurship But first ? Brainstorm all of the potential legal issues you should consider as an entrepreneur. Four legal and regulatory challenges Regulatory regimes that impact ease of doing business How to protect intellectual property Under what legal form to incorporate the firm Regulations concerning climate change and global warming Location, location, location What makes Australia a global leader in wine exports? What made Malaysia a world leader in palm oil production? How did New Zealand make it to global ranks in the creative industries? What propelled South Korea into the forefront in electronics? Asia-Pacific regulatory environments The amount and nature of regulation across the region is characterised by extremes. Doing business in the Asia-Pacific is generally getting better, at least for start-ups. Asia-Pacific regulatory environments Asia-Pacific regulatory environments Source: International Finance Corporation & the World Bank (2012) Example variation in regulation Starting a business - In Australia, a new business can be started in two days; in the Sultanate of Brunei it takes on average 101 days. Licensing and permits - In New Zealand construction there are six procedures to build a standard warehouse; there are 34 in India. Example variation in regulation Tax rates - In Hong Kong the company tax applied to profits is 23%; and in Sri Lanka is 105%. International trade - Due to 'red tape' (administrative tasks), it takes on average four days to import a container into Singapore, and 20 days into India. Instability and corruption Entrepreneurs need to be aware of the potential impact of political instability and corruption. Frequent government changes often result in frequent changes in regulations. It is possible, but more difficult, to do business in a country with transitory governments or inconsistent policies. Intellectual property (IP) ? What is 'intellectual property'? What actions are prohibited under intellectual property laws? IP theft and piracy Growth of IP theft and trade in fakes and pirated materials threatens innovative and creative economies. Tension: - Owners of IP are working to secure their old entitlements and pushing for increasingly restrictive laws and enforcement. - Vast parts of the world are removing IP and setting up offshore havens for infringers. IP theft and piracy World Health Organisation estimates 10% of medicines sold in developing countries are counterfeit. The National Committee on Intellectual Property Rights in the Philippines reported seizing US$189.75 million worth of counterfeit goods in 2011. IP and the entrepreneur Ideas and knowledge are a global trade. IP is the engine that drives economy. IP provides the ability to earn from invention - and entrepreneurs need an incentive to create. IP and the entrepreneur Entrepreneurs can: - obtain and exploit IP from abroad - protect their IP abroad, including negotiating payment for using their IP. Many of the creators and inventors of IP consumed in the Asia-Pacific are located overseas. International protections World Trade Organization (WTO) agreements and Trade-Related Aspects of Intellectual Property Rights (TRIPs) Berne Convention for the Protection of Literary and Artistic Works World Intellectual Property Organization (WIPO) treaties Patent Cooperation Treaty (PCT) Types of IP rights Patents Contract between society and an inventor A temporary monopoly on the invention Exclusive rights to hold, transfer and license For products or processes that are 'new, involve an inventive step and are capable of industrial application' Granted through registration under national laws of individual countries Patents - weigh up the value Weigh the value of the innovation against time and money to obtain the patent Patents are not a fool proof system and can be contested, which presents risks: - Patents can be declared invalid - An alleged breach of rights may not be upheld - Those bringing suit against the patent holder may show that patent rights were misused. Patents - guidelines 1. Create an IP-protective environment to minimise the risk of losing IP being able to apply for protection. 2. Pursue patents that are broad, are commercially significant and offer a strong position. 3. Prepare a patent plan in detail. Patents - guidelines 4. Take actions related to your original patent plan. 5. Establish an infringement budget. 6. Evaluate the patent plan strategically. Copyright Granted automatically Protection of literary or artistic works (including software) Not possible to copyright an idea, just the way an idea is expressed Typically extends 50 to 70 years after death of author Rights under copyright can be transferred Copyright protection Must be in a tangible form (written or recorded) Must be the author's own work Before bringing a lawsuit, register with the National Copyright Office of the resident country 'Fair use' or 'fair dealing' provisions exist Normal remedy is recovery of actual damages plus any profits the violator receives Always use the copyright notice (), although you are automatically protected Trademarks A distinctive name, mark, symbol or motto identified with a company's product(s) May be registered at the National Trademark Office Types of 'marks' Trademarks identify and distinguish goods. Service marks identify and distinguish services. Certification marks denote quality, materials or other aspects of goods and services and are used by someone other than the mark's owner. Collective marks are trademarks or service mark used by members of groups or organisations to identify their goods and services. Advantages of listing Nationwide notice of the owner's right to use the mark - It is still recommended to mark the goods or services with the symbol. Protection against importers using the mark. In some countries (in the US, but not Australia), the mark is incontestable after five years. Avoiding trademark pitfalls 1. Always do a trademark search first 2. Trust the advice of your lawyer 3. Seek a coined or a fanciful name or mark over a descriptive or highly suggestive one 4. Select a distinctive logotype for descriptive or suggestive words 5. Avoid abbreviations and acronyms 6. Ensure that use is made of the trademark 7. Monitor use to ensure it is not used descriptively to avoid invalidation (e.g. Hoover) Domain names Internet domain names are important business identifiers. 'Cyber squatters' offer domain names for sale back to the rightful owner under trademark laws. Uniform Dispute Resolution Policy (UDRP) is for disputes, but has been accused of favouring large corporations. Trade secrets Business processes and information that are: - unpatentable - patentable but not enforceable - patentable but you do not wish to disclose them. For example, customer lists, pricing information and production techniques. Trade secrets Protection is only possible with employer and employee diligence. Often based on discoveries or inventions that could be patented, but the owner has chosen to keep the discovery or invention secret (e.g. the formula for Coca-Cola). Under the law Information is a trade secret if: 1. it is not known by the competition 2. the business would lose its advantage if the competition were to obtain it 3. the owner has taken reasonable steps to protect the secret from disclosure. Changing IP attitudes Advances in technology have opened up whole new areas of patentable products - e.g. biotechnologies and computer software. Technology development is making it increasingly difficult to enforce many conventional forms of intellectual property - e.g. MP3 file-sharing on the Internet. Changing IP attitudes Responses: - Toughening protection to halt piracy and the decline in revenues and profits for established firms - The creation of new business models such as Apple's iTunes Time for a radical rethink of traditional IP? Alternative approaches Australia and India sidestep agriculture patents of large American multinationals to develop competitive technologies - leaving the intellectual property open and unrestricted India is skirting patents to create generic AIDS drugs that are much less expensive than those of the transnational drug companies Entire nations (for example, China) are leaving Microsoft and installing open-source operating systems ? Legal structures for entrepreneurial ventures What kinds of legal business structures are you aware of? Legal structures for entrepreneurial ventures Incorporation is the creation of a company or corporation. Other (unincorporated forms) include: - - - - - Sole trader Partnership Trading trust Cooperative Non-profit organisation. Legal structures for entrepreneurial ventures A legal structure must be chosen. Choosing a legal structure is complicated and involves consideration of a range of factors. Important factors Asset protection - Risk to personal assets Limited liability - Personal liability for debts Distribution flexibility - Different types of payment to different participants Financing - Ease of future financing Important factors Taxation - Minimising tax burden Business environment - Regulatory approval systems and technological risks Personal and community relationships - Shared ownership Incorporated companies An incorporated company has similar legal rights and obligations to 'a natural person'. Incorporation gives legal form to a 'company'. A variety of terms: GmbH, Ltd, LLC, LLP, Pty Ltd, PLC, etc. The term Inc. is used in the USA to signify an incorporated company; in Australia it refers to an incorporated (not-for-profit) association. Limited liability companies Two common forms: - Private company (in Australia uses Pty Ltd) - Public company (in Australia uses Ltd) A private company cannot legally offer its shares to the public. Private companies In the event of bankruptcy, losses are limited to the assets of the company. In theory, individual directors do not go bankrupt. In practice, directors are liable if they allow the company to trade knowing it cannot meet its debts Also, creditors and banks often require directors' personally guarantee before opening trading accounts. Most businesses (particularly small ones) are private companies. Advantages of private companies Limited liability of shareholders Separate legal entity May enter into agreements Retained profits are taxed at company tax rate Ease in attaining ownership (by acquiring shares) Ease of ownership change Advantages of private companies Additional capital is more easily available Shares are transferable Controlled authority of shareholders (by share type) Continuity of the company's existence Disadvantages of private companies High set up, administrative and operating costs Increased statutory requirements Revenue and capital losses must be retained by the company - these cannot offset the owners' incomes Public companies Shares may be offered for sale to the public. Ltd or PLC status is roughly equivalent to a US corporation. Many float (so shares can be traded) Statutory requirements on public companies are more rigorous than private companies. Public companies Advantages Those of a private company, plus ... Increased potential for raising finance by share issues or through other investors Disadvantages Most expensive to set up More open to hostile takeover (if publicly traded) Tighter levels of regulation Minority shareholders have no real control 49 Quasi-incorporated businesses Limited partnerships - Capital investment - No responsibility for management and no liability for losses beyond initial investment Limited liability partnership - Liability of a partner limited to their financial contribution - Common in oil exploration and motion picture ventures Incorporated limited partnership - Flexible investment vehicles for venture capital and private equity investors Unincorporated businesses Sole tradership (sole trader) Partnership Sole traderships A business owned and operated by one person (also known as 'sole proprietor'). No legal existence independent of its owner. Individual has a right to all of the profits and liability for all the debts. Liability is unlimited. Business and personal assets stand behind the operation. Advantages of sole traderships Ease of formation Inexpensive business structure Least government reporting Losses reduce personal taxes Sole ownership of profits Not required to share profits Decision making in one owner Advantages of sole traderships Relative freedom from governmental control Freedom from corporate taxes Proprietors taxed as individuals Easy to wind up Disadvantages of sole traderships Few tax concessions Personal tax rate may be high Unlimited liability Personal responsibility for debts Lack of continuity Lack of personal freedom Disadvantages of sole traderships Few holidays/no one to run business Less available capital Relative difficulty obtaining long-term financing Depends on one person's ability Partnerships Group of people: - Contribute time, talents and money - Share the responsibilities and profits Potentially difficult interpersonal dynamics Written agreement is preferable to oral agreement Advantages of partnerships Ease of formation Direct rewards Flexibility over sole tradership Responsiveness over sole tradership Relative freedom from governmental control Confidentiality regarding profits Disadvantages of partnerships Few tax concessions Unlimited liability of at least one partner Lack of continuity Relative difficulty obtaining large sums of capital Bound by the acts of just one partner, which obligate all partners Other business forms Trading trust - Operates as a business - Can pay profits to beneficiaries who do not work in the business Cooperative society - Main difference is dividend distribution - Operates on a service motive Other business forms Charitable trust - Non-profit corporation (or 'not-for-profit') religious, charitable or educational organisation - Can make a profit if it is left in the trust Franchise - Not a legal form, but a consideration in launching a venture Legal structures ? In choosing a legal business structure, what should an entrepreneur consider? Key questions What is the size of the risk? What is the amount of the investor's liability for debts and taxes? What would the continuity (life) of the firm be if something happened to the principal(s)? What legal structure would ensure the greatest administrative adaptability for the firm? What effects will federal, state and local laws have on the operation? Key questions What are the possibilities of attracting additional capital? What are the needs for and possibilities of attracting additional expertise? What are the costs and procedures associated with starting the operation? What is the ultimate goal and purpose of the enterprise and which legal structure can best serve this purpose? Bankruptcy 'When a fall in revenues and/or rise in expenses are of such magnitude that the firm becomes insolvent and is unable to attract new debt or equity funding; consequently, it cannot continue to operate under the current ownership and management' Reasons for bankruptcy The liability of newness - the high cost of learning new tasks, and risks from competitors Overconfidence of the entrepreneur Lack of experience of the entrepreneur and other parties Predictors of bankruptcy New competition enters the market Other firms with products a generation ahead R&D budget less than the competition's Retailers always seem overstocked Regulation and climate change CFC bans were effective from the 1980s. Emissions regulation is increasing in various markets. Most of Asia has ratified the Kyoto Protocol, but does not report on emissions or announce reduction targets. Expectations of investors and consumers are increasing. Key concepts ? (close your books) 1. How can you protect your intellectual property? 2. What are the legal forms available for entrepreneurs structuring their ventures? Key concepts Intellectual property - - - - - Patents Copyright Trademarks Domain names Trade secrets Key concepts Legal business structures - Incorporated companies - private and public - Quasi incorporated businesses - various - Unincorporated businesses - sole traderships and partnerships - Other business forms Chapter 14 Sources of capital for entrepreneurial ventures Objectives 1. To be able to distinguish among the five forms of entrepreneurial capital 2. To identify how informal investors differ from other parts of the funding community 3. To differentiate between debt and equity as methods of financing 4. To examine commercial loans and public stock offerings as sources of capital 5. To understand the stages of venture investing Objectives 6. To study the market for venture capital and to review venture capitalists' evaluation criteria for new ventures 7. To discuss the importance of evaluating venture capitalists for a 'best fit' selection 8. To discuss private placements as an opportunity for equity capital 9. To examine the business angel market 10. To describe new forms of entrepreneurial capital beyond financial capital Objectives 11. To be familiar with Islamic finance and microcredit 12. To understand the criteria used by socially responsible investors 13. To appreciate the need for raising natural capital as part of an entrepreneurial venture But first ? 1. Where does the money for start-ups come from? 2. What about later? Context The global financial crisis has impacted on access to capital for new start-ups and business development. Entrepreneurs must demonstrate understanding of customer requirements and the ability to ensure products deliver on their value. Capital '...any resource (human-made or natural) that is used to create other goods or services'. The five capitals Economic capital - Financial capital - Money - Manufactured capital - Material goods or fixed assets that contribute to production Cultural capital - Non-financial social assets Human capital (or human resources) - Peoples' health, knowledge, skills, intellectual outputs, motivation and capacity for relationships The five capitals Social capital - The value of a person's network - 'know-who' rather than 'know-how' Natural capital - The stock of natural ecosystems used by the venture The five capitals model Source: Forum for the Future Sources of financial capital Entrepreneurs have a number of sources of financial capital as their ventures develop. The level of risk and the stage of the firm's development help determine the appropriate source of financing for entrepreneurial ventures. Sources of financial capital Informal investing ? What are some informal sources of investment? 'Informal investing' Informal investors are often from the 4Fs: - Friends, family, founders and other 'foolhardy investors' - Also, neighbours, work colleagues and even strangers Rates of informal investing Numbers of adults investing: - 4% of adults worldwide - 14% of Indians Average amount invested: - $308 in the Philippines - $44 000 in the Netherlands Expectations Expected returns are affected by altruism - Strangers expect higher returns than parents - Men expect higher returns than women - Older persons expect lower returns than younger ones - Entrepreneurs expect higher returns than nonentrepreneurs - Entrepreneurs expect higher returns on investments in their own businesses than on their investments in others' businesses Informal investment vs venture capital If there was no informal investment, there would be virtually no new ventures. If there was no venture capital, new ventures by the millions would still be getting off the ground. Attention paid to venture capital is inversely proportional to its importance to start-ups. The 'kitchen table pitch' Know your investor's motivations Debt is better than equity for informal investors Make the pitch in person; follow-up in writing Try to treat them as strangers Try to avoid a repayment schedule Don't give voting stock Debt vs equity financing Debt vs equity financing Debt financing Most new ventures require debt financing - Short-term debt for working capital - Repaying out of sales or other revenue within one year or less OR - Long-term debt for property or equipment (that can serve as collateral) - Repaying in one to five years or longer Commercial banks A major source of debt financing for small business Loans are secured by fixed assets, receivables, inventories or other assets Generally require collateral and systematic payments Not interested in future prospects Commercial banks The usual questions: - - - - - What do you plan to do with the money? How much do you need? When do you need it? How long will you need it for? How will you repay the loan? Other debt financing sources Trade credit Accounts receivable financing (by commercial banks) Finance companies Factoring Hire purchase Other debt financing sources Leasing companies Mutual savings banks and savings-and-loan associations Insurance companies Equity financing ? What kinds of people or organisations might buy ownership in a new venture and why? Equity financing No obligation to repay But, the entrepreneur gives up part ownership Equity capital can be raised in two ways: - Public stock offerings, called initial public offering (IPO) - Private placements, which involves private investors purchasing shares or sometimes bonds Public stock offering (by IPO) 'Initial public offering' (IPO) First-ever sale of shares to the public 'Going public' or 'floating' The IPO market has been a rollercoaster since the late 1990s Public stock offering (by IPO) Advantages Size of capital amount Liquidity Value Image Disadvantages Costs Disclosure Requirements (paperwork) Shareholder pressure VCs and angels ? What are venture capitalists and angel investors? Venture capital Venture capitalists can provide: - - - - - - - - - capital for start-ups and expansion market research and strategy management consulting functions contacts with prospective customers and suppliers assistance in negotiating technical agreements help in management and accounting controls help in employee recruitment help in risk management guidance with government regulations. Funding stages with VCs Funding stages with VCs Venture capital in the new era Activity has slowed VCs are positive, as a down market means: - Lower valuations - Less intense competition Great ideas will still be funded Venture capital in the new era In the Asia-Pacific: - Asia has been partially insulated from the GFC - India and China are catching up with the West. Venture capitalists' objectives Different to other investors Concerned with security and payback - return on investment (ROI) Examine the product/service and management Returns are expected to be consistently high Venture capitalists' objectives Bank lenders might expect a return of 6.5% per annum over the term of a loan. Venture capital providers expect 42%. Private equity groups expect 25%. Evaluating new-venture proposals VC evaluation process Evaluating the VC Don't hesitate to evaluate the venture capitalist - Does the venture capitalist understand the proposal? - Is the individual familiar with the business? - Is this someone I can work with? Business angel financing An angel investor has already made their money and now seeks out promising young ventures. Expecting lower valuations and more control In the USA in 2010, business angels invested $20.1 billion in 61 900 ventures - In 2007 $26 billion was invested in 57 120 ventures. Where business angels fit Types of angel investors VCs and angels ? Would you prefer to attract a venture capitalist or an angel investor? Why? New forms of entrepreneurial capital Islamic finance - High growth ethical investment operating under a strict moral code - Emphasises justice and partnership - Forbids speculation and the charging of interest Ethical finance (socially responsible investing) - Seek a financial return on activities delivering social good; requiring a different 'pitch' New forms of entrepreneurial capital Micro-credit - Providing micro-loans in absence of collateral, regular employment and credit history (including micro-credit on the web or Banking 2.0) Natural capital - Delivering ecosystem services, such as atmospheric stabilisation, disturbance avoidance and nutrient cycling Key concepts ? (close your books) 1. What is the difference between debt and equity finance? 2. What are the sources of each type of finance? Key concepts Debt finance - Borrowing money, with an obligation to pay it back with interest on a timeline - Sources: commercial banks, trade credit, finance companies, factoring, etc. Equity finance - Selling ownership in the venture - Sources: public and private stock offerings, venture capitalists and angel investors