Legislative Update for January, 2012
Filed under: Corporations, Funding, Internet Law, Securities, Startups
Each month the Gillespie Law Group compiles the most recent legislative and regulatory developments that could affect startups, tech companies, and website owners.
“Crowdfunding” Update: As we reported last month, the House approved the Entrepreneur Access to Capital Act, H.R. 2930, known to many as the “crowdfunding” bill. This bill would allow businesses to raise money selling unregistered securities using “crowdfunding,” which is the raising of money through mass aggregation of small investments. Although the bill is strongly supported by the Obama administration, the Senate corollary bill, the Democratizing Access to Capital Act, S.1791.IS, is having a hard time getting out of the Senate because of efforts by the North American Securities Administers Association (NASAA) who has been lobbying heavily against the bill because it would infringe on state regulatory power. Additionally, the bill has been slowed because of two Senate hearings that highlighted the potential for increased fraud under the bill.
The House version of the bill would allow issuers, in any 12-month period, to raise up to $2 million if the issuer provides potential investors with audited financial statements, which is not always cheap. Crowdfunders then must comply with a variety of protective measures including warning investors that certain risks are associated with the issuer and that resales are restricted, as well as by providing the SEC with certain other information. Importantly for crowdfunders wanting to avoid SEC registration, investors who purchase securities under the crowdfunding exemption would not count toward the 500-shareholder threshold for SEC registration in Section 12(g) of the Securities Exchange Act of 1934. The Senate version of the bill does have some significant differences from the House version:
- Securities could only be issued through a “crowdfunding intermediary,” which would exclude raising funds through websites like Facebook and Twitter
- Each investor would be limited to investing only $1,000 in any 12-month period
- While the House bill preempted State registration law, the Senate bill would allow for some State registration requirements
A second Senate bill over this issue is also in the Senate, S.R. 1970, painfully entitled “CROWDFUND,” for “the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act.” The CROWDFUND bill even more narrowly defines what intermediaries investments can be sold through as “funding portals” and investors are limited to the greater of $500 or a 1-2 percentage of his or her annual income, per company to invest in.
General Solicitation. In addition to the the Access to Capital for Job Creators Act, H.R. 2940, the House bill we reported on last month, the SEC’s Advisory Committee on Small and Emerging Companies had made formal recommendations that the SEC should permit general solicitation and advertising in private offerings under Rule 506 where the securities are only sold to accredited investors.
The Access to Capital of Job Creators Act, which passed in the House, would amend Section 4(2) of the Securities Act of 1933 by exempting from SEC securities regulation “transactions by an issuer not involving any public offering, whether or not such transactions involve general solicitation or general advertising.” Importantly, both this bill and the SEC Advisory Committee’s recommendations would generally go against the long-held goal of the securities exemption rules of prohibiting general solicitation of investors by general and open advertising. Instead, both would actually permit general solicitation or advertising provided that all purchasers of the securities are accredited investors and that the issuer has taken reasonable steps to verify that purchasers of the securities are accredited investors.
Internet Law. SOPA and its detractors became major news in the past month with websites such as Google and Reddit actually removing their services from the web for 24 hours on January 18. Recently SOPA and PIPA, a similar bill in the Senate, have been opposed by President Obama and have seemingly been shelved for the time being, however it is likely that new legislation or changes to these proposed bill are coming. For an in-depth look at SOPA, please read our analysis of the bill: SOPA – Cutting Through the Hype.
SOPA – Cutting Through the Hype
This article was published on January 18, 2012 and the information contained within may become inaccurate as the bill, its support, and opposition continue to rapidly evolve. This article is longer than our typical blog post and continues after the jump.
Much has been written about the Stop Internet Piracy Act (SOPA) in recent months – most of it important, all of it passionate, but through all the fervent positioning, the actual contents of the proposed bill can easily be missed. The purpose of the bill is to expand intellectual property protections on the internet by making it easier for content owners to stop the spread of infringing materials on foreign-based websites. However, the bill has received pushback by vehement detractors who believe that SOPA will lead to abuse of websites by copyright holders, infringe on free speech rights, and possibly even disrupt the functionality and security of the internet. The purpose of this article is to wade through the hype of what the bill does and does not do and to discuss what will actually happen to website owners if SOPA passes in its current form. SOPA has a corollary bill in the U.S. Senate entitled the PROTECT IP Act, also known as PIPA, which has many of the same purposes as SOPA. This article focuses on SOPA because, as it currently stands, most of the effort and emphasis in Congress and the media is on SOPA. If SOPA fails, PIPA may become the more important bill.
SOPA was introduced in October of 2011 by Representative Lamar Smith and quietly gained widespread support from both sides of the aisle as well as from many businesses and arts organization. Because of the huge initial push, SOPA seemed destined to fly through House. Because this bill would primarily benefit very few (mostly large media corporations) to the detriment of many (most internet users), quick and quiet passage was likely its best chance for making its way out of the House and into the Senate. However, opposition for the bill built quickly after a widely publicized committee hearing where supporters of the bill and members of the House failed to show a strong understanding of the implications of the bill. Since then, SOPA has been hotly debated and will likely not see a full House vote until March 2012.
What is perhaps most important to understand, and can be easily lost in the push and pull of the debate is that SOPA is intended to block infringement only of foreign-based websites and has actually been amended to make this more clear. While there are certainly legitimate complaints about SOPA, the idea that SOPA can be used to shutdown U.S. sites like Google and YouTube is now no longer a reality. Read more
Entrepreneurs Shouldn’t Wait to Think About Intellectual Property
Filed under: Copyright, Intellectual Property, Startups, Trademark
This post originally appeared as guest blog post on The Metropreneur Columbus.
There are a million and one things to think about when launching a new business − from employees, partners, suppliers, lenders and investors to just making a product that works and that people want to use. It can be tempting to let many legal issues slide. However, for several reasons, properly identifying and protecting your intellectual property assets should be viewed as a priority from the very beginning.
Protecting Value
Protecting your intellectual property preserves the value you create in your company in two main ways.
First, there is value in the brand you are creating and developing, i.e. your name and even your look and feel. Apple’s brand itself is estimated to be worth $153 billion− almost half of its market capitalization. Trademark protection is the primary method by which you will protect your brand. However, not all brands can be protected by trademark. You should not invest time and money in a brand until you know that it qualifies for trademark protection.
Second, you are creating value in the original aspects of your products or services, original content you create for marketing or other purposes, original processes you design that create efficiencies or otherwise give you a competitive advantage, or other aspects of your “secret sauce.” Intellectual property tools, such as copyright, patent and trade secrets, allow you to protect your “secret sauce” from misappropriation by others. It is important to understand when you are creating intellectual property assets in your business and takes the necessary steps to protect them.
Monetizing Value
Intellectual property tools are not just defensive mechanisms, however. They are also the means by which you identify value so you can “monetize” it, i.e. sell it, license it, or even use it as collateral for a loan.
A useful analogy is the tools used by ranchers (branding irons, fences, etc.) to identify and separate their cattle from both wild cattle and cattle owned by others. If you can’t point to it and prove you own it, lenders, investors, and potential buyers are unlikely to attribute any value to it.
Trademarks, patents, copyrights, and trade secrets are the tools that enable you to point to and prove you own the intellectual property assets you’ve created in your business. A properly maintained intellectual property portfolio can generate much more favorable terms for a bank loan or investment, additional revenue streams via licensing deals, or even a significantly higher price paid for your business should you sell it in the future.
Experienced entrepreneurs know that planning for a new business, right from the beginning, should include careful consideration of how you can create valuable intellectual property assets and the steps you need to take to protect and monetize them.
Trying to Raise Money? Pre-Plan for a Smooth Transaction
Filed under: Corporations, Funding, Intellectual Property, Startups
Prior to entering into negotiations with an angel investor or venture capitalist there are multiple due diligence-related items the VC will want evaluate in order to make the decision whether to invest in your company, and if so, how much they want to invest. Failing to properly plan for these issues can at best slow down the process and at worst completely derail the deal. However, the good news is that with some forethought and preplanning, you can have many these issues squared away from the beginning.
Register Your Company
First, regardless of whatever entity type you have chosen (Delaware C-Corp is the most typical for venture capital investment), you need to make sure that you have properly registered with the formation state and that all of your formation documents are in place and organized in a way that can easily be shared with an investor. These documents should clearly state the ownership, include vesting provisions for the founders, and be structured in a way that will allow for future investment from outside parties without too much procedural difficulty. Additionally, it is important to keep detailed corporate records. The lawyer who helps you with your initial formation can help you understand and plan these details.
Intellectual Property
When it comes to intellectual property, an investor is going to want assurances that no one outside the company will have any claim to the IP the company claims to own. To do this, somewhere in the company’s formation agreements should be language that assigns all IP to the company and if not, it should explicitly outline what is owned by whom and under what arrangement the Company is using those rights. Additionally, you may want to have started registering any trademarks, copyrights, or patents your company has created.
Contractual Agreements
Similar to IP ownership, you should make sure to have all of your contractual agreements solidified. This includes everything from referral agreements to perhaps the most important, employment agreements. You should be able to identify who is an employee and who is an independent contractor and have the documentation to back it up. Not only will documentation suggest to the investor that you are highly organized and a good investment, but these agreements will ensure no surprises down the line with employees and independent contractors, regardless of whether there is impending investment or not. Employment issues, especially when dealing with intellectual property ownership, can be a particularly difficult problem if not dealt with early.
Having these issues dealt with before engaging with an investor will help to ensure smoother negotiations and possibly more company-friendly terms once V.C. or angel investment becomes a reality. While you may be able to handle some of these issues on your own, your lawyer can help to ensure that some of the trickier issues like vesting provisions and intellectual property assignment are completed properly.
What’s the Deal With the Facebook Settlement?
This past Tuesday Facebook agreed to a settlement with the Federal Trade Commission regarding its ever-controversial privacy policy. The complete settlement can he found here. The charge against Facebook was that that company deceived consumers “by telling them they could keep their information on Facebook private, and then repeatedly allowing it to be shared and made public.” Of the several points that Facebook agreed to, two are most important for other website owners to consider:
• Facebook can no longer make misrepresentations about the privacy or security of users’ personal information.
• Facebook must obtain consumers’ affirmative express consent before implementing changes that are in contrast to users’ privacy preferences.
As Facebook has been on the forefront of internet-based privacy issues in the past few years there are several instructional points for website owners to take away from the suit and settlement.
First, as Jerry Seinfeld once explained, any restaurant can take a reservation, but it’s another thing to actually fill the reservation. Likewise, while most websites have already realized that their privacy policy must actually be tailored to their website (rather than copy and pasting from someone else’s privacy policy), website owners must take the additional step of actually following their policy. A privacy policy not only serves to inform users, but it sets guidelines that the website itself must follow. A company that doesn’t follow its own privacy policy can get into costly trouble.
Second, it is now clear that if you are changing your privacy policy, you must adequately inform your users. While some users may not be that concerned about how public their personal information is, some users will care quite a bit. If you are going to change the policy in a material way, you will need to do more than just change policy on your site and hope users will notice. You must keep your users updated on what you are doing with their information or else there will be no soup for you!
Third, the Facebook settlement may represent the final tidal wave in the sea change from opt-out privacy options to opt-in. Facebook liked to change its privacy options by making users’ personal information public and then asking users to “opt-out,” meaning that the information was first made public, then users had to manually find the option and click the option to make it private. Now, when Facebook wants to change its privacy protocol, the personal information will be kept private until the user chooses to allow the information to be public, thus “opting-in.” Opt-in privacy options are likely to become the privacy norm and depending on your business model and how you use your users’ information, you may be well advised to follow this principle in your own privacy practices.
New gTLDs Offer Updated Approaches to Web Addresses and Branding
In June of this year, the Internet Corporation for Assigned Names and Numbers (ICANN) voted to allow a new program for the creation of new generic top-level domains (gTLDs), the end section of a web address, like .com, .org, and .net. These new gTLDs will offer new opportunities for brand owners and other parties who register them, but at this point should not be too much of a concern for brand owners who choose not to apply for them.
Prior to this new program, the amount of TLDs was limited to just 22 in the US and country codes like .uk and .ca (and yes – .ly was intended for Lybia, although it has taken on a life of its own in the link shortening sphere via bit.ly). However starting in January of 2012, ICANN will begin accepting applications to apply for new gTLDs. During the first year of registration, ICANN plans to allow for the creation of 300 to 1,000 new gTLDs in 2012. The application fee comes in at the very serious figure of $185,000 with additional fees likely further along in the process.
Perhaps the most important aspect of being granted a new gTLD is that once a gTLD is created, the party who was granted it will own it and be responsible for administering domain names with that gTLD extension. For businesses, there are two important types of gTLDs that applicants might consider applying for. First are branded TLDs such as .apple or .hp and second are more general gTLDs like .bank or .car. Because of the high cost of registration and possible ways to use them, each type of new gTLD offers very different incentives and potential value for applicants.
Branded gTLDs
The allure of a branded TLD should be fairly obvious. It would streamline web addresses and a branded TLD would lend a strong sense of gravitas to a brand, as only elite brands would have either the need or money to have their own TLD. Companies with strong consumer identification as forward-thinking, elite, or even luxurious, such as Apple or DKNY might be well-served with a branded TLD. For instance web addresses like as http://ipad.apple or http://menswear.dkny would make for nicely streamlined and brand-centric web addresses – much better than having the cumbersome .com attached to the address. However, consumers are undoubtedly comfortable with extensions like .com and with the high cost attached to obtaining a branded TLD, there is a real question of whether obtaining the TLD would be economically worth it. Likely, it will take one large company to obtain their branded TLD and pioneer the proper utilization of it.
Trademark and brand owners have expressed concerns about cybersquatters or other parties obtaining their marks, especially since there is no reservation process available for the new gTLDs. However, these mark owners will likely have little to actually worry about. First, unlike the very easy process for obtaining domain names, application process for the new gTLDs will be complex, take from 9-20 months, and take into account many variables including worldwide trademark statuses. Second, mark owners can object to filings, although it is likely that the objection process itself will have high costs associated with it. Third, while the high cost of registration will keep most brand owners from registering, that same high cost will likely deter most cybersquatters as the high cost and intense scrutiny will make it unlikely that cybersquatter will be able to obtain the branded TLD in the first place.
Non-Branded gTLDs
The other types of applications will be for non-branded TLDs like .bank or .law. The appeal of owning a TLD like this is that a party that owns the TLD then has full control of all domains within that TLD and can do whatever it chooses with them. A TLD owner could choose to sell domains at a high cost or block any other party from obtaining them. For instance, if Chase Bank obtained the .bank TLD, it could sell domains under it for a million dollars or be the only bank using the TLD. However, it remains to be seen how consumers will react to these TLDs and whether such approach will be worth the high cost of registration. Like the branded TLDs, the popularity and value of non-branded TLDs will likely depend on a visionary owner to show how to properly use and profit from these new types of TLDs.
For those interested in knowing what gTLDs are likely to be applied for in the coming year, dot-nxt.com is keeping a list of all the likely candidates and their corresponding sponsor. Just a few of interesting upcoming generic applicants include .bank, .app, .bike, and .dental. According to the same site, some of the upcoming branded applicants include .canon, .deloitte, .motorola, and .unicef.
Even for brand owners that do not plan on registering for their own gTLDs, it is advisable to keep a watchful eye for registrations that may infringe on domain or trademark rights. New gTLD applicants can be monitored by using services like dot-nxt.com, newtlds.tv, Valideus, or registries.tel. Additionally, brand owners should be prepared to submit comments, objections, and questions to ICANN should they become aware of possible infringing registrations. The possibilities of usage and optimization are wide-open and a prudent website or brand-owner should keep an eye on developments in this area as they occur as the best practice of wait-and-see may change.
“Isn’t My Domain Name Enough?” – The Interplay Between Domain Names and Trademark Protection
There is a common misconception that having a registered domain name is all that is needed to protect a brand identity. However having only a registered domain name will make it much harder and more expensive to protect against infringing domains or other types of infringement. This is where trademark protection comes in. Trademark registration will aid in protecting both your brand identity and domain rights. Simply, registered trademark rights strongly protect domain rights, but domain rights without a registered trademark will offer only minimal protection against both domain name or trademark infringement. Therefore, when economically feasible, a company with a domain name should register the name as a trademark as well.
A registered trademark is the best and most economical way to stop unauthorized domain name registrations or use. This could happen if you own “example.com” and someone registers “example.biz” and is operating in a way that is similar to your website. If you have your name registered as a trademark you can stop the infringing party’s use of the domain name through federal lawsuit or through the independent international organization, ICANN, that oversees domain disputes. This can also be helpful if you somehow forgot to renew your domain registration and another party swoops in to take the registration. Additionally, having the trademark registered will allow you to stop parties from using your trademark in online advertising such as with Google AdWords as well as online auction sites like eBay.
It should be noted that these avenues of protection are available without trademark registration, but if you have a dispute you will still have to prove to a court that you are entitled common law trademark rights based on usage of the mark, which will be difficult and costly. This is true for both traditional trademark infringement situations like somebody using your name as well as for domain infringement issues like cyber-squatting. From an economic perspective, if you end up having a situation where someone is infringing on your rights, it will cost much more to protect yourself than if you obtained trademark rights in the first place.
Having a proper domain name is an important beginning step for a business with an internet presence, however it offers little legal protection. The best bet to protect your company’s brand as well as domain rights is still to obtain federal trademark registration.
Bootstrapper’s Guide to Not Screwing Up – Slideshow
Gillespie Law Group head honcho Dave Gillespie gave a presentation this past week at the Startup Weekend event in Columbus, OH. The presentation was entitled “Bootstrapper’s Guide to Not Screwing Up–Too Badly”, and his slideshow can be viewed below. Questions? Post them in the comment section and we’ll try to answer.
Twitter On its Way to Finally Securing “Tweet” Trademark
After trying and failing to register the term “Tweet” with the USPTO, Twitter will likely soon acquire the trademark rights for the term. Twitter has been in negotiations with the owner of the mark, Twittad, for some time and the parties have finally settled on terms that will transfer the trademark to Twitter. For full details, check out this explanation over at TechCrunch.
What makes this story even more interesting is that Twittad is a third-party developer of Twitter’s API and was able to register “Tweet” before Twitter – even though Twittad was using “Tweet” in reference to Twitter’s use of the term.
There are several take-aways from this story. First, Twitter smartly created language to use on its website, most importantly with the word Tweet. However, it made the mistake of not initiating trademark registration before Twittad. For new products and services, it may not seem imperative to register for trademarks right away, but then real examples like this occur and it ended up costing Twitter an undisclosed, but likely substantial amount of money to obtain the trademark rights.
Second, this story acts as a cautionary tale for technology companies that allow third-party development and then allow those developers to use their trademarks. Those companies have a need to be proactive in what they allow third-party developers to do and how they use their trademarks. Since the “Tweet” trademark issue first began, Twitter has heavily beefed up its protective plan and has published an in-depth trademark usage guide, a highly advisable tactic in the fast-paced world of technology mixed with third-party development.
The Importance of Vesting Provisions For Founders’ Equity in Startups
While it might at first seem counter-intuitive, initial ownership in your startup should not be based on entirely on who had the idea or who has contributed the most so for. The nature of startup relationships are unpredictable, and oftentimes founders have different ideas on what is expected of one another. Ownership should, at least in part, be based on future contributions to the Company. The way to accomplish this is to subject at least a portion of the founders’ initial ownership in the startup to vesting requirements. Vesting works to ensure the company can get back some of the equity initially granted to a founder if that founder does not fulfill their expected contributions to the Company.
The Case of the Lost Founder. The worst-case scenario of this is what can be called a “lost founder” – an initial founder who is granted a substantial ownership interest but then disappears because of either disagreement, a change of circumstances, or even a loss of interest. Without vesting provisions, a lost founder will retain their initial ownership, while contributing nothing to the company’s growth. The lost founder can sit and wait for a payday that is unearned, potentially leading to loss of motivation and resentment in the other founders and killing any momentum the startup had. Furthermore, since sophisticated investors will recognize the potential for that loss of motivation, a lost founder often discourages potential investors. A properly structured founders equity arrangement will avoid this outcome.
Why Not Just Grant Equity Later? Founders often suggest that stock just be issued in the future when tasks are completed or after a founder works for the required time. Although perhaps simpler, the problem with this method is that it can have significant tax consequences for the founder since stock granted at a later date is likely to be worth much more at the time of grant than stock granted when the company is formed (let’s hope so). Since they would receive that stock in exchange for working, they’ll have to pay taxes (at ordinary income rates) on the value of it when they receive it; and often neither they nor the company have cash to pay those taxes. To prevent this result, stock (subject to vesting) is issued at the very beginning to the initial founders (and perhaps some of the first employees) and, provided that the correct tax forms are filed (see previous post on 83(b) election), taxes on that stock will be either very small or nothing at all.
Find the Sweet Spot. Since the ultimate goal of vesting arrangement is to properly align the incentives of the founders, great care should be taken to structure these arrangements in a manner that accurately reflects the expectations of the founders. Don’t rely on what your friend says his startup did or what is in some form you found on the internet. The most important question to ask is what is each person supposed to contribute and when is that expected to occur? Is it related to a specific task such as, perhaps, building a particular product? Or is it leadership or expertise provided over time? Has some of it already occurred? You don’t want too much of the equity to vest until the bulk of what is expected of the founder is completed.
To reach that result, founders can specify exactly what portion of the stock is subject to vesting (the more the better) and then specify how and when the vesting will occur, i.e. either time-based vesting, milestone-based vesting or even a combination of both. Time-based vesting means that vesting will occur with the passage of time. Four-year vesting arrangements are common, but time-based arrangements should be based on the structure and plans of the startup, and not just on industry convention. Milestone vesting involves the vesting of ownership shares by articulated events, or milestones. For instance, if one founder will be writing the code for a website, that founder could have 25% of the shares vest upon the launch of the beta version of the site and another 25% upon launch. Milestone vesting works well for founders actively working on particular projects and helps to provide continuous incentive to complete that project.
Put it in Writing. Co-founders armed with a basic understanding of why vesting is important and the various types of vesting arrangements should be able to think through these issues at or near the onset of them working together. Founders shouldn’t attempt to document a vesting arrangement at home as seemingly insignificant drafting variances can have very significant consequences. Having thought through these issues before going to see your lawyer, however, should help keep costs under control.
Stay Informed
