Founders’ Friday: What’s Your Big Idea?

In addition to spending time creating business plans, marketing plans, and succession plans, founders should make sure that they are developing a sound plan for handling their company’s intellectual property (aka your big idea).  The reality is that every startup began with an idea.  Existing businesses typically come up with new ideas as well.  Regardless of the stage of your business, when an idea strikes, you, as a founder, must ask: (1) Does my idea qualify for any intellectual property protection; and (2) If I use my idea, could I be infringing someone else’s idea/business?

In order to determine whether an idea qualifies for any intellectual property protection, founders must first understand which type of intellectual property is necessary since different intellectual property options offer different forms of protection.  The main areas of intellectual property to consider are as follows:

• Patent: Protects an invention based on the idea, such as machines, industrial processes, and chemical compositions.
• Copyright: Protects original works of authorship fixed in a tangible form, such as novels, movies, songs, and computer software.
• Trademark: Protects a word, phrase, and/or logo that identifies and distinguishes the source of the goods or services of one party from those of others.
• Trade Secret: Protects confidential information that has economic value.

Founders are often faced with having to decide what types of intellectual property protection is best or most appropriate for their company.  A common dilemma is whether or not to pursue patent protection for an idea or to maintain it as a trade secret.  Each offers distinct benefits and risks, so the founder will need to make an informed decision based on the business goals/objectives of the company.  It is always best to obtain the advice of an intellectual property attorney in order to truly make an informed decision.

Once a founder has determined the type of intellectual property protection that he/she is interested in pursuing, the next step involves working with an intellectual property attorney to determine the likelihood of achieving such protection and the relevant processes and costs involved.  As an example, conducting thorough patentability searches are vital for determining whether you are likely to obtain a patent for your invention.  In other words, the patentability search helps determine whether it makes sense to move forward with the cost and time involved with preparing and filing a patent application.  Similar types of searches may be conducted when evaluating the likelihood of achieving trademark or copyright protection.

After addressing the likelihood of achieving intellectual property protection, the next issue involves determining whether or not the use of an idea could be infringing someone else’s intellectual property.  The threat of infringing someone else’s intellectual property is perhaps the largest potential liability looming for founder.  Sticking to the patent realm, a patentability search (as described above) will not help founders determine whether they can move forward without fear of being sued for infringement.  A patent clearance search or freedom to operate opinion would need to be conducted to determine whether a legitimate claim of patent infringement can be made.  Similar types of searches and opinions are relevant when evaluating potential liability for trademark or copyright infringement.

Assuming that there is a likelihood of achieving the desired intellectual property protection without a true risk of infringing on someone else’s intellectual property rights, developing a strategy for registering a founder’s intellectual property becomes essential.  Founders should work with an experienced intellectual property attorney to determine what type of applications need to be filed and the countries/jurisdiction in which these applications need to be filed.  As a result, founders can hopefully obtain intellectual property registrations that provide additional value to their businesses.

 

Founders’ Friday is a series published by attorney Brian A. Hall of Traverse Legal, PLC d/b/a Hall Law on Fridays dedicated to legal considerations facing founders and start-ups. This week’s post contributed by patent attorney Tony Klemptner.

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Founders’ Friday: Choice of Business Entity

It is a question we get all the time. What kind of business entity should I use for my new company? To answer, we must first highlight the different business entities founders can select for starting their new business and then outline some important questions to ask when choosing the right entity.

There are four main types of business entities that founders typically choose from: (1) C-Corporation; (2) S-Corporation; (3) Limited Liability Company (LLC); and (4) Limited Partnership (LP). In selecting one of those four entity structures, there are many factors to consider. As a founder, ask yourself the following to help determine which entity structure is best for your business, being mindful of some of our tips related to each.

1. Do you need limited liability?

This answer should always be yes and each of the above entity structures provides limited liability for the owners/investors. Sole proprietorships and general partnerships are entity structures that do not provide limited liability and therefore are generally not recommended.

2. Do you want profits and losses to pass through to your personal income tax returns?

If the answer is yes, then a C-Corp is typically not the right entity for you and you need to either be an S-Corp, LLC or LP.

3. Will all of the parties be actively involved in management?

The answer for founders is almost always yes. You are the business so of course you are going to manage it. In each of the four structures referenced above, a business attorney can ensure that you maintain management control, throughout your fundraising endeavors.

4. How much capital is needed?

This is usually the million-dollar question (pun intended). The amount of capital needed isn’t as integral to the entity selection as the next question that asks about where that capital is coming from.

5. How much will be raised from third parties? Debt or equity? Likely sources?

Next to the answer in question 2, the answer to this group of questions will determine entity type and structure as much as anything else. Depending on the amount of money you need (question 4), you might be able to finance through friends and family only, or you may have to start there and then look angel investors or venture financing as your needs grow. Generally, unless you are launching an investment fund, you probably aren’t going to be a Limited Partnership. Therefore, your business will either be an LLC or a corporation (C or S, the difference between the two designations is the tax treatment). However, since the owners of equity in an S-Corporation can only be US residents (limited exceptions do apply), if any of your investors are going to be investing through an entity, which is likely, then your business will need to be either an LLC or C-Corporation. Both LLCs and C-Corps allow you to raise funds through issuances of equity or debt, and the mechanics of each are similar. In addition to the tax treatment, one place where things vary between the two entity types is structuring equity compensation for employees, but that topic deserves its own post.

6. Is there a form of entity that the funding source prefers or, alternatively, would avoid?

If you are in a position where you know what type of entity your prospective investors want, then this question becomes an important consideration and you’ll likely end up structuring your business the way your investors want. That said, regardless of the entity structure initially chosen, you can always change your entity type as you move forward in the process. Regularly founders form their businesses as LLCs because of the increased flexibility that structure provides, knowing they can always change later (i.e. conversion) if needed for business, tax or investor reasons.

7. How much flexibility is required for structuring ownership and management?

Flexibility is a key difference between corporations and LLCs and LPs. Corporations must be governed by a board of directors, and the board of directors must designate officers to manage the day-to-day operations. The stockholders must approve certain major decisions of the company.

Default management in an LLC depends on the state of formation, but in most cases is initially vested in the members (equity holders). The members can then delegate management to one member or a single manager or a board of managers. The members must approve certain major decisions.

Management in an LP is initially vested in the general partner(s). The general partner(s) may delegate management and officers but do not need to. Certain major decisions have to be approved by the limited partners.

Being mindful of and ultimately answering these questions, preferably with business counsel and related tax and other advisors, will help lead you to selecting the appropriate entity structure for your business. If you are like most founders, your focus is on building your business and not worrying about how to put it together from a legal standpoint. Nevertheless, an educated founder is typically a more successful founder. So, even if you retain experienced business attorneys who can help answer those questions and walk you through the pros and cons of each, founders are best served when providing valuable input into what will ultimately be the right entity for your business.

Founders’ Friday is a series published by attorney Brian A. Hall of Traverse Legal, PLC d/b/a Hall Law on Fridays dedicated to legal considerations facing founders and start-ups.  This week’s post contributed by corporate and securities attorney Stephen M. Aarons.

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Founders’ Friday: From Idea to Exit

With the news breaking, particularly loudly in our office here in Austin, Texas, of Amazon buying Whole Foods for $13.7 Billion, I am reminded of how a simple idea can ultimately turn into a successful exit for a company.  In 1978, the co-founders of what is now Whole Foods had an idea — create a natural foods supermarket.  The first store opened in Austin in 1980, countless mergers and acquisitions later, Whole Foods is now being acquired.  Interestingly, it is being acquired by Amazon, the world’s largest internet-based retailer.  Amazon is a tech company, so why is it buying a grocery store?  Well, for a company that started selling books, expanded into production of consumer electronics (e.g. Kindle) and is the largest provider of cloud infrastructure, there does not appear to be any limitations.  Put another way, Amazon’s verticals are endless.  So what does all this mean for founders?  Well, it is yet another real-world example of an idea blossoming into a sustainable business that becomes ripe for an exit.

Despite condensing decades of history into a paragraph, make no mistake about it that both Whole Foods and Amazon, and their respective founders, took a legal path to ensure their ideas were protected, their products and services were sustainable and their business was viable and worthy of financing.  Granted, each had its intricacies, unique make-up and challenges.  Nonetheless, most founders, and I would surmise that both Whole Foods’ co-founders John Mackey and Renee Lawson Hardy as well as Amazon’s Jeff Bezos had to, answer the following questions as they transform from idea to exit:

1. What’s your big idea?  This translates to intellectual property in the legal world.  Intellectual property can include a patent for an invention, trade secret for a formula, copyright for a original work or trademark for your brand.  As a founder, you must ask: (1) Does your idea qualify for any intellectual property protection; and (2) If I use my idea, could I be infringing someone else’s idea/business?  Once you know, registering your intellectual property becomes an important next step.
2. Is this a hobby or a business?  Yes, this is a loaded question, but the reality is that founders need to recognize early that it is a business and take the necessary steps to form a corporate entity.  As part of that effort, co-founders need to agree upon ownership and control provisions and consider expansion, including additional issuances of stock/membership interests, such as for key employees.
3. Will you be going at it alone?  If not, then critical employment/independent contractor as well as third-party (e.g. manufacturer/supplier) agreements should be utilized.  This is particularly important to protect your idea (think NDAs and Confidentiality Agreements).
4. Are you bootstrapping or are you financing?  If financing, you will need to identify your funding source (e.g. angel investors, crowdfunding, VCs).  This decision can impact the kind of entity you choose and how you structure it.
5. Are you operating as you should?  This becomes particularly important in highly regulated industries, but it also applies to any kind of business that must comply with such things as truth-in-advertising, privacy and other laws.  Oftentimes, standard terms and conditions can go a long way toward protecting a business online as well as against customers and other third parties.
6. Are you exit-ready?  An exit, which can come in many forms, will require that you have your proverbial legal house in order.  Remember, your acquirer will have lawyers performing due diligence into the above items, and others.

This process is not as linear as it may appear.  There are always facts and circumstances that require iteration on the legalities associated with a business.  Nevertheless, most founders, and particularly repeat founders, will confirm that they were faced with these questions and had to address them in order to get to their exit.  Reading the tea leaves, it is not out of the question, and may be more likely, that Amazon may ultimately buy you (and everyone else for that matter).  Be prepared.

 

Founders’ Friday is a series published by attorney Brian A. Hall of Traverse Legal, PLC d/b/a Hall Law on Fridays dedicated to legal considerations facing founders and start-ups.

 

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Can Derivative Works Be Copyrighted?

Image yourself an artist (of any sort) who has drawn such great inspiration from another (copyrighted) work that you would like to modify that work to create something new.  Are you allowed to do so?  Could you get a copyright to your new creation? As with most questions in law, the answer is: it depends.

“A work consisting of editorial revisions, annotations, elaborations, or other modifications which, as a whole, represent an original work of authorship” (17 U.S.C. § 101) is called a Derivative Work.  The original copyright owner typically has exclusive rights to “prepare derivative works based upon the copyrighted work” (17 U.S.C. § 106(2)).  It is considered copyright infringement to make or sell derivative works without permission from the original owner, which is where licenses typically come into play.

While creating a derivative work requires authorization, the right to register a copyright in a derivative work requires no such authority.  However, when copyrighting a derivative work, the copyright only extends to the material contributed to the original work and does not affect the scope of the original copyright.  Therefore, when registering the derivative work copyright, it is necessary to disclaim the portions previously copyrighted.

One issue that often arises is whether a derivative work is actually derivative, or rather new and different enough to be considered completely transformative.  When a work is deemed transformative, it is fair use to utilize a previously copyrighted work.  One famous case of arguably derivative works being considered transformative fair use is Cariou v. Prince.   Artist Richard Prince created works from Patrick Cariou’s black and white photographs, such as this one:

In 2013, the Second Circuit determined that “Prince’s artworks manifest an entirely different aesthetic from Cariou’s photographs.”  Specifically, the Court found Cariou’s black and white photographs to be “serene and deliberately composed portraits” while Prince “created collages on canvas that incorporate color” with the overall “composition, presentation, scale, color palette, and media” being “fundamentally different and new compared to the photographs.”

Richard Prince has also found himself in similar hot water for his 2015 exhibition “New Portraits” that consisted of photos taken from other Instagram users without permission.  Because Prince added his own commentary to these photographs, they were considered original artwork.

Overall, with artists such as Richard Price and cases such as Cariou v. Prince existing, the line between derivative and transformative can become blurred.  If you are creating a derivative work based upon another’s copyrighted work, Traverse Legal’s Attorneys can help you determine your rights and also file copyright to your derivative work.  Give us a call today!

 

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Fair Use Under Copyright Law

Not every use of a copyrighted work is considered infringement.  Fair Use is an exception that permits limited use of copyrighted material without acquiring permission from the rights holder.  Typically, fair use includes categories such as criticism/parody, comment, news reporting, teaching, scholarship, and research.  When determining whether fair use exists, courts look to whether the use is transformative by examining four factors:

1. The purpose and character of the use, including whether such use is of a commercial nature or is for nonprofit educational purposes;
2. The nature of the copyrighted work;
3. The amount and substantiality of the portion used in relation to the copyrighted work as a whole; and
4. The effect of the use upon the potential market for or value of the copyrighted work.

Regarding the first factor, a major consideration is whether the use is noncommercial.  Under the second factor, if a work is previously copyrighted, the original owner’s rights to control derivative works comes into play.  The third factor favors fair use in the event a smaller portion of the copyrighted work is utilized.  Lastly, the fourth factor considers whether the use in question acts as a direct market substitute for the original and whether potential market harm exists beyond that of a direct substitution.  Overall, fair use is heavily fact intensive and court analyses have rendered various results throughout the years.

Fair use has been a particularly hot topic in the music industry, with recent copyright infringement lawsuits aimed at hit singles such as Robin Thicke’s “Blurred Lines”, Bruno Mars’ “Uptown Funk,” and Lil Jon’s “Turn Down For What.”  The lawsuits accuse these artists of violating copyrights to older songs, but the artists maintain that any such use is purely inspirational, and thus fair.  Older music copyright cases, such as Campbell v. Acuff-Rose Music, Inc. have found that 2 Live Crew’s “Pretty Woman” was a parody of Roy Orbison’s “Oh, Pretty Woman”, and therefore fair use.

If you are curious whether your use of a copyright, or another’s use of your copyright, is considered fair use, give Traverse Legal’s Copyright Attorneys a call.  Our skilled Lawyers will do the research and assess whether fair use exists in your circumstances.  Contact us today!

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