Top 10 Startup Considerations

Startups face a multitude of decisions: some have to be made at the outset and many along the way. Having experienced legal counsel assist with making those decisions at the start can go a long way to ensure that the decisions made down-the-line are in furtherance of achieving the company’s goals, rather than fixing issues that could have been avoided if properly addressed during the earliest stages. Below is a list of ten considerations we, as startup lawyers, feel that every entrepreneur needs to carefully evaluate when launching a startup.

1.  Entity Selection

The first decision for any entrepreneur with a new business idea is to select the type of business entity to form in order to run the business, limit liability and achieve desired tax treatment. Corporations and LLCs are the typical options, though not the only ones. Experienced corporate counsel can outline the pros and cons of the various options and help entrepreneurs choose the best entity structure for their startups.

2.  Selecting State of Incorporation/Forming

Many founders might think that geographic location would dictate where they should incorporate. However, most startups, especially those with an eye on raising capital (either now or later), should utilize their legal counsel to understand the benefits of forming in a state like Delaware versus their home state. Fortunately for many Texas startups, there are numerous similarities between the Texas and Delaware laws that govern corporations and limited liability companies (LLCs). If founders do incorporate in a state outside of the state where their startup’s principal place of business is located, they need to be sure to register to do business as a foreign entity in the state where the principal place of business is located and may need to consider tax implications.

3.  Founders Agreement & Vesting Schedule

At the outset (and hopefully throughout the startups life-cycle), all the founders are fully committed and devoted to spending the necessary time to turn their startup into the best company possible. Unfortunately, as tends to be the case, some founders end up being more committed than others and if not properly accounted for initially, it can be a nightmare to remove an absentee founder. However, one way to ensure commitment from all founders and to mitigate against the risks if things change is to enter into an operating agreement (founder’s agreement) defining the relationship between the founders. Typically, this includes a vesting schedule for the founders’ equity, voting rights, lock-up provisions, veto rights on company sale and provisions for removal of a founder. Furthermore, many investors will insist that the founders’ equity be subject to a vesting schedule before making an investment and if one already exists, investors are more likely to accept it than negotiate for implementation of a different schedule.

4. Debt or Equity Financing

Startups looking to raise have a multitude of avenues through which they can raise funds. The first question founders need to answer is should the company issue debt, like a convertible promissory note, or should the company issue preferred equity (e.g. stock) to investors? Understanding the pros and cons of the various types of fundraising methods is crucial in making the right decision for a startup because the fundraising method chosen will have implications throughout the entire life-cycle of the company.

5. Securities Laws Compliance

Many entrepreneurs may think that they can take money from family and friends without triggering any securities laws issues. The thinking is that “these people want to support my business, help me grow and they fully understand the risks.” However, even a friends and family raise requires compliance with both federal and state securities laws. It is imperative that entrepreneurs utilize legal counsel to ensure compliance with securities laws, regardless of how they raise their money and from whom they raise it.

6. Employee Compensation – Equity Compensation Plans

An option or equity compensation plan is a great way for a startup to attract and retain skilled employees, especially when cash on-hand to pay salaries is limited. Implementing an incentive mechanism is a complicated process that has both tax implications and requires compliance with securities laws. Experienced legal counsel can assist with creating a plan that enables companies to retain their key contributors.

7. Intellectual Property Protection

A company’s intellectual property is one of the most precious assets it has. This is especially true with startups who are pioneering new products and concepts. Startups are well-served to have experienced intellectual property attorneys that can advise them on securing, protecting and monetizing their patents, trademarks, service marks, copyrights and trade secrets. Startups should not forget the importance of structuring agreements with employees and service providers to ensure that intellectual property produced for the company stays with the company. In the event of infringement or disputes, these steps will help the company.

8. Investor Due Diligence

This may not seem significant to a first-time entrepreneur eager to close a round of funding for their startup, but given the level of research investors conduct on potential investments in startups, it only makes sense that founders take the same approach with potential investors. Founders should understand the industry experience their potential investors have and ensure that these are the right long-term partners to help the founders’ vision for the startup become a reality. Founders need to determine whether they want passive money or active money.

9. Business Contracts

As the startup grows, it will be entering into a multitude of contracts: employee contracts, user agreements, licensing agreements, service agreements and possibly franchise agreements. Startups typically need a set of standard documents that can then be tailored for specific needs. Some examples for any business with a website include website agreements, namely a Terms of Use (or Terms of Service) Agreement and Privacy Policy for the website. Having a set of standard documents on hand increases efficiency and puts the startup in an advantageous bargaining position during negotiations.

10. Legal Counsel

Expenses are a big concern for any business, especially a startup where the founders have often bootstrapped their idea to prove its concept and may have incorporated themselves or used a national doc-in-a-box company to provide them with the basic documents needed for formation. However, as outlined above, good legal counsel is integral to a startup’s success and is not something to be brushed aside to do later down the line when there is more money. Seek attorneys that will work to structure an engagement that makes sense for both parties. Set budgets and have your counsel prioritize your legal needs, which can be handled as your funds allow. An experienced startup lawyer is a good place to start.

 

 

 

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Commercial Non-Competes

The Michigan Supreme Court recently established a new rule clarifying that non-competes, which are of a commercial nature, and in this case a non-compete between two businesses, are to be evaluated for the reasonableness under a new standard. Traditionally, non-competes in Michigan were evaluated under a reasonableness statute, MCL 445.774(a), which was a statute, under the Michigan Trust Law, relating to the establishment of non-competes between employers and employees. The Michigan Supreme Court in Innovation Ventures v Liquid Manufacturing, decided on July 14, 2016, determined that as between two businesses, that the correct standard was under a section of the Michigan Antitrust Reform Act, MCL 445.772, which is the general contract provision of the Michigan Antitrust Act. The Michigan Supreme Court announced that Court’s evaluating non-compete agreements between two business entities, must look at the federal interpretation of comparable statues under Federal Law.

The Michigan Supreme Court explained to invalidate a contract under the Antitrust Rule of Reason requires more than simply an unreasonable impact on the party, which was an analysis traditionally used for evaluating non-compete. The proper focus, as between businesses, includes whether the non-compete may suppress or even destroy the competition and that merely injury to a contracting party will not suffice.

The Court further explained, the test under the Rule of Reason, whether competition in the overall market has been harmed.

Now this will be, under the present pronouncement, a very difficult standard to meet in an effort for validating non-competes, including businesses. Essentially, it appears that the court an enunciated a standard that will require an adverse impact on the relevant market, in order to invalidate a non-compete. In practice, it would appear that will be extremely difficult hereafter in Michigan to invalidate non-compete between two business entities. The reach of the new decision has not been determined. Commentators have argued that this new rational applies to all commercial non-compete agreements defined as everything other than a non-compete agreement between an employer and employee, and can also include the sale of a business, or buy out situation where an owner of a company is bought out and executes a non-compete agreement.

The Innovation Ventures decision, remanded the case to the lower court for an evaluation under the new standard annunciated by the Michigan Supreme Court, and there may be yet further guidance on this case on how this standard may be applied to the real world. Stay tuned for updates.

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What is Reverse Domain Name Hijacking?

Opposite of domain hijacking (more commonly known as cybersquatting, whereby an individual registers a domain name that is confusingly similar to a registered trademark and then attempts to sell it to the trademark owner), Reverse Domain Name Hijacking (“RDNH”) “occurs where a trademark owner attempts to secure a domain name by making false cybersquatting claims against a domain name’s rightful owner.”  Under the ICANN’s Uniform Domain Name Dispute Resolution Policy (“UDRP”) Rules, RDNH means “using the Policy in bad faith to attempt to deprive a registered domain-name holder of a domain name.”

The UDRP was developed to assist trademark owners in regaining domain names that had been cybersquatted in bad faith.  However, some trademark owners – typically large companies or famous individuals with deep pockets – have viewed the UDRP as an easier means than litigation to gain control over domain names that incorporate their trademark.  World Intellectual Property Organization (“WIPO”) panels are apt to find RDNH in instances where the domain name registration predates the trademark; where there is no evidence of bad faith registration; or where the UDRP is used as a back-up for failed business negotiations.

RDNH has increased significantly in the recent years.  One famous example of RDNH was in 2013 against politician Ron Paul when he attempted to utilize the UDRP to secure RonPaul.com and RonPaul.org, websites actually registered and owned by avid Ron Paul supporters.  As the owner of the RON PAUL trademark, Ron Paul alleged that the website registrants had tried to sell the domains to him for an “exorbitant” price and were selling merchandise.  WIPO denied Ron Paul’s complaint and found that him guilty of RDNH because there was evidence that the website registrants had actually offered the RonPaul.org domain to Ron Paul for free and that the registrants’ use of the domains was noncommercial fair use as a fan site.  The registrants still have the domains today.

As a good faith domain registrant, you have a right to stand up against trademark owners who try to bully you through the UDRP process.  If you believe that someone is attempting to secure your legitimate domain through RDNH, Traverse Legal’s Attorneys have the expertise to help you navigate the UDRP and WIPO process.   Give us a call today!

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Commercial Non-Compete Agreements

How Animals Like Grumpy Cat Use Copyright & Trademark to Protect Their Brand

“I had fun once – it was awful”; “It’s not me – It’s you”; and “Nope” are phrases commonly associated with Grumpy Cat, the frowning feline who became an internet sensation for her mean mugging memes.  Unless we are dealing in patent law, intellectual property and animals do not frequently overlap.  Even though a Federal Judge has ruled that a monkey cannot own the copyright to his selfie, there are other ways that animals (or rather, animal owners) can utilize intellectual property law to protect their originals works and brand.  Grumpy Cat, for example, is protected by several federal copyrights and trademarks.

With Grumpy Cat originating as a picture on Reddit before going viral, her owner’s would have difficulty combating infringement activity without registered IP protection.  While actually policing memes is a difficult and sometimes controversial task, Grumpy Cat most benefits from her IP protection in regards to merchandise.  After Grumpy Cat’s popularity skyrocketed, her owners began producing items such as magnets, mugs, socks, shirts, plush toys, cards, phone cases, and more.  With such mass production of merchandise, it is only a matter of time before someone else tries to capitalize on the popularity.

Most recently, Grumpy Cat sued Grenade Beverage for copyright and trademark infringement stemming from a line of Grumpy Cat roasted coffee, which Grumpy Cat claims was unauthorized under a License Agreement entered into between the entities.  Over the course of a year, the parties have exchanged counterclaims and motions without any substantive outcome.  Hopefully it will be determined soon as to whether Grumpy Cat is successful in her enforcement endeavor or not. The important thing is that the copyrights and trademarks are in place for Grumpy Cat to adequately protect her brand far into the future.

While no animal has achieved the same level of popularity as Grumpy Cat, the opportunity exists for other famous animals to have robust IP protection as well.  Now we just have to wait for the next internet animal superstar to take off before we can realize the full potential.

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Patent Exhaustion and Sale of Patented Item

The U.S. Patent Act (35 U.S.C. § 271(a)) grants a patent owner the right to prevent others from making, using, selling, offering for sale or importing a patent invention within the U.S.  The doctrine of patent exhaustion limits the patent owner’s ability to control the use of patented items after those items have been sold.  In other words, the first authorized sale of a patented item terminates/exhausts all patents rights to that item.  As a result, the purchaser of the patented item has the right to use or resell the patented item without it being considered infringing of the patent owner’s rights.

 

In Impression Products, Inc. v. Lexmark International, Inc., 816 F.3d 721 (Fed. Cir. 2016), cert. granted, 84 U.S.L.W. 3563 (U.S. Dec. 2, 2016) (No. 15-1189), the Supreme Court decided to review the Federal Circuit’s decision regarding patent exhaustion.  The main issue that the Supreme Court will examine is whether a patent owner can implement post-sale restrictions on the use or resale of a patented item to avoid the application of the patent exhaustion doctrine.  Thus, the Supreme Court’s decision could potentially expand the rights of the patent owner.

 

In this case, Impression Products, Inc. bought printer cartridges from a third party for resale in the U.S.  These cartridges were first sold by Lexmark and some of them were subject to the single-use/no-resale restriction.  Impression Products, Inc. acquired a modified version of the cartridges from a third party and sold these cartridges.  Lexmark sued Impression Products, Inc. for patent infringement and Impression Products, Inc. argued that the patent exhaustion doctrine applies.

 

The Supreme Court’s decision in this case will affect both patent owners and authorized purchasers of patented products.  The scope of a patent owner’s rights in these types of matter will likely be more clearly defined.  Along with the rest of the patent community, we will be keeping a close eye on the outcome of this case.

 

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The Importance of Trademarks to NonProfit Organizations

A nonprofit organization (NPO) is a type of entity that has a purpose other than making a profit, such as a social cause.  Put another way, rather than distributing profit to shareholders, as is typical in a corporation, any additional revenues are used to further the nonprofit’s mission.  That said, make no mistake about it, nonprofit organizations are not always charities and it is typically equally important to maintain organizational sustainability.  As such, nonprofits will identify ways to generate revenue so as to allow them to continue to invest time and resources into furthering their mission.  Some examples of nonprofits include UNICEF, Rotary, Kiva, Ted Talks, LPGA, United Way, Livestrong and Goodwill.  These nonprofits own registered trademarks and attend to them just as a for-profit organization does.

As one can imagine, just like a for-profit business seeks to leverage its brand and identity in order to further garner goodwill and generate revenue, nonprofits also are well-served when they do the same.  In addition, nonprofits want to avoid public confusion with like-minded nonprofits and, even worse, non-affiliated entities that try to profit off the consumer recognition of the nonprofit.  So, just like for-profit organization, as a nonprofit you should:

1. Identify your marks, including character mark, logos and taglines
2. File trademark applications with the United States Patent and Trademark Office (USPTO) and other government bodies in geographic locations in which you operate or intend to operate.  You should be particularly mindful to file in connection with your particular services, such as in International Classes 35 and 36 for charitable fundraising services” for solicitation of donations, promoting public awareness of . . .” or “public advocacy to promote awareness of . . .” for advocating a particular cause or issue or the interests of a group’s members or a certain class of people.
3. Ensure proper usage of your trademarks via licensing agreements and otherwise.  However, be mindful of the potential to create unrelated business income tax” (“UBIT”) on income earned from activities regularly carried on that are not substantially related to the organization’s tax exempt purpose (typically pursuant to 501(c)(3)).  Also, it is important to avoid any private inurement or benefit that may again impact the nonprofits tax exempt purpose.
4. Monitor unauthorized third party usage of your trademarks.
5. Take action in the event of trademark infringement, dilution of your brand or other unfair competition that adversely effects your nonprofit.

If you are nonprofit, you can not ignore the importance of sound business decisions, which necessarily includes proper management of intellectual property.  Remember, trademarks are important to furthering your mission and part of a sustainable organization.

 

 

 

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