Founders’ Friday: Should You Bootstrap or Finance Your Startup?

Before digging deeper, let’s start with a question: what do a self-made millionaire and a venture-backed millionaire have in common?  Yes, that’s right, so with that in mind, now we can discuss the fact that you have a great new business idea and are ready to make your idea a reality. You will undoubtedly be asking yourself where the funds to make that idea a reality are going to come from? Granted, resources (time, money, etc.) are needed, with cold, hard cash being king. Thus, whether to bootstrap or finance is one of the most important and earliest questions a founder needs to ask when pursuing a new business venture. Initially there are two paths, bootstrap (self-finance) or finance (raising capital through outside sources). The path you take depends on a multitude of factors, including the capital you have on hand, your access to outside capital (friends/family, angels, VCs) and the runway needed prior to MRR (monthly recurring revenue).

Almost every new business venture starts in the bootstrapping stage. Bootstrapping a business means you’re self-funded. You’re likely using savings, income from your current job, and/or personal credit cards in order to support your business. The longer you can build your business while bootstrapping, you will undoubtedly benefit from the financial and creative control of your business, without any investors demanding you move in a certain direction. You’ll improve your negotiation position with potential on investors, which typically means you’ll end up giving up less of your equity. Of course, there is also a downside to bootstrapping. Your business budget is limited to your personal finances and there is often not enough money to draw any form of salary for the founders and just enough to cover overhead expenses.

Eventually, it is unlikely that you’ll be able to bootstrap until profitability. That said, it has been done! If bootstrapping is no longer viable, it’s time to look for external funding sources. For a startup with limited operating history, this will usually be accomplished through a private offering to accredited investors (as such term is defined under the Securities Act of 1933) as opposed to traditional bank financing. In order to move forward with a private offering, you’ll need to identify the funding sources and funding methods. Funding sources typically include friends and family, crowdfunding, angel investors, and venture capital firms. Funding methods include convertible debt, convertible equity, common equity and preferred equity.

The funding source and method will vary depending on the funding stage of the startup. A startup’s funding rounds can be broken up into the following stages: (1) Seed Round; (2) Angel Round; and (3) Venture Round. When a startup is in the Seed Round, it is typically looking to raise less than $250,000, likely issuing some form of convertible debt or convertible equity (i.e. SAFE) or in some situations common equity. Often the investors in this raise are friends and family. In the Angel Round, the company is typically looking to raise less than $1M from angel investors, who are accredited investors looking for early stage companies with high upside. These angels sometimes invest through various angel networks that often have pitch nights where startups can come in a pitch an entire room full of angels. In this round, startups will over both convertible debt and equity, preferred equity, common equity and sometimes even warrants.

Both in the Seed and Angel Rounds, the structure of the startup is less of a concern to investors. As long as the terms of their investment make sense and you are either an LLC or C-Corp, then the choice of entity decision doesn’t really exist. However, once a startup reaches the Venture Round, there is often a strong preference from VC Firms that their portfolio companies are structured as C-Corps and that the VCs are issued preferred stock for their investment. The first VC Round is called a Series A Round and the size of the raise can range from $1M to $10M. In many situations startups will have multiple VC Rounds, with each subsequent round identified as a different series (i.e. Series A-2, B, C, D and so on).

Ultimately, whether to bootstrap or finance depends on all of the factors identified in this article, if not more. An analysis of those factors with your corporate counsel will help set your startup for success now and in the future.

Founders’ Friday is a series published by attorney Brian A. Hall of Traverse Legal, PLC d/b/a Hall Law 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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Is A Registered Copyright Necessary for a DMCA Takedown?

Imagine this: you just attended a concert at your local concert venue. Assuming it was a lot of fun, you want to share the experience with friends and family, so you post the photos you took on Facebook before going to bed. When you wake up the next morning, you sip your coffee and read the online edition of your local newspaper. Suddenly, you see in an article about the concert you attended—containing your photo—taken right from your private Facebook profile! You never registered your copyright to these images, so can you still file for a DMCA Takedown request? The answer is, yes.  Will it be successful? The answer is, maybe.

Although you did not register the copyright to your photo, you still have exclusive rights to your photo. Most photos, videos, or written content people generate and post do not end up being registered with the copyright office, but this does not mean they aren’t subject to copyright law. Providing proof of your copyright can be as simple as providing the ISP host with the image and date posted or direct URL and an affirmation you are the copyright holder. This applies to any content you have produced, not just social media material as provided by the example above.

If, however, you encounter a host who sends back a counter-notification letter, notifying that copyright was not infringed, you would have 10-14 days to file a lawsuit. In order to do so, you would need to register your copyright. Often times, registering a copyright with the standard $35 application fee can take 6 weeks to 6 months, which long exceeds the 10 to 14 day statute of limitation. Even with the expensive expedition option offered, which costs $760 in addition to the standard copyright application fee, it is not guaranteed to provide you registration within the 10 to 14 day statute of limitation.

In conclusion, while you can send a DMCA takedown request with regards to unregistered copyrights in attempt to achieve protection of your material, a registration is required for a lawsuit. It is highly encouraged that if you have material you really want to protect, register your copyright before its publication.

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Supreme Court Strikes Down Lanham Act’s Disparagement Clause

On June 19, 2017, the Supreme Court issued an opinion in Matal v. Tam, 137 S. Ct. 1744 (2017), striking down the disparagement clause in the Lanham act that had been in place since 1946. The clause reads that no mark will be registered that is a “matter which may disparage or falsely suggest a connection with persons, living or dead, institutions, beliefs, or national symbols, or bring them into contempt, or disrepute.” 15 USC § 1052. The ruling has massive implications for Trademark Law moving forward, but before we jump into that, let’s examine the court’s rationale in striking down the disparagement clause.

In Matal v. Tam, an Asian-American band wanted to register the mark “The Slants,” which was deemed to have been offensive to other Asian-Americans, and therefore was denied registration. On appeal to the United States Patent & Trademark Office (“USPTO”), Tam, the registrant, was again denied. Tam then appealed to federal court, where the Federal Circuit found the Disparagement Clause to be facially unconstitutional under First Amendment free speech. On the government’s appeal to the Supreme Court affirmed the Federal Circuit holding. Two of the main arguments proffered by the government for preserving the disparagement clause include:

#1.  The government argued that trademarks are government speech, and therefore not subject to First Amendment protection. The Court found this claim to be farfetched, in that simply giving a private mark a seal of approval and calling it government speech is a slippery slope to silencing or muffling the expression of a disfavored viewpoint, exactly the activity the First Amendment is supposed to protect against.

#2.  The Government made an argument that government programs were able to provide subsidies for private speech which expressed a particular viewpoint, without having to subsidize the alternative or conflicting viewpoint, such as funds to family planning services. The Court distinguished that a trademark registration was nothing like a subsidy, as no mark owner is monetarily compensated for registering their mark. The opposite is true as registrants must pay a $225-$600 filing fee and $300-$500 every 10 years to keep their mark active, which ultimately funds the USPTO services. Therefore, trademark registration is not considered a subsidy, but more similar to the fees for motor vehicle registration and a license to operate a motor vehicle, which are not expressive of promoting a viewpoint.

Ultimately, all of the governments arguments failed to satisfy the Court, and it was ruled that trademarks are not exempt from the first amendment free speech clause on the grounds that it was government speech. So, what does this mean moving forward?

The most famous and obvious dispute this case implicates is the Washington Redskins professional football team, who will likely be allowed to continue using its trademarks. Further, we could see the Scandalous and Immoral Clause tested and struck down the same way the Disparagement Clause was. In a case pending before the Fourth Circuit, the USPTO submitted a letter brief stating that the same reasoning applies to the Scandalous and Immoral Clause as well. This opens up many doors for trademark registration, including pornographic marks, and marks bearing racial slurs, as well as offensive religious material, we may also see many registrations of groups attempting to reclaim offensive words, much like the mission of The Slants. Be on the lookout for more cases dealing with these issues, as they are sure to come up as time goes on.

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Patent Exhaustion Update

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. Recently, this act’s provisions were called into question in the case of Impression Products, INC. v. Lexmark International, 137 S. Ct. 1523 (2017). In the case’s rise to the Supreme Court, the Sixth Circuit Court of Appeals gave remanufacturers quite a scare when it found that patent rights to a product could be retained after the sale of the product when the patentee imposes restrictions upon the sale of the product. The Supreme Court, however, reversed the Sixth Circuit, holding that the sale exhausted patent rights in the product being sold regardless of any restrictions the patentee attempts to impose on the location of the sale.

In the Impression Products, Inc. v. Lexmark International case, Lexmark was the patent holder of a type of laser printer toner cartridges. Once the toner ran out, they could be refilled and resold, and many companies took advantage of this by purchasing the empty cartridges, refilling them, and reselling them at a lower price than listed by Lexmark. To combat this problem, Lexmark created a return program, where they would sell its toner cartridges at a discounted price, where upon sale, purchasers entered into a contractual agreement to use the cartridge only once, and refrain from transferring the cartridge to anyone but Lexmark. They also placed special chips on the return program to make it more difficult to refill the cartridges, which also identified them as part of the return program. Remanufacturers, including Defendant Impression Products, continued to purchase and refill Lexmark cartridges in the return program, as well as purchase and import Lexmark cartridges sold internationally to refill and resell.

The first Issue the Supreme Court chose to analyze is whether a patentee that sells an item under an express restriction on the purchaser’s right to reuse or resell the product may enforce that restriction through an infringement lawsuit. In deciding this issue, the sixth circuit court of appeals reasoned that the sale of the cartridges did not give authority to resale, as that right was retained by Lexmark, and because Impression products new of these restrictions, Lexmark could sue Impression for infringement. When this issue was placed before the Supreme Court, however, disagreed. They reasoned that while clear and enforceable restrictions through use of contracts with purchasers were eligible for a suit under contract law, the exhaustion doctrine applied upon sale of the item, and all patent rights are exhausted regardless of any contractual presale restrictions that may be in place, therefore Impression was not liable for patent infringement.

The second issue pertained to international sales of a patented item, and its purchase and import back into the United States. The Sixth Circuit reasoned that the foreign sale of a patented product is different. They stated that because the item is sold abroad, where U.S. patent law does not apply, they do not exhaust their patent rights unless they expressly or implicitly transfer or license its rights. The determined that because the market abroad is not subject to U.S. patent law, A deluded market will make it more difficult to sell the product for the same price abroad as it is sold in the United States, so importing and refurbishing the product would be unfair to the patent holder. The Supreme Court, again, disagreed with the reasoning laid out by the sixth circuit. They compare the first sale doctrine of copyright law, which has no geographical restrictions as to a copyrights exhaustion after first sale. They also reason that a patent holder has the option to sell the product abroad or not. Patent law makes no guarantee of compensation received, and it is up to the patent holder to determine whether or not to sell their patented item at that price. Ultimately, the court held that upon sale, whether that sale be domestic or international, patent rights are exhausted.

The Supreme Court’s opinion in Impression Products, Inc. v. Lexmark International did distinguish the sale of a product and the licensing of a product. As a result, we can likely expect to see more attempts to structure transactions as licenses rather than sales.  Further, this decision may result in companies increasing foreign prices to match those in the U.S., such as consumer products and electrical components.

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Accidental Copyright Infringement Is Still Infringement

“Strict Liability” is a term used to describe legal liability in which a Plaintiff does not have to prove a Defendant’s fault, but simply show that their rights were infringed. Copyright infringement is strict liability, which means you remain liable for copyright infringement even though you did not intend or realize you were infringing a copyright.

One of the most common “honest mistakes” involves cutting and pasting someone’s photos on the internet onto your own website or otherwise use the photos for your own promotional purposes. It’s easy to do and there is a lot of misinformation on the internet about permissible use of someone’s photograph without permission. Even in situations where a business owner contracts a third-party web designer to build their website, both the business and the web designer can be held liable for copyrights violated if they are used on your website. If use of a copyrighted photo is related to commercial purposes, it is almost certain you have infringed. There are uses of copyrighted material called “fair use”, such as use for an educational purpose, which would not subject you to copyright infringement. However, even if you have a good faith, honest belief you are not infringing, if you are found to have infringed you will be liable to pay damages to the owner of the copyright regardless of your intent or belief.

Copyright infringement can be expensive. Under federal copyright law, statutory damages can be up to $150,000 per infringement, plus attorney’s fees and court costs. It is wise to err on the side of caution to ensure you are not violating a copyright in order to avoid infringement because ignorance is not an excuse for copyright infringement. If you have any questions regarding copyright infringement, do not hesitate to contact one of Traverse Legal’s experienced copyright attorneys.

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Founders’ Friday: Legal Agreements Preserve and Protect Your Growing Business

Any Founder, especially a repeat-Founder, will tell you that the proverb of “an ounce of prevention is worth a pound of cure” applies to legal agreements.  As a start-up business owner you will need several critical written agreements to assist in securing and growing your business. Unless you go it alone without any legal assistance, there are several key agreements recommended to keep your business secure after the business has been formed and as it begins to ramp up.

Employment Agreements

Employment agreements and independent contractor agreements can be utilized to help avoid disputes with those individuals, either employees or independent contractors, who you will employ to grow your company.   These agreements will define these work relationships with critical items such as compensation and duration of employment, paid time off and benefits, status of employment (usually at-will employment terminable at the will of the employer), and contain other key provisions such as methods for resolving disputes via mediation or arbitration or court proceeding, location for resolving disputes as well as applicable state law to be used in the event of a dispute. Independent contractor agreements, in particular, will need what IP attorneys refer to as magic language, namely “work for hire” provisions.

Non-Compete and Non-Disclosure Agreements

Non-compete and non-disclosure agreements will assist in the protection of your trade secrets, customer accounts, and other confidential information that your employees who leave have access to or third-parties who will be exposed to during the course of their contact with your business.

A non-compete agreement generally restricts employers and contractors for a period of time and within a determined location from your business from working for a competing business, which may put your customers or business secrets at risk, and are generally enforceable to varying degrees in most states. Employment or non-compete agreements may also contain confidentiality or non-disclosure provisions that help prevent disclosure of your important business information to competitors or others.

A stand-alone non-disclosure agreement can be utilized when negotiating deals with customers or whenever sharing sensitive financial or other confidential information about your company to third-parties in the course of growing your business. A non-disclosure agreement (sometimes referred to as an NDA) prevents the disclosure of sensitive information or your unique ideas or inventions, reserves ownership rights of the information or ideas in you or your business, and dictates the return of such information at the end of your discussions or negotiations.

Manufacturer or Supplier Agreement

Manufacturer or supplier agreements are utilized in the event you require the services of a manufacturer or supplier for your business. As with employment agreements, these agreements detail the terms of your engagement and can contain confidentiality provisions together with dispute resolution provisions such as mediation, arbitration and other means to enforce legal remedies as well as choice of forum and choice of law provisions for any disputes arising under those agreements. There are few things that are more expensive or inconvenient to your business than being dragged into another county or another state to defend a dispute in court with your manufacturer or supplier. Well-drafted manufacturer or supplier agreement can typically save you those headaches.

Trademark License Agreements

Trademark license agreements are essential to provide to any affiliates promoting your goods or services through the use of your brand identity or trademarks, even if you are at the point where you have not registered a trademark. A failure to properly license others in the use of your trademark can result in the loss of your trademark rights and jeopardize the otherwise exclusive right to your brand or business name. Remember, trademarks are not the only kind of IP that you could license, and you should also consider other intellectual property license agreements.

Budgeting for your legal business needs to protect your growing business through the use of key business agreements is essential for your long term growth and success. Such agreements will be imperative to have in place in the event you intend to exit or sell your business to a third-party who will want to see that you have minimized risks associated with the business through the use of these essential business agreements.

 

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 Partner Mark Clark.

 

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Texas Uniform Trade Secrets Act Amendment

The Texas Legislature recently passed a bill amending the Texas Uniform Trade Secrets Act (“TUTSA”), scheduled to take effect September 1^st of this year. Along with a few minor modifications, there are five notable changes that any business who carries a trade secret may want to familiarize themselves with, before they decide to file a claim in court.

(1) The first change to TUTSA was to expand the definition of Trade Secrets within the Act. Before, Trade Secrets were defined as “Information, Including a Formula, pattern, compilation, program, device, method, technique, process, financial data, or list of actual or potential customers or suppliers. “This definition was expanded to include “business, scientific, technical, economic, or engineering information,” taken verbatim from the federal Defend Trade Secrets Act (“DTSA”). Also added to the definition were “design, prototype, plan, program device, code, and procedure,” as well as a clause which reads “whether tangible or intangible and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing.” This applies so long as the owner has taken reasonable measures to protect his trade secret. While TUTSA moves to align its definition more closely to the DTSA, it is in large part more inclined to include more elements under the umbrella of trade secret, such as the inclusion of lists of actual or potential suppliers, or customers. TUTSA encompasses all types of information, whereas DTSA requires the information be reasonably related to financial, business, scientific, technical, economic, or engineering information.

(2) The modifications made to TUTSA will also clarify the requirements for a court ordered injunction. Previously, TUTSA allowed for relief after actual or threatened misappropriation of a trade secret. This remains true, although the amended version now includes language which suggests that general knowledge, skill, and experience that a person acquired during employment does not qualify for injunctive relief. This is simply a clarification which the legislature thought necessary to include.

(3) Willful and malicious misappropriation are added to the definitions section of TUTSA, defined as “intentional misappropriation resulting from the conscious disregard of the rights of the owner of the trade secret.” Clear and Convincing was also added to the definitions section as “the measure or degree of proof that will produce in the mind of the trier of fact a firm belief or conviction as to the truth of the allegations sought to be established.” This simply establishes the degree of proof plaintiffs are held to.

(4) The amended act also defines the owner as “with respect to a trade secret, the person or entity in whom or in which rightful, legal, or equitable title to, or the right to enforce rights in, the trade secret is reposed.” No changes, however, were made to the claimant section of TUTSA, which remains to be a key distinction between TUTSA and DTSA.

(5) Finally, the amended act spells out a seven-factor balancing test to determine whether or not to exclude or limit a party from the courtroom to protect the trade secret(s) of the other party. The factors read as follows:

– (1) the value of an owner ’s alleged trade secret;
– (2) the degree of competitive harm an owner would suffer from the dissemination of the owner’s alleged trade secret to the other party;
– (3) whether the owner is alleging that the other party is already in possession of the alleged trade secret;
– (4) whether a party ’s representative acts as a competitive decision maker;
– (5) the degree to which a party ’s defense would be impaired by limiting that party ’s access to the alleged trade secret;
– (6) whether a party or a party ’s representative possesses specialized expertise that would not be available to a party ’s outside expert; and
– (7) the stage of the action.

Compared to DTSA, a few key differences remain in TUTSA. The definitions of “trade secret” and “misappropriation” in TUTSA, while tailored to mirror some of the language in DTSA in the amended version, are broader and more inclusive than the definitions in DTSA. TUTSA provides means to grant protective orders for trade secrets with the balancing test presented in the amended statute. Some provisions in DTSA that remain different include the whistleblower immunity clause, which grants individuals who disclose a trade secret in confidence to their attorney or the government immunity if their purpose is to report or investigate a suspected violation of the law. DTSA also contains an ex parte seizure provision allowing the court to seize property in order to prevent the spread of a trade secret in extraordinary circumstances. The amended TUTSA became more aligned with DTSA with its inclusion of the injunctive guidelines and limitations, however, differences still remain. TUTSA did not go so far as to disallow conditions on a persons employment, or conflict with state law that prohibits restraint on the practice of a lawful profession, trade, or business, where DTSA has these restraints.

Choosing whether to make your trade secret claim in State or Federal Courts will largely affect the way a trial will play out, and could ultimately change the outcome. There are many factors that go into this decision, and you do not want to go in the wrong direction. If you have any questions regarding trade secret law and your options, contact an experienced Traverse Legal trade secret attorney to help work out your best course of action.

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