In a closely watched 5-to-4 decision authored by retiring Justice Kennedy in South Dakota v. Wayfair, 585 U.S. ___ (2018), the U.S. Supreme Court reversed decades of Supreme Court precedent, giving state and local governments the right to collect sales taxes from out of state retailers on online sales made into the local jurisdiction.

Business Taxation
Copyright: yupiramos / 123RF Stock Photo

The case involves Wayfair, a furniture and home company which sold products over the Internet into the state of South Dakota.  The law in question required the payment of a 4.5% sales tax by out-of-state retailers that make at least 200 sales or sales totaling at least $100,000 in South Dakota.

Prior to the Wayfair case, the standard, from two Supreme Court cases named Bellas Hess and Quill, was that a company had to have a physical presence in the state in order to be required to pay local tax.  A “physical presence” was something like a retail outlet, employees or property in the jurisdiction.

The Supreme Court stated, overruling decades of precedent, that the physical presence rule is unsound and incorrect. The Court noted that the rule has become removed from economic reality as technology has advanced.  The Court stated that the physical presence rule creates market distortions and puts local businesses and others at a competitive disadvantage given the new online marketplace.

The court concluded that, if a retailer establishes a substantial nexus with a state, that state can tax the sales in that state.  In this case, they concluded that the South Dakota law’s requirements of number of sales or total value satisfies the substantial nexus requirement.

Given that so many states rely on sales tax revenue for huge portions of their budgets and state governments have a strong aversion to new income taxes, this green light from the Supreme Court means that other states are likely to take a hard look at their laws and consider the enactment of laws calling for the collection of online sales taxes like the one in South Dakota.

This information does not constitute legal or tax advice.  You should, of course, consult an attorney or tax adviser regarding any taxation issues you might have, as each situation is unique.

BitcoinOur colleague Kristen Howell has published an alert reporting on an important development in the cryptocurrency industry. The U.S. Securities and Exchange Commission has declared that Bitcoin, Ethereum and other coins operating on truly decentralized platforms are not securities. The agency’s reasoning was revealed in remarks by William Hinman, Director of the SEC’s Division of Corporate Finance, at the Yahoo Finance “All Markets Summit: Crypto” on June 14. Hinman explained that since the value of cryptocurrency is not based on the expectation of profits resulting from the success or failure of the issuer, it does not compare to a typical security. You can read Kristen’s alert on the Fox Rothschild website.

Startups represented by seedling growthStartup clients often rely on independent contractors and advisors during their early stages but do not have the cash to pay them, so they turn to equity compensation. Stock options are a great incentive tool, but founders should consider the following before issuing options to advisors or independent contractors:

  1. How Much?: Most founders grant early advisors and contractors options that cover anywhere from 0.10% to 1% of the company’s fully diluted stock on a case-by-case basis. Founders should consider (i) how important the advisor or contractor is to the success of the company, (ii) how much time the advisor will commit to the company, and (iii) the maturity level of the company and its future growth prospects. Advisors and contractors may talk to one another about their option grants, so be consistent and prepared to explain the rationale behind the grants.
  2. Vesting: Just like option grants to employees, advisor grants should be subject to a vesting schedule. Advisor grants typically vest on a monthly basis without a cliff over a period of 12-24 months, although shorter or longer vesting schedules may be appropriate. In certain scenarios, vesting schedules for independent contractors may be customized so that all or a significant portion of the grants do not vest until completion of the project for which the contractor was hired.
  3. Exercise Period: Vested Incentive Stock Options (ISOs), which can only be granted to employees, must be exercised within three (3) months after the employee’s termination. This is not the case for Non-Qualified Stock Options (NSOs) issued to contractors and advisors, but most equity incentive plans require both types of options to be exercised within the three (3) month period. Experienced advisors may negotiate to extend the exercise period because they do not have the cash to exercise the options or are not prepared to pay the tax associated with exercising the options. Depending on the relationship with the advisor, it may be in the company’s best interests to extend the exercise period, especially with advisors who may be able to help the company in the future through their expertise or connections.
  4. Intellectual Property: All advisors should sign some form of confidentiality and invention assignment agreement. Although many advisors or contractors may resist, such agreements can be tailored to address the advisor’s concerns while still protecting the company ownership of its intellectual property, which is key to the company’s future success and ability to obtain venture financing.

Attention all Los Angeles area emerging companies!

Fit and confident female athlete in starting position ready for running

Want to get the most out of your people and your investment? Focus on your company’s HR and corporate governance.

Join Fox Rothschild Employment and Corporate attorneys Sahara Pynes and Emily Yukich as they host a free workshop for startups and emerging companies.

Enjoy breakfast on us as you learn how to keep growing businesses on track, create invested teams, manage risk and cultivate top-notch culture.

When:
April 24, 2018, 8:30am – 10:00am

Where:
Fox’s Los Angeles Office
10250 Constellation Blvd.
Suite 900
Los Angeles, CA 90067

Agenda:
8:30 – 9 am: Registration and Breakfast
9 – 10 am: Presentation

We invite you to register for this event, and hope to see you there.

Recently, we discussed generally the NVCA’s updated model legal documents on this blog. Of particular interest in the new forms is the NVCA’s attention to anti-discrimination and anti-harassment policies for emerging companies. Discrimination and harassment issues have impacted many industry-leading companies in the last year – and investors, board members and company executives all have aligned interests to ensure that the companies they are building are actively working to prevent discrimination and harassment.

Word cloud of harassment-related termsTwo of the documents published by the NVCA are the “Sample H.R. Policies for Addressing Harassment and Discrimination” and the “Sample H.R. Best Practices for Addressing Harassment and Discrimination”. Although the sample documents state that they were developed for use by venture capital firms and are not designed to be used as models for other companies without legal guidance, the documents provide a general framework that may be useful to many growing companies when considering how to implement such policies.

Key provisions covered by the documents include: the company’s mission statement, provisions explaining the company’s policies relating to harassment and discrimination, definitions of prohibited conduct, and examples of prohibited conduct. The documents include bracketed optional provisions that apply in certain states and localities, as well as a link to California’s anti-harassment pamphlet that must be given to all new hires.

In addition to these general documents, the NVCA has published documents that apply in several key jurisdictions where startups are frequently located. Examples include the sample Diversity and Inclusion Policies for San Francisco businesses and a Diversity Policy designed for use by businesses located in New York.

These documents provide a useful starting point for emerging companies as they develop policies relating to anti-discrimination and harassment, even if the documents are not designed to be used in the same off-the-shelf manner as the NVCA’s model legal documents.

Cybersecurity
Copyright: maxkabakov / 123RF Stock Photo

On Fox’s Privacy Compliance & Data Security blog, associate Michelle Rosenberg provided a breakdown of the EU’s General Data Protection Regulation (GDPR), a widely discussed and substantive change to European data privacy rules going into effect on May 25, 2018. Michelle notes the global impact on companies large and small that possess, transfer and process personal data of EU individuals. She also provides an overview of the methods of compliance available to such companies, namely binding corporate rules (BCRs), model contractual clauses and certification mechanisms like Privacy Shield, in relation to EU-U.S. data transfers.

We invite you to read Michelle’s informative post.

Startups represented by seedling growthFor early-stage companies in need of capital, finding potential investors can be difficult and time-consuming, especially when conditions in the capital markets are tight. For many companies, using a “finder,” an individual or entity that identifies, introduces and negotiates with potential investors, to help locate potential investors may seem to be a promising solution to this problem. However, there are risks involved in using finders, including those arising from potential violations of the SEC’s broker-dealer registration requirements. These risks are significant and, as investors become increasingly wary of the potential consequences, could threaten a company’s ability to raise capital in the future and its prospects for long-term growth and success. Finders operating as unregistered broker-dealers also face significant risks, including the possibility of severe SEC sanctions.

On April 12 at the ABA Business Law Section Spring 2018 Meeting in Orlando, Fox partner Emily Yukich and associate Matt Kittay, as well as Martin Hewitt, prominent New Jersey attorney and chair of the ABA’s Committee on State Regulation of Securities, will provide an in-depth CLE presentation on these risks. They will discuss the main risks finders face when acting as an unregistered broker-dealer, cover a critical SEC No Action Letter on the topic (the M&A Broker Letter), and will look at certain state regimes in applying the general prohibitions and restrictions in place.

The program will take place from 9:00 AM to 10:00 AM at the Rosen Shingle Creek in Orlando.  If you’d like to attend, please register for the Spring Meeting on the ABA’s website.

The National Venture Capital Association (NVCA) publishes model legal documents for venture capital financings, including a Certificate of Incorporation, Preferred Stock Purchase Agreement and Investors Rights Agreement. These documents enjoy wide industry acceptance as baseline agreements that parties and their counsel can tailor for each deal. They also include commentary on East and West Coast practice and bracketed alternative provisions to insert/omit depending on the deal terms. Perhaps most attractive to the parties, starting from a standardized form can decrease legal hours (and, more importantly, fees) from term sheet to closing.

Venture capital
Copyright: ar130405 / 123RF Stock Photo

Recently, NVCA updated the model legal documents for the first time since 2014. Considering the wide use of these documents, these revisions are likely to impact future VC financings. Here are some of the key changes:

Certificate of Incorporation

  • Protective Provision for Cryptocurrency/Blockchain Issuances: VCs typically negotiate for veto rights over a company issuing additional equity and debt securities. Now, the model Certificate includes a protective provision giving investors the right to veto token, cryptocurrency and blockchain-related offerings.
  • Redemption Rights: VCs might negotiate for a redemption right, which requires the company to repurchase their preferred stock under certain conditions.  If the company does not fulfill a redemption request, the model Certificate now includes a high rate of interest on the redemption price of any shares not redeemed “for any reason”. Recent case law suggests that a board may be protected by the business judgment rule if it determines not to use funds to redeem preferred stock despite an obligation to do so.  (See e.g., TCV VI, L.P.  Trading Screen, Inc., Case No. C.A. 10164-VCN (Del Ch. Ct. Feb. 26, 2015); SV Investment Partners, LLC v. Thoughtworks, Inc., Case No. C.A. 2724 (Del. Ch. Ct. Nov. 10, 2010). Triggering an interest payment “for any reason” gives investors increased leverage and some compensation.

Stock Purchase Agreement

  • Provisions for Life Science Transactions: Life science companies are attractive to VCs due to their potential for rapid growth and significant ROI. The updated Stock Purchase Agreement includes provisions specific to life science transactions.  These include more robust treatment of milestone closings, including undersubscription procedures and penalties for an investor’s failure to close, and new reps and warranties related to government and university sponsored research, clinical trials and FDA approvals.

Investors Rights Agreement

  • Anti-Harassment Covenant: In a timely addition, the Investor Rights Agreement now includes a covenant requiring the company to adopt an anti-harassment policy and a code of conduct governing appropriate workplace behavior. NVCA recently published a set of model documents and resources addressing harassment and discrimination.

Voting Agreement

  • Drag Along Rights: A drag along provision can permit VCs to “drag” the junior preferred and common holders into a sale of the company.  Under certain circumstances, dragged shareholders can receive little or no compensation in a drag sale, which may prompt a legal challenge.  The updated drag provision is intended to more effectively implement drag transactions and reduce the likelihood of a minority stockholder claim.

Users already familiar with NVCA’s model documents will be glad to see the revisions are not extensive.  However, given the wide acceptance of these forms, it’s safe to say that the updates will be impactful. This is especially true with respect to anti-harassment policies, which is both a high-profile issue and has obvious benefits for all parties.  Stay tuned to Emerging Companies Insider for a follow-up blog addressing NVCA’s new model documents addressing harassment and discrimination.

On Fox’s Franchise Law Update blog, partner John Gotaskie recently discussed an important upcoming deadline for businesses, including emerging companies, and entrepreneurs that operate websites that accept user-generated content:

If your franchise–or your franchisees–operate a website that accepts user-generated content, NOW is the time to contact the Copyright Office.

Whether you realize it or not, your website probably accepts user-generated content. Examples of such content include e-commerce websites that accept product reviews, franchise-sponsored blogs that publish user comments on posted articles, and brand fandom sites that permit users to share photos or videos.

It can be very difficult for you to determine whether user-generated content posted to your brand’s website was created by the user who posted it, or whether the content infringes someone else’s copyright.

To learn how to protect your brand from liability for copyright infringement in such content, we invite you to read John’s full discussion.

Over $1.5 billion has been raised by token offerings – also known as initial coin offerings or ICOs – so far in 2017. Not surprisingly, many startups are eager to capitalize on this possible funding source.

Initial Coin Offering (ICO) concept illustrationAlthough ICOs can be a useful method of raising capital, a number of legal issues must be considered in structuring and completing an ICO. One such issue is whether the tokens being offered in an ICO will be considered securities. A report issued by the SEC late this summer highlights the issue.

The SEC’s report was related to a token offering by an organization called The DAO. In its report, the SEC concluded that the tokens issued by The DAO were securities. Prior to the issuance of the SEC’s report, some advisors were telling startups that ICOs would not raise the same sort of securities concerns as traditional capital raises. Although the SEC has not issued formal guidance or regulations in this area, the report makes it clear that at least some tokens will be considered securities and that some platforms will be considered securities exchanges.

Many practitioners argue that there is a distinction between “security tokens” (designed to raise capital) and “utility tokens” (designed with some functionality and not purely to raise capital). The analysis in determining whether a token is a utility token is complex. Some tokens with utility characteristics may even be securities.

The law surrounding ICOs and the treatment of tokens is still evolving. Startups wishing to purse an ICO should seek legal advice early in the process. The danger of not doing so can be dramatic – since the date of the SEC’s report, at least one ICO was cut short after the SEC launched an inquiry into the ICO. The founders had not considered securities implications of conducting the ICO and ultimately decided to refund the funds raised to investors.