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.

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.

Trademarks
Copyright: silvia / 123RF Stock Photo

In an Alert published today, I examined the Trademark Trial and Appeal Board’s recent decision in In re Morgan Brown:

Owners of medical marijuana dispensaries cannot obtain federal trademark protection on marks used in connection with marijuana sales — even if their home state’s laws have legalized marijuana businesses — because marijuana is an illegal substance under federal law, and therefore encompasses a use that is unlawful, the Trademark Trial and Appeal Board has ruled.

In its July 14 decision in In re Morgan Brown, the TTAB upheld the decision of a trademark examiner at the U.S. Trademark Office who denied protection of a marijuana dispensary’s mark citing federal anti-drug laws.

To read my full discussion of the board’s ruling, please visit the Fox Rothschild website.

After the Supreme Court’s decision in Alice v. CLS Bank, many in the patent community have faced frustration in trying to understand when software-related inventions are patent eligible. A recent Federal Circuit decision provides some much-needed guidance on this question.

Copyright: hywards / 123RF Stock Photo
Copyright: hywards / 123RF Stock Photo

The court in Enfish LLC v. Microsoft (Fed. Cir. 2016) disagreed with a lower court ruling that claims covering a self-referential table were patent ineligible because they were directed to an abstract idea. The court found that the claims were instead “directed to a specific improvement to the way computers operate, embodied in a self-referential table.”

The court explained, “[w]e do not read Alice to broadly hold that all improvements in computer-related technology are inherently abstract…nor do we think that claims directed to software, as opposed to hardware, are inherently abstract…[s]oftware can make non-abstract improvements to computer technology just as hardware improvements can, and sometimes improvements can be accomplished through either route.”

Further, the court determined the claims at issue were patent eligible because, unlike claims in previously decided cases which recited use of an abstract mathematical formula on any general purpose computer, or covered tasks ordinarily performed by a computer, the indexing technique embodied by the claims in Enfish was directed to a specific improvement to computer functionality – specifically the ability of a computer to perform faster searches of data than it could using a relational model.

As such, the Federal Circuit’s decision in Enfish has provided a glimmer of hope to applicants and patent holders seeking to protect software-related inventions that in some way improve the functioning of a computer.

Jim Singer writes:

Copyright: bacho12345 / 123RF Stock Photo
Copyright: bacho12345 / 123RF Stock Photo

Have you updated your company’s form employee and independent contractor non-disclosure agreements lately? Do they comply with notice requirements relating to “whistleblowers” that took effect May 11, 2016 under a new federal law? If your answer is “no” or “I don’t know,” read on.

The new Defend Trade Secrets Act helps U.S. businesses protect their trade secrets by asking federal courts to order seizure of property necessary to prevent dissemination of the trade secrets. It also permits businesses to seek injunctions and damages in federal court for trade secret misappropriation. The DTSA applies to any company that owns trade secrets and wants to protect those trade secrets from theft, breach of a duty to maintain secrecy, or espionage.

The DTSA also provides some immunity for whistleblowers who disclose trade secrets under certain circumstances to government officials or attorneys in connection with reporting or investigating a suspected violation of law or in lawsuits alleging whistleblower retaliation.

The immunity section of the DTSA is especially important for employers because it requires employers to provide notice of the DTSA’s immunity clauses “in any contract or agreement with an employee that governs the use of a trade secret or other confidential information.” The Act defines “employee” to include both actual employees and independent contractors. If an employer does not comply with the notice requirement, the employer’s ability to recover damages against that employee in a federal action for misappropriation of trade secrets will be limited.

Employers can comply with the notice requirement by updating their form employee and independent contractor agreements to include either the notice requirement or a cross-reference to a policy document (such as an employee handbook) that states the employer’s reporting policy for a suspected violation of law.

For assistance reviewing or updating your company’s form non-disclosure agreements, please contact the attorneys in Fox Rothschild’s intellectual property, labor & employment or corporate departments.


Jim Singer is a partner and chair of the firm’s Intellectual Property Department, resident in the Pittsburgh office.

Philadelphia Magazine just published an article I wrote examining common legal issues for startups. In it, I provide a checklist for founders looking to establish their businesses while minimizing or avoiding common legal headaches later on. Here’s an excerpt:

Checklist
Copyright: mexrix / 123RF Stock Photo

Startup founders make countless decisions about their businesses. Here’s a list of 10 legal issues that can make-or-break their businesses:

1. Choice of Entity. Although many factors go into determining whether to form a startup as a corporation or an LLC, two important factors are the startup’s funding and hiring plans. A startup will typically form as a corporation if founders expect to raise venture capital (generally $1 million or more), as VC firms often prefer to invest in a corporation to avoid the pass-through profits and losses of the LLC being attributable to the individual partners of the VC firm. Further, if founders intend to incentivize employees through the issuance of stock options, a startup will typically form as a corporation, as a stock option plan of a corporation is typically less expensive to put in place and easier to administer than a profits interest plan of an LLC.

To continue reading, please visit the full article on the Philadelphia Magazine website.

As legal advocates, we counsel companies to enter into NDAs (non-disclosure or confidentiality agreements) whenever they share proprietary information.  An NDA serves several purposes.  It substantiates the date and terms on which information was shared, and if properly drafted, it can be enforced to halt damaging use of the information and give the company a boost when seeking compensation for any resulting damages.

A company undergoing a private equity investment or merger transaction enters NDAs with at least two parties: investment banks which may negotiate the deal and any potential acquirer before substantive meetings takes place.

But Angels and “Alphabet Stage” VCs serially refuse to enter into such agreements with target companies.  Eric T. Wagner frames the tension in this Forbes article, noting that “when it comes to courting professional investors… who literally see hundreds, if not thousands, of [pitches] every year, you can forget about it. Stick your NDA back in your pocket because it won’t get signed. And worse, you’ll look like a fool for asking.”

Angels and VCs articulate at least three reasons for not signing NDAs:

  • Company execution, not an uniqueness of an idea, propels the opportunity
  • NDAs create undue liability for investors, considering the high volume of pitches they hear
  • Companies would not pitch to them if they have a reputation for stealing ideas from entrepreneurs

Each of these points are valid for the most part.  However, there are horror stories alleging unethical dealings (if not theft) perpetrated by investors that would cause any entrepreneur to think twice.

Ultimately its the investor’s prerogative however, since they’re421837-throw-on-a-floor-photo-with-paths writing the checks.  So what should a cautious company do to protect itself, knowing that asking for an NDA won’t get anywhere, and might even make the entrepreneur look unseasoned just for asking?

Here’s some ideas:

  • Learn about a potential investor’s process and reputation by talking to their portfolio companies, companies who have pitched them, and connected advisers
  • Don’t overshare, and appreciate that digital media makes it very easy to copy and forward sensitive information
  • Execute company-judo, using lack of an NDA to motivate an in-person meeting for sharing more critical and sensitive details after the potential investor has reviewed sanitized materials
  • Have a draft term sheet ready to go which does include confidentiality restrictions- they are more acceptable at this later stage of negotiation

While it is true that a company won’t get the protection of an NDA when dealing with Angels and VCs, a thoughtful approach to the conversation can increase investor confidence and help you land the funding.

Matthew R. Kittay is a corporate attorney in Fox Rothschild’s New York office and Co-Chair of the American Bar Association’s Angel Venture Capital Subcommittee

Navigating intellectual property protections and issues can be a complicated and challenging process for emerging companies. In the fast-paced start-up world, it is not unusual for IP concerns to take a backseat. But disciplined and proper IP management is critical to any emerging company. Strong IP rights can be used to impose a barrier to competition, generate a portfolio of assets that can be leveraged, and help increase the value of a business. Here are four essential steps to protecting and strengthening your IP assets.  :

Copyright: stuartburf / 123RF Stock Photo
Copyright: stuartburf / 123RF Stock Photo

1. Insist that developers assign all IP rights to your company

Anyone who creates IP for a company should be under a written obligation to assign the rights in such IP to the company. This includes employees, independent contractors, suppliers, other developers and even company founders. Often, companies assume that because they are paying for development work, they own the results of the development. However, this is usually not the case, especially with respect to independent contractors. When it comes to development, having a written agreement that details assignment obligations is always a wise approach.

2. File early for patent protection

Patent protection may not be a top priority for an emerging company during its early stages due to cost concerns or because an invention has not yet perfected. But often, it is the technology developed during the early stages that ultimately has the most value. A wait-and-see approach to patent filing carries with it certain risks. For example, in the United States, a patent application must be filed within one year from the first public disclosure (i.e., a non-confidential, enabling disclosure of an invention such as a public use of the invention, a sale of the invention, an offer to sell the invention, a journal article describing the invention, a trade show presentation or the like). In addition, the United States operates on a first-to-file basis, meaning that the first person to file a patent application has rights for protection of the invention. As such, waiting to file for patent protection risks someone else filing first.

3. File for patents before public disclosure—especially for foreign protection

Although the United States has a one year grace period during which a patent application can be filed after a public disclosure, the majority of countries outside of the United States do not have comparable grace periods. Unlike the United States, a public disclosure is considered a bar to patentability in these countries. If foreign patent protection is part of a company’s IP strategy, then it is important to file a patent application before a disclosure in order to preserve foreign rights.

4. Understand and comply with the terms of your open source software

Open source code is often an efficient and cost free solution for emerging companies. Although use of open source software may be free of monetary cost, it is not free of responsibility. As a general rule, users may not use or distribute software without a license from the owner. And this rule applies equally to open source software despite its being publicly available or available for free. Like commercial software, the use of open source software is usually governed by a license agreement that includes terms and conditions controlling use of the software.  It is critical to understand the license terms and also how conditions may apply to open source software usage. In addition, it is important for users to understand the terms of any viral open source software, especially if the open source software is being combined with or integrated into proprietary software. Failure to do so could lead to an obligation to make proprietary source code available under a similar license.

 

Jianming Jimmy Hao, Ph.D. writes:

In 2014, after 5 years of rapid growth, annual foreign direct investment (FDI) by Chinese entities into the U.S. exceeded FDI by U.S. investors into China.  This rise in FDI is due in part to recent increases in Chinese investment into U.S. technology startup companies.

Copyright: niyazz / 123RF Stock Photo
Copyright: niyazz / 123RF Stock Photo

Recently, surging investment by Chinese companies in U.S. research labs is yielding a fast-growing trove of patents, which is part of a larger push by China to mine America for ideas to help it shift from serving as the world’s factory floor to becoming a driver of innovation.  The recent Chinese National Patent Development Strategy highlights the country’s plans through 2020, including seven strategic industries positioned for growth: biotechnology, alternative energy, clean energy vehicles, energy conservation, high-end equipment manufacturing, broadband infrastructure and high-end semiconductors.  While investment in the U.S. is a well-known part of the Chinese geopolitical strategy, the U.S. federal government encourages this investment through programs such as EB-5, which grants green cards to foreigners who, for example, create or preserve at least 10 jobs by investing at least $500,000 in commercial enterprises in high-unemployment areas.  State and local governments also offer potential investors tax incentives to compete with one another to attract this capital.

For emerging U.S. companies, however, investment from China can be a double-edged sword.  On one hand, money is always crucial for these young companies.  On the other hand, legal compliance can present challenges as there are a number of agencies in both China and the U.S. that regulate these investments.  For example, Chinese companies investing overseas must comply with certain registration formalities or obtain government approvals from several agencies including the National Development and Reform Commission, the Ministry of Commerce State, and Administration of Foreign Exchange.  State-owned enterprises also need approval from the Chinese state-owned Assets Supervision and Administration Commission.  In the U.S., the Committee on Foreign Investment in the United States (CFIUS), an interagency committee, is charged with reviewing transactions by foreign investors that may implicate U.S. national security considerations.  Accordingly, emerging U.S. companies should approach these investments cautiously and seek advice from legal professionals who have experience with the ins and outs of Chinese investments.


Jianming Jimmy Hao, Ph.D. is an associate in Fox Rothschild’s Princeton office.

These days, patent infringement lawsuits are increasingly being filed by “patent trolls,” entities that buy up vague and overly broad patents and send out demand letters asking for money in exchange of not being sued.  Many patent trolls specifically target start-up companies.

More than a year after the Senate defeated a bill aimed at curbing patent troll lawsuits, another bill recently emerged in the House referred to as the “Innovation Act.”  A copy of this bill can be found via the Library of Congress.

The Innovation Act is designed to weed out patent troll lawsuits by requiring courts to determine the validity of the patent at the early stages of the case.  The Innovation Act also imposes greater pleading requirements in a Complaint requiring the patent owner to identify:  i) each patent allegedly infringed; ii) each patent claim allegedly infringed; and iii) each product that the patent owner alleges is infringed, among other things.

On June 11, 2015, the bill was passed by the House Judiciary Committee.  Many people believe that the prospects for Congress passing this bill is improved this year due to a “super-coalition” of supporters, known as the United for Patent Reform coalition, consisting of technology and social media companies, such as Google, Adobe Systems and Facebook, as well as retailers like Macy’s, restaurant and hotel trade groups and start-ups and small businesses through trade groups.  A listing of the members of this coalition  can be found here.

While the bill, if passed, may curb some patent troll lawsuits, the bill should not be viewed as immunizing a start-up from a patent infringement lawsuit.  In fact, there is no absolute way of avoiding such a lawsuit.  However, there are steps a start-up can take to mitigate risks.  A good start is to obtain patents covering the start-up’s technology.  By doing so, the start-up can beat others to the punch by being the first to secure rights on its own technology.  Patents may also incentivize venture capital firms to provide investment in the start-up because the patents may provide some assurances to the venture capital firm that the start-up has rights on its technology.