The Trump administration recently announced it is delaying – and likely rescinding – the Obama-era International Entrepreneur Rule (the “Rule”). The Rule was slated to go into effect on July 17, 2017. It would have made it easier for foreign entrepreneurs to establish startup companies in the U.S. We blogged in detail on the final Rule when it was published in early 2017.

The White House, Washington, D.C.Now the Rule’s effective date has been delayed until March 14, 2018; however, implementation seems highly unlikely: the delay is to allow the Department of Homeland Security (DHS) an opportunity to obtain public comment on a proposal to rescind the Rule.

The Rule establishes criteria for granting “parole” (temporary permission to be in the U.S.) to certain foreign entrepreneurs to permit them to oversee and grow their stateside startups. To obtain parole, entrepreneurs would need to show that their startups have potential to grow rapidly, create jobs and provide a significant public benefit to the United States. Startups would be judged by, among other things, how much venture, angel or accelerator capital and/or government grants they’d received.

DHS decided to delay the Rule after President Trump signed an executive order on January 25, 2017 relating to border security and improving immigration enforcement. The order required DHS to ensure that parole is only granted on a case-by-case basis involving urgent humanitarian reasons or a significant public benefit. DHS is seeking public comment on the delay until August 10, 2017.

The move has drawn criticism from notable investors, business leaders and other stakeholders, including the National Venture Capital Association, a trade association for startup investors. Critics note the substantial contributions made by immigrants to the U.S. entrepreneurial ecosystem, especially in the tech sector. For example, 60% percent of the top 25 tech companies and 42% of Fortune 500 companies were founded by first- or second-generation Americans according to a 2013 report published by the venture-capital firm Kleiner Perkins Caufield and Byers. The Rule is not dead yet, but the prognosis is grim. The uncertainty alone seems likely to make the U.S. less competitive in the global market for ambitious and innovative minds.

An incentive plan is a tool used to motivate and reward employees to grow a business and exceed goals. A common form of an incentive plan for startups is an equity incentive plan. An equity incentive plan rewards key employees with equity, which is ownership in a company. Equity can be a company’s stock if it is a corporation or its membership interest if it is a limited liability company. For startups, equity incentive plans can be a great way to motivate and retain early employees when the company does not have the financial resources to pay high salaries or large bonuses.

The concept behind the equity incentive plan is that employees are given equity when the value of the company is relatively low (because the company is just getting started and not yet profitable), but as the company grows and becomes profitable, the value of the equity grows and the holders realize large financial gains. The two most common forms of equity incentive plans are restricted stock and stock options.

Restricted stock is exactly that, stock in the company that is restricted by the company in some form. The most common restriction is “vesting”. Vesting is the process where the employee gains ownership of the stock over a period of time, most often a number of years. Vesting protects the company because it incentivizes employees to stay with the company instead of leaving for a different job. Depending on the details in the plan documents, if an employee leaves before his or her restricted stock has fully vested, he or she forfeits some or all of the restricted stock. For example, a startup may give an early employee 50 units of restricted stock in the company as a bonus but with the restriction that the stock does not “vest” with the employee for three years. If the employee leaves one year later, the company retains the restricted stock because the employee did not complete the three-year vesting process.

Stock options are the right to buy a certain number of shares of stock in the company at a set price, regardless of the current value of the stock. For startups, stock options can be another great way to reward and incentivize key employees. Most stock option plans include a vesting period like the restricted stock discussed above. Once vested, stock options allow the holders to realize financial gains if the company’s value has increased since the stock options were granted. For example, if the current value of a share of stock for a company is $10, the company can grant a stock option to an employee to purchase 100 shares of company stock at that $10 value. Once the employee’s stock option has vested, he or she would have a set period of time in order to exercise the option. If during the employee’s option period the value of a share of stock rises to $20, the employee can use the stock option to purchase the allotted 100 shares of the stock at the $10 option value and create a $1000 gain based on the option price paid versus the current value of the stock.

Both restricted stock plans and stock options allow startups to reward employees without jeopardizing the current financial status of the company. With the expectation that the company will succeed and grow in value, equity incentive plans can be a great benefit to both the employee and the company. If you have any questions about restricted stock plans, stock options, or equity incentive plans in general please contact Kevin P. Dermody at kdermody@foxrothschild.com or 215-444-7159.

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The U.S. Citizenship and Immigration Services recently published the International Entrepreneur Rule (the “Rule”), which finalizes regulations intended to increase and enhance entrepreneurship, innovation and job creation in the U.S.  The Rule becomes effective on July 17, 2017.  In a prior blog, we analyzed the Rule when it was first proposed in August 2016.  Since then, the Rule has been through a period of public comment.  The resulting amendments generally make it easier for foreign entrepreneurs to establish startup companies in the U.S.  However, the Rule was spearheaded by President Obama, and its future is reportedly uncertain under the new administration.

Statue of Liberty
Copyright: dvrcan / 123RF Stock Photo

The Rule establishes criteria for granting “parole” (temporary permission to be in the U.S.) to certain foreign entrepreneurs to facilitate their ability to oversee and grow their stateside startups.  These entrepreneurs must show that their startup has potential to grow rapidly, create jobs and provide a significant public benefit to the United States. Startups will be judged by, among other things, how much venture, angel or accelerator capital and/or government grants they’ve received.

Applicant entrepreneurs must have a substantial ownership interest in the startup entity and an active and central role in its operations.  They must show they would substantially further the entity’s ability to engage in R&D or otherwise conduct and grow its U.S. business.

In response to public comments, the final Rule is generally more entrepreneur-friendly than the proposed rule that we described in our original blog.  Some key changes are listed below.

  • Startup Formation: To apply, startup entities must be “recently” formed.  Under the original Rule, this meant that the startup entity must have been formed within three years of the parole application.  Under the final Rule, the timeframe is extended to five years.  Since the entire potential parole period is five years (discussed below), startups could be 8-10 years old during their re-parole period, a ripe time for exits.
  • Definition of Entrepreneur: Under the original Rule, a person was only an eligible entrepreneur if he or she owned at least 15% of the startup at the time of the initial parole application, and 10% at the time of re-parole.  Under the final Rule, the ownership thresholds are reduced to 10% and 5% respectively.  The change benefits teams of founders who split equity among themselves and accounts for dilution during future financing rounds.
  • Minimum Investment Amount: Under the original Rule, entrepreneurs were only eligible if their startup had received at least $345,000 from one or more “qualified investors” (discussed below).  These investments had to be received in the 12 months prior to applying.  Under the final Rule, the investment threshold is reduced to $250,000, reflecting analysis of median seed investments of firms graduating from accelerator programs.  The timeframe is extended to 18 months.
  • Qualified Investor Definition: Under the original Rule, an investor was considered “qualified” if it made investments in startups in at least three different years in the preceding five year period of no less than $1 million and if at least two of these investments created at least five qualified jobs or generated at least $500,000 in revenue, with annualized revenue growth of at least 20%.  Under the final Rule, the investment threshold is reduced to $600,000, again to reflect median seed investments for firms successfully exiting accelerators.  The three year requirement is eliminated, but the investment performance criteria remains the same.
  • Re-Parole: Under the original Rule, the initial parole period was two years and entrepreneurs could apply for a re-parole period of up to three years.  Under the final Rule, the initial parole period has been extended to 30 months, but the re-parole period has been reduced to 30 months.  The net result is that, despite the changes, the entire parole period remains five years.  The increase in the initial parole period will give entrepreneurs additional time to qualify for re-parole (receive qualified investments or government funding, increase revenue or achieve job creation).

Generally, the final Rule is responsive to issues raised during public comment, and the changes largely make it easier for foreign entrepreneurs to build their businesses in the U.S.  Despite the apparent benefits to the U.S. startup ecosystem, the Rule may be in jeopardy under the new administration.  Emerging Companies Insider will stay on top of the story as it develops.

A recently passed House bill would permit certain start-up employees to defer taxes on stock options and restricted stock units (RSUs).  The proposed legislation aims to help emerging companies attract and retain talent by offering equity compensation on more attractive terms.

Business Taxation
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Cash-strapped start-ups often grant an ownership stake to employees to compensate for below-market wages.  This strategy also aligns incentives by giving employees a share of the company’s growth.

However, current tax law makes such equity compensation less attractive than it might otherwise be.  When employees exercise their stock options or when RSUs vest, they must pay taxes on the excess difference between the current fair market value and the purchase price.  Of course, the employee hasn’t actually pocketed any cash.  So the income is “phantom” income, but the tax burden is real.  Public company employees have the option to sell shares on the open market, but there is typically no market for private company stock.  Employees must choose between paying taxes out of pocket or foregoing their ownership stake.  This Hobson’s choice can dilute the value of equity compensation, making it more difficult for emerging companies to attract top talent.

The Empowering Employees through Stock Ownership Act (the “Act”) seeks to alleviate this tax burden on illiquid income.  Qualified employees working at eligible companies could defer paying taxes on income from qualified stock for up to 7 years.  Let’s unpack those terms:

  • Qualified Employee:  To take advantage of the tax deferral, employees must be “qualified employees”.  This includes all employees except certain owners and officers:  owners of 1-percent or more of the company, certain executives (CEO, COO or individuals acting in such capacity), and the company’s four highest earning officers are excluded.
  • Eligible Companies:  The Act is intended to incentivize broad-based employee ownership.  If a company wants its employees to qualify, it must have a written plan under which at least 80% of all U.S. employees who provide services to the company are granted stock options or RSUs on an annual basis.  The company must also offer stock options or RSUs to employees on similar terms.  Finally, the company cannot be traded on an established market.
  • Qualified Stock:  Qualified stock includes stock received in connection with the exercise of a stock option or vesting of a RSU.  The stock must be received as compensation for services performed as an employee of the company.  Importantly, stock is not qualified if the employee has the right to sell the stock to the company at the time of exercise or vesting or to otherwise receive cash in lieu of the stock.
  • 7-Year Deferral:  Employees are currently required to pay taxes in the year in which they exercise stock options or their RSUs vest.  Under the Act, employees would not have to recognize (or pay taxes on) this income until 7 years after exercise or vesting.  Certain triggering events could cause employees to have to pay taxes prior to the 7-year anniversary:  if the stock becomes transferable (including to the employer), if the employee becomes an excluded employee, if the stock becomes tradeable on an established market, or if the employee revokes the election.

Despite some controversy over how this tax deferral will be paid for, the Act is generally receiving praise as a move to strengthen the economy and create jobs by helping early stage companies attract the talent that will help them succeed.

A new rule proposed by the U.S. Citizenship and Immigration Services (USCIS) grants limited entrée to entrepreneurs establishing stateside startups.  The “International Entrepreneur Rule” would permit the Secretary of Homeland Security to offer parole (temporary permission to be in the U.S.) to individuals whose businesses provide “significant public benefit.”

Who Qualifies?

Statue of Liberty
Copyright: dvrcan / 123RF Stock Photo

So what is a “significant public benefit”?  According to the proposed rule, an entrepreneur can meet this standard by demonstrating that the startup has substantial potential for rapid growth and job creation, and that the entrepreneur’s parole would significantly help the startup conduct and grow its business in the US.

These are still abstract concepts, so the rule proposes benchmarks to evaluate entrepreneurs and their businesses. To qualify:

  1. The startup must be recently formed in the U.S. (i.e., generally within 3 years of its application).
  2. The individual must possess a substantial ownership interest in the entity (i.e., generally 15% or more) and have an active and central role in the business.
  3. The entity must have:
    1. received substantial investment from qualified investors (at least $345,000) with established records of successful investments; or
    2. received substantial awards or grants from certain governmental entities (at least $100,000); or
    3. partially satisfied one or both of the above criteria and must submit additional evidence of potential public benefit (e.g., acceptance into a startup accelerator, creation of new technologies or focus on cutting-edge research).

Notably, “qualified investors” are not determined based on the traditional definition of “accredited investors.”  Instead, the proposed rule focuses on investors’ track records.  Specifically, a startup must show that its investors have a history of making startup investments on a regular basis over a five-year period and that at least two of their investments have experienced significant growth in revenue or job creation.

For How Long?

Initial parole terms are for up to two years, and grantees have the opportunity to apply for an additional term of up to three years.  Renewal applications are determined on similar criteria as above, but thresholds differ.  For example, renewal applicants only need to own 10% of the startup, to account for dilution due to financing rounds during the initial parole period.

Join the Debate

The DHS is currently seeking public comments on the proposed rule, including with respect to the definition of “entrepreneur” and investment thresholds.  The proposed rule is a step in the right direction, but will generate comment and criticism, especially regarding its balancing act of encouraging innovation, promoting the public benefit and preventing fraud.  While investment thresholds are intended to weed out lifestyle businesses, they may also eliminate endeavors that serve the public good but are not scalable or otherwise likely to provide market venture returns.  The five-year maximum parole term seems a close shave given the time it can take from founding to exit (even the proposed rule recognizes that from 2009-2012 the average age of a company at public exit was 7.9 years).  Finally, focusing on investor track records instead of traditional accreditation concepts may discourage bad faith parole-for-cash investments, but it is likely to generate uncertainty.

These issues are likely to be addressed during public comment, and perhaps resolved before final publication.  The effort is certainly praiseworthy and may permit one or more foreign entrepreneurs to build their “New Colossus.”

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
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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.

Michael J. Meehan writes:

Employees collaborating
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Successful entrepreneurs tend to live, breathe and sleep their businesses.  They make decisions based on what is best for the business, often to their own immediate personal or financial detriment.  With so much personal investment, hiring and incentivizing employees can be among an entrepreneur’s greatest challenges.

Last week, Fast Company featured an excellent article written by Drew McLellan on this subject entitled, “How to Give Every Employee a Personal Stake in Your Company.”  McLellan’s piece encourages business owners to think about how they are investing in their employees.  He challenges entrepreneurs to evaluate the company’s big-picture objectives and to consider whether their employee salary and bonus structures are aligned with those goals.

As an example, the article mentions an advertising company that cancelled its traditional holiday bonus program in favor of allowing all employees to share in a bonus pool tied to the company’s adjusted gross income (AGI).  Under the new policy, employees had a clear incentive to (a) understand what comprises the AGI figure and (b) take steps to monitor expenses, reduce overhead, and encourage new client acquisitions to increase AGI (and the bonus they could ultimately earn because of it).  Although McLellan acknowledges that the utility of such a policy would vary greatly across industries, the value for him is in the process: Employee policies and agreements play an important role in incentivizing executives and employees to invest in a company’s success, and a successful entrepreneur should ensure that such policies and agreements are serving the company’s best interests.

The article provides useful advice to entrepreneurs facing hiring decisions or seeking to craft creative policies to help meet company objectives.  In particular, an incentive program such as a bonus pool or option plan can be a terrific way to motivate employees and align individual and corporate goals.  However, I would be remiss not to add an important caveat to McLellan’s suggestion: All employee policies, agreements and incentive arrangements and any changes to them should be reviewed on a regular basis by the company’s legal counsel to ensure the incentives comply with federal, state and local laws.  An open line of communication between the company and its attorney will help to ensure that these types of employee arrangements align with the company’s big picture objectives and that any risks to the company or its employees with respect to such arrangements are identified as early as possible.


Michael J. Meehan is an associate in the firm’s Exton, PA office.

In a December 2014 post, I presented an overview of what items should be included by an employer in a covenant not to compete in order to make it enforceable with respect to the employer’s employees and when that covenant should be implemented by the employer.  This post highlighted a Superior Court of Pennsylvania case being followed by many Pennsylvania attorneys, including my colleague, John Gotaskie.  I supplemented that post with another piece in February of this year which examined the issues being considered by the Pennsylvania Supreme Court on appeal of this case.  While this case is still on appeal, the original ruling held that a covenant not to compete is not enforceable against a former employee who went to work for a competitor due to the fact that the covenant was not supported by additional consideration given by the employer.

Another one of my colleagues, Alex Radus, recently provided another cautionary tale concerning covenants not to compete.  In a June 2015 post, Alex highlighted a Nebraska Supreme Court case which held that a franchisor’s overly broad covenant not to compete would not be enforced against a former franchisee.  One of the two reasons the court gave for not enforcing this overly broad covenant was that the State of Nebraska has a long-standing rule which provides that if a portion of a covenant not to compete is legally unenforceable, then the entire covenant will be unenforceable.  Unlike most other states that allow their courts to rewrite or “blue pencil” an otherwise illegal covenant not to compete in order to make it enforceable, Nebraska courts are not permitted to rewrite the overly broad portions of a covenant not to compete.

Alex concludes his piece by noting that franchisors and their lawyers should ensure that their covenants not to compete are enforceable from the outset under local law, especially in states that do not allow their courts to “blue pencil” these covenants.  Of course, this advice is equally applicable to employers as it is to franchisors.  However, his piece led me to place myself in the shoes of many of my clients who will likely have the following two questions:  What is my local law with respect to covenants not to compete and how do I find out if my state will allow courts to rewrite covenants that are deemed to be overly broad and unenforceable?  For those looking for answers to these questions, Fox Rothschild provides an outstanding resource.

National Survey on Restrictive CovenantsThe National Survey on Restrictive Covenants prepared by colleagues in my firm’s Labor and Employment and Securities Industry practice groups gives a state-by-state overview as to the enforceability of covenants not to compete (as well as covenants not to solicit, covenants not to hire and confidentiality covenants) and whether the so-called “blue pencil doctrine” is allowed to be used by that state’s courts.  As is the case with most laws, the answers provided in this survey are not always cut and dry and will undoubtedly continue to evolve over time, so please be sure to consult your lawyer with respect to particular questions.  In the meantime, feel free to familiarize yourself with your state’s requirements and find out whether your state will permit courts to scale back an otherwise unenforceable covenant not to compete.

 

Copyright: vipdesignusa / 123RF Stock Photo
Copyright: vipdesignusa / 123RF Stock Photo

The US Citizenship and Immigration Service (USCIS) announced today that it has reached the congressionally mandated H-1B cap for fiscal year (FY) 2016. The agency began accepting petitions from employers on April 1.

For more details, I invite you to read yet another excellent blog post by my colleague Catherine Wadhwani in Pittsburgh, writing for our Immigration View blog. In it, she provides a concise rundown on the latest from USCIS. And if you’d like to read more on the intersection between immigration and emerging companies, the Immigration View blog offers a Startup Companies category with relevant posts.