Can The Secretary Of State Refuse To Enforce California’s Board Gender Quota Law?

The constitutional infirmities of California’s novel board gender quota law have been remarked on by everyone from former Governor Jerry Brown to the legislative consultants who prepared bill analyses.  Now there is a pending constitutional challenge.  See Legal Challenge To California Board Gender Quota Law Filed.  In the meantime, should Secretary of State continue to expend funds to administer and enforce a law that is constitutionally suspect?

It is doubtful that the Secretary of State may refuse to enforce the law even if he concludes that it is unconstitutional.  The reason lies with Article III, Section 3.5(a) of the California Constitution which provides:

“An administrative agency, including an administrative agency created by the Constitution or an initiative statute, has no power:

(a) To declare a statute unenforceable, or refuse to enforce a statute, on the basis of it being unconstitutional unless an appellate court has made a determination that such statute is unconstitutional;”

The California Constitution does not define “administrative agency” and it thus may be argued that this provision does not apply to a constitutional officer per se.  However, a panel of the Court of Appeal has assumed that the Secretary of State is subject to the policy, if not the letter, of Article III, Section 3.5(a). Stirling v. Jones, 66 Cal. App. 4th 277, 288 n.3 (1998).  The California Supreme Court granted, and then withdrew, review of the case.  At the request of the Secretary of State, the Supreme Court ordered the depublication of the case.  Stirling v. Jones, 1998 Cal. LEXIS 6656.


© 2010-2019 Allen Matkins Leck Gamble Mallory & Natsis LLP
Read more about board diversity on the National Law Review Corporate & Business Organizations law page.

Delaware, Consent, And The Adequacy Of Email Notice

Since the turn of this century, Delaware has allowed corporations to give notices to stockholders by electronic transmission.  8 Del. Code § 232(a).  However, the statute is conditioned upon the stockholder’s consent.  California has a similar consent requirement in Corporations Code § 20.  Delaware is now proposing to amend Section 232 to permit a corporation to give notice by electronic mail unless the stockholder has objected.  See Senate Bill No. 88.  The bill would also define “electronic mail” for the first time.

As I was pondering these changes, I came across the following observations about the adequacy of email notifications penned by the estimable and eminently quotable Justice William W. Bedsworth of the California Court of Appeal:

“Email has many things to recommend it; reliability is not one of them. Between the ease of mistaken address on the sender’s end and the arcane vagaries of spam filters on the recipient’s end, email is ill-suited for a communication on which a million dollar lawsuit may hinge.  A busy calendar, an overfull in-box, a careless autocorrect, even a clumsy keystroke resulting in a ‘delete’ command can result in a speedy communication being merely a failed one.”

Lasalle v. Vogel, 2019 Cal. App. LEXIS 533 (footnote omitted).  Justice Bedsworth’s comments were directed to the adequacy of email notice before taking a default judgment and not the Delaware bill.  Nonetheless, his concerns about the adequacy of email are entirely opposite to stockholder notice.

 

© 2010-2019 Allen Matkins Leck Gamble Mallory & Natsis LLP
Read more about Corporate Law on the National Law Review Corporate & Business Law page.

Seller Beware? 4 Key Features of Business Sale Transactions that Sellers Should be Familiar with Before Negotiating

You have prepared your business for sale and have determined an enterprise value with which you are comfortable. Perhaps you have already found a buyer and signed a letter of intent, or at least agreed in principle on the overall purchase price for the business.

While determining the overall value of your company is an important step, negotiating the final terms of the business sale is just as important and oftentimes is far more arduous. Some business owners, especially first-time sellers, are surprised by the complexity of the sale process and are unprepared for negotiating through the many common provisions that affect how, when, and even if the full purchase price is ultimately disbursed to the seller.

This article analyzes key deal terms of a business sale and provisions that affect the timing and ultimate payment of the purchase price. This article also reviews the responsibilities of the parties after the deal closes, so that sellers can anticipate what the buyer is likely to demand and how to negotiate from a position of strength. It is important for sellers to keep in mind that nearly all of the items described here are designed to allocate risk. Buyers want to receive the value they expected from purchasing the business and allocate risk to the seller if there is an unexpected obstacle in the transition to new ownership. Sellers want to avoid business-related risks after closing and retain as much of the full purchase price as possible.

Understanding these key provisions allow sellers to identify early in the process which provisions may be more or less risky based on their understanding of the business, which provisions to prioritize, and how to build a negotiating platform that fits their expectations and goals. Sellers should consult with financial and legal consultants for the most recent market trends and figures related to the topics in this article.

Feature #1: Economic Terms.

Generally, buyers want to avoid going after a seller post-closing to recover funds already disbursed because the funds may no longer be available; to accomplish this, buyers want to maintain control over some portion of the purchase price funds until their window for making claims against the seller has expired. This section outlines common economic terms in purchase agreements that affect the timing of payments to the seller and portion of the overall price ultimately paid by the buyer.

Escrow Holdback. A certain portion of the purchase price will be placed in escrow at closing and held for a period of time in order to fund post-closing claims against the seller without requiring the buyer to go directly after the seller for proceeds already disbursed. The escrow holdback is usually a key provision of the deal and heavily negotiated by both parties given the funds in escrow are at risk and not available to the seller until the escrow holding period expires. The amount of funds held in escrow will vary depending on deal size, industry, business risk, negotiating leverage and other factors.

Escrow Holding Period. In connection with the amount of funds held in escrow, sellers should consider the amount of time that is acceptable to the seller for the escrow funds to be unavailable to the seller at risk for buyer claims. A longer holding period can often be a trade-off on the part of the seller to get a better position on a different priority during negotiations, but the seller must balance their short-term cash needs against the longer holding period. The escrow holding period can range from months to a few years after the closing date.

Target Working Capital. The seller is generally expected to provide working capital to fund the operations of the business immediately after closing, and the seller and buyer should work together to come to a realistic working capital number. At closing, the buyer will calculate the actual working capital in the business using an agreed-upon formula, at which time the parties will “true up” the working capital to match their agreed-upon target number. If the actual working capital at closing is deficient compared to the agreed-upon target working capital, the seller must pay the difference to the buyer. If the actual net working capital is in excess of the targeted amount at closing, the buyer will pay the excess amount to the seller, increasing the seller’s proceeds from the business. Keep in mind that working capital adjustments, unless otherwise agreed to, are generally considered separate from indemnity claims and are usually paid within 90 to 120 days after closing.

Set-off Rights. A purchase agreement may contain broad set-off rights in favor of the buyer, allowing the buyer to set-off funds owed to the seller but still in the buyer’s possession (such as working capital excess, or earned but unpaid earn-outs) against claims the buyer has against the seller. Setoffs are another way for buyers to mitigate risk by controlling funds.  Sellers should be careful that set-off provisions are consistent with indemnity provisions to avoid having more funds at risk than anticipated.

Earn-outs. The parties may agree to pay a portion of the purchase price in future year earn-outs, such as annual bonuses to the seller for meeting certain financial metrics in post-closing business operations. Buyers may favor earn-out provisions if the seller is going to remain an employee of the ongoing business, as it aligns interests in working toward the continued success of the business. For sellers, earn-outs can be a great way to negotiate a better purchase price and push a portion of the seller’s tax liability into future years; however, the benefits must be balanced against the likelihood of meeting the earn-out metrics and the seller’s short-term financial needs. An earn-out can also bridge the gap if the parties disagree about the value of the business.

Feature #2: Indemnification.

Indemnification provisions provide the buyer recourse against the seller for post-closing expenses and liabilities resulting from the seller’s misrepresentations or inaccuracies when providing the buyer with information (or withholding material information) during due diligence. As discussed further below, buyers will often try to expand their indemnity coverage through various legal provisions.

Representations and Warranties (RWs). RWs are assurances that the seller makes and on which the buyer relies when purchasing the business and are the basis for the buyer’s indemnification claims after taking over operations. A seller’s breach of RWs resulting in costs to the buyer triggers indemnification claims to recover the damage caused by the seller’s breach. RWs are generally divided into two types: fundamental and non-fundamental.

  • Fundamental. RWs are critical to the buyer’s willingness to consummate the transaction, and which, if breached, usually call into question the legitimacy or enforcement of the entire business sale. Breaches of fundamental RWs carry higher indemnification liability for the seller in order to place the buyer in a position as if the transaction never occurred. Fundamental RWs commonly include representations regarding ownership of the business equity, authority to enter into the transaction, and non-existence of other ownership claims against the business. They may also include other key issues or risks that the buyer feels are especially important to the deal.

  • Non-fundamental. RWs are statements and disclosures made by the seller that the buyer relies on for a smooth transition of ownership and operations of the business immediately after the closing date; generally, this includes all RWs made by the seller in the purchase agreement that are not fundamental RWs.

Ideally, sellers will want to make as few fundamental RWs as possible; the goal is to (i) limit the seller’s top-end exposure to a handful of statements that the seller is generally comfortable making, and (ii) cap the remainder of its aggregate liability to the indemnity cap amount. Sellers can be creative in reducing the number of fundamental representations they need to make by working with buyers to find alternative ways to mitigate buyer risk and seller liability; for example, exploring insurance options can be a sound strategy.

Indemnity Threshold. The indemnity threshold sets the minimum amount of aggregate damages a buyer must accrue against a seller before the buyer can recover any damages for indemnity claims. There are two main types of indemnity threshold:

  • Deductible. The “deductible” method of indemnity operates much like consumer insurance. The buyer must absorb all aggregate damages up to the “deductible” (indemnity threshold) amount, and the seller indemnifies the buyer for all claims in excess of the indemnity threshold.

  • First Dollar. The first dollar method of indemnity requires the seller to pay all damages once the buyer’s aggregate damages reach the threshold amount. Illustratively, this can be thought of as a tipping bucket. The buyer must “fill” the bucket with damages against the seller. Once the amount of damages fills the bucket (reaches the indemnity threshold amount), the bucket “tips” and all damages down to the “first dollar” become the liability of the seller.

Ideally, sellers want the deductible type of indemnity threshold because it reduces their overall risk. However, sellers may be able to leverage a concession on first dollar indemnity in exchange for a higher threshold amount, which can ultimately produce a better outcome because the likelihood of any liability is reduced as the threshold amount increases. Additionally, sellers should try to negotiate indemnity threshold provisions in tandem with other indemnity provisions.

Indemnity Cap. Whereas the indemnity threshold sets the minimum amount of damages a buyer must accrue before the seller is liable, the indemnity cap limits the maximum amount the buyer can recover due to the seller’s breach of RWs. The indemnity cap is often a heavily negotiated provision, as it caps the risk for the seller, and conversely, raises the cost to the buyer for the most expensive seller breaches. For fundamental representations, the indemnity cap usually equals the full purchase price of the business. For non-fundamental representations, the indemnity cap is commonly a fraction of the deal value. Matching the indemnity cap to the escrow holdback amount can provide benefits to both parties: the buyer does not need to recover any funds directly from the seller; and, barring breach of a fundamental representation, the funds disbursed to the seller at closing are not at risk.

Indemnity Period. The indemnity period is the amount of time that the buyer has to make a claim against the seller for breach of the seller’s RWs. Generally, fundamental representations survive until, at minimum, the statute of limitations expires on the underlying claim. For example, if one of the seller’s fundamental representations is that all taxes have been timely paid, the indemnity period for the seller’s tax representations might be the time limit that the IRS could audit or bring a claim for unpaid tax liability accrued through the closing dates.

Non-fundamental representations often have a much shorter indemnity period, which may match the escrow holding period or expire according to some other defined schedule, usually not longer than a couple of years after closing. Sellers want the shortest possible indemnity period; however, defining which RWs are fundamental versus non-fundamental may be more productive than spending negotiating capital on shortening the indemnity period, where there is often less room to maneuver.

Feature # 3: Legal Provisions.

This section covers terms only a lawyer could love—obscurely worded and buried deep in the bowels of the purchase agreement far removed from the exciting topics like financial terms; however, these legal provisions affect the overall application of the economics and liabilities of the deal, which can have sweeping consequences for the seller if not properly understood and negotiated.

For sellers, ideally both of the terms discussed below – knowledge disclaimers and materiality scrapes – would be removed from any purchase agreement; however, transaction trends show that about half of all purchase agreements contain at least one of these legal provisions, if not both. Depending on the seller’s negotiating leverage, they may have to decide whether to walk away from the deal or get comfortable with these provisions and try to use them as leverage for a better position on other negotiating points.

Knowledge Disclaimers/Sandbagging Provisions. Knowledge disclaimer provisions (commonly referred to as “sandbagging” provisions) generally prescribe that a buyer’s right to recover from a seller is not affected by the buyer’s knowledge, whether by the seller’s disclosure or the buyer’s own due diligence, of the inaccuracy or noncompliance by the seller of a representation or warranty. Stated more simply, the buyer is saying to the seller, “Even though we knew about the inaccuracy of your representations before we closed the deal, we can still sue you for any damages resulting from those misrepresentations after closing.” From the buyer’s point of view, this encourages proper due diligence and may be added protection. From the seller’s perspective, this makes due diligence an expensive but largely meaningless exercise, wherein buyers can identify deal flaws but consummate the transaction anyway and then sue the seller post-closing.

From a practical standpoint, sellers can mitigate this risk by properly disclosing exceptions to their RWs in disclosure schedules, which are incorporated into the purchase agreement and make the seller’s RWs accurate with the incorporated disclosures.

Materiality Scrape. A materiality scrape is a stand-alone provision that purports to eliminate materiality qualifiers from some or all other provisions of the agreement when: determining a breach of a seller representation or warranty; assessing damages for a breach; or both.

Because this concept is a legal art form, the following example will illustrate how this provision operates: The seller represents to the buyer that the company is in material compliance with all required permits at the date of closing. The company requires a permit to store a barrel of industrial cleaning chemicals that the business uses infrequently in its operations. Right before closing the seller files a renewal application for the chemical permit, but the application is filed three days late which results in the buyer being assessed a $20 late application fee after closing when the permit is finally processed and renewed.

Generally, this breach would not be considered material, as the permit is likely not material to operations and the permit is not adversely affected by a late renewal application. Additionally, the damages ($20) would also not be material, as it is a very small amount relative to the business’ day-to-day expenses and operations. Therefore, the seller would not have breached its representation regarding permit compliance. However, if the purchase agreement contains a materiality scrape, then for purposes of determining a breach of the permit compliance representation, we would ignore the word “material” and in theory the buyer would have a claim against the seller for each technical breach of the seller’s RWs, including permit compliance. Additionally, if the materiality scrape also affects the determination of damages, the buyer would include every damage claim, no matter how small (including the $20 late fee in our example above), to its aggregate claims against the seller, potentially filling the indemnity threshold bucket much faster than if only material claims were considered.

In fact, materiality scrapes can have the effect of filling the indemnity threshold quickly, so a seller may want to try to mitigate this risk by pushing for a higher indemnity threshold as a tradeoff.

Feature #4: Ancillary Documents.

Depending on how the business sale is structured, there may be substantial ancillary documentation in connection with the transaction, such as transition agreements, consulting agreements, employment agreements, shareholder agreements, and non-competition/non-solicitation agreements, to name a few. Although an in-depth review of these agreements is outside the scope of this article, it is important for sellers to analyze how the ancillary documentation operates in connection with the purchase agreement and how it affects the financial goals of the seller, such as illiquidity of assets, inability to re-enter the market, ongoing obligations or liabilities, and liquidation event triggers that are out of the seller’s control, among others.

For example, if the seller receives the buyer company’s stock as partial consideration for the sale of the business, the seller will likely be required to execute a shareholders agreement which may contain “black out” periods or call options where a buyer can force the seller to sell their shares. Sellers should not wait until just before closing to review and negotiate the terms of ancillary documentation; instead, sellers should request drafts of and review any other ancillary documentation concurrently with the purchase agreement so that all terms of the deal can be analyzed together in connection with the seller’s overall strategy.

Conclusion

When preparing to sell a business, the big issues, such as finding the right buyer and company valuation, are key considerations; however, the terms of the sale can be just as important for the seller, especially as it relates to ongoing risk and short-term financial planning. Buyers want the benefit of their purchase and prefer to hold back some portion of the purchase price until their window for bringing claims against the seller expires. Sellers want to ultimately receive the full purchase price and feel secure in moving on after closing without the threat of claims against their proceeds.

By preparing for key purchase agreement terms ahead of time, sellers can identify which terms to prioritize, which terms to sacrifice for negotiating leverage, and areas where creative solutions may be appropriate. And perhaps more importantly, sellers can plan the terms of the deal around their financial needs and expectations.

Copyright © 2019 Ryley Carlock & Applewhite. A Professional Association. All Rights Reserved.
This post was written by Jessica Ann Benford and Joshua J. Hencik.

What Start-ups Need to Know About Intellectual Property

As any entrepreneur is well aware, the early stages of a new business venture are an incredibly busy time. Entrepreneurs must focus on building the core team, structuring the company, attracting investors, developing the product/service, and developing key partnerships, sales channels and marketing plans. These tasks are typically all-consuming for the founders, taxing both their financial and time resources.

During this time, it may be a challenge to simultaneously focus on intellectual property issues.  However, this early time period is also a critical time for ensuring that a business takes steps to protect its core intellectual property and avoids the risk of third party intellectual property issues. Today, more than ever, having a solid understanding of intellectual property and developing an IP strategy that aligns with the business is a crucial part of building a new venture on a solid foundation.

This article includes an overview of the different types of intellectual property and provides advice to start-up companies on how to secure their own intellectual property as well as protect against intellectual property risks from others.

The three basic types of intellectual property that startups should understand are:

  • Patents
  • Trademarks
  • Copyrights

Patents

Not every startup business will be best-served by investing its resources in building a patent portfolio, but the question of whether to pursue patent protection warrants a hard and early look. Knowledge of the role of patents is critical for two reasons:

  • To protect your own business and inventions from your competitors
  • To avoid the risk of being exposed to assertions of patent infringement by competitors and other third parties

It is important for startups to understand the different kinds of patent protection and how they fit into their business.

Utility patents can be obtained for processes, machines, articles of manufacture, or compositions of matter that are deemed new, useful and non-obvious. The traditional subject matter of such utility patents covers tangible, technical inventions, such as improvements to client-server systems, motors, radios, computer chips and various technical product features. For example, Boeing’s US Patent No. 6,227,447 is a patent that covers methods of remotely controlling a vehicle. Patents can also be directed at new product features and functions. As another example, Facebook’s US Patent No. 8,171,128, titled “Communicating a newsfeed of media content based on a member’s interactions in a social network environment,” protects its News Feed feature.

A separate category of patent, the design patent, may be sought to protect ornamental (non-functional) designs. Some examples of notable design patents include Apple’s D 604,305 covering the design of its iPhone interface and Lululemon’s design patent covering its yoga pants.

The role of patents

Although patents are the most expensive and time-consuming type of intellectual property to obtain, they also provide the best scope of protection. A patent provides its holder with the exclusive right to make, use or sell an invention.  This means that it can exclude a competitor from making or selling the patented invention, irrespective of whether or not the competitor copied the invention or even previously knew of the patent.  For this reason, a patent that covers an important feature that drives consumer demand and/or distinguishes one’s product or service from that of competitors, can be very valuable.

Benefits of patents for a young business

Patents may provide a number of benefits to young businesses. For example, a robust patent portfolio or a key patent can help attract investors, since it may serve as barrier to entry by competitors. Furthermore, the filing of a patent application will enable the company to advertise “patent pending” along with its product or service.  In addition to potentially attracting investors, the “patented” or “patent pending” labels may deter would-be competitors, or force those competitors to adopt different designs and technologies.

As indicated above, once a patent issues it may be used to stop competitors from entering the field and allows for recovery of damages for infringement. Patents can also help the finances of a business by providing an opportunity to generate revenue from licensing.

How to obtain a patent

A patent is obtained by filing an application with the United States Patent and Trademark Office. The application includes a description of the invention accompanied by drawings, followed by a list of the elements that form the invention, called the patent claims. The patent claims set out the metes and bounds of the invention.  Third-party products or services that practice the elements of a claim infringe the patent.

When a patent application is first filed, an examiner is assigned to it. The examiner will reject or allow claims based on an assessment of their patentability, and the patent applicant will have an opportunity to respond to the examiner’s decisions. This back-and-forth with the Patent Office, known as prosecution, can take a number of years and is best done by an experienced patent attorney who understands the procedures, the legal requirements and the art of drafting strong patent claims.

Impact of the America Invents Act

Changes in the patent law implemented by the America Invents Act (AIA) half a decade ago have impacted the leading practices for businesses looking to file for patent protection. First, the U.S. is a “first inventor to file” system. This incentivizes early disclosure of inventions and early filing of patent applications.

When two people independently come up with the same invention, the first inventor to file for a patent on his or her invention is awarded the patent, regardless of which actually invented first. For this reason, it is important for businesses to streamline operations to reduce the time from invention to filing of patent applications.

Early and cost-effective filing can be achieved through provisional applications, which are essentially invention disclosures that can be converted to full patent applications within one year.

In addition, the AIA also provides for a prioritized examination procedure, which expedites the patent examination process. While the use of prioritized examination is more costly up-front, it may reduce overall legal expenses, since a patent can be obtained within one year.

Avoiding infringement of other patents

A second important aspect that startups should consider with respect to patents is a defensive one, i.e., avoiding infringement of the patents held by others. As a matter of practice, startups should conduct a patent search to verify that their business is free of patents that could be asserted against their product or service. The up-front cost of performing this search and related analysis is relatively minor and is offset by the potential for huge savings, both in terms of litigation costs and wasted investment in an infringing idea. The cautionary tale of Vlingo underscores this point.

Vlingo spent years developing voice recognition technology that led to talk of partnerships with Google and Apple. However, another voice recognition company, Nuance, which held a patent on voice recognition, sued Vlingo for patent infringement. Although Vlingo ultimately won the lawsuit, by then the company had already lost its potential partnerships, and the cost of defending the suit forced Vlingo to sell its business to Nuance. An early patent search could have revealed the Nuance patent and may have allowed Vlingo to take appropriate strategic steps to address the issue. For example, they might have been able to adopt a different design to avoid a run-in with Nuance.

Trademarks

Trademarks take us into the world of branding.  Trademarks serve to build brand awareness and business goodwill. They can impart consumer confidence in a product by its association with a brand the consumer recognizes and trusts. A trademark can be words, symbols, logos, slogans or product packaging and design that identify the source of goods or services. The Coca-Cola logo is one of the more famous trademarks.

Unlike patents, trademark rights are only acquired through use. Even without registration, the symbols “TM” or “SM” may be used to accompany trademarks or service marks to designate products or services. However, only registered marks may be accompanied by the “®” symbol.

Although registration with the US Patent and Trademark Office is not required to gain trademark rights, registration provides certain important benefits to the trademark holder. For example, without a registration, the trademark rights are limited to the geographic area in which the product or service is marketed and sold, and protection begins only after the product or service is available for sale on the market.

In contrast, federally registered marks provide nationwide rights. Registration also creates a prima facie case of validity of the ownership as well as an exclusive right to use the mark for specified goods or services. Once registered, the owner of a mark can stop importation of infringing products through U.S. Customs.

Clearing and registering key trademarks

Just as with patents, when seeking trademarks, businesses should be aware of whether their desired name, logo or domain name is already in use by others. Searching for existing uses is known as trademark clearance, with the goal being to “clear” a desired mark for use. Clearing the name and brand early on will reduce the likelihood of problems down the road.

Startups should look to protect their brand early by clearing and registering key trademarks. Registration is relatively quick and inexpensive, generally a few thousand dollars for a clearance search and subsequent filing for registration. A trademark application must specify the type of mark — i.e., whether the mark consists of just words or includes a stylized design or even an identifying color or sound. The application must also specify the particular goods or services to which the mark will apply.

As the company grows, it will become increasingly important to police infringing uses of its marks. Such efforts will help ensure that the business is not losing customers due to confusion with knock-offs.

Copyrights

Copyright is a form of intellectual property that protects the expression of ideas. Books, music, art, photographs, architecture and even computer software can be protected by copyright.

However, while copyrights protect the expression of ideas, they do not protect ideas or concepts themselves. For example, a copyright can protect a particular photograph of a bird, but others may still create their own photographs of the same type of bird.

Another requirement for copyright eligibility is that the work must be “an original work of authorship.” Facts, titles, phrases, and forms per se cannot be copyrighted.

Exclusive rights to copyright owners

Like trademarks, copyright registration is optional. As soon as a work is written or recorded or otherwise made “tangible”, it is considered to be copyrighted. US law provides various exclusive rights to copyright owners, including the rights to reproduce the work, prepare derivative works and distribute copies, irrespective of registration.

However, registration provides significant procedural benefits. Critically, registration is necessary in order to file a lawsuit for copyright infringement. It is also necessary to receive certain remedies, such as statutory damages and attorney fees. Registration also provides a presumption of originality and ownership, and it allows US Customs to stop the importation of infringing or counterfeit works.

Businesses should include the “©” symbol or the word “Copyright” on all distributed materials. They should also include the year of first publication, the name of the owner, and the language “All rights reserved.”

Businesses should consider registering any important materials so that the option of filing lawsuits is available to address infringement. Registration can be filed online with the US Copyright Office for a nominal fee.

Startups should also be careful to avoid using third-party photos, music, or writings on their website, marketing materials or products. Such use could lead to a potentially costly infringement dispute with the copyright holder.

Finally, because the author is the copyright owner by default, startups should take steps to ensure that they receive the rights to any copyrightable work created by employees or third-party contractors. The Copyright Act lists specific requirements for works for hire, and employment and third-party contractor agreements should include specific language to address ownership of any copyrightable works.

Conclusion

While intellectual property issues may sometimes get brushed aside during the early stages of a business, developing a diligent and intelligent IP strategy early on is important.

Startups should evaluate the types of intellectual property that can impact their business and strategically consider pursuing patent, trademark and copyright protection as appropriate.

Defensively, startups should also assess the intellectual property landscape of their business. That awareness should include clearance efforts to ensure that the company will not infringe the intellectual property of others, as it develops its products and services.

Learn more about Legal Issues for High-Growth Technology Companies. 

© 1998-2018 Wiggin and Dana LLP

Legal Issues for High-Growth Technology Companies: The Series

High-growth technology companies face a unique set of challenges and roadblocks that their leaders must address in order to continue to expand and compete. This article series is intended to provide high-growth companies with a roadmap on how to navigate many of the interdisciplinary legal issues they might face during a particular stage of their life cycle. Below is a preview of what this series will cover. The articles that are currently available are hyperlinked and include:

Please check back in with us over the next couple of months for updates as we plan to publish the remainder of the articles on a regular basis.

Choice of Entity: Tax Implications

This post by Peter Gruen and Amy Drais will provide a high level overview of the tax implications of each type of entity from a variety of perspectives: taxation of the entity, taxation of its owners and employees and concerns of potential investors. The entities to be discussed are limited liability companies, partnerships, C corporations and S corporations.

What Start-Ups Need to Know About Intellectual Property

Today, more than ever, having a solid understanding of intellectual property and developing an IP strategy that aligns with the business is a crucial part of building a new venture on a solid foundation.  Michael Kasdan’s article will provide an overview of the different types of intellectual property and provide advice tailored to start-up companies on how to both secure your own intellectual property while protecting against intellectual property risks from others.

What Security to Sell to Investors and Why it Matters

Your business is ready for a financing—what security will you issue?  There’s no one right answer and not surprisingly, your investors get to have a say as well. This article by Evan Kipperman and Adam Silverman will discuss the pros and cons of various types of securities an early stage company may sell during a financing, including preferred equity, convertible debt, debt, and lesser known vehicles such as the SAFE and KISS documents.

Risk Considerations in Commercial Contracts with Customers

As an emerging company goes to market with new offerings, it will need to determine the terms and risk profile on which it will sell its services and products. Many companies develop terms of use (generally for products or services provided or sold through the web) or contract templates. An emerging company will want to have terms that are consistent with market norms for the relevant industry and are “sellable” to customers, but are protective of the company’s interests and go-to-market strategy. Having balanced terms can reduce negotiation time and energy, allowing the company to get customers and close sales more quickly. This article by Sarvesh Mahajan focuses on three key area of risk that typically need to be considered in offering services and products: warranties, indemnification, and liability.

Cybersecurity: Starting Your Company with Sound Data Privacy and Security Strategies

In the wake of recent privacy and security issues at major U.S. platforms, the climate for privacy regulation may be changing.  Recent revelations concerning Facebook’s dealings with Cambridge Analytica have regulators on both sides of the Atlantic considering tighter rules for data sharing and secondary data use by social media platforms and their ecosystems of app developers, analytics firms and other business partners.  In addition, the enforcement of the European Commission’s strict General Data Protection Regulation (“GDPR”) also portends a new era of heightened monitoring and enforcement of consumer privacy rights in the global digital economy.  Emerging technology companies with data-driven business models can expect increasing scrutiny of their data practices by users, investors, the plaintiffs’ bar and regulators.   How can emerging companies and startups, with limited resources, focus their efforts to prepare effectively for a heightened regulatory and due diligence environment for data privacy?  The article by John Kennedy will focus in particular on key privacy and security practices that regulators have emphasized and on the usefulness of following principles of privacy and security ‘by design.’

Wage and Hour Law Fundamentals: A Guide for Early Stage Companies

Even early stage companies need to be proactive when it comes to employee relations issues.  In this article Mary Gambardella and Lawrence Peikes will discuss fundamentals in the wage and hour area, including proper job classifications (exempt/non-exempt; independent contractors); pay practices; timekeeping; and equal pay laws.

The Battle for Patent Eligibility in a Changing Landscape

Over the last five years, the United States Supreme Court has changed the landscape of patent eligibility with its decisions in Mayo Collaborative Servs v Prometheus Labs, Inc (132 S Ct 1289 (2012)) and Alice Corp Pty Ltd v CLS Bank Int’l (134 S Ct 2347 (2014)).  While patent eligibility was not a primary focus in the life sciences area, the Supreme Court decisions and their progeny have sent shock waves through the life sciences field.  Numerous biotech and diagnostic patents have been found to be ineligible under the threshold patent statute.  This article by Sapna Palla addresses the changing landscape and key court decisions, suggests new avenues for companies to navigate the changed landscape and provides practical guidelines for companies in protecting and enforcing patents in the life sciences area.

You’ve Been Sued: What to Do (and Not Do)

Your company is doing well and building momentum, but then you get hit with a lawsuit.  What do you do, and what shouldn’t you do?  Litigation doesn’t have to be the death knell of a growing company, but it (and its cost) can quickly spiral out of control if not handled properly.  This article by Joe Merschman will provide an overview of litigation and explore issues to consider when your company is faced with a lawsuit.

Are You an Exporter? You Might Be.  The Often Overlooked Controls on Software with Encryption Capacity

Given the common use of encryption in software today, and an increasingly global market for software products, it is important for companies, particularly emerging ones, to recognize that software with cryptographic functionality is controlled by U.S. export law.  The consequences of not recognizing the export compliance obligations associated with encryption products could be costly, and not only because regulators might catch a company breaking the law (and have the power to impose penalties even for unintentional violations).  Start-ups being acquired by larger companies may have to disclose non-compliance with export law in the due diligence process leading up to purchase, forcing money into holdback escrows to serve as security for the buyer, which will inherit liability for any violations and understandably look to shunt any successor liability and compliance expenses to the seller in the deal.  Luckily, avoiding this outcome is relatively easy, if a company making or selling software expends minimal effort to: (1) know if their product is of the type that concerns the U.S. government; and (2) satisfy their export compliance obligations, which may amount to little more than submitting an annual “self-classification” report to the government by email. Daniel Goren  and Tahlia Townsend explore these issues.

Estate Planning for Founders

Founders have unique needs that necessitate proactive estate planning as early in a company’s existence as possible in order to maximize tax and liquidity options.  This article by Michael Clear and Erin Nicolls will discuss the intersection of the personal planning and startup lifecycle, as well as various milestones for estate planning that impact tax efficiency, business continuity, and asset management and protection.  We will focus on transfer tax strategies to minimize the effect of estate and gift taxes and to set the Founder on a financial path for future success.

Blinded by the Price: From Enterprise Value to Net Payment at Closing

In the sale of a business, the difference between the headline purchase price and the net payment to the equity holders can be significant.  Seller may have negotiated an attractive multiple to determine enterprise value.  But the presence of rollover equity stakes, deferred purchase price, escrows and purchase price adjustments, as well as payments to third parties in connection with payoff of indebtedness and other debt-like items, transaction bonuses, advisor expenses and other deal-specific amounts, may mean that some amounts will come off the top before equity holders get paid. Understanding whether certain items should (or should not) be paid at closing, and why (or why not) is fundamental to structuring the transaction appropriately. James Greifzu and Aaron Baral discuss these issues.

 

© 1998-2018 Wiggin and Dana LLP.

New Jersey Extends EDA Loan Program to Minority or Women Owned Businesses

Governor Christie signed A1451 into law this week making EDA loans through the Urban Plus Program available to small, minority or women owned businesses located in designated New Jersey regional centers or metropolitan planning areas as if such businesses were located in urban centers.   Minority or woman owned business enterprises (MWBE) must be certified through the Department of Treasury.  As a qualification, MWBE applicants must demonstrate that the business is operated and controlled by a management team of women or minorities and such company is owned by a majority of minorities or women. The business must be involved with a commercially useful function and the minority or female ownership and management must be real, substantial, and continuing and not merely in name only.

 

© 2018 Giordano, Halleran & Ciesla, P.C. All Rights Reserved.
This post was written by Melissa V. Skrocki of Giordano, Halleran & Ciesla, P.C. 

Chicago City Council Committee Approves Hands Off-Pants On Ordinance to Protect Hotel Employees

On October 2, 2017, the Chicago City Council Committee on Workplace Development and Audit approved an amendment to the Municipal Code (the “Ordinance”) that, if approved by the full City Council, will require hotel employers to equip hotel employees assigned to work in guestrooms or restrooms with portable emergency contact devices and develop and implement new anti-sexual harassment policies and procedures. The Ordinance is in response to multiple reports of sexual assault and harassment targeted at hotel employees by hotel guests.

The Ordinance in its current form will require hotel employers to (1) equip employees who are assigned to work in a guest room or restroom, under circumstances where no other employee is present in the room, with a panic button (at no cost to the employee) which the employee may use to summon help from other hotel staff if s/he reasonably believes that an ongoing crime, sexual harassment, sexual assault or other emergency is occurring in the employee’s presence; (2) develop, maintain and comply with a written anti-sexual harassment policy to protect employees against sexual assault and sexual harassment by guests; and (3) provide all employees with a current copy of the hotel’s anti-sexual harassment policy, and post the policy in conspicuous places in areas of the hotel where employees can reasonably be expected to see it.

With respect to the anti-sexual harassment policy mandates, employers must develop a policy that:

  • Encourages employees to immediately report to the employer instances of alleged sexual assault and sexual harassment by guests;
  • Describes the procedures that the complaining employee and employer shall follow in such cases;
  • Affords the complaining employee the right to cease work and leave the immediate area where danger is perceived until such time that hotel security or the police arrive to provide assistance;
  • Affords the complaining employee the right, during the duration of the offending guest’s stay at the hotel, to be assigned to work on a different floor or at a different station or work area away from the offending guest;
  • Provides the complaining employee with sufficient paid time to (a) file a complaint with the police against the offending guest, and (b) testify as a witness at any legal proceeding that may ensue as a result of such complaint;
  • Informs the employee that the Illinois Human Rights Act and Chicago Human Rights Ordinance provide additional protections against sexual harassment in the workplace; and
  • Informs the employee that it is unlawful for an employer to retaliate against any employee who reasonably uses a panic button or exercises any right under the Ordinance.

Employers in violation of the Ordinance would be subject to a fine between $250-$500 for each offense, and each day that a violation continues constitutes a separate and distinct offense.

Consequently, it is critical that Chicago hotel employers monitor the status of this Ordinance, which is now pending before the full City Council. If passed and signed into law, the Ordinance will take effect within 90 days of signature. Employers should consider preparations for providing panic buttons to those employees protected by the Ordinance and training hotel employees on their use, and revisiting anti-sexual harassment policies, whether stand-alone or included in employee handbooks, to ensure compliance with the Ordinance’s mandates. Additionally, employers should consider providing updated anti-sexual harassment and anti-retaliation training to all employees, including those who are assigned to work in guest rooms or restrooms, to ensure that all employees fully understand their employer’s policies and procedures.

This post was written by Shawn D. Fabian & Michael J. Roth of Sheppard Mullin Richter & Hampton LLP., Copyright © 2017
For more legal analysis go to The National Law Review

The Corporate Transparency Act: A Proposal to Expand Beneficial Ownership Reporting for Legal Entities, Corporate Formation Agents and – Potentially – Attorneys

In late June, Representatives Carolyn Maloney and Peter King of New York introduced The Corporate Transparency Act of 2017 (the “Act”). In August, Senators Ron Wyden and Marco Rubio introduced companion legislation in the Senate. A Fact Sheet issued by Senator Wyden is here. Representative King previously has introduced several versions of this proposed bipartisan legislation; the most recent earlier version, entitled the Incorporation Transparency and Law Enforcement Assistance Act, was introduced in February 2016.  Although it is far from clear that this latest version will be passed, the Act is worthy of attention and discussion because it represents a potentially significant expansion of the Bank Secrecy Act (“BSA”) to a whole new category of businesses.

The Act is relatively complex.  In part, it would amend the BSA in order to compel the Secretary of the Treasury to issue regulations that would require corporations and limited liability companies (“LLCs”) formed in States which lack a formation system requiring robust identification of beneficial ownership (as defined in the Act) to themselves file reports to the Financial Crimes Enforcement Network (“FinCEN”) that provide the same information about beneficial ownership that the entities would have to provide, if they were in a State with a sufficiently robust formation system.  More colloquially, entities formed in States which don’t require much information about beneficial ownership now would have to report that information directly to FinCEN – scrutiny which presumably is designed to both motivate States to enact more demanding formation systems, and demotivate persons from forming entities in States which require little information about beneficial ownership.

 

However, there is another facet to the Act which to date has not seemed to garner much attention, but which potentially could have a significant impact. Under the Act, formation agents – i.e., those who assist in the creation of legal entities such as corporations or LLCs – would be swept up in the BSA’s definition of a “financial institution” and therefore subject to the BSA’s AML and reporting obligations.  This expanded definition potentially applies to a broad swath of businesses and individuals previously not regulated directly by the BSA, including certain attorneys.

Clearly attempting to gain steam from last year’s Panama Papers scandal – although the Act’s various predecessor bills were introduced before that scandal erupted – the “Findings” section of the Act lays out the case for its passage. According to that section, the Act is necessary because:

  • Few States obtain meaningful information about the beneficial owners of entities formed under their laws, and often require less information than is needed to obtain a bank account or driver’s license;
  • Many States have automated procedures which allow the formation of a new entity within 24 hours of the filing of an online application;
  • Some Internet Web sites highlight the anonymity provided by certain State incorporation practices as a reason to incorporate in those States, along with offshore jurisdictions;
  • Criminals have exploited these weaknesses to conceal their identities and use newly formed entities to promote terrorism, drug trafficking, money laundering, tax evasion, securities fraud, and foreign corruption;
  • The lack of beneficial ownership information has stymied law enforcement;
  • The Financial Action Task Force (“FATF”), described as “a leading international anti-money laundering organization,” has criticized the U.S. for failing to obtain timely access to adequate, accurate and current ownership information;
  • In contrast to the U.S., every country in the European Union requires formation agents to identify the beneficial owners of the corporations formed in those countries.

In the media, the backers of the Act have latched onto another argument to advocate for its passage: national security.  They say that the Act will assist in battling terrorist financing and unseemly conduct such as the alleged interference by Russia in the 2016 U.S. election for President. In the press releaseaccompanying the proposed House legislation, Representative King catalogued the various anti-corruption/transparency groups which are backing the bill, such as Global Witness. Although the support of such groups is not surprising, the press release also highlights the support of a prominent banking industry group, The Clearing House Association (whose President, Greg Baer, has appeared as a guest blogger here on the topic of reforming the current AML regulatory regime).

If passed, the Act would represent another chapter in the domestic and global campaign to increase transparency in financial transactions through information gathering by private parties and expanded requirements for AML-related reporting. As we have blogged, this ongoing campaign has included FinCEN creating reporting requirements for title insurance companies involved in cash purchases of high-end real estate; FinCEN issuing regulations which require covered financial institutions to identify the beneficial ownership of new accounts opened by legal entity customers; Congress recently introducing the Combatting Money Laundering, Terrorist Financing, and Counterfeiting Act of 2017which in part seeks to expand cross-border reporting requirements under the BSA; and the FATF issuing in December 2016 its Mutual Evaluation Report on the Unites States’ Measures to Combat Money Laundering and Terrorist Financing, which (again) found that that a continued lack of timely access to adequate, accurate, and current information on the beneficial owners of entities represented a “fundamental gap” in the U.S. AML regulatory regime.  As suggested by its Findings section, the Act also would represent a partial response by the U.S. Congress to international critiques, such as those posed by the FATF and the European Parliament, that the United States has become a haven for suspected money launderers and tax evaders and is lagging behind other nations in AML compliance.

In our next post, we will describe the proposed Act’s details and its potential implications for a new category of defined “financial institution” – formation agents, which might include attorneys.

This post was written by Peter D. Hardy and Juliana Gerrick of Ballard Spahr LLP Copyright ©
For more legal analysis go to The National Law Review

Federal Laws Do Not Preempt Connecticut Law Providing Employment Protections to Medical Marijuana Users

Connecticut employees using medical marijuana for certain debilitating medical conditions as allowed under Connecticut law for “qualified users” are protected under state law from being fired or refused employment based solely on their marijuana use. Employers who violate those protections risk being sued for discrimination, according to a recent federal district court decision.

Background

In Noffsinger v. SSC Niantic Operation Company (3:16-cv-01938; D. Conn. Aug. 8, 2017), the federal district court ruled that “qualified users” are protected from criminal prosecution and are not subject to penalty, sanction or being denied any right or privilege under federal laws, such as the Controlled Substances Act (CSA), the Americans with Disabilities Act (ADA) and the Food, Drug and Cosmetic Act (FDCA), because the federal laws do not preempt Connecticut’s Palliative Use of Marijuana Act (PUMA).

PUMA prohibits employers from refusing to hire, fire, penalize, or threaten applicants or employees solely on the basis of being “qualified users” of medical marijuana. PUMA exempts patients, their caregivers and prescribing doctors from state penalties against those who use or distribute marijuana, and it explicitly prohibits discrimination by employers, schools and landlords.

In Noffsinger, Plaintiff was employed as a recreational therapist at Touchpoints, a long term care and rehabilitation provider, and she was recruited for a position as a director of recreational therapy at Bride Brook, a nursing facility. After a phone interview, she was offered the position at Bride Brook and accepted the offer, and she was told to give notice to Touchpoints, which she did to begin working at Bride Brook within a week. Plaintiff scheduled a meeting to complete paperwork and routine pre-employment drug screening for Bride Brook, and at the meeting, she disclosed her being qualified to use marijuana for PTSD under PUMA. The job offer was later rescinded because she tested positive for cannabis; in the meantime, Plaintiff’s position at Touchpoints was filled, so she could not remain employed there.

Litigation

Plaintiff sued for violation of PUMA’s anti-discrimination provisions, common law wrongful rescission of a job offer in violation of public policy and negligent infliction of emotional distress. Defendant filed a Rule 12(b)(6) pre-answer motion to dismiss based on preemption under CSA, ADA, and FDCA. The federal court denied the motion and ruled that PUMA did not conflict with the CSA, ADA or FDCA, because those federal laws are not intended to preempt or supersede state employment discrimination laws. The court concluded that CSA does not make it illegal to employ a marijuana user, and it does not regulate employment practices; the ADA does not regulate non-workplace activity or illegal use of drugs outside the workplace or drug use that does not affect job performance; and the FDCA does not regulate employment and does not apply to PUMA’s prohibitions.

The court’s decision is notable in that it is the first federal decision to determine that the CSA does not preempt a state medical marijuana law’s anti-discrimination provision, and reaches a different result than the District of New Mexico, which concluded that requiring accommodation of medical marijuana use conflicts with the CSA because it would mandate the very conduct the CSA proscribes. The Noffsinger decision supplements a growing number of state court decisions that have upheld employment protections for medical marijuana users contained in other state statutes. These decisions stand in stark contrast to prior state court decisions California, Colorado, Montana, Oregon, and Washington that held that decriminalization laws – i.e., statutes that do not contain express employment protections – do not confer a legal right to smoke marijuana and do not protect medical marijuana users from adverse employment actions based on positive drug tests.

Key Takeaways

Employers may continue to prohibit use of marijuana at the workplace; and qualified users who come to work under the influence, impaired and unable to perform essential job functions are subject to adverse employment decisions. Employers in Connecticut, however, may risk being sued for discrimination for enforcing a drug testing policy against lawful medical marijuana users.  In those cases, employers may have to accommodate off-duty marijuana use, and may take disciplinary action only if the employee is impaired by marijuana at work or while on duty.

It remains unclear how employers can determine whether an employee is under the influence of marijuana at work. Unlike with alcohol, current drug tests do not indicate whether and to what extent an employee is impaired by marijuana. Reliance on observations from employees may be problematic, as witnesses may have differing views as to the level of impairment, and, in any event, observation alone does not indicate the source of impairment. Employers following this “impairment standard” are advised to obtain as many data points as possible before making an adverse employment decision.

All employers – and particularly federal contractors required to comply with the Drug-Free Workplace Act and those who employ a zero-tolerance policy – should review their drug-testing policy to ensure that it: (a) sets clear expectations of employees; (b) provides justifications for the need for drug-testing; and (c) expressly allows for adverse action (including termination or refusal to hire) as a consequence of a positive drug test.

Additionally, employers enforcing zero-tolerance policies should be prepared for future challenges in those states prohibiting discrimination against and/or requiring accommodation of medical marijuana users. Eight other states besides Connecticut have passed similar medical marijuana laws that have express anti-discrimination protections for adverse employment actions: Arizona, Delaware, Illinois, Maine, Nevada, New York, Minnesota and Rhode Island. Those states may require the adjustment or relaxation of a hiring policy to accommodate a medical marijuana user. Additionally, courts in Massachusetts and Rhode Island have permitted employment discrimination lawsuits filed by medical marijuana users to proceed.

Finally, employers should be mindful of their drug policies’ applicability not only to current employees, but also to applicants.

This post was written by David S. Poppick & Nathaniel M. Glasser of Epstein Becker & Green, P.C.  ©2017. All rights reserved.
For more Health Care Law legal analysis go to The National Law Review

Using “Finders” to Find Capital: Avoiding Problems for Your Company

Raising money for your startup can be hard. Not every entrepreneur can walk into Silicon Valley with a business idea and walk out with multiple VC term sheets in hand. Sometimes the only path to financing your startup is through the hard work of pitching and cobbling together a group of angels and other individual investors. But that path takes time and can be frustrating. Potential investors may hesitate to commit or, even worse, give you the dreaded “you’re-too-early-for-us” response. The offer from a “finder” to introduce you to investors with cash sounds attractive. Why not, right? What’s the downside?

You can use a finder if their role is limited and their compensation is structured properly. But you can cause major problems for yourself and the finder if they’re too involved and paid commissions on the money raised. These are activities that only registered broker-dealers (persons or firms engaged in the business of buying and selling securities for themselves or others) can engage in. If your company uses a finder acting as a broker-dealer, you might find your fundraising round unraveling, and your finder might find themselves in trouble with the Securities and Exchange Commission (SEC).

A “true” finder

A “true” finder can be OK if they limit their role to making introductions, receive a flat or hourly consulting fee that is not contingent on the success of the offering, and avoid any active role in negotiating and completing the investment. Finders acting in this very limited capacity are not considered broker-dealers. As a result, true finders are largely unregulated under the securities laws and need not be registered with the state or federal government as broker-dealers. This area is murky, however, because there are not clear regulations and the rules of the road have been developed in court cases and case-by-case “no-action” letters from the SEC.

The real problem is that many finders do not limit their activities to mere introductions. These finders end up assisting in structuring and negotiating the offering, providing advice regarding the offering and investment, and even encouraging and inducing investors to invest. These activities make them a “broker” under the securities laws, and federal and state governments require that brokers be registered. Often the finder is not registered as a broker.

Finders also prefer success-based compensation, calculated as a percentage of the funds raised by the company, and companies prefer to pay finders only if and when they’re successful in helping to raise capital. Both courts and the SEC, however, take the position that such success-based compensation (also referred to as transaction-based compensation) is the telltale factor indicating whether a finder is acting as an unregistered broker-dealer.

So, what’s the risk?

For the company, using an unregistered broker-dealer to assist with an offering could create a rescission right in favor of the investors. If investors succeed in rescinding their investments, the company must return their money. For the finder acting as an unregistered broker-dealer, they could be subject to severe SEC sanctions and the company could void the finder’s engagement agreement, requiring return of the finder’s compensation. Moreover, even if a finder’s activities and compensation are perfectly legal, the relationship alone can still give rise to problems for the company. Any financial relationship with a finder must be disclosed to investors and listed on the company’s Form D filed with the SEC and state securities departments. Disclosure of such a relationship, again, even if perfectly legal, may nevertheless prompt some states to initiate an investigation.

The situation in Michigan, however, is even murkier. In the recent case Pransky v. Falcon Group, the Michigan Court of Appeals held that a “finder” as defined in the Michigan Uniform Securities Act, was not required to be registered with and regulated by the State of Michigan, even where the company agreed to pay success-based compensation. Michigan companies and finders, however, should not take the opinion as a green light to engage in a finder relationship, structured with success-based compensation, without fear of regulatory oversight. The trial court initially dismissed the case on summary judgment, and as a result there was no evidence in the record of whether or not the finder’s activities went beyond mere introductions. In addition, some commentators have criticized the court’s decision. Perhaps sensing such impending criticism, the Court of Appeals, in a footnote, cautioned that the “better course of action would be for finders acting pursuant to similar contracts to protect themselves by registering, at the very least, as broker-dealers; the line between a finder’s activities and that of a broker-dealer…is a thin one and persons acting under such contracts without being registered are inviting litigation.”

The bottom line

Using finders for raising capital is not the easy solution it appears to be at first glance. Worse yet, it can lead to significant problems. As the saying goes, nothing worth having is easy. If you don’t have a VC-backable business, you may have an even harder time raising capital than most. Regardless, when it comes to raising money for your startup, be your own “finder”. Network, hustle, and tell your story. No one is more effective than you at explaining your business and the investment opportunity.

For more legal analysis check out the National Law Review.

This post was written by Matthew W. Bower of  Varnum LLP.