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Rethinking Worker Classification in the Emerging On-Demand Economy

Corina Uber Blog.v2

Classifying workers may raise fundamental questions for on-demand economy startups.

The emerging on-demand and sharing economy has presented no shortage of legal issues for tech startups.  One of the key factors underlying the success and future of these companies lies in the way they harness and classify their workforce. Startups entering this space must be aware of the developments in employment law because worker misclassification can have drastic financial consequences on their business.  So critical is the classification of workers as independent contractors to the on-demand economy that many of these business models would crumble under an employee (as opposed to independent contractor) worker classification schema.

And there is no dispute that the class action litigators are gunning for companies whose cost structure relies on the 1099 workforce.  The pending Uber cases provide prime examples of this issue in the on-demand economy, but misclassification cases are by no means restricted to companies operating in this space. Starbucks, FedEx, Lyft, Homejoy, Postmates, and Caviar are all companies that have been on the receiving end of these attacks.

The Uber Class Action Lawsuits

Uber has been under legal fire for class action lawsuits filed by their drivers accusing the company of misclassifying them as independent contractors rather than employees.  Among other things, these workers claim that their services are central to Uber’s business and that Uber has the requisite level of control over them to place them in the employee bracket. We covered key factors that courts and the IRS consider in a previous post.  In essence, the drivers claim that they are Uber employees even though they benefit from a work environment that allows them complete flexibility of scheduling, no minimum required hours, and the freedom to work for competitors of Uber.  Ultimately, the drivers and their advocates want better protection and compensation packages for these workers, benefits that are typically reserved for employees as opposed to freelance independent contractors.

In response, Uber has asserted that there is no such thing as a single type of Uber driver.  All sorts of people are drawn to working for the company due to its flexible scheduling and the manner in which drivers can perform the services.  Uber continues to maintain that its core business is a platform that allows these drivers to use it as they wish.

But in 2015, U.S. District Judge Edward Chen stated in court that “The idea that Uber is simply a software platform, I don’t find that a very persuasive argument.”  It is not enough for a company merely to assert that they are a logistics company or a software platform to retain the benefits of a 1099 workforce. These cases will set significant precedent with regard to worker classification for companies operating in the on-demand economy.  Jury trial for the California Uber class action lawsuit is scheduled to commence in June 2016.

Consequences of Worker Misclassification

In a previous post, we also discussed strategies for defining the employer-worker relationship and avoiding worker misclassification.  But how much of a problem can worker misclassification really cause?  The short answer is that the ramifications can be substantial.  Companies may be liable for thousands, millions, or billions of dollars (if you’re Uber) in back wages and taxes, fines, penalties, insurance contributions, and workers compensation costs.  And it is important to remember that the company’s intentions regarding the misclassification are irrelevant – intentional or not, you’re still on the hook for misclassification damages.

The Proposed Third Category of Worker or a Revised Test

The sharing economy is powered by so-called “micro-entrepreneurs,” workers who want the flexibility of scheduling and use of personal resources to earn what they need when they want.  According to peers, the “future of work will include a portfolio of income streams” that enables workers to have the choice to “build their work around their life, not their life around their work.”  Arguably, it is a different breed of worker that calls for the jobs provided by companies operating in the on-demand economy.  But they cannot have it all.  And this goes for both sides of the coin – employers and workers alike.

If workers for companies such as Uber are classified as employees rather than independent contractors, the added costs might run the company into the ground, or at least cause it to raise its fares.  This is an undesirable situation for everyone, calling for new solutions in the field of employment law.  One such solution is the proposed third category of worker, the “dependent contractor.”  Under this category, dependent contractors would gain some (but not all) of the protections or benefits afforded to employees while retaining the flexibility and control over their work.  Similarly, it seems clear that the current standards used to evaluate worker classification need to be revised to address the features and needs of on-demand workers and companies operating in this sector.

It is difficult to imagine the crash of the on-demand economy, but only time will tell as to how these companies evolve in response to worker classification issues.

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The Diversity Problem in Tech

While America is becoming increasingly diverse, the tech industry is not and more work is needed.

While America is becoming increasingly diverse, the tech industry is not and more work is needed.

America has long prided itself on being a melting pot, made up of many different nationalities, ethnicities, and journeys to make it to the land of the free. Looking at current projections, we can expect our country to grow to be more diverse over time. By 2040, Hispanics alone will represent more than half of the American population, with Hispanics, Asian, Pacific Islanders, and Blacks combining to compose more than three-fourths of the population.

Though America is becoming increasingly diverse, issues regarding the lack of opportunity for our diverse populace remain. Over the past few years, one of the hot button issues pertaining to opportunity in the workforce has been the lack of diversity in Tech. According to the U.S. Bureau of Labor Statistics, the American labor force is 47% female, 16% Hispanic, 12% Black and 12% Asian. However, in 2011, Blacks represented only 6% of STEM workers and Hispanics 6%. Even more alarming, among 7 Silicon Valley companies that released their employment statistics in 2014, only 2% were Black of and 3% of were Hispanic.

For some Tech companies, the answer to this problem was that there are simply not enough qualified candidates in the applicant pool. However, data shows that this is simply not true. According to data from the Computing Research Association, 4.5% of all new recipients of bachelor’s degrees in computer science or computer engineering from prestigious research universities were African American and 6.5% were Hispanic. Essentially, the elite universities are churning out graduates in this field at twice the rate that top Tech companies are hiring them.

So if the issue here isn’t producing better applicants, then how can we fix the problem of diversity in Tech?

 1. Increase the Applicant Pool.

Although I agree that it isn’t an issue of having better Hispanic and Black applicants, simply creating a larger pool of these applicants will make it virtually impossible not to hire more Hispanic and Black candidates. There are a number of ways that we can work to enhance this pool, but some are already in motion.

One effort that we’ve seen to increase this pool is President Obama’s Educate to Innovate program, which is a nationwide effort that has raised over $700 million to hit major milestones in several priority areas, building a CEO-led coalition to leverage the unique capacities of the private sector, preparing 100,000 new and effective STEM teachers over the next decade, showcasing and bolstering federal investment in STEM, and broadening participation to inspire a more diverse STEM talent pool. The last milestone seems the most relevant to our purpose, but in actuality, these issues are all interconnected. Most obviously, training better STEM teachers and bolstering federal funding in the field should help to inspire a more diverse STEM talent pool, assuming that these resources will be distributed equally across different communities. Having the commitment of CEOs from major Tech companies would also demonstrate the industry’s commitment to improving diversity, which could result in a broader applicant pool. Although the President taking the lead on this initiative is highly influential, another way to advocate for change would be voicing these concerns to our respective Senators and Representatives. It is our duty to hold elected officials accountable for enacting the change that we, their constituents, desire to see.

In addition to the support of this initiative led by the President, the power of starting companies and organizations dedicated to increasing the pool of talent can not be emphasized enough. One example of a successful organization working in this field is CODE2040, which is a nonprofit that creates programs that increase the representation of Blacks and Latino/as in the innovation economy. Starting by selecting top Black and Latino students as fellows, the program inserts the fellows in a summer accelerator which includes a summer internship program and career building sessions. CODE2040 has been very successful, with their applicant pool increasing to over 1,000 students, and more than 200 companies expressing interest in hosting their fellows for summer internships. With many companies expressing an interest in improving on their diversity, organizations like this present a viable solution for them to easily identify some of the top talent. Having more organizations like this could only be more helpful when seeking to increase the applicant pool.

2. Changing the Narrative.

Although I believe that increasing the applicant pool is the biggest need, both the Tech industry and the underrepresented communities need to work together in order to change that narrative around minorities in Tech. One important way to do this is to increase the visibility of the Tech industry’s prominent minority figures.

In an article with the New York Times, Van Jones, CNN political commentator and founder of #YesWeCode, stated, “A lot of African-Americans want to grow up to be LeBron James, Jay Z or Barack Obama. They don’t hear about David Drummond at Google, who is at the center of one of the biggest companies in the world.” This statement certainly relies on some dangerous stereotypes and overgeneralizations regarding role models in the Black community, but I think that there is value in the basic assumption here. Jones is saying that the youth in these communities are unable to to visualize individuals in this industry that they can aspire to be, largely because the CEOs, CTOs, and General Counsels of color in these companies aren’t placed on the same platform as many of their counterparts. Young Black and Latino youth being able to see the stories of people like them could have an immeasurable impact on their own ambitions and dreams. Not only could they aspire to be the legal counsel of a company like Google, they could also visualize the individual that they hope to be.  

Along with his efforts to increase the talent pool, President Obama was also a driving force behind the “Let Everyone Dream” campaign, which is based on the documentary Underwater Dreams, depicting the story of a group of under-resourced Hispanic high school students taking on a MIT team in an underwater robotics competition. This is a multi- sector coalition that has launched with over $90 million. It focuses on inspiring more under-represented students to succeed in STEM subjects. Some of the commitments of the coalition include investing millions of dollars into a national campaign with the purpose of increasing visibility of Latinas in STEM, committing $15 million to STEM programs for women and underserved minorities, and partnering with top universities to support financial aid, internship, and career readiness programs for first-generation college students, women and minorities.

3. Encouraging Blind Hiring

One of the issues with hiring in Tech are the inherent biases that exist among those in the positions of power. Naturally, we tend to gravitate towards people who look like us, have similar backgrounds, or to whom we have a prior connection. Unfortunately, in an industry that is predominately white, this ultimately has a negative affect on minorities who don’t fall into one of these categories. In an industry that fancies itself as championing principles of a meritocracy, it seems odd that so much of the hiring depends on who you know, as opposed to your own qualifications.

One way to address this issue is encouraging blind hiring in the industry. One Black entrepreneur, Stephanie Lampkin, has already created a mobile app called Blendoor to help with this problem. According to a 2014 research study jointly conducted by Stanford University and the Paris School of Economics, a person’s foreign-sounding name on his or her resume can adversely affect that candidate’s chances of being called for an interview. Lampkin hopes to take the inherent bias out of the hiring process by using Blendoor to hide the candidate’s name and photo from the employer during the initial stages of the recruiting process. Lampkin has already made major headway with her application, being enlisted to help with the likes of Google, LinkedIn, and Microsoft to help with their hiring. There may be an unconscious bias working against minority candidates, but steps are being taken to further level the playing field and solve the issue of diversity in Tech.  

 

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University Trademarks and Leveraging the Brand

Many student entrepreneurs want to use their university's brand as part of their product.

Many student entrepreneurs want to use their university’s brand as part of their product.

It is a well-known fact that universities foster innovation and entrepreneurship. But what happens when you want to incorporate your university’s brand into your startup concept?

It is time to consider trademark law.

Trademark Basics

A trademark is a word, phrase, symbol, and/or design that identifies and distinguishes the source of the product and seeks to prevent consumer confusion. Universities register trademarks in an effort to protect their brand, maximize revenue and maintain control over the way their trademarks are presented to the public.  Universities are some of the most diligent institutions when it comes to protecting their marks. They usually have significant resources dedicated to seeking out infringements. Therefore, before leveraging the brand of the university, it is especially important to take preventative measures and understand what is available for use.

Acquiring Trademark Rights

Trademark rights may be acquired in either of two ways:

  1. Common Law- rights are acquired through the use of the mark in commerce
  2. Registration- rights are acquired by registering with the USPTO

The following symbols may be used with trademarks, although they are not required for one to claim trademark protection:

™ symbol indicates an unregistered trademark

® symbol indicates a registered trademark

This prior post provides more information on the trademark registration process.

University Trademarks

A university can acquire rights to more than just its name and logo; colors are also protectable. Courts have decided that specific color schemes, whether registered or not, are so related to the university that they develop a “secondary meaning.” At which point, customers would likely identify the university as the source of the product. This, along with other factors including medium, sales, advertising and intent, determine if the university has trademark rights to its colors. Universities have recently gotten more creative with colors and trademarked the distinctive name of the colors or the colors in association with other objects.

Many schools will have a website that outlines their expectations regarding the use of their trademarks. Often, you will need to request permission from the university and include a detailed explanation of your plans for the mark. Approvals are granted depending on the applicant, often more favorable to students, alumni, and faculty. The university will also consider how the mark will be used (if it is commercial in nature) and the medium for its display.

Information regarding the use of the University of Michigan’s trademarks can be found here.

It is a good idea to consult your university before making decisions about using their brand as part of your startup product or service.

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Pitching Investors: Watch for General Solicitation Rules

Securities laws may restrict how you discuss how your startup plans to raise money.

Securities laws may restrict how you discuss how your startup plans to raise money.

Many people think securities laws are only relevant to big companies in their billion dollar public offerings. Securities laws, however, are also relevant to your startup.

The general rule in the Securities Act of 1933 prohibits selling securities other than by means of a registration statement. Fortunately, the statue also provides certain registration exemptions for transactions that are not public offerings.

One critical concept under Regulation D is the general solicitation rule. Failing to comply with the general solicitation rule may cause a start-up to lose the exemption status. Under some circumstances, pitching your company could be deemed a general solicitation. Therefore, it’s critical for founders to pay attention to the Regulation D and the general solicitation requirements before pitching your company.

Safe harbors in Regulation D

Most startups rely on Regulation D, promulgated by the SEC as the exemption from the registration requirements of the securities laws. There are three main safe harbors in Regulation D – Rule 504, 505, and 506. Rule 504 and Rule 505 are less popular because the issuers have to comply with the securities laws in each state where they are selling securities (see previous post for more information of Rule 504 and 505).

The most commonly used exemption is Rule 506, which allows a company to raise an unlimited amount of capital from an unlimited number of accredited investors (see previous post for information of accredited investors). Rule 506 has two separate but related exemptions—Rule 506(b) and Rule 506(c). Rule 506(b) prohibits general solicitation while the new Rule 506(c), subject to a variety of conditions, allows offering through public advertising and general solicitation.

What is General Solicitation?

Regulation D doesn’t define general solicitation, but gives some examples of prohibited solicitations, including any advertisement published in any media (e.g., television, newspapers, magazines, Internet, radio, public seminars, or cold calls), and any meeting whose attendees have been invited by a general advertising.

When is a solicitation not general? The SEC interpreted the prohibition as requiring that the issuer (or a person acting on its behalf) has a “pre-existing relationship” with each offeree. Examples of pre-existing relationship including:

  • Use an outside agent, such as a broker, to serve as an intermediary
  • Use questionnaire to request investors providing self-verification regarding their financial status
  • Use password protection to prevent general public from accessing investment information on the website

The New Rule 506(c) Under the JOBS Act

On July 10, 2013, the SEC revised Regulation D to remove prohibition on general solicitation and general advertising in offerings and sales under Rule 506(c), provided that all purchasers of the securities sold in these offerings are accredited investors. The major differences between Rule 506(b) and Rule 506(c) are summarized in the chart below.

Rule 506(b) Rule 506(c)
Limitation on amount of capital raising Unlimited Unlimited
Type of investors Accredited investors and up to 35 non-accredited sophisticated investors Only accredited investors.
General solicitation Prohibited Allowed
Accreditation process Allow Self-certification Take reasonable steps to verify accredited investor status

Although Rule 506(c) allows general solicitation, which seems to be a huge advantage, there are several reasons an issuer may prefer to rely on Rule 506(b).

First, Rule 506(c) requires an issuer to take “reasonable steps” to verify that all investors in the offering are accredited investors. According to the SEC guidance, self-certification by investors, for instance questionnaires in which investors self-report their income or net worth, does not satisfy Rule 506(c)’s standard. Instead, issuers must generally request investors to provide tax returns, bank statements, or credit reports to demonstrate their income or net worth. Not only will this requirement add an additional administrative burden on an issuer, it may also alienate some investors.

More importantly, Rule 506(b) is a non-exclusive safe harbor. This means that an issuer can still use the general Section 4(a)(2) exemption under the Security Act if the offering fails to satisfy Rule 506(b)’s requirements. However, an issuer using general solicitation in reliance on Rule 506(c) does not have this fall-back option as general solicitation is prohibited by the Section 4(a)(2) exemption.

Finally, the SEC has also proposed to add new disclosure requirements to Rule 506 and Form D, which may offset Rule 506(c)’s Advantages. For example, the proposed rule requires a Rule 506(c) issuer to file an advance Form D at least 15 days before any general solicitation (instead of the current requirement, 15 days after the first sale). The proposed rule also requires an issuer to file the general solicitation materials, which must have specific mandated legends, with the SEC on or before the date of the general solicitation. These requirements may be difficult or impossible to comply with in practice.

If you do decide to rely on Rule 506(b), here are some tips to help avoid running into the general solicitation trap.

  • Limit offers and solicitations to persons with whom you have a “preexisting substantive relationship.”
    • When attending a pitch event, make sure the attendees are limited to persons with whom the event organizer has a pre-existing relationship or who have been contacted through a network that the event organizer can rely upon to create that relationship.
  • Avoid making “offer” to people you do not have a preexisting relationship.
    • To avoid making offer, only provide factual business information and do not include projections.
  • Monitor the activities of any agents or representatives to ensure that they are not performing general solicitations.
  • Prepare a list of likely investor targets as early in the process as possible and stick to it.
  • Be very circumspect in any interactions with the press.
  • Keep strict control over the dissemination of offering materials.
  • Use password protection and online questionnaires to prevent nonaccredited investors from accessing investment information on a website.
  • Review your website content.

 

 

 

 

 

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Can I start a company if I’m in the US on a student F-1 visa?

Hands, 1

CPT or OPT programs may allow you to launch your startup while on a student visa.

America is great.

Because of the strength of the United States’ higher learning institutions it attracts a high number of international students a year, and the number is steadily increasing. Most students come from China and India, with the percentage of Brazilian students growing in sum each year.

According to a report by the Institute of International Education the U.S. was host to around 975,000 international students in the 2014-2015 academic year, up 10% from the previous year.

More students means more ideas, and of course more money. The Department of Commerce reports that international students added around $31 billion to the U.S. economy in the 2014-15 school year. One hundred and ninety-seven thousand of those students came to study business in the last academic year. At the University of Michigan students come from 114 different countries, with around two-thirds studying at the graduate level. Michigan Law is represented by 15 countries and full-time international MBA students at Ross make up 35% of the class total.

The F-1 Visa

F-1 visas are issued to international students if they are either attending an academic program or English Language Program at a U.S. university. There are varying requirements to hold this type of visa, but the gist is that you have to be taking a full course load and you can only stay in the U.S. 60 days after the completion of your program. The difficulty comes in the ability to work as an international student. Under this type of visa status students are not allowed to work off-campus during the academic year unless they face some sort of economic hardship and are authorized by their school to do so. However, they are allowed to work on-campus subject to certain conditions. After their first academic year F-1 students can engage in three different types of employment:

  • Curricular Practical Training (CPT)
  • Optional Practical Training (OPT) (pre-completion or post-completion)
  • Science, Technology, Engineering, and Mathematics (STEM) Optional Practical Training Extension (OPT)

Under these three categories F-1 students cannot work more than 20 hours per week, unless they are on break, then they are allowed to work up to 40 hours per week.

CPT

Curricular Practical Training (CPT) is a temporary authorization for employment. This means that the job has to be directly related to your major. CPT is a way for students to take part in internships and other modes of employment, including self-employment. CPT must be required by your degree program, or at the very least you must receive a number of credits for it. This type of employment must be done before graduation. If you accumulate more than 12 months of CPT authorization then you lose the ability to apply for OPT.

OPT

Optional Practical Training (OPT) is another type of work authorization that must be related to a F-1 student’s major. Whereas CPT is required by a student’s field of study, OPT is optional and you do not need to earn any credits in relation to it. OPT is not employer specific and may be done before or after graduation. According to the U.S. Department of Homeland Security “a student on OPT may start a business and be self-employed. The student must be able to prove that he or she has the proper business licenses and is actively engaged in a business related to the student’s degree program.” Students can generally do OPT for a period of 12 months.

The OPT STEM Extension

There is an exception under OPT for STEM students. However, the exception doesn’t apply to students who are self-employed or starting their own business.

Working vs. Owning

Poet and modern rap artist Jay-Z once crooned “I’m not a business man, I’m a business man!” And so I ask you, are you the owner or the employee? Let’s face it. No one wants to work for someone else anymore. Let’s call it the curse of Zuckerberg – and it’s as if every single millennial is affected by this curse. It’s likely why you’ve endeavored to build your own business.

There is a pretty important distinction to be made between working for and owning your own business in this discussion. If you are not part of the CPT or OPT programs then it is in fact illegal to work for an LLC, C-corp, or S-corp in the United States, even if it’s your own. I mean think about it. Why would the government see any difference between an F-1 student working for a large corporation like Coca-Cola and working for a 10 student strong start-up. Well, now that I’ve said it aloud there are an array of dissimilarities between the two, but that doesn’t change the fact that it’s still illegal. Although that doesn’t mean that an F-1 student cannot create an entity or hold shares in one. In fact, the U.S. does not require any founders in a (LLC or C-corp) company to be of American citizenship. S-corps do not allow for non-US citizen founders. So it all comes down to the type of work one does with the company and at what stage. If you are coming up with a name, filing trademarks, or forming an entity then you’ve done nothing illegal. However, once the entity is formed then things get a bit trickier. If you start to do any administrative tasks or employee like functions then you enter into a very gray area. Therefore, the best option (after entity formation) is for an F-1 student to enter into the CPT or OPT programs.

To Infinity & Beyond, the H1-B Visa

After graduation and after having been in the CPT and OPT programs students might want to consider obtaining an H1-B visa.

The H1-B visa allows employers to temporarily employ foreign professionals in specialty occupations within the United States. Specialty is defined as having a specialized knowledge in a certain sector or field. The most stringent requirement for a start-up is that one must have an employer-employee relationship with the petitioning U.S. employer.

According to the U.S. Department of Homeland Security “If you own your company you may be able to demonstrate that an employer-employee relationship exists if the control of your work is exercised by others.” This can be demonstrated by having a board of directors, preferred shareholders or investors – all of which show that your company controls the terms of your employment. Some evidence which demonstrates the distinction between your ownership interest and the right to control your employment includes:

  • Term Sheets
  • Capitalization Tables
  • Stock purchase Agreements
  • Investor rights Agreements
  • Voting Agreements, and
  • Organizational documents and operating agreements

The U.S. Government only gives 65,000 H1-B visas out each fiscal year. The first 20,000

petitions filed on behalf of beneficiaries with a U.S. master’s degree or higher are exempt from the cap. If your start-up is a nonprofit then you’re also exempt.

Good luck!

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How to Win the Name Game

Selecting a strong brand might be more difficult, yet more important, than you anticipate.

Selecting a strong brand might be more difficult, yet more important, than you anticipate.

What’s in a name? As Shakespeare once said, “That which we call a rose by any other name would smell as sweet.” And it is true that the success of a start-up is ultimately determined primarily by the quality of its value proposition and its ability to execute rather than its name. But names are still very important. If they weren’t, we wouldn’t have trademark law to protect names and creative firms wouldn’t be able to charge exorbitant fees to come up with great names.

While a start-up’s value proposition may be strong, if other start-ups have the same or a similar idea, whoever can get their name out there to the most people first often wins. If a start-up chooses a name someone already owns, they may need to change names late in the game, leading to potentially drastic setbacks, as they rebuild name recognition and combat customer confusion. Choosing a bad name can signal many things—not only to customers but also to potential investors. A bad name can signal a lack of self-awareness and diligence, and poor attention to detail, among other bad traits. Investors who hear a pitch for a start-up with a terrible name may have thoughts like, “If they didn’t realize their name was bad, what else won’t they realize? What else won’t they pay attention to? What else is wrong with this company besides the name?” These are thoughts you want to avoid. In short, the quality of a name can be a proxy for the quality of the team behind it.

Moreover, a solid, catchy name can create brand-building power. We often use the best names of companies as verbs. We Google things, we Facebook people, we blow our nose with a Kleenex, we Xerox things, we Uber to places, etc.   Every time someone uses a company name in this manner, the company gets free publicity. Having this universal recognition does not come without a good name. Below are some tips on how to brainstorm name ideas and then some rules of the road for what to do once you have your name.

Brainstorming

Often one of the hardest parts of starting a business is coming up with a name. It seems easy at first but after staring at a blank sheet of paper for hours, many entrepreneurs grow frustrated and either settle for a bad name or hire someone else at significant cost to come up with a name for them. A proper brainstorming process can solve these problems and help you come up with many strong name ideas.

  • Make a list of words/names that relate to your product or value proposition. Use a thesaurus to find related words.
    • Example: If your business is a financial services application, you might list words like coin, blue chip, money, cash, banking, finance, etc. Then, use a thesaurus to find less common, but more interesting or catchy words.
  • Use foreign words. Foreign words can evoke positive responses by lending an exotic, new, and fresh sound to your name. Take the list of words related to your business and try translating some of them into other languages.
  • Always be listening. Things may come up in daily life that inspire the perfect name. Jot down ideas as they come up in a simple journaling or note-taking mobile application.
    • Example: The company, Caterpillar, found its name when a photographer was taking a picture of a tractor and remarked that the tractor crawled like a caterpillar.
  • Make up Words. Using made up words can help your company stand out. Try combining words, changing the spelling of words, and simply creating words that sound catchy.
    • Example: The name Kinkos was created because the founder had very curly hair with lots of kinks.

Rules of the Road

 Coming up with a good name early on can save you a lot of headache down the road. Avoid the pitfalls of many entrepreneurs by following these rules:

  • Keep it short. Twitter, Facebook, Nike, Pixar, eBay, Google, Apple, Kinkos—what do these iconic names have in common? They are all two syllables long. Try to keep your name to two syllables or less. This will maximize its repeatability and memorability.
  • Keep it punchy. What else do the above names have in common? They make use of strong consonant sounds. This will help the name to stand out in conversation and stick.
  • Never make your move too soon. Once you have a list of names, spend at least a week mulling over the options. The best names will be remembered without you having to go back to the list. The proof is in the pudding.   The names that you remember are likely the better names. If it sticks in your mind, it will be more likely to stick in the minds of others and this “stickiness” is exactly what you should be after.
  • Get quality feedback. Try to do more than simply ask close family and friends for feedback. It will be hard for them, if not impossible, to avoid bias. Test the names out on random people and see how they react. Ask them questions to see what they think about the names and what responses the names evoke. Record your findings and analyze them.
  • Make sure the name is available. Cover your bases by conducting appropriate searches including trademark searches via the US Patent Office and company name searches via your state incorporation website.

A rose by any other name may smell as sweet. But what good is the rose if no one gets to smell it? A great name can help propel your business or product through the early stages and contribute to the likelihood of survival. After you’ve followed the above rules and found your name, it’s time to file a trademark.

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Entities for Businesses with Social Missions

RobMeyerBlogPostImage

If your business has a socially beneficial mission but wishes to operate with a for-profit model, then you may be interested in forming a hybrid entity.

Low Profit Limited Liability Company (L3C)

 An L3C functions like an LLC with a socially beneficial business purpose. While L3Cs operate like LLCs, they benefit from a tiered capital structure that permits the L3C to raise capital through both the Program Related Investments (PRIs) of private foundations as well as commercial investments.

Advantages:

                Like an LLC, an L3C benefits from flexible ownership structure and pass-through taxation.  Unlike an LLC, an L3C may implement a tiered capital structure through which private foundations effectively subsidize commercial investments.  The lowest tranche of this tiered L3C capital structure is allocated the highest risk and the lowest rate of return.  This tranche is reserved for PRIs made by private foundations.  PRIs allow foundations to contribute to for-profit businesses without incurring negative tax-penalties.  To qualify as a PRI, the use of a foundation’s investment must correspond with the foundation’s charitable purpose and the funds are prohibited from inuring as a benefit to other private parties.  The restriction on private inurement means that a foundation’s investment cannot be used to make excessive distributions to L3C insiders or its other investors.  The mezzanine tranche is reserved for socially responsible investors who may be willing to take on below-market returns because of their commitment to the L3C’s social or charitable goals.  Finally, private commercial investors are relegated to the upper tier where returns are highest and risk is lowest.  Through this tiered capital structure, an L3C may be able to attract both profit-driven and charity-driven investors.

Moreover, while many commercial investors are hesitant to invest in social businesses, investors and customers who share similar convictions may be drawn to the commitment to a particular cause evidenced by the choice of the L3C entity.

 

Requirements/Disadvantages:

 

First, only Vermont, Michigan, Wyoming, Utah, Illinois, Louisiana, Maine and Rhode Island have L3C statutes, limiting L3Cs to those states.  Second, L3Cs must be organized in accordance with three principles: 1.) an L3C must be organized around the primary goal of achieving a charitable, educational or socially-beneficial purpose, 2) the production of income or appreciation of property may not be a significant purpose of the L3C, and 3) an L3C may not seek to accomplish any political or legislative purpose.

Attracting PRIs may pose particular difficulty and risk.  In order for a private foundation’s investment to qualify as a PRI, the L3C must further the foundation’s charitable goals.  If the IRS rules that an investment in an L3C jeopardizes the tax-exempt purpose of a particular private foundation, then that foundation will be subject to an automatic 10% excise tax and the potential for additional penalty taxes.  Further still, even if a private foundation’s investment qualifies as a PRI, if any part of the foundation’s investment inures to a private individual, such as a commercial investor in the L3C, the private foundation may lose its tax-exempt status.  To mitigate these risks, private foundations will typically negotiate for management rights.

Furthermore, the L3C structure is risky because it is extremely new. The IRS has not designated private foundation investments in L3Cs as automatically qualifying as PRIs, nor have they articulated that such investments are entitled to a rebuttable presumption of PRI qualification.

Finally, the L3C is risky because it is built on the competing interests of profit and social benefits. It remains to be seen how courts will interpret that combined mandate.  How venture capitalists and angel investors will treat L3Cs in the long-term remains equally unclear.

Benefit Corporation

The Benefit Corporation is a status available in 30 U.S. states.  That status accords legal protection to corporate directors and officers who wish to balance financial and social interests when making corporate decisions.

Advantages:

The primary advantage of a Benefit Corporation is that its officers and directors may simultaneously seek to maximize profit and social impact. Unlike the standard corporate form where directors and officers have a duty to its shareholders to maximize profit, directors and officers of a Benefit Corporation have the freedom to balance the Corporation’s profit motive with the achievement of its social mission.  This Benefit Corporation structure thus permits socially minded entrepreneurs to protect their social mission as a critical part of their business.  Furthermore, stockholders have the increased power to hold directors and officers accountable in their duty to pursue that social mission.  The Benefit Corporation’s accountability structure thus may be attractive to socially conscious investors who want to ensure that their investment is impactful.

Requirements/Disadvantages

A Benefit Corporation must hold a public benefit as part of its stated mission and assign a benefit director to oversee the progress towards achieving that mission.  Benefit Corporations are subject to heightened reporting requirements, namely the requirement to release a benefit report to the public (in Delaware the report need not be public).  The benefit report is meant to facilitate transparency so as to inform the public of the corporation’s social performance, inform directors so they are better able meet their duties in pursuit of the public mission, and inform shareholders of the Corporation’s progress towards its social mission so that they might exercise their rights to hold the directors and officers accountable.

Finally, like the L3C, Benefit Corporations are fairly new and how courts will interpret the combined mandate of seeking profit and social benefits remains unclear.  Likewise, how venture capitalists and angel investors will treat Benefit Corporations in the long-term is equally uncertain.

B Corp.

 

A B Corp is a for-profit company that has been certified by the nonprofit organization, B Lab, to meet rigorous standards of social and environmental performance, accountability, and transparency. Such designation is meant to signal customers, investors, and other corporations that the entity satisfies certain desirable benchmarks of corporate responsibility.

All entity types are eligible to apply for B Corp status. In applying, entities must subject themselves to a rigorous assessment and review of their goals and practices.  In addition, 10% of B Corps are subjected to random on-site review each year.  Each B Corp is required to resubmit the majority of its assessment every two years for reevaluation.

The easiest road to B Corp status is to first become a Benefit Corporation. In states where Benefit Corporations are not available, or if your entity is an LLC, C Corp, S Corp, or Partnership, you may amend your articles of incorporation or organization to permit officers or members to weigh the environmental and social effects of the company’s operations alongside the interest of the shareholders.  Introducing a social or charitable mission into your business purpose is the best way to shape your entity and its practices to qualify for B Corp status before applying.

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Alternative Dispute Resolution in Terms of Service

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As web-based startups grow, they naturally begin to attract users across state lines and international borders. For founders who have worked hard to get this traction, this is rightfully considered cause for celebration, but it is important to consider that this expansion comes with a bit of additional risk. With larger and more widely distributed user bases, startups are exponentially more likely to see an increase in the frequency and complexity of disputes involving its users. While these disputes are to some degree inevitable, a startup can still safeguard its interests by crafting a clear dispute resolution policy in its terms of service.

There are a range of different ways that a dispute resolution policy can be crafted in a company’s Terms of Service, but the startup’s choice essentially boils down to two means of conclusively settling disputes- litigation and arbitration. As described below, the latter presents significant advantages to early-stage companies.

Litigation: If a startup chooses to use litigation as its preferred means for final dispute resolution, its Terms of Service will generally indicate that a particular state’s laws govern (i.e. Delaware or the state where the company is located). This does not, however, ensure that the dispute will be heard in a court in that particular state. Under certain circumstances, users-turned-litigants may be able to have their suits against the company heard in a federal court (referred to as “removal”) that will apply the designated state’s laws, even though the federal court may not be located within that state. Hence, while this method provides a startup with some certainty as to applicable law, there remain a number of drawbacks to a dispute resolution policy crafted in this fashion which include:

Forum: A litigation-based dispute resolution policy doesn’t necessarily provide for certainty as to forum given the possibility of removal to federal courts. Should removal occur, the startup will still have the “home field advantage” in terms of governing law, but, depending on the federal court selected by the user, it might lose the convenience of settling its dispute close to company headquarters. Instead, founders may be forced to travel to a federal court across the country to settle disputes with users. For founders short on time and money, this may pose a tremendous obstacle to mounting a defense.

Expense: It is also important to remember that this type of policy will require founders to incur great expense in the event of a dispute. Litigation involves significant costs in the form of court filing fees and attorneys’ fees, and even if the startup is successful in defending itself in court, it is highly unlikely that the company will be able to recover these expenses. In the event of removal to federal court, the startup may also face significant (and unrecoverable) travel costs. For early-stage companies trying to carefully manage limited funds, these enormous expenses may be prohibitive and the company may be forced to settle disputes on highly unfavorable terms.

Time: Another downside to litigation is that it can be an incredibly drawn-out process. Between initial motions, discovery, and the actual hearing (assuming no settlement is reached), the process can take years. When appeals are taken into account, disputes can continue on seemingly without end.

Public Relations: Beyond the substantive hurdles associated with litigating disputes, there is also the problem of public perception. Lawsuits, particularly suits where users are making incendiary allegations, can turn off users and destroy a company’s momentum. In a similar vein, pending litigation may also turn off investors who may not be willing to associate themselves with a company that has experienced a loss of reputation in the public eye. This sort of damage is incredibly difficult to recover from, even if the company ultimately prevails in handling its dispute.

Arbitration: While some of the issues associated with litigation are unavoidable (disputes with users will always entail a loss of time and money), arbitration presents an alternative that can in many ways mitigate these downsides.

Forum Certainty: An arbitration policy typically identifies not only the particular arbitration company that will be administering the arbitration, but also the location where disputes will be settled.

Reduced Cost: While there is no clear consensus as to whether or not arbitration is cheaper than litigation, there are reasons to think that arbitration can cut costs. While both litigation and arbitration require the use of an attorney, arbitration offers more flexible procedures than courts, so there may be reduced costs associated with motions and discovery. Additionally, where the parties have agreed to “final and binding” arbitration, the costs associated with the appeals process are eliminated.

Increased Efficiency: In addition to being cheaper, arbitration also generally provides for a quicker resolution of disputes than litigation. Additionally, arbitration policies can be crafted to eliminate appeals, further shortening the dispute resolution process.

Confidentiality: While filings and court orders in litigation automatically become part of the public record, arbitration allows for much of the dispute resolution process to occur outside of the public eye. One reason for this is that arbitration companies are private entities and are thus not subject to the same disclosure requirements as their government counterparts. Another is that arbitration provisions may explicitly require parties to agree that dispute resolution in arbitration will be confidential. The consequence of this heightened confidentiality is that the dispute resolution process has much less of a prejudicial effect on the company’s reputation and, by extension, its prospects of obtaining venture financing.

In light of these points, a dispute resolution policy centered around arbitration should be given strong consideration by most early-stage ventures. However, even if an arbitration provision proves to be the appropriate choice for a particular startup, its founders would be wise to consult an experienced startup attorney to handle its drafting, as they are complex provisions and, in light of the Supreme Court’s 2011 decision in AT&T Mobility v. Concepcion, they need to be drafted very carefully to ensure that they are fair and enforceable.

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Revisiting Regulation A+: A Few Considerations

Entrepreneurs should consider the risks and rewards of a Reg A+ offering. Image by Andrew Magil on Flicker. CC By 2.0 License.

Entrepreneurs should consider the risks and rewards of a Reg A+ offering. Image by Andrew Magil on Flickr. CC By 2.0 License.

The ability to successfully fundraise is typically a significant factor in an early technology venture’s success. While most seek to raise capital from a small number of wealthy individuals or institutions, such as angel investors or venture capital firms, entrepreneurs are increasingly seeking the ability to raise capital through larger groups of investors, each offering a smaller financial contribution. Until recently, startup financings have typically fallen under Regulation D, a set of three rules – 504, 505, and 506 – which carve out exemptions to the registration requirements of the Securities Act of 1933, as described in this prior post. However, “Reg D offerings” are not without limitations – offerings conducted under Rule 504 are capped at a modest $1M, while offerings under 505 and 506 significantly limit the number of unaccredited investors. Although still a popular option, Reg D offerings often do not give capital-starved ventures the ability to sell to a much larger pool of interested investors, especially one including unaccredited investors..

It is not surprising then that there was significant excitement within the entrepreneurial community when the SEC finalized amendments to Regulation A in June 2015. Similar to Regulation D, the existing Regulation A provided an alternative set of exemptions to the Security Act of 1933, but these exemptions did not include limitations on the number of unaccredited investors. However, prior to this recent amendment, due to the fact that Reg A offerings were capped to $5M per sale and subject to burdensome “blue sky” security laws of individual states where securities would be sold, Reg A offerings have failed to take off. The new amendments to Regulation A, dubbed “Regulation A+,” created buzz by raising the dollar limit from $5M to $20M and $50M for each of the respective Tier 1 and Tier 2 offerings. Combined with a new coordinated review process for Tier 1 offerings and blue sky law exemptions for Tier 2 offerings, Regulation A+ gives entrepreneurs the ability to raise much more per sale while bypassing the time and financial costs associated with blue sky law compliance.

Since June 2015, the SEC has received many filings and have qualified around a dozen sales to date. A few examples of recently qualified offerings include:

  • Sun Dental Holdings, LLC – A traditional dental device manufacturing company that also focuses on digital scanning, cloud-based data management system and 3D printing to produce dental devices.
    • Sun Dental filed and qualified a Tier 2 offering for $20 million (9/3/15 – 12/1/15).
    • Disclosed costs include $330K in legal fees, $380K in audit fees, and $950K in underwriting fees.
  • Groundfloor Finance Inc – An online investment platform designed to source financing for real estate development projects.
    • Groundfloor has had two Tier 1 offerings qualified, the first for $545K (3/23/15 – 8/31/15) and the most recent for $1.5M (10/7/15 – 10/29/15).
    • Disclosed costs for the first offering included $458K in legal fees, $30K in audit fees.
  • Elio Motors – An automobile company planning on manufacturing low-price, compact cars for a fraction of the price.
    • Elio filed and qualified a Tier 2 offering for $25M (8/28/15 – 11/20/15).
    • Disclosed costs include $110K in legal fees, $25K in audit fees.

While Reg A+ offerings have been gaining some traction, there are still significant obstacles in pursuing this financing option. Some issues entrepreneurs should consider before proceeding include:

  1. Cost. The first obstacle to Reg A+ has been the fees associated with completing and filing the application. While not as costly as an actual IPO, Regulation A+ still requires a dedicated team of lawyers and accountants to produce the offering circular and the financial statements (audited, if conducting the more lucrative Tier 2 offering). Recent filings have put legal fees anywhere from the low thousands up to $485K, and auditing fees typically add on another $20K to $30K. Due to the complexity of securities law and filing requirements, experienced counsel and the associated fees are essential to the process.
  2. Administrative Burden. In addition, the venture must be prepared to handle the administrative aspect of filing and selling securities under Regulation A+. Developing the substance of the offering circular will be time consuming, and companies conducting a Tier 2 offering will be on the hook for ongoing reporting requirements. For a leanly staffed team, the administrative burden might be a significant worry.
  3. Liability. Sellers of Regulation A+ securities are liable for any material misleading statement or omission made in an offering circular or oral communications, and anything said in the offering circular could be used in litigation down the road. As such, entrepreneurs must be careful to engage with experienced counsel in developing their circular.
  4. Impact on Future Investors. Experienced attorneys have brought up concerns surrounding the impact of introducing many unaccredited investors into a company’s cap table. There appears to be a consensus that VCs and other institutional investors tend to shy away from companies that have “crowded cap tables” because it can be difficult and risky to invest in a early-stage company with such a composition.
  5. Public Disclosure. Entrepreneurs will need to provide significant disclosures about their business and financials in its offering circular. This can sometimes be an issue for a venture that prefers to keep certain facts about its technology or financials internal until a more appropriate time.

While brimming with potential, Regulation A+ offerings can hardly be considered “easy money.” These very real obstacles are substantial, and should give any prudent entrepreneur pause to entertain other, more traditional financing methods. Those who do decide that they have the appetite to pursue a Regulation A+ offering should do so with ample resources, experience counsel, and a clear understanding of the difficulties involved in the process.

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Possibilities for Blockchain and the Legal Implications

FrankieRufinBlogPicBlockchain technology is a new way of establishing trust in the presence of unreliable parties. Although it owes its current celebrity to Bitcoin, the cryptographic power of blockchain can be harnessed in a variety of different ways, making it capable of revolutionizing a lot more than just how we do business. Along with these new possibilities, however, new complex legal issues are expected to arise.

What is blockchain technology?

Blockchain is best known as the underlying technology that makes Bitcoin possible. Bitcoin’s system of transactions is decentralized, meaning that no central authority tracks, approves, or secures transactions made on the Bitcoin network. Instead, Bitcoin relies on blockchain technology—rooted in cryptography—to achieve a secure and usable system.

For those new to blockchain technology, it is essentially a decentralized public ledger of transactions that works as follows:

  • When a user initiates a new transaction, the transaction is grouped with others into “blocks” and consistently added to the ledger.
  • The blocks are then redundantly verified by the distributed computing power of the users connected to the network and added to the “block chain.”
  • A unique cryptographic “hash” identifies all blocks and transactions and permanently fixes them in chronological order, making it virtually impossible to modify past transactions in the chain.

The result is “trustless” system of transferring assets with no need for a central processor. Every payment is recorded and verifiable by anyone who accesses the public blockchain.

Blockchain is the next big thing.

Blockchain technology is not limited to transfers of virtual currencies. It has far-reaching potential in a wide variety of industries and applications. In brief, blockchain technology makes it possible for a community to manage something that previously required a centralized authority.

A growing number of organizations are beginning to use blockchain technology to build infrastructure to support decentralized peer-to-peer applications, while others are attempting to create decentralized versions of existing internet applications. From regulatory reporting to derivatives settlement, blockchain technology can be utilized to revolutionize many key service industry sectors, yielding increased consumer power, greater personal data ownership, and reduced transaction costs over the long term.

Legal Implications.

Thus far, regulators and enforcement agencies have focused on the legal issues surrounding the use of virtual currencies in financial transactions. However, the legal landscape gets markedly more complicated when discussing the broad applications of blockchain technology.

As outlined in a recent Bloomberg BNA Banking Report, anticipated legal issues include—but are not limited to—the following:

  • Utilizing blockchain in the context of intellectual property would necessitate a doctrinal and legislative shift, as current IP licensing law is based on contractual relationships between parties, not on transferable property rights that could be sold later on.
  • In the storage of identity information, legal implications could include privacy concerns and whether a right to privacy would even exist in such applications.
  • The use of smart contracts raises several legal concerns. For instance, the automatically enforcing nature of smart contracts would make it difficult to apply some classic contract doctrines (ex. voiding a contract due to coercion), and the contracts may be programmed to be impossible to breach, even efficiently. In addition, these interactions would carry privacy concerns, as contracts between parties would be publicly viewable in the ledger.
  • Advanced applications of smart contracts would allow for the existence of decentralized organizations, raising issues of liability and ultimate responsibility. Legal systems would have to determine who to hold responsible if laws are broken, as “management” is conducted automatically. Further, it is possible that existing legal frameworks relating to corporations and other business entities are insufficient, and that new regulations would need to be developed.
  • Blockchain can accomplish escrow services utilizing “multi-signature transactions” although the arbiter in the transaction does not actually take possession of the virtual asset.  Because existing legal frameworks are designed to regulate escrow agents who assume full control of an asset, they may prove to be incompatible.
  • Attempts to offer securities and financial products are likely to increasingly implicate securities laws.

We have already seen virtual currency ‘rock the boat’ and swiftly prompt significant legal and regulatory change. With the potential applications of blockchain technology—capable of completely revolutionizing the way we interact and exchange information and value—we can reasonably expect momentous changes to our legal framework.