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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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Uber’s Regulatory Drama Continues: Portland Sues Uber

The City of Portland sued Uber on December 8 seeking to enjoin Uber from operating in the city limits.

The City of Portland sued Uber on December 8 seeking to enjoin Uber from operating in the city limits.

Yesterday’s post discussed Michigan’s proposed bill HB 5951 which would implement state regulations permitting ride-sharing services such as Uber and Lyft to operate in the state of Michigan provided they met certain regulations that are largely consistent with Uber’s existing practices.  That bill would preempt various city regulations (such as Ann Arbor’s), some of which conflicted with Uber and Lyft’s existing practices.  Just a few days after Michigan’s house committee approved HB 5951 and recommended the house pass the bill, a strikingly different approach has been taken in Portland, Oregon.

City of Portland v. Uber

On Monday, December 8, the City of Portland sued Uber seeking to enjoin Uber from operating in the city of Portland.  This lawsuit comes just days after Uber began operating in Portland on Friday, December 5.  The conflict involves Portland City Code Chapter 16.40, which requires as follows:

  • “for-hire transportation” drivers must obtain a “for-hire transportation” permit
  • for-hire vehicles must have certain decals and plates
  • taxicabs must adhere to certain fare and meter rates
  • taxicabs must adhere to certain regulations related to wheelchair accessibility
  • for-hire vehicles must maintain certain levels of insurance
  • taxicabs must maintain a dispatch system in operation 24 hours/day
  • taxicabs must service city-wide 24 hours/day, 7 days a week and accept any request received within the city
  • taxicab companies must have at least 15 cabs in their fleet and have at least 2/3 of their fleet in service at all times
  • for-hire vehicles must pass regular inspections
  • for-hire vehicles must be equipped with digital security cameras

According to the City of Portland’s complaint, which can be read here, Uber violates Portland City Code because it:

  • does not hold a valid company permit
  • all prospective Über customers must first download the Uber app and enter into an online agreement under terms dictated by Uber, including a waiver of any and all liability to Uber
  • the customer must provide credit card information to Uber, which is charged, rather than having drivers collect a fare from the customer
  • customers hail an Uber vehicle through the Uber app instead of a human dispatcher
  • the Uber app calculates fares based on time and distance rather than through a certified taxi meter
  • Uber’s drivers and vehicles are personally insured, and Uber does not require its drivers to purchase commercial at insurance
  • Uber does not require its drivers to be certified by the City of Portland
  • Uber’s drivers are not required to be dispatched to all ride requests in the city, but rather only to passengers who can pay via credit card and have access to the Uber app or website to request a vehicle

Portland’s Cease and Desist Letter to Uber

On December 8, the City of Portland sent a cease and desist letter to Uber demanding that Uber cease operations in the city limits.  The cease and desist letter is attached to the complaint as Exhibit A. While there have been varying reports of the city’s enforcement against individual Uber drivers, it does appear the

Support for Uber and Success in Other Markets

As of publication, close to 10,000 individuals have signed a petition to support Uber’s operations in Portland.   Uber remains wildly popular and it generally overcomes the legal obstacles it has faced in other markets.  As previously reported, Uber faced initial obstacles in Ann Arbor and Detroit.  While Ann Arbor sent Uber cease and desist letters, it generally did not crack down on Uber’s operations, and now a Michigan bill is likely to preempt any local regulations.  In Detroit, Uber worked with the city to enter into an operating agreement stipulating how the company could operate in Detroit.

Ride-sharing In and Around Portland

While regulatory issues are nothing new to Uber, the situation in Portland is slightly unique.  Uber is already operating in several cities in close proximity to Portland, for instance, Vancouver Washington.  Additionally, various tweets, such as the one below, were bring broadly disseminated citing the limited availability of traditional taxi services in and around Portland:


 Going Forward

Going forward, the legal questions related to whether Uber is complying with Portland’s City Code appear to be relatively clear:  Uber is not.  As in other cities, this is likely not a legal battle, but rather one of politics and policy.  If Portland desires to have Uber available in its city, it will ultimately amend its city code to provide for transportation network companies such as Uber, to obtain permits to operate in the city.  Alternatively, as happened in Michigan, the state of Oregon could pass statewide regulations that preempt the regulations of any particular municipality, thus permitting Uber to operate statewide as long as it abides by the state-level regulations.

So far, Uber’s tactics of commencing operations and then working out any regulatory hurdles have worked out with staggering success.  Indeed, Uber recently raised another $1.2B at an amazing $40B valuation.  So far, Uber has proven that massive customer acquisition can cure all evils – even legal and regulatory ones.

 

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The Risks of Corporate Incubators May Outweigh the Generous Rewards

Corporate incubators can nurture a small startup with big company resources.

Corporate incubators can nurture a small startup with big company resources.  Photo by Pete Prodoehl.

We have seen a recent wave of fortune 500 companies breaking into the entrepreneurship game by establishing their own corporate incubators – Nike, Google, Microsoft and Samsung just to name a few. This article provides an overview of considerations for whether your start-up should accept an offer to join a corporate incubator.

Overview of Corporate Incubators

Corporate incubators are industry specific accelerators that help start-ups and entrepreneurs build a successful company/product but only within the structure of a large corporation. As compared to the traditional accelerator (e.g. Techstars or Ycombinator) that invest money and resources in a broad array of startups which span many platforms, corporate incubators are designed to help the sponsor build a portfolio of long-term product options, develop offshoots to existing products and generate innovative ideas that can help the sponsor grow its profits.

Why Established Companies Seek to Incubate Startups

Corporate incubators and accelerators are a vital source for idea generation and growth. Particularly for markets that are constantly evolving, an in-house incubator can help large companies pivot and change directions or develop a new business quickly. Even for companies in mature industries where M&A is drying up quickly (i.e. manufacturing or many food & beverage sectors), incubators and accelerators have become a part of their corporate structure to derive new profits. Not only do corporate incubators provide valuable ideas but they can also provide a company with home grown talent if the company runs short on valuable human capital. Given the level of visibility and access corporate executives have to talented young entrepreneurs through the incubator, it is not uncommon for the sponsor to make employment offers from its toy chest full of start-ups.

Benefits to Joining a Corporate Incubator

While joining a corporate incubator may seem like “selling out,” the benefits of a corporate sponsor may be too much temptation for any starry-eyed entrepreneur to resist. Corporate incubators give a start-up access to the company’s vast array of resources such as R&D, legal services, mentorship and often stable financial assistance to help the start-up scale its business. Furthermore, as compared to your typical accelerator or incubator, corporate incubators are generally industry focused and can provide tailored mentorship and resources that even some of the top accelerators such as Ycombinator or Techstars may not have access to. Not only are the resources a substantial benefit but another advantage is that a corporate incubator can immediately place a start-up on the radar of a strategic acquirer. Getting support from a corporate sponsor can be a significant step in the right direction for a start-up and often signals that the entrepreneurs may be on to something big and therefore should think seriously about an offer to join a corporate incubator. Like most things in life, however, there is often no such thing as a free lunch and there some serious challenges that start-ups should be aware of before joining the corporate payroll.

Considerations to Joining a Corporate Incubator

(1)  Make sure you have clean title to your intellectual property

Joining a corporate incubator can be tricky when it comes to IP related issues especially when dealing with who owns any new IP that comes out of the incubation process. Before starting at a corporate incubator, make sure that all IP that has been created by any of the founders or employees has been documented and assigned to the business. While negotiating with a corporation is not easy and offers are often provided on a take-it-or-leave-it basis, try to work with legal counsel to ensure that any and all IP developed while in the incubator belongs to your start-up.

(2)  Corporate bureaucracy can crush a start-up’s flexibility

One of the best aspects of being a start-up is the ability to be nimble and make quick decisions when needed. Large corporations are often not afforded this benefit as their size and governance structure can slow decision-making. If the corporation running the incubator obtains certain veto or control rights in a startup, that startup may lose its ability to make quick decisions. Getting caught up in such corporate bureaucracy and indecision (or a slow and lengthy decision making process) can quickly destroy a budding company. A startup can protect against this risk by closely reviewing the deal documents and avoiding granting the company running the incubator control over important decisions that a startup needs to make quickly (i.e., hiring, product direction, market strategy, issuances of equity to new hires, etc.) If the company running the incubator insists on such control rights, a startup should get to know and staying aligned with the key corporate decision makers and stakeholders.

(3)  Corporate sponsorship may drive away venture capital funding

If you do choose to join a corporate incubator, don’t be surprised if you don’t have too many venture capitalists knocking on your door at the end. While VCs won’t necessarily be bothered by the “selling out” aspect of corporate sponsorship, they will be very concerned about having to deal with XYZ conglomerate as a significant investor not only with a sizeable equity stake but also potentially pro-rata rights and big city corporate lawyers to enforce all the initial investor rights agreed to by the start-up. Even if VCs can get over having to deal with the corporate sponsor, many will be concerned with whether the management team has that magical start-up wherewithal that makes them worth investing in. VCs often view companies in corporate incubators as being hand-held and as a result may not have learned the hard lessons necessary to run and scale a successful business.

Conclusion

Joining a corporate incubator or accelerator can be one the best steps a young and potentially successful company can take and should be given serious thought if such an offer should present itself. It is important, however, to understand the risks of doing so and what it can mean for your company’s brand, image and future opportunities as it starts to take-off. Finally, if you do choose to join a corporate incubator, always always always have a well thought out Plan B in your back pocket as large companies are known for pulling the plug on such corporate programs without much notice even with the slightest downturn in quarterly earnings.

 

 

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Financing a Startup Company Series: Venture Capital

According to the National Venture Capital Association, venture capitalists are long-term investorswho take a hands-on approach with all of their investments and actively work with entrepreneurial management teams in order to build great companies.

According to the National Venture Capital Association, venture capitalists are long-term investorswho take a hands-on approach with all of their investments and actively work with entrepreneurial management teams in order to build great companies.

This continues our Financing a Startup Company Series and focuses on venture capital.  Venture Capital refers to professionally managed investment funds that usually have between $10MM and $1 billion to invest in early stage companies.  VC funds vary widely in their investment strategy, both in terms of the industry and stage of startup companies that they will invest in.  Some funds invest in very early companies, others in more developed startups.  Some invest in web companies, others prefer biotech.

To attract VC funding, a company must usually have a hugely scalable business plan that involves high growth in sales.   Venture Capitalists are sophisticated investors who see a lot of startups come through their doors looking for funding, and thus competition to get VC funding is tough.  Each VC fund has specific company profiles that they are looking for – it pays to learn about the VCs and the types of companies in which they invest.  It is important to know: 1, what industries the fund focuses on, 2, in which geographic locations they invest, 3, the stage of companies that they invest in, and 4, the size of deals that the fund will participate in.

When VCs invest, they take preferred stock that can convert to common stock if the VC so chooses.  Preferred stock provides control rights over the company and gives some financial protection to VCs because in case of a liquidation or sale of the company, they will get paid out before the common stockholders. The rights that the VCs want will be spelled out in a term sheet that the VC provides to the company when the VC decides that it would like to invest.  Experienced counsel can help explain the terms and their impact on your company, but some of the key terms are:

  • Price Per Share – the company will usually be valued on its “pre money” valuation: the value of the company before the investment.  This valuation, divided by the number of shares, gives the price per share.  When determining the number of shares, negotiation sometimes occurs over which shares to include.  A “Fully diluted” basis means that you include all shares that have been issued plus any issued options or warrants that could be exercised in the future (such as options issued to employees).
  • Liquidation Preference – provides additional downside protection to investors in the event that the company is liquidated or acquired by allowing holders of the preference to get paid before other shareholders.  A 1x liquidation preference gives investors a return of their money before anyone else is paid, a 2x preference would allow an investor to collect two times its original investment, etc.
  • Participation– allow preferred stock holders to share in any distribution of proceeds from a sale of the company alongside the common stock holders.
  • Anti-Dilution – encompasses several methods of protecting shareholders relative ownership of the company, at the expense of the company and future investors, in the event that there is a down round (an issuance of shares at a lower price than prior issuances).
  • Conversion Rights – allow preferred stockholders to convert their shares to common stock, usually at a 1:1 ratio.
  • Registration Rights – give investors the right to force a company to go public and register its shares with the SEC for sale to the public.
  • Dividend Rights – give holders the right to receive cash from the company on a periodic basis.  They can be cumulative (where it must be paid each year, or if not paid one year, must be paid in the future) or non-cumulative (where the stockholders only get the dividend if it is declared by the board).
  • Protective Rights – give investors the right to veto certain specified actions such as selling the company, changing the terms of stock and issuing new stock.
  • Voting Rights – give investors a right to vote separately to approve actions that might hurt their interests.

Advantages

  • Because of the variety in VC funds, it is possible to raise everything from fairly small investments of a few hundred thousand up to hundreds of millions of dollars.
  • Venture Capital firms have large networks of advisors, mentors and business contacts.  They can help make introductions to get quality people hired into key positions.
  • Obtaining funds from a reputable VC fund is a huge mark of validation for a startup and can make it easier to attract employees, press coverage and future funding.

Disadvantages

  • VC funds will take a large equity stake in a startup, thus diluting the founders immensely.  But, it is better to own 10% of a $100MM company than 80% of a $100K company.
  • VC funds will often impose controls over the company’s management and take seats on the board.  Although the board may have been a formality before accepting much outside funding, once a VC is on the board, it will begin to exercise more power over the corporation. While this is not necessarily a bad thing (having a seasoned VC on the board can be a huge advantage), the VCs interests in protecting and growing its investment may not always align with those of the founders.
  • VC funds are very selective.  Venture capitalists see a huge number of business ideas and choose to fund only the ones that they perceive to be the very best.

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Financing a Startup Company Series: Crowdfunding 2.0 – Equity Based

If implemented, the JOBS act may make equity-based crowd funding legal.

If implemented, the JOBS act may make equity-based crowd funding legal.

This post continues our Financing a Startup Company Series and focuses on equity-based crowdfunding.

A relatively new model for crowdfunding (Crowdfunding 2.0) involves issuing equity to members of the general public in exchange for money.  In the past, companies were prohibited from advertising to the general public when attempting to sell stock (think posting on Facebook that you are accepting investors, or offering stock for Kickstarter donations).  Further, the types of people who could invest in startups were also limited.  The only options for startups to sell to the general public were to issue stock through an IPO (expensive and limited to later stage startups), or by navigating the complex rules governing private stock offerings.  The private stock offering rules are complex and among their numerous restrictions prohibit advertising the offering to the public, limit the number and wealth of investors.  For example, Rule 506 allows raising up to $5MM from the sale of stock to an unlimited number of Accredited Investors, but only 35 non-Accredited Investors.  Accredited Investors are generally people with $1MM in net worth excluding their home, or $200K annual income.  Because of the complexity of the SEC regulations involved with the raising money from investors (whether through public or private offerings) make sure that you consult first with an attorney who has experience assisting startups with these issues.

Because of the ban on general advertising, raising money through equity-based crowdfunding was exceptionally difficult.  A few crowdfunding portals, such as Crowdfunder, legally offer equity-based crowdfunding by only allowing carefully vetted Accredited Investors to participate.

In the near future, however, the process of selling to the public should become somewhat less restricted: in 2012, Congress passed the JOBS Act, instructing the SEC to write regulations to enable wider use of equity based crowdfunding.  When finalized, the regulations will likely allow companies to reach out to the public at large for cash in exchange for equity.  While this potentially opens the door to selling stock in an early stage startup to the general public, there will be regulatory strings attached.  The proposed rules issued by the SEC this fall (2013) impose the following regulations:

  • Equity based crowdfunding will only be allowed through regulated funding portals.
  • The maximum amount of funds a startup may raise using equity based crowd funding will be capped at $1MM per year.
  • Over a 12-month period, individual investors with incomes below $100,000 may only invest up to 10% of their annual income or $2,000.  Investors with incomes greater than $100,000 may invest 10% of their annual income, up to a maximum of $100,000.
  • Companies that pursue this model may have to provide an annual report to the SEC and audited financial statements (an expensive undertaking) to their investors.
  • The securities that are sold will likely have resale restrictions imposed by the SEC.

These are only some of the regulations, and the SEC has not yet finalized the rules.  Thus, reaching out to the general public to offer equity for cash remains off limits.  Once the regulations are finalized, before attempting to use equity based crowdfunding, consult with a knowledgeable attorney to avoid running afoul of the SEC rules.

Even when equity-based crowdfunding is allowed, the following potential issues will still exist:

  • Materially misleading statements in advertising materials can still lead to §10b-5 antifraud liability.  Antifraud violations are much more serious than false advertising claims and can be ruinous for a company and its executives.  Consult with a lawyer before posting what your marketing person creates.
  • State securities laws still cover the investors in their territory and can require a filing notice and payment of a fee.
  • In order to raise funds, you will need to pitch your business to the public.  This may mean that your company has to disclose to competitors information about sensitive, confidential, technology or business plans.
  • There will likely be ongoing responsibilities to report to the shareholders on the financial and business performance of the company.  These can be expensive, time consuming, and open the door for antifraud liability.
  • Even if equity-based crowd funding becomes legal, and common, one should also consider whether other sources of financing, such as sophisticated angels and VC’s, will invest in a company that has raised equity-based crowd funding.  It might be the case that VC’s will not want to get involved with a company that has so many shareholders.

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Patent Freedom to Operate Part 2: When Not to Seek a Freedom to Operate Opinion

"Patent freedom to operate" refers to whether one can conduct its business model without infringing another's patent rights.

“Patent freedom to operate” refers to whether one can conduct its business model without infringing another’s patent rights.

Part 1 of this series discussed the concept of patent freedom to operate (“FTO”) and why it might be important to analyze at the early stages of a technology-based startup.  There may be situations, however, where it might NOT be appropriate or your startup to invest resources in having an attorney analyze your FTO.  In particular, despite the benefits of an FTO opinion, hiring an attorney to perform an FTO search can be costly, and the results might not provide the benefits you’re looking for.  One should weigh the following considerations before deciding to whether (and how much) to invest in a FTO analysis.

(1) Time and Cost.  FTO analyses can be very costly, in terms of both time and money. An attorney needs to understand your product or service, conduct an extensive search for potentially problematic patents, and review those patents.  For potentially problematic patents, an attorney must closely read the entire patent, construe the elements of the patent claims, review the prosecution history of the patent (the documented application process), and apply the patent claims as construed to your product or service.  This process can easily cost tens of thousands of dollars, if not more.

(2) Ambiguous Patent Claim Language. Even a well-funded FTO analysis will not provide absolute certainty regarding whether you are in the clear. Patent claims are notoriously difficult to interpret—although a well-trained attorney can make educated guesses, nobody can be certain of how a court might interpret a certain claim. Accordingly, an attorney is likely to encounter patent claims where she cannot guarantee whether your product will or will not infringe.

(3) Unpublished Applications. It is not possible to identify all potentially problematic patents.  The PTO does not publish pending applications until 18 months after they are filed.  This means that even the most thorough searcher may not find certain applications that will ultimately pose a problem because they are not yet accessible.

(4) Changing Patent Scope. Even if potentially problematic patent applications have published, their claims may change during the application process.  Pending patent applications include draft claims that the searching attorney must analyze. It is not uncommon for these claims to change before the patent is ultimately issued. Since the attorney cannot predict how these claims will change, the effect of a pending patent application is very difficult to determine.

(5) Difficulty of Keyword Searching. It is also difficult to identify problematic patents because they may use different terminology.  Patentees are permitted to create their own terminology in describing their inventions.  Even if a patentee is not purposefully ambiguous with their terminology, patents may not use the accepted terminology in a field because that patent was filed before a particular market developed standardized vernacular. Accordingly, it might be hard to identify potentially problematic patents if they don’t contain the terms you use in your keyword searches.

(6) Do the results matter?  You might not want to know (or might not care about) the answer.  As we discussed above, willful infringes can face increased damages.  Therefore, some companies may decide to avoid becoming aware of problematic patents to limit the risk of being found to have acted willfully in infringing another’s patent.  This concern might be especially relevant in the information technology field, where it is common more numerous overlapping patents to relate to various aspects of accessing and transferring information via computers.  Accordingly, it might not be possible to design any product or service in the information technology field in a way that avoids any potentially problematic patents, an companies may make the business decision that a freedom to operate analysis does not provide any information that is relevant to their product design.

(7) Premature?  You should have an understanding of your potential product or service.  If you have a general idea for your actual invention, but don’t have a working prototype (or at least some idea of the specifics of your product or service), your invention is probably too early stage for a robust FTO analysis. You definitely don’t need to wait until your technology is finalized before you move forward with a FTO search, but performing a search too early is likely to be inefficient. You may have a strong business plan, or a general idea of how your invention will work, but you haven’t tested it yet. At this point, your design is likely to change dramatically. Since every patent claim has unique boundaries, even a small change in your design can have a big impact on whether you may or may not infringe a patent. Particularly given the ambiguities discussed above, an FTO search at this point may soon become obsolete if you encounter a technical or business obstacle that requires you to redesign your invention. At that point, you’ve spent a lot of time and money to procure an opinion that will not be very helpful in the long run.

Analyzing patent freedom to operate can be a valuable step in deciding whether to pursue a technology venture or how to design a particular product or service.  Startups should consider the above in deciding whether and when to expend valuable resources in addressing patent freedom to operate.  Being strategic in addressing patent freedom to operate can help one more efficiently obtain a more relevant and helpful analysis concerning patent infringement issues.

 

See Patent Freedom to Operate Part 1: Why Analyzing Patent Freedom to Operate is Important.

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Angel Investors II: Structuring the Angel Investment

Entrepreneurs have a number of options for structuring an angel investment.

Entrepreneurs have a number of options for structuring an angel investment.

This is part 2 of a 2 part series on receiving angel investments.  Once your company has decided to take on an angel investor, you have a couple of decisions to make.

Convertible Notes vs. Equity Purchase: What is right for you?

As discussed above, angel investors may be flexible in how the financing is structured. Two possible approaches a financing could take are convertible notes and equity purchase. The differences between the two are discussed below:

Convertible Notes

Convertible notes act like traditional notes, but grant the investor the option to convert the balance of the note into equity instead of seeking repayment at the choosing of the investor, or automatically upon a specified date. You do not need to value the company in order to execute a convertible note. These notes are also easier to produce than full-financing documents, resulting in lower legal costs. Convertible notes will often contain a provision specifying that the note will automatically convert into equity in the event of a qualified financing, usually defined to be the closing of a set round of a specific dollar amount or higher.  In that case, the note will convert to whatever type of equity is issued in that round of financing.

Equity

In this type of deal, the investor will purchase equity in the company in exchange for cash. The investors and entrepreneurs will agree on a set price that the investors will pay for each share of the company. This is how many financing deals are structured, and may be the preferred format for an angel investor.

One thing to keep in mind when structuring an equity deal is that convertible notes previously issued by the company may have an automatic conversion provision that will be triggered by this new round of financing.  If that is the case, the value of these notes and the corresponding stock that will be issued in exchange for them must be taken into account when valuing the company.  The two different methods traditionally followed in the industry to account for the convertible notes when setting the price of the new round are:

a. Convertible notes as part of the pre-money One choice is to include the value of the convertible notes in the pre-money valuation of the company. This is complicated, though, because the value of the convertible notes is determined by the price per share at which they will convert. The price-per-share is set by the new round of financing, which under this method is determined based on the value of the convertible notes. This method will rely on an iterative excel calculation to determine the price-per-share for both the convertible notes and the newly purchased shares.  One way to estimate this calculation is to simply subtract the amount of convertible debt (perhaps factoring in the discount or cap to calculate the purchasing power of the convertible debt) from the negotiated pre-money valuation.  Generally, this will result in a lower price and so will benefit the investors.

b. Convertible notes as part of the post-money. Another option is to factor the convertible notes as part of the new money coming into  the company. The investors and the company will decide on a price-per-share for the round based on a pre-money valuation of the company that does not include the convertible notes. This will generally result in a higher price per share, benefiting the company.

Compliance with Securities Laws

The SEC considers both a sale of equity or a convertible note as a sale of a security. As such, you will want to make sure that you meet one of the SEC’s private offering exemptions and that you file the necessary forms with the SEC and with the state in which the investor(s) reside. You will want to research the requirements for your specific financing directly on the SEC website and on state websites. Do not rely on general advice. Most angel investors will be accredited investors, making the exemption under Rule 506 available to you if they are.  Generally, you will need to file a Form D with the SEC within 15 days after the sale is made.  You may also need to make a notice filing and pay a fee to the state in which the investor resides within that time frame. Note that if you are receiving money from an angel syndicate but each individual investor will be writing a check you must comply with each investor’s home state filing requirements. Be sure to check out www.sec.gov and each state’s secretary of state website and http://www.NASAA.org to ensure that you comply with all regulations.  Also, note that the SEC requires that Form D be filed electronically. This will require access to the EDGAR database and may take multiple days to set up. Be sure to look into the securities filings early so that you do not miss the deadline.

In general, angel investors may be a good match for your company’s financing needs. Before agreeing to bring in an angel investor, though, be sure to assess whether this is the best fit for your company. Once you’ve made the decision to follow through with the financing, consider how to best structure deal to suit your company’s needs and be diligent in complying with necessary federal and state regulations.

Read part 1 of this 2 part series:  Angel Investors I: Should You Take Money From an Angel?

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Startup Legal Lessons from the Biography of Steve Jobs (Part 4)

Walter Isaacson's bestselling biography of Steve Jobs touches upon numerous legal issues common to startups.

Walter Isaacson’s bestselling biography of Steve Jobs touches upon numerous legal issues common to startups.

This is Part 4 of a multi-part series examining the startup legal issues raised in Walter Isaacson’s biography of Apple co-founder Steve Jobs.  This post discusses how Apple has strategically used design patents to protect its user experience.

Throughout the Jobs biography, patents (both utility and design patents) are frequently referenced to show Apple’s innovation under Jobs. This prior post discusses the basics of design patents and how innovators are increasingly using design patents to protect the ornamental design of a product and therefore provide a competitive advantage.  Perhaps no company has been more effective at using design patents than Apple.  In fact, as of the Fall 2013, Apple has received over 900 design patents on its electronic products and over 30 design patents just on its packaging.  On page 347 of the Jobs biography, Isaacson describes how Apple would even use design patents to protect the packaging for its products.

One of the ways Apple has strategically used design patents is by filing multiple design patents on a single product.  Rather than seeking to claim the overall product design in a single patent, Apple focuses each patent on a discrete design aspect.  An example of this strategy can be seen in Apple’s protection of the design for the Apple Macbook Air.

Apple has used a series of design patents as part of its strategy to protect its ornamental design of the MacBook Air.

Apple has used a series of design patents as part of its strategy to protect its ornamental design of the MacBook Air.

Apple’s filed its first application for a MacBook Air design patent on January 4, 2008 and the PTO issued that patent, U.S. Patent D604,294, on Nov. 17, 2009.  While that patent has several figures, the following figure shows how this patent focused on the tapered clam-shell design of the MacBook Air:

U.S. Patent D604,294 focused on the tapered clam-shell design of the MacBook Air.

U.S. Patent D604,294 focused on the tapered clam-shell design of the MacBook Air.

The solid lines show required elements of the design where as the dotted lines show optional design elements.  Had Apple depicted the entire design with solid lines, a competitor could more easily evade the covered design by merely altering one aspect of the design.  Instead, Apple covers just a single aspect of its design in each design patent, and then seeks to cover the other aspects of the design in subsequent patents.  In the case of the MacBook Air, Apple filed numerous continuation design patents.

On Oct. 19, 2010, Apple received U.S. Patent D625,717 (claiming priority to the original filing date of Jan. 4, 2008).    This patent focused on the metallic color, the black keys, and the clam-shell shape of the computer.

Apple's U.S. Patent D625,717 focuses on the metallic color, black  keys, and clam-shell shape of the MacBook Air.

Apple’s U.S. Patent D625,717 focuses on the metallic color, black keys, and clam-shell shape of the MacBook Air.

Apple then received U.S. Patent D635,566 on April 5, 2011, which claimed the metallic color of the computer but made the color of the keys optional.

Apple's U.S. Patent D635,566.

Apple’s U.S. Patent D635,566.

Apple next received U.S. Patent D661,693 on June 12, 2012, focusing on the side port in the computer:

Apple's U.S. Patent D661,693 focuses on the side port.

Apple’s U.S. Patent D661,693 focuses on the side port.

Apple wasn’t finished.  On July 30, 2013 it received U.S. Patent D687,030.  That patent focused on the black keys and the appearance of the mouse pad.

Apple's U.S. Patent D687,030.

Apple’s U.S. Patent D687,030.

Note how most other features of the shape of the computer are not required elements of this claimed design.  Apple is likely not finished yet, and we will probably see another design patent on the MacBook Air design issuing in the next year.  While all of these patents likely receive the benefit of the parent patent’s filing date, Jan. 4, 2008, the 14 year term of the design patent starts to run upon issuance of each patent.  Contrast this with the 20 year term of utility patents that runs from the filing date of the first nonprovisional patent.  Accordingly, by filing continuation design patents in series, as Apple has done here, they can extend some portions of their design patent term because a new 14 year term starts to run upon the issuance of each new continuation patent (although that patent term will apply only to the specific design aspects covered in that new patent).