Startup Journey--From Starting Out to Exit, in the Co-Founder's Own Words

It has been a while since I blogged, my sincere apologies as it has been a very busy summer and fall at CyberlawStudio. However, recently I came across an article which I would like to share with my readers. For a startup and business lawyer who has read many articles and advised many clients on the topic , I find this article to be one of the most comprehensive article on the subject of startups. The article, "Lanyrd: from idea to exit--the story of our startup,"  was written by Natalie Downe, the co-founder and CPO of Lanyrd.com, a social conference directory platform which was eventually acquired by Eventbrite. In the article, the author talked about the history of her company, the experience of going through an incubator program, how to pitch to investors (and pick them),  tips on hiring, interactions with the press, and the eventual acquisition. In the event that you work at a startup, or are interested in starting a company, this article will be very helpful. You can read the article by clicking here.

ICANN Domain Name Expansion--Trademark Issues for Trademark Owners

Currently, when we log onto the Internet, we are familiar with  generic top-level domains (gTLD) such as .com, .net, .org, .biz, etc.. To be specific, there are currently 22 gTLDs.  Some of us may find that overwhelming. Others may have appetite for more and their dream may come true. ICANN, the governing body of the domain name system, is currently reviewing more than 1900 applications for new gTLDs, which, if approved, may very well likely introduce more than 1000 new gTLDs by the end of 2013. Website registry companies like Donuts, a $100m startup, spent $55 million to apply for more than 300 gTLDs (it costs $185,000 to apply for a new gTLD).  Applications for new gTLDs such as .music, .hotel, .buy, .property, .realestate, etc.. have been filed. What does this mean for trademark owners?  What trademark owners will likely see is an increased cost and policing effort in enforcing their rights.

With the increase in the number of gTLDs, trademark owners with website presences will need to purchase more domain names to protect their rights.  To begin with, owning a trademark registration provides the owner with the right to stop a third party from using exact or similar domain names only if the third party is offering goods and services that are related to the owner's. For example, if Mr. Smith owns a trademark registration for the mark "Purple Moon" and sells cupcakes via his website "www.purplemoon.com,"  he may be able to stop another person from registering the name "purplemoon.biz" if the person is offering to sell desserts using the mark, but not if the person is using the mark to offer spa services.  Therefore, a common pre-emptive strategy would be for Mr. Smith to purchase as many similar domain names as possible to decrease the chances of third parties purchasing those domain names. In this context, in event that the new gTLDs are introduced, not only does Mr. Smith have to purchase similar "purple moon" domain names ending in the .com, .biz., .net, etc.. he will have to look into purchasing similar "purple moon" domain names ending in .cake, .bakery, .desserts, etc...

To address potential infringement issues, ICANN proposed a few protection mechanisms, all of which require payment of fees  by the trademark owner. One of them is inclusion into the Trademark Clearinghouse. By registering its marks with the Clearinghouse, owners will be notified by the Clearinghouse in event a third party attempts to register a name identical to the owner's mark as a domain name. The Clearinghouse will also notify the third party of potential infringement. Once notified, it is up to the owner to decide whether or not to challenge the domain name through various legal measures, all of which will incur costs.  To register with the Clearinghouse, the owner will need a valid trademark registration and show proof of use. Fees for registering is $150 per mark per year, $435 per mark for three years and $725 per mark for five years.  Last but not least, Clearinghouse will notify the owner only if the mark to be registered by the third party is exactly the mark owned by the owner. Going back to the scenario of Mr. Smith's Purple Moon, in event a third party attempts to register "purplemoone" using a new gTLD, Mr. Smith will not receive notification from the Clearinghouse of such attempt.

Another protection mechanism available is the "sunrise registrations," which allows owners to register their marks in the new TLDs within the 30-day period before the general public is allowed to register domain names in the new TLD.  Only marks that are registered with the Trademark Clearinghouse will be eligible for sunrise registrations. Again, this adds additional costs to the trademark owner in its protection efforts.

As of last month, the CEO of ICANN stated how the company is not ready to launch the new gTLDs and if it were up to him, he would delay the release of the new gTLDs by at least a year due to scaling and technology issues. In addition, trade industries such as the Association of National Advertisers, together with leading professional and industry groups representing a wide variety of industry sectors, have strongly urged ICANN to slow down the creation of new gTLDs and proposed a defensive mechanism called the limited preventative registration allowing trademark owners to prevent registration of their exact trademarks across all the registries for a single reasonable fee.  Whether or not if the .cake, .salon, .pizza, .vacation, and all the 1000 or more new gTLDs will indeed be launched by the end of 2013 remains to be seen. In the meantime, it will be wise for trademark owners to consult with their IP attorneys to  start devising a strategy to protect their portfolio of trademarks in light of the impending explosion of new gTLDs.

The Art of Naming Your Business When Incorporating

When incorporating a business, the first question that usually comes up is, what should the name of your company be? As your lawyers or internet research may tell you, it is always good to come up with a company name that is unique. Otherwise, there is a high chance that your application will get rejected by the state agency due to your corporate name being similar to other existing companies in the state’s database. As it usually takes several weeks for the state agency to get back to you (unless you file on an expedited basis), it is advisable that you get the name right on the first try. What is more, in the event that you wish to use your business name as a trademark, such as Facebook Inc. advertising its online social networking business as “Facebook,” you will also need to do a trademark search. In this article, I will focus on the availability of the name as a corporate name for incorporation purposes. 

 Is the Name Available? 

Is there a quick and easy way to check whether if the name’s available? Unfortunately, the answer is no, at least not in the State of New York (which I believe, is also the case with many other states). The Corporation and Business Entity database on the state’s website is not a database showing name availability on a real-time basis. Rather, it is a database that shows the names of entities that are already formed. Therefore, it does not show the names of entities whose incorporation applications are pending, names that may conflict with yours. 

You can, however, write to NY State to ask them to conduct a name availability search. However, it may take days, even weeks to hear from NY State. What is more, even if the name is available, it does not mean, again, that the name will be available at the moment you file. This applies to all types of searches performed out there, whether it be through NY State or on-line name availability search services such as LegalZoom. The search only assures that, at the time when the search was conducted, the name was available. 

 Even if the Name is Available, Will the Examiner Approve the Name? 

Not only does the name have to be available at the time of filing, the examiner will need to approve the name, as explicitly stated on the NY State website:

A finding that the name is available is not an approval of the name by the Department of State and is not a determination that the proposed name satisfies any particular requirement of law. 

On what basis will the examiner reject a name even if it’s available? There are various reasons, the most popular reason being that the name is not “distinguishable” from existing names on file. Is there a hard and fast rule, or a checklist that we can use to see if our names are distinguishable? Unfortunately, the answer is no. According to my conversations with various NY State examiners, the rules change all the time--depending on the workload of the examiners, the volume of lawsuits out there where company name confusion is at issue, etc…Therefore, just because you find an “A & B Construction Co.” co-existing with “AB Construction LLC” in NY State’s Corporate and Business Entity database does not guarantee that an examiner will approve your company “C & D Construction Co.” if there is already a “CD Construction LLC” existing in the database. 

As a result, when it comes to naming companies, I advise my clients to come up with a name as distinctive as possible from those names already sitting in the state agency’s database. Just tweaking the spelling of a name will not suffice as the examiner also looks for phonetic similarities. If the state’s database shows a company with the name “Credian Co.” in New York, do not try to get around it by filing for “Credien Co.,” as your application will likely be rejected. However, you can add a word behind “Credien,” such as “Credien Designs Co.” to distinguish your company from the existing company. 

The difficulty comes particularly with initials. We may think our initials are special, but so does the rest of the population (unless your initials are composed of the last remaining characters of the alphabet X, Y, and Z). Just a quick search of companies with my initials “JC” returned more than 500 entities in New York starting with the same initials. This does not include entities starting with “J & C,” which yielded 102 more results. What distinguished these results from one another were the words appended to the initials, such as “JC Appraisal Network Inc.,“ “JC Beauty World, Inc.,” etc. When considering the type of words to add after the initials, if at all possible, try to avoid general terms like “Management,” “Properties,” “Partners,” “Consulting,” etc., as these are again, very common words. You can distinguish company names with property addresses (“230 Park Management”) or by type of consulting (“Educational Consulting”). 

As several of my clients have reflected, starting a company really tests one’s skills at creative problem solving. What better way to start the journey than to think of a name for your company? Good luck!

Crowdfunding Tax Implications

Ever since I published the first post regarding crowd funding--explaining the different types of crowd funding, as well as what it means for entrepreneurs, I've received a few questions from readers, one of them being the good old question of tax.  Recently I came across this article from Reuters regarding tax implications. It is really worth a read as the article talks about how, depending on whether the contribution is treated as income, donation, or investment for equity, the tax treatment differs. Some food for thought for accountants and entrepreneurs! Check it out--Crowdfunding Businesses May Owe Taxes, Too

The Crowdfunding Festival—JOBS Act, Kickstarter & Indiegogo--What Do They Mean to Entrepreneurs?

The founder of Pebble Watch, a smartwatch that pairs with phones to run apps, had hoped to raise $100,000 on crowdfunding site Kickstarter and raised over $10 million instead. With technology enabling investors and entrepreneurs to connect quickly and the recently-signed JOBS Act allowing small companies to raise capital through crowdfunding,  it’s no wonder entrepreneurs are asking: What is going on? Is crowdfunding good for them? Should they participate, and if so, how?

After all, what is crowdfunding exactly?  Of the so-called crowdfunding platforms out there--Kickstarter, Indiegogo, Microventures, Crowdfunder, etc.. how do they differ?  What does a company need to do to participate and what are the obligations, if any, that a company has after raising the funds?  Through this blog post I will try to answer each of these questions and provide some food for thought for entrepreneurs thinking about joining the crowdfunding fete.

What is Crowdfunding?

To begin with, crowdfunding is the act of pooling financial resources from a group of people, usually through the Internet, to support a certain cause, project or venture.  It can be raising funds to support building maternity clinics in Africa, an indie film project, or a company selling customizable watches that sync with iPhones. Depending on the type of crowdfunding, what you get in return for your financial contributions differ.

Different Types of Crowdfunding Platforms—Kiva, DonorsChoose, Kickstarter, Indiegogo, Microventures, Crowdfunder, etc.

Of the several types of crowdfunding, one type is lending-based crowdfunding on sites such as Kiva, where funders lend their monies to projects and are repaid over a period of time.  For example, a potential funder can loan $1000 to an Ecuadorian food vendor to help him purchase a food truck and get paid back over a period of 6 months.   Another type of crowdfunding is donation-based, such as DonorsChoose.org, where funders donate monies to a particular cause, for example, tsunami relief.  Then, there is perk-based crowdfunding (aka reward-based crowdfunding), with the most-talked about being KickStarter and Indiegogo, where funders contribute funds in exchange for certain perks, such as contributing to an indie film project and in return, receiving a limited edition DVD copy of the film.

The latest type of crowdfunding, as well as the most-hyped form of crowdfunding signed into the law by Obama in April 2012, is equity-based crowdfunding, also known as crowdinvesting. Rather than repayment of a loan, a thank-you letter for donation, or a limited edition DVD, funders receive a stake (so-called equity) in the company. In other words, funders become shareholders of the company with their contributions. If the company does well, the funders may receive returns on their capital. If the company goes bust, the funders lose all of their contributions.  MicroVentures and Crowdfunder are examples of equity-based crowdfunding.

This blog will focus on perk and equity-based crowdfunding platforms as they receive the most attention from the media.  Also, they are the most likely venues for entrepreneurs to pursue should they wish to raise capital without the obligation of repayment. However, before I move on to the next section, I would like to bring it to the readers’ attention that equity-based crowd funding platforms permissible under the JOBS Act are not allowed to accept investments as of yet.  Although signed into law in April 2012, the SEC still needs to figure out how to implement the law, and has until January 2013 to do so. With regards to Microventures, it is allowed to operate under a different set of laws:unlike the JOBS Act-enabled crowdfunding platforms, which would be open to mom and pop investors, Microventures is open only to accredited investors as of now (i.e. investment funds and individuals with a net worth of at least $1 million). However, once the JOBS Act is implemented, Microventures may expand to accept mom and pop investors.

Perk versus Equity Based Crowdfunding—The Big Picture Questions

Before the entrepreneur dives into the sea of platforms comparing and analyzing each of them, the initial questions an entrepreneur should ask him or herself are:

·       how much capital does s/he need to raise?

·       nature of the project—is it one-time, or is it ongoing?

·       what is s/he comfortable with giving away—perks or equity?

·       at what stage is his/her project at—just starting, or already in operation?

How Much Capital--$1M Cap for Equity-Based Crowdfunding Within 12 Month Period

While there is no limit as to how much an entrepreneur can raise through perk-based crowdfunding, in the event that the entrepreneur wishes to raise monies through equity- based crowdfunding, the entrepreneur can raise no more than $1M for the company within a 12 month period. The cap applies to all monies raised during those 12 months, regardless of source.  In other words, in the event you raise $999,999 through Crowdfunder by Christmas Eve, and your uncle wishes to invest $100 that night, you can take no more than $1 from him, and will have to wait till next Christmas to take the remaining $99. On the other hand, if you raise monies through perk-based crowdfunding, like Kickstarter, the sky’s the limit.

Nature of the Project

Before loading up your application onto the crowdfunding platforms, it is good to take a minute to think about exactly what it is that you’re seeking monies for—is it monies to finish a comic book, monies to fund a social media website, or monies to fund the expansion of an existing company that owns renewable energy plants?  For projects that are one-time in nature with a discrete goal, such as finishing a comic book, perk-based crowdfunding platforms such as Kickstarter or Indiegogo will be the appropriate choice. Equity-based crowdfunding requires that the project or venture be an ongoing operation, of which funders will have a stake in the venture’s future. For ongoing ventures such as a social media website or a renewable energy company, equity-based crowdfunding will be more appropriate.  In fact, Kickstarter explicitly mentions how starting a business or social media sites do not qualify as a project, and hence, they are not eligible to apply to Kickstarter.

Note however, certain projects, depending on how you wish to reward your funders, may qualify for both perk and equity-based crowdfunding.  For example, if you have a game company with a topseller iPhone game called Angry Pigs and you’re seeking monies to develop an Android version, you can either raise monies as a project on KickStarter, or, if you’re comfortable with people sharing a stake in your company’s future as a whole (which can include making Angry Pigs and a bunch of other games), apply to an equity-based crowdfunding platform to raise funds for the company.

Perks or Equity-Your Comfort Zone

The third question an entrepreneur will want to ask is: what does the company need to give in exchange for the monies raised? First, the entrepreneur will need to pay the crowdfunding platform provider its usual administrative and transaction fees. What the entrepreneur needs to give to the participant though, is very different with a perk vis a vis equity based crowdfunding. With perk-based crowdfunding, you give your contributors a perk, such as a limited edition DVD of the indie film. The contributor has no say in your project nor any connections with your company. You take the money and you have no other obligations to the contributors other than completing the project and giving them their perks—their limited edition DVDs.

With equity-based crowdfunding, you are required to give your funders (so-called investors) equity in your company. Equity comes in various flavors and can be in the form of common stock, preferred stock, convertible notes, etc. In other words, through equity, these funders may have shareholder rights equal or superior to yours.  The type of equity and portion the funders receive correlate with how much the venture is worth as of the time of raising capital, as to be discussed in the next section.  These funders will not go away.  Unless they sell their shares at some point in the future, the company will have to report to them, and in certain instances seek their approval regarding certain major company events.  Sometimes, depending on the terms of their equity, they may be able to participate in future rounds of financing.  Are you ready for such participation by strangers?

Equity-based Crowdfunding--Stage of Development—Startup or Existing

For equity-based crowdfunding, the type and portion of equity you have to give away to the funders depend on how much your venture is worth at the time of raising capital,   as well as how much capital you need.  If your venture is worth $10K and you need to raise $2K, you’ll probably give away a smaller portion of your company than if your venture is just starting (worth $0). Therefore, the impact of giving control to strangers through equity may be lessened if your company has a high valuation, as you will have more leverage in terms of the type and portion of equity to be issued to the investors.

Perk versus Equity Based Crowdfunding—The Application Process

Now that we’ve taken care of the big picture questions, the next question is, what does it take to apply? For perk-based crowdfunding, the application process usually involves submitting materials describing your project, such as a project pitch and video.  Certain perk-based platforms, such as Indiegogo, post all projects, while others, like KickStarter, has a screening process where they review applications and may reject if your project does not conform to their guidelines. 

The application process for equity-based crowdfunding platforms is much more strenuous. The company is required to submit a business plan, capital structure, planned use of proceeds, and (depending on target offering amount) income tax returns and officer-certified financial statements. In addition, if the company seeks to raise between $100K and $500K, the company is required to retain accountants to review its financial statements, and for raises between $500K and $1M, the financial statements must be audited. The legal and accounting fees can be high.  In light of the differences, perk-based crowdfunding may be more suitable for startups, and equity-based crowdfunding may be more suitable for companies with track records.

Perk versus Equity Based Crowdfunding—The Aftermath

Suppose you have succeeded in raising the monies you seek. Congratulations! Is there anything else you need to do other than accepting the monies and paying the platform providers their fees?  In the event that you raised the monies through perk-based crowdfunding, using the indie film project as an example, the only things you need to do are to finish the indie film as promised, update your contributors with your results,  and deliver to your contributors their limited edition DVDs.

In the event that you raised the monies through equity-based crowdfunding, you are in a different ball game. Unlike perk-based crowdfunding, equity-based crowdfunding is governed under securities laws, as equity is considered a “security.”  As the issuer of equity, you are required under the law to file annual financial statements with the SEC. Also, there is a chance that you may be required to publicly disclose confidential, proprietary or competitive information. In addition, the officers and directors of the company face potential liabilities for securities fraud in the event any materials submitted to investors or the SEC contain material misstatements or omissions.

Last but not least, your funders have not disappeared. They own a part of your company, they are shareholders.  As shareholders, they will have approval rights on certain major company decisions. What is more, they are required to be invited to the company’s annual meetings. In event you have many shareholders, the task of seeking their approval or notifying them can be daunting. As they are your shareholders, you have a fiduciary duty toward them and they can sue you for breach of fiduciary duty if they are disgruntled.

Final Thoughts

There is no clearcut rule as to what type of crowdfunding works best for a certain venture or project. Like all other major decisions to be made, one needs to weigh several factors—the amount of capital to be sought, the nature of the project or venture and what the venture is capable of fulfilling in terms of the obligations imposed by the various crowdfunding platforms and the laws. What is more, as the SEC is still drafting the laws to implement the equity-based crowdfunding supported under the JOBS Act (and they are behind schedule as of today), it remains to be seen what type of financial statements that recipients of equity-based crowdfunding will need to file, as well as the type of information that needs to be disclosed. Also, we have yet to test the equity-based crowdfunding market—will the investors be comfortable with crowdfunding? How much equity will they want? Will it be difficult to manage the investors? Will it be difficult to raise monies from VCs and angels further down the road if they know you have 100 mom and pop investors out there whom they may need to deal with in event they invest in your company?

Like the Olympics, we never know how the games will play out. Just join, know the rules, play your best and enjoy the fȇte!