kendall college presesntation

Small Business Opportunity CenterPresentation for Kendall College

Top Legal Issues Facing EntrepreneursFebruary 3, 2010

2Northwestern University - Small Business Opportunity Center

Contents

Intellectual Property

Entity Choice

Top 10 Legal Issues Entrepreneurs Should Know

Questions


Why is Intellectual Property Important?

Intellectual property represents approximately 70% of an average firm’s value (up from 40% in the past).1

Entrepreneurs can use intellectual property laws to help protect and realize the value of their assets.

All businesses need to take precautions to avoid violating other’s intellectual property rights – even unintentional violations can ruin a business.

1 Kevin G. Rivette & David Kline, Discovering New Value in Intellectual Property, Harvard Business Review, Jan-Feb 2000, at 58.


Types of Intellectual Property

Intellectual property is a number of distinct types of legal monopolies where the owner is granted certain exclusive rights to:

a variety of intangible assets, such as musical, literary, and artistic works;

ideas, discoveries and inventions; and words, phrases, symbols, and designs.

Common types of intellectual property include: Trade Secrets Copyrights Patents Trademarks


Trade Secrets

A Trade Secret is: (1) any information, including any formula, pattern, compilation,

program, device, method, technique, or process, that (2) provides a business with a competitive advantage from not

being generally known by current/potential competitors or readily discoverable through legitimate means, and

(3) is the subject of reasonable efforts to maintain its secrecy.

Examples: business plan, customer list, products formula, custom software, survey results, sales data, financial statements.

Is a product that can be “reverse engineered” be a trade secret?


Establishing Trade Secret Protection

Identify Trade Secrets – all documents that contain trade secrets should be marked as “Confidential.”

Pre-employment Clearance stress that no trade secrets from former employers are to be used

on the job or shared with others in the company. Review any employment or nondisclosure agreements that any

new employee had with a former employee.

Nondisclosure Agreement – a promise by an employee to avoid the unauthorized use or disclosure of the company’s trade secrets and to use care to prevent unauthorized use and disclosure from occurring.

Noncompetition Agreement – prevents employees who leave the company from using trade secrets and other sensitive information on behalf of a competitor.


Copyrights

A Copyright gives the author of an original work exclusive legal right to obtain certain economic benefits from the work, including the right to prevent reproduction and distribution of the work.

Examples: software, movie, music, multimedia, photos, website, plays, advertisements, diagrams

Duration: For an individual creator – life of creator plus 70 years For work made for hire – earlier of 95 years from publication or

120 years from creation

Doctrine of Work Made for Hire – employer owns works created by its employees in the scope of their employment.


“Exclusive Rights” of Copyrights

Exclusive rights granted with copyright: (1) to reproduce copies of the work (2) to develop derivative works based on the copyrighted work (3) to distribute copies of the work (4) to perform the work publicly (5) to display the work publicly

“Derivative Work” is a work that is based on another work Ex: Translation of book into another language

Copyrights do not protect ideas Ex: Book can be copyrighted, but not the ideas in the book!


Obtaining Copyright Protection

To be eligible for copyright protection: (1) work must be fixed in a tangible medium of expression (2) work must be original (3) work must contain some minimal level of creativity

Protection automatically arises when an original work of authorship is first fixed in a tangible medium of expression!

Advisable to place copyright notice “©” with name of author and year of publication, along with “all rights reserved”

To pursue an infringement suit, the owner of the copyright must register the copyright with the Register of Copyrights.


Patents

A Patent is an exclusive right granted by the federal government that entitles the inventor to prevent anyone else from making, using, selling, or offering to sell the patented process or product in the US for a specific period of time (20 years).

Requirements:

1. Patentable (Utility & Design)

2. Useful

3. Novel

4. Non-obvious

Scope of Rights to Exclude:– Specified rights: makes, uses, offers to sell, or sells– Geographic Limits: only within the United States– Time Limits: Only during the term of the patent


Trademarks

A Trademark is any word (or phrase), name, symbol, sound, or device that identifies and distinguishes one company’s products from those made or sold by others.

Service Mark – trademark used in connection with a service Trade Name – a businesses’ formal, legal name

Trademark law helps to protect both trademark owners and consumers from the confusion that can result when different companies use the same name or confusingly similar indentifying marks.


Establishing a Trademark – Inherently Distinctive

Trademark must identify and distinguish the product from those of competitors. Seek distinctiveness – the more distinctive, the better.

Inherently distinctive marks are the strongest form of trademark because these mark have not meaning within the industry before their adoption. Three types of “inherently distinctive” trademarks:

(1) Fanciful Marks – made up works (e.g., “Exxon”) (2) Arbitrary Marks – real word that has no relation to product

(e.g., “Apple”) (3) Suggestive Marks – suggestion something about the product

but do not describe it (e.g., “Chicken of the Sea”)


Establishing a Trademark – Descriptive

Descriptive marks indicates characteristics of the product it identifies.

Ex: “Rapid Seal”

Descriptive marks are not immediately protectable but may become fully protectable once they acquire secondary meaning in the marketplace.

Secondary Meaning is acquired when a significant number of people come to associate the mark with particular company or product.


Create Rights in the Trademark

Rights are obtained by using the trademark in business. If the mark is inherently distinctive, the first person to use the

mark becomes the owner. If the mark is descriptive, using the mark beings the process of

developing secondary meaning.

Additional rights – trademark registration with USPTO. Benefits: (1) Registration is evidence of ownership if contested (2) Everyone is presumed to be aware of the trademark (3) After five years, trademark declared “incontestable” (4) Allows the owner to prevent use of trademark


Contents


Entity Choice


Questions


Why is Entity Choice Important?

Impacts every aspect of your business:

1. Formation

2. Ownership

3. Control

4. Governance

5. Attractiveness to potential investors and lenders

6. Liability

7. Tax


Liability

Limiting liability is one of the most important reasons to form an entity instead of continuing as a sole proprietorship or general partnership.

Protect your personal assets.

Prevent courts from piercing the corporate veil.

Encourage potential investors to invest in your company because creditors cannot seize their personal assets.


Tax

Types of tax treatment:

1. Flow-through

2. Double taxation

Affects the types of financing you would like to pursue because certain entities are more or less favorable for investors based on their tax treatment.

Talk to an accountant!


Types of Entities

Common types of entities include: Sole Proprietorship General Partnership Limited Partnership Limited Liability Partnership C-Corporation S-Corporation Limited Liability Company L3C


Sole Proprietorship

A sole proprietorship is a business owned by one person.

Prevalent but risky Forms automatically Unlimited liability Tax is structured as personal income (Schedule C)


General Partnership

A general partnership is two or more persons as co-owners.

Formation: informal Each partner:

- Is an agent of the partnership

- Has unlimited liability for the debts of the partnership

- Has power to incur obligations on the other’s behalf Profits are split 50/50 Tax structure is “flow-through” Governed by Partnership Agreements

- The more detailed the better State statutes are default


Limited Partnership

A limited partnership has one or more general partners and one or more limited partners.

General Partner has unlimited liability and controls the business Limited Partner has limited liability but does not control the

business Formation: Must file Partnership Agreement with the Secretary

of State.

- The more detailed the better Tax structure is “flow-through”


Limited Liability Partnership

A limited liability partnership is a hybrid entity.

Only open to certain professions Each partner has personal liability and limited partnership

liability

Tax structure is “flow-through”

Sources of capital for partnerships are limited to partner contributions and loans


C-Corporation

A C-Corporation is a legal entity owned by its shareholders.

Shareholders elect the board of directors, which is responsible for major decisions.

Officers carry out day-to-day management of company.

Taxed as a separate legal entity.

Common choice of entity for publicly-traded companies.


S-Corporation

An S-Corporation is a type of corporation that allows its shareholders to operate as a corporation while being taxed as individuals.

Requirements:

– Maximum of 100 shareholders (can only be individuals, certain tax-exempt organizations, qualifying trusts or estates)

– All shareholders must be U.S. citizens– Only one class of stock

Does not pay federal income tax at an entity level

– Profits/losses flow through to individual shareholders

Most commonly used for family or closely owned businesses that raise capital from the shareholders or debt from outside sources – No equity incentives on a significant scale– No raising capital from VC funds or institutional investors


Limited Liability Company

A limited liability company combines the pass-through federal tax treatment of a partnership with the liability protections of a corporation.

Members have no personal liability for LLC’s obligations.

No ownership limitations (such as with S-Corp).

Not suitable for businesses financed by VC funds.

Attractive for businesses financed by corporate investors and wealthy individuals (angels).

File articles of organization with secretary of state and adopt operating agreement.


L3C

A low-profit limited liability company (L3C) is a hybrid structure that combines the financial advantages of an LLC with the social advantages of a non-profit entity.

Primary focus is to achieves socially beneficial aims – Secondary focus on profitability

Not tax-exempt– Contributions are not tax-deductible

Illinois’ L3C bill takes effect 1/1/10– VT, MI, WY, UT and ND have passed L3C laws


Contents


Entity Choice


Questions


1. Make sure you are free to start your business

For Faculty: Can you spend time on the new business?– “External activities that compromise or diminish a Faculty

Member's capacity to meet these obligations represent a Conflict of Commitment. Accordingly, Compensated Professional/Commercial Activities, including outside consulting activity, should not generally exceed, on the average, one day per calendar week during that portion of the year when a Faculty Member is drawing academic year or summer salary.” [www.research.northwestern.edu/policies/faculty-conflict-of-interest.html]

For Employees: NU owns your invention if it is related to your work at NU or if you use NU facilities, but NU does not own your song, painting, book or (in some cases) computer program [http://www.northwestern.edu/ttp/policies/index.html]


2. Consider ways to prevent others from stealing your idea or product

Do not disclose the idea to any outsider too early!

Types of Protection:– Trade Secret– Copyright Law– Patent


3. Be careful when selecting a business name

Name availability

Trademark infringement

Name uniqueness


4. Think about incorporating or forming a limited liability company

Sole proprietorship

Partnership

Corporation

Limited Liability Company


5. If you have a business partner, put it in writing

Shareholders Agreement

Operating Agreement


6. Think about your relationships with other people who work for your business

Employee

Independent Contractor

Intern


7. Some thoughts about your first lease

Option on adjacent space

Termination

Personal guaranty

Consider local incubators or rental lab space “The Incubator” [www.theincubator.com] www.iltechparks.com


8. Consider sub-licensing your intellectual property

You do not necessarily need to manufacture and distribute your own product


9. Negotiate contracts with vendors, customers and others

Same “page”

Important terms


10. Consider financing options, including bank loans and outside equity investors

Loans

Equity


Contents


Entity Choice


Questions