alan r. singleton, esq. elizabeth c. kellner · 2017-05-25 · alan r. singleton, esq. elizabeth c....
TRANSCRIPT
Alan R. Singleton, Esq. Elizabeth C. Kellner [email protected] Entrepreneurship Specialist/
Paralegal
Research Park at the University of Illinois 2001 S. First St., Suite 209, Champaign, IL 61820
217-352-3900 phone 217-352-4900 fax
1. Business Entity Selection Chart
2. Business Entity Selection Presentation
3. Entity Formation Filing Fees
4. Motivating Employees through Company Equity
5. Motivating Employees through Company Equity – Scenarios
6. Not for Profit Tax Exemptions Article
7. Not for Profit and Tax Exempt Entity Organization and Maintenance Checklist
8. Not for Profit Formation Basic Filing Fees
9. L3C – Bridging the Gap
10. IP Protection Chart
11. IP 101 Presentation
12. Patent Reform
13. Patent Filing Fees
14. Trademark Filing Fees
15. IP and SBIR Awards Presentation
16. Intellectual Property Audit Checklist
17. Using Intellectual Property to Gain a Competitive Advantage in the Marketplace Article
18. Questions to Ask in the Development of a Software License
19. Mobile App Development Legal Issues
20. Joint Ventures, Joint Development Agreements, Strategic Alliances Presentation
21. Exit Strategies for the Technology Company
22. Speaker Bio
Electronic version of these handouts as well as others that may be of interest can be found at www.singletonlawfirm.com by clicking on the library tab.
At a Glance
Sole Proprietorship
General Partnership
S CorporationC
Corporation
Limited Liability
Company
Single Member Limited Liability
Company
An individual carrying on a
business for profit.
Association of two or more co-owners carrying on a business
for profit.
Unlimited personal liability for the
owner.
Partners have unlimited
personal liability for partnership
debts.
Single level of income tax.
All income and expenses reported on Schedule C of the owner's 1040.
Limited liability for
owners makes it a
better choice than
sole proprietorsh
ip unless cost of
formation or
maintenance is a
controlling factor.
LLC files a partnership tax return
(form 1065) with all
income and expenses
being passed through to individual owners of
the LLC on a K-1.
Disregarded entity from an income
tax perspective -all income
and expenses
are reported on
the sole member's tax return
and no income tax return need be filed by the LLC.
Liability (Limited v. Personal)
Limited liability for shareholders
even if they participate in management.
Limited liability for
shareholders even if they participate in management.
Combines limited liability
provided by a corporation
with pass through
partnership tax
treatment.
Tax Implications
Pass through tax treatment (partnership
files form 1065 but all income and expenses
pass through to individual
partners on Schedule K-1).
Pass through tax treatment under most
circumstances but not as
complete as for the LLC.
Tax at both corporate and shareholder level - this
double tax can be avoided to some extent
by payment of reasonable salaries to
shareholders in exchange for services
actually rendered.
Business Entity Selection Alan R. Singleton, Esq.
Resarch Park at the University of Illinois, 2001 South First Street, Suite 209 Champaign, IL 61820-3654 217-352-3900
Sole Proprietorship
General Partnership
S CorporationC
Corporation
Limited Liability
Company
Single Member Limited Liability
Company
Relatively simple to start.
Relatively easy to start -
partnership agreement is
typically entered into but is not
legally required.
Formation similar to S corp except
Sub S election not filed with
IRS.
Formation steps include filing articles
of organization
with the Secretary of
State, contributing
an appropriate amount of capital, and adopting an operating
agreement.
Formation process
similar to multiple-member
LLC except that the
operating agreement will likely be
less complex.
If business conducted other than under the
name of the sole proprietor,
assumed name publication needed.
Managed by the partners or as
described in the partnership agreement.
Can be managed by the members
or, more often, by managers
selected by the
members. Can also
elect officers.
Managed by the sole proprietor.
Problem: Any partner can bind the partnership.
Self-employment
tax treatment
may be less favorable than for S
corp.
Complexity of Formation and Management
Formation steps include filing Articles of
Incorporation with the
Secretary of State, filing Sub S election with
the IRS, adoption of Bylaws and,
usually, adoption of a Shareholder (buy-sell)
Agreement.
Typically required for
publicly traded corporations, businesses that require
venture capital, or if a broad based stock option program is
utilized.
In addition to
circumstances where a
sole proprietorship would be considered,
a single-member
LLC is often used by a
corporation or LLC as a subsidiary to insulate the liability associated
with a particular
line of business.
Sole Proprietorship
General Partnership
S CorporationC
Corporation
Limited Liability
Company
Single Member Limited Liability
Company
Any transfer of the business would be of the underlying assets as opposed
to a transfer of shares in the
business.
Ability to raise capital is limited
since most investors would prefer to invest
in an entity offering limited
liability.
Limit of 100 shareholders, only one class
of stock is allowed,
difference in voting rights is
allowed, partnerships
and corporations cannot be
shareholders, only U.S.
citizens and residents may
be shareholders.
No limits on type or
number of shareholders,
different classes of
stock allowed (common and preferred) thus
enabling different
priority for return of capital.
No limitation on the
number of members, no limitation on
who may invest,
treatment of gain on
distribution of
appreciated property
more favorable, different classes of ownership are allowed so there is
the flexibility to provide
for a priority return of capital to investors.
Capital needs - addressed through
loan to sole proprietor.
LLC is almost always the
better choice if partnership tax treatment is the
goal.
Is easier to convert S corp
to C corp than it is LLC to C corp in event venture
capital is sought.
If venture capital is being
sought, incorporation should be in the state of Delaware.
Often used to own
commercial real estate.
Information provided on this chart is intended to be general information only, in the nature of advertising. You should consult your attorney when making legal or business decisions and should not rely upon the content of this chart. Alan Singleton is licensed to practice law in the state of Illinois and is a patent
attorney registered to practice before the U.S. Patent and Trademark Office.
© 2007 Alan R. Singleton - www.singletonlawfirm.com
Capital - Effect on Ability to Raise Capital
through Angel Investment,
VC or IPO
Outside investment
allowed only if
converted to a multi-member
LLC.
1
Alan R. Singleton
Singleton Law Firm, P.C.
Re se a rc h Pa rk a t the Unive r s i t y o f I l l i no i s
2 0 01 S . F irst S t . , Su i te 2 09
Cha mpa ig n, IL 6 1 82 0 -3 6 5 4
(217) 352-3900 phone
(217) 352-4900 fax
s ingleton@ sing letonlawf irm.com www.s ingle tonlawf i r m.com
Business Entity Selection
Common Corporate Mistakes Made By Entrepreneurs
Creating a ―cheap stock‖ tax problem by
o Failing to incorporate early in the company’s life (i.e., well before a funding event that sets the price of the stock) or
o Failing to include all ―founders‖ in the company until just before a funding event that sets the price of the stock
Not creating a vesting schedule for founders’ stock for a student startup (if all vests immediately, may create unfair reward to those who do not continue to support company)
Failing to make 83(b) election on stock issued in return for services
Failing to consider employees’ or founders’ obligations to other employers
Failing to comply with securities laws as it raises capital
Considering only the valuation as it negotiates an investment
Common Business Entities
Sole Proprietorship
General Partnership
S Corporation
C Corporation
Limited Liability Company
Single Member Limited Liability Company
2
Factors to Consider When Selecting an Appropriate Business Entity
Liability—Limited vs. Personal
Tax implications
Complexity of formation and management
Capital—Effect on ability to raise capital through angel investment, venture capital, or initial public offering (IPO)
Credibility in the business world
Sole Proprietorship
An individual (or husband and wife team) carrying on a business for profit
Unlimited personal liability for owner
Single level of income tax—all income and expense items reported on Schedule C of the owner’s 1040
Relatively simple to start
If business not conducted under the name of the sole proprietor, assumed name publication needed
Managed by the sole proprietor
Any transfer of the business would be of the underlying assets as opposed to a transfer of shares in the business
Capital needs—Addressed through loan to sole proprietor
General Partnership
Two or more co-owners carrying on a business for profit
Partners have unlimited personal liability for partnership debts
Pass-through tax treatment (partnership files Form 1065 but all income and expense items pass through to individual partners on Schedule K-1)
Relatively easy to start—Partnership agreement is typically entered into but is not legally required
Managed by the partners or as described in the partnership agreement. Problem: Any partner can bind the partnership
Ability to raise capital limited since most investors would prefer to invest in an entity offering limited liability
LLC is almost always the better choice if partnership tax treatment is the goal
3
Limited Partnership
Limited partnerships are partnerships with two types of partners: general partners and limited partners
For the general partners, the law is the same as it is for the traditional general partnership
o General partners exercise management and control
o General partners can legally bind the partnership—and the other general partners—by their actions
o General partners are subject to unlimited personal liability
Limited partners, on the other hand, enjoy liability limited to the value of their registered investment
Tradeoff is that limited partners can not exercise control in the partnership, although the law is changing/has changed on this issue
Limited partnership are often used for:
o Family limited partnerships (FLIPs) — an estate planning device
o Private equity firms
S Corporation
Limited liability for shareholders even if they participate in management
Pass-through tax treatment under most circumstances, but not as complete as for the LLC
Formation steps include: filing Articles of Incorporation with the Secretary of State, filing Sub S election with the IRS, adoption of bylaws, and, usually, adoption of a Shareholder (buy-sell) Agreement
Limitations on the number and type of shareholders and limits on the ability to raise capital:
o Limit of 100 shareholders o Only one class of stock is allowed so ability to give priority return
of capital to investors is compromised o Differences in voting rights are allowed o Partnerships and corporations cannot be shareholders o Only US citizens and residents can be shareholders
Is easier to convert S corp to C corp than it is LLC to C corp in the event that venture capital is sought
C Corporation
Limited liability for shareholders even if they participate in mgmt
Tax at both corporate and shareholder level. This double tax can be avoided to some extent by payment of reasonable salaries to shareholders in exchange for services actually rendered.
Formation similar to S corporation except Sub S election not filed with IRS
Typically required for publicly traded corporations, businesses that require venture capital, or if a broad based stock option program is utilized
No limits on type or number of shareholders
Different classes of stock allowed, for example, common stock and preferred stock, which enables different priority for return of capital
If venture capital is being sought, incorporation should be in the state of Delaware
4
Limited Liability Company
Combines limited liability provided by a corporation with pass through partnership tax treatment
LLC files a partnership tax return (Form 1065) with all income and expenses being passed through to the LLC’s individual owners on a K-1
Formation steps include: filing articles of organization with the Secretary of State, contributing a suitable amount of capital, and adopting an operating agreement
Can be managed by the members or, more often, by managers selected by the members. Can also elect officers.
Self employment tax treatment may be less favorable than for S corporation
Offers several advantages over the S corporation:
o No limitation on the number of members o No limitation on who may invest (corporations, partnerships, and non-US
residents can invest) o Treatment of gain on distribution of appreciated property more favorable o Different classes of ownership are allowed so there is the flexibility to
provide for a priority return of capital to investors
Often used to own commercial real estate
Single Member Limited Liability Company
Limited liability for owners makes it a better choice than a sole proprietorship unless cost of formation or maintenance is a controlling factor
Disregarded entity from an income tax perspective
o All income and expenses are reported on the sole member’s tax return and no income tax return need be filed by the LLC
Formation process similar to multiple-member LLC except that the operating agreement will likely be less complex
In addition to circumstances where a sole proprietorship would be considered, a single member LLC is often used by a corporation or LLC to insulate the liability associated with a particular line of business
Outside investment allowed only if converted to a multi-member LLC
LLC vs. Corporate Structure
LLC
Corporation
Members
Managers
(optional)
Officers
(optional)
Shareholders
Board of Directors
Officers
5
Bylaws and Shareholder Agreements for Corporation
Bylaws
o Procedures for shareholder and director meetings o Election and terms of directors, types officers and officer
duties, and indemnification provisions for officers and directors
Shareholder Agreements
o Restrictions on the transfer of stock ownership (including upon death, disability, or cessation of employment)
o Provisions for resolving deadlock among the shareholders o Method of establishing price of shares o Rights to purchase additional shares issued by the corporation
(preemptive rights), rights to sell shares if other shares of the corporation are sold (co-sale rights), rights to cause a minority shareholder to sell its interest in the corporation when the majority votes to do so (drag along rights)
o Ownership of intellectual property
LLC Operating Agreements
Take the place of both the bylaws and shareholder/buy-sell agreement used for a corporation
Address issues such as type of membership interests, who owns the membership interests, rights and duties of members, whether the LLC is member-managed or manager-managed, rights and duties of any officers, capital accounts, allocation of profits, transferability, and indemnification of managers, employees and agents
Piercing the Corporate Veil
Limited liability associated with a corporation or an LLC can be lost if appropriate formalities are not followed:
o Corporation or LLC should be appropriately capitalized upon setup
o Annual meetings of shareholders and directors (or members and managers if an LLC) should be conducted and minutes of those meetings placed in the corporate or LLC book
o Separate financial records and bank accounts should be maintained for corporation or LLC
6
Using Company Equity to Motivate and Retain Employees
Incentive Stock Options
Nonqualified Stock Options
Restricted Stock
Phantom Stock
Employment Agreements
Nondisclosure of information/trade secrets
Noncompetition
Nonsolicitation of employees and customers
Assignment of ownership of intellectual property to company (Illinois Employee Patent Act)
Employee duties
Compensation
Term of agreement and ability of parties to terminate
Non-Profit Corporations and Tax-Exempt Organizations
The initial steps to forming an Illinois not for profit corporation are the filing articles of incorporation with the Illinois Secretary of State, electing officers and directors and adopting bylaws- however these steps do not confer the federal tax exemption that frequently accompanies non-profit status.
Federal tax exemption is governed by Internal Revenue Code section 501(c) - an application must be made to the IRS in order to receive it
Charitable organizations and chambers of commerce are both exempt from paying income tax under § 501(c).
Contributions to (501(c)(3) charitable organizations are typically deductible to the donor as a charitable donation; contributions to chambers of commerce (501(c)(6)s) are not deductible as a charitable donation but dues are likely deductible as a business expense
7
501(c)(3) — Charitable Organization
501(c)(6) — Business League or Chamber of Commerce
Exempt from federal income tax
Contributions are tax deductible to the donor
Exempt from federal income tax Contributions are not tax
deductible to the donor as charitable contribution; but may be deductible as a business expense by a business
Non-Profit Corporations and Tax-Exempt Organizations
Non-Profit Corporations and Tax-Exempt Organizations
The HDF Group
o Located in Research Park at University of Illinois
o Organized as a 501(c)(3) not-for-profit corporation ― That is, it enjoys the advantages of both tax exemption and tax
deductible contributions
o Its charitable mission is ―to ensure the sustainable development of HDF technologies and the ongoing accessibility of HDF-stored data.‖
o ―Most of The HDF Group products and services will be available to all persons for free.‖
o Source: company website
o This demonstrates that the 501(c)(3) not-for-profit form is hardly limited to conventional charitable causes
Non-Profit Corporations and Tax-Exempt Organizations
Additionally, Illinois law provides the following exemptions from state taxes:
o State income tax – tracks federal
― Tax will be due at both the state and federal level on income earned from the incidental conduct of business not related to the exempt purpose (unrelated business income)
o Sales tax exemption – different standard and test
o Property tax – different standard and test
Illinois (as well as other states) requires that certain charitable organizations register with the Attorney General and to file an annual report with that office
8
Low-Profit Limited Liability Companies: L3Cs
A new form created to:
o ―bridge the gap between non-profit and for-profit investing
o by providing a structure that facilitates investments in socially beneficial, for-profit ventures
o while simplifying compliance with IRS rules for program related investments.‖
Most private charitable foundations are required to distribute at least 5% of their average net assets annually to recipients that further the stated charitable purpose of the foundation.
Often this is in the form of grants.
o But there is an alternative: the program related investment (PRI)
o Ordinarily, investing activity would not go toward satisfying the minimum distribution requirement. PRIs, however, can.
Program-related investments leverage foundation assets.
o Instead of grants, which don’t come back through the door, PRIs (which take the form of loans, financing guarantees, and other investment forms) are made with the anticipation of return of capital.
Low-Profit Limited Liability Companies: L3Cs
PRIs have three requirements o The primary purpose is to accomplish one or more of the
foundation's exempt purposes
o Production of income or appreciation of property is not a significant purpose
o Influencing legislation or taking part in political campaigns on behalf of candidates is not a purpose
How does an L3C facilitate receipt of PRI funds?
o By adopting the L3C form, with its accompanying requirement to document explicitly its charitable purpose and related restriction, the L3C signals its eligibility to receive such funds
o In the alternative, foundations would have to go through a due diligence process—perhaps even going so far as getting a Private Letter Ruling from the IRS—before making the investment
Low-Profit Limited Liability Companies: L3Cs
Although it has generated some excitement among practitioners of non-profit organization law, others are skeptical that it will be a ―magic bullet‖
o In particular, the L3C form, while it makes it easier to meet IRS technical requirements in one fell swoop, does not add any substantive rights or authority.
o That is, everything that can be done with the L3C could already be done (and was already being done) with the more traditional forms of organization—albeit with greater administrative burdens for the parties
9
Business Financing
General Concepts
Risk vs. return
Equity (e.g., stock ownership) vs. debt (e.g., a loan)
―Smart‖ money vs. ―dumb‖ money
―Free‖ money
Dilution
o Substantial outside equity investment at early stage of company will cause loss of control whereas same dollar investment when company is more mature and more valuable might not
o Small piece of big pie worth more than 100% of marginal company
Business Plan
Written business plan required by most financing sources
Even if outside funds are not being obtained, or if a friend or relative is providing the funds, a written business plan is a good idea
10
Sections of the Business Plan
Executive Summary
Description of Business
Marketing
Financial Plan/Statements
Management Team
Business Plan—Sources of Assistance
Attorneys and accountants
SCORE
SBDC
Sources of Funding
Personal funds
Friends and family
Champaign County Regional Planning Commission
Banks (SBA)
Loan brokers
Bootstrap (company profits)
Government and foundation grants
Joint development agreements
Angel investors
Venture capital
Bonds
Initial public offering (IPO)
11
Personal Funds
People who are considering loaning you money or otherwise investing in your business are more likely to do so if they see that you are also investing some of your own funds
Friends and Family
Run the risk of losing a friend or straining family relationships if there is difficulty with repayment
Best reserved only for situations where the friend or family member can afford to lose the money
Banks
Asset based lenders
Risk averse, but the cost of borrowing is less
Require good credit record
Will want to see a written business plan
Typically want 20% financed by you
SBA loans through banks can allow bank to take on more risk
12
Champaign County Regional Planning Commission
Provides debt and equity financing to qualifying small businesses in Champaign County
Preference towards capital-intensive and/or technology-oriented businesses
Must create a specific number of full time jobs
Can’t constitute more than 50% of the total project investment
Work with a local bank as well
Bootstrap
Use company profits to grow the business
o Revenues from sale of product o Revenues from consulting used to support
product development o The ―old fashioned‖ way o Not possible for some businesses
Grants
Available only under very limited circumstances
Typically not available for retail, restaurants, etc.
―Free‖ money but not ―easy‖ money
Don’t have to repay
Typically retain ownership of intellectual property, subject to certain conditions, particularly in government grants
Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) Programs through US government agencies (www.sbirworld.com)
13
Joint Development Agreements
Big company interested in small company’s technology will ―give‖ small company money and resources to refine product
May lead to eventual license of IP to a big company
Be careful with respect to ownership of IP generated under the JDA
Nondisclosure agreements needed
Risks associated with dealing with big company include superior litigation resources available to big company in event of dispute
Angel Investors
Angel investors are typically high net worth persons or an entity owned by these individuals
Three types
1. Passive 2. Ones that add value to company through
expertise or contacts 3. The kind that think they add value but really
don’t!
Venture Capital
Only available for certain types of businesses (for example, commercializing a technology)
Can accelerate the growth of the company through contacts and management expertise added by the VC
14
Stages of a Venture Capital Transaction
Courting process
Letter of intent
Term sheet
Due diligence
Final agreements
Ongoing input from VC
Assistance with location of follow on rounds
Exit
Bonds
Debt whereby the issuing company or governmental body promises to pay the bondholders a specific amount of interest for specific amount of time and to repay principal on expiration date
Can offer a very favorable interest rate and no loss of equity
Typically feasible only for substantial amounts of capital
Initial Public Offering
Very few companies actually go public
Most exit through sale to another company or just operate and then wind down
Very expensive
Very difficult to go public in current market and economy
15
Attorney Roles
Advisor—Assist in identifying appropriate funding sources and preparing a credible presentation to financing sources
Referral source—To venture capital firms, bankers, and private investors
Assist by reviewing and negotiating terms of the financing and by making sure you understand what you are signing
Alan R. Singleton
Singleton Law Firm, P.C.
Re se a rc h Pa rk a t the Unive r s i t y o f I l l i no i s
2 0 01 S . F irst S t . , Su i te 2 09
Cha mpa ig n, IL 6 1 82 0 -3 6 5 4
(217) 352-3900 phone
(217) 352-4900 fax
s ingleton@ sing letonlawf irm.com www.s ingle tonlawf i r m.com
Business Financing
Alan R. Singleton, Esq.
Illinois Corporation
Standard Illinois
LLCDelaware
CorporationDelaware
LLC
$281.25 $207.00 *
$614.75 $190.00
$320.00 * $645.00
$46.65 $46.65$281.25 $614.75 $573.65 $881.65
$158.50 * $308.75 $158.50 * $308.75
$50.00 n/a
$350.00 * $250.00
$46.65 $46.65$158.50 $308.75 $605.15 $605.40
Information provided on this chart is intended to be general information only, in the nature of advertising. You should consult your attorney when making legal or business decisions and should not rely upon the content of this chart. Alan Singleton is licensed to practice law in the state of Illinois and is a patent attorney registered to practice before the U.S. Patent and Trademark Office. © 2009 Alan R. Singleton - www.singletonlawfirm.com
Articles/Certificate of Incorporation
Articles/Certificate of Organization
Authority to Transact Business in IL
Delaware Registered Agent fee
Corporate Formation Basic Filing Costs
Initial Setup:
IL annual report/franchise tax (minimum)
All fees are based on 24-hour filing.
* Based on minimum filing fees. Actual amounts vary based on paid in capital and/or shares authorized/issued.
The above information is accurate to the best of our knowledge and based on numbers published on the Illinois and Delaware Secretary of State websites as of 03/30/2012. Actual numbers may vary based on individual situations.
Delaware fees listed above may include certified copy fees (when necessary for IL filing) and courier fees.
Notes:
DE annual report
Delaware Registered Agent fee
Annual fees:
2001 South First Street, Suite 209, Champaign, IL 61820 phone 217-352-3900 fax 217-352-4900
DE franchise tax (minimum)
1
Motivating Employees Through Company Equity
Alan R. S ing le ton
Single ton Law F i rm, P.C .
R e s e a r c h P a r k a t t h e U n i v e r s i t y o f I l l i n o i s2 0 0 1 S . F i r s t S t . , S u i t e 2 0 9C h a m p a i g n , I L 6 1 8 2 0 - 3 6 5 4
( 2 1 7 ) 3 5 2 - 3 9 0 0 p h o n e
s i n g l e t o n @ s i n g l e t o n l a w f i r m . c o mww w. s i n g l e t o n l a w f i r m . c o m
Presentation Outline
I. Benefits of Employee Ownership II. How to Motivate Employees
Financial Compensation Non-Financial Compensation
III. Types of Equity Compensation Instruments Stock Options
Incentive Stock Options Non-Qualified Stock Options
Restricted Stock Phantom Stock Stock Appreciation Rights (SARs) Special Considerations in LLC and S Corporations
IV. The Importance of Fair Market Value - 409A of the Internal Revenue Code
V. Which Plan is Right for Your Company Sample Calculations
1
I. Benefits of Employee Ownership
Employee ownership offers attractive tax benefits to employees, employers and/or bothIt allows growing companies to compensate employees with equity or its equivalent rather than cash
2
Benefits of Employee OwnershipProductivity Gains
Just as important are the productivity gains accruing to the company…
Studies consistently show employee ownership plus a participative management style results in companies performing better than expectedNeither ownership nor participation alone accomplish these significant gainsCompanies need employees to “think and act like owners”What better way to do so than by making them owners?Tech firms, in particular, increasingly attract quality employees through offering company equity
Benefits of Employee OwnershipSubstantial Growth in Company Ownership
Over the past decade, the number of companies sharing ownership with employees grew substantially:
According to the National Center for Employee Ownership, approximately 9 million employees participate in some 3,000 plans, up from only 1 million in 1990There are approximately 11,500 ESOPs in the U.S. covering almost 14 million participants and controlling several hundreds of billions of dollars in assets
Of these, approximately 5% are in publicly traded companies while the remaining 95% are in closely held firms
The median percentage of employee ownership for private firms is about 30-40%, with about 3,000 companies now majority employee ownedA significant number of companies provide stock options or other kinds of individual equity to most or all employees
Benefits of Employee OwnershipAdditional Reasons to Share Company Ownership
Employee ownership benefits owners, employees and their companies in a variety of ways
Aligning the interests of the employee with those of the company, thereby promoting dedication to the companyAssisting the company in attracting and retaining good employeesProviding an avenue for buying out an existing owner when necessaryPromoting shared entrepreneurship and lessening the burden on any single entrepreneurRaising and conserving capital by exchanging equity for lower wagesProviding valuable tax benefits
3
Companies typically motivate, attract and retain quality employees through a combination of Financial and Non-Financial Compensation programs
A strategic combination of the two typically produces optimal results for the company and employees alike
II. How to Motivate Employees
Base SalaryBonuses
DiscretionaryBased upon goals met by the individual or the organization as a whole
BenefitsHealth Insurance (employee and dependents)Life InsuranceDental InsuranceFlexible Spending Accounts & 401(k) Plans
Granting an Equity Interest in the Business
How to Motivate EmployeesFinancial Compensation
How to Motivate EmployeesNon-Financial Compensation
Thank God It’s Monday!Job TitlesLeadership RolesFlexible SchedulesRecognition/AttentionGood Work EnvironmentAsk Employees What They Want! (you might be surprised ― and easily able to accommodate employees’ desires making for a relatively effortless win-win situation)
4
How to Motivate EmployeesElements of Total Compensation
Health, LifeDental Insurance
Pay for TimeNot Worked
Employee Services& Perquisites
IndirectCompensation
Profit-Sharing
StockAwards
401(k)
Deferred Comp/Benefits
Fixed
ProfitSharing
Incentive Bonus
Variable
DirectCompensation
Financial Nonfinancial
Extrinsic Rewards Intrinsic Rewards(Thank God It's Monday!)
III. Types of Equity Compensation Instruments
Equity compensation instruments include:Stock Options
Incentive Stock Options (ISOs)Non-Qualified Stock Options (NSOs)
Restricted Stock
Phantom StockStock Appreciation Rights (SARs)
Stock Options Definition
Stock options give an employee the right to:Buy (“exercise”) a certain number of shares of the employer’s stockAt a specified price (the “award,” “strike” or “exercise” price)Over a certain period of time (the “exercise” period), which is typically ten years or less
Stock options typically are subject to vesting such that the employee has the right to purchase a certain percentage of shares over period of time –e.g., 25% after two years, 50% after three, 75% after four and 100% after five years
5
Stock OptionsTwo Common Types of Plans
Employee stock options come in two basic flavors:Incentive Stock Options (ISOs) ISOs are a class of options created by the IRS and subject to the Internal Revenue Code rules, which, if followed, qualify the options for preferential tax treatment. Hence, they are also known as “Qualified Stock Options.”
Non-Qualified Stock Options (NSOs)NSOs are those options that do not “qualify” or meet the requirements of ISOs. Further, if an employer/employee fails to adhere to the restrictions of an ISO, the stock automatically reverts to non-qualified status.
Incentive Stock Options (ISOs) Requirements
ISOs offer preferential tax treatment. In order to qualify for such tax benefits ISOs must meet multiple eligibility requirements including, to name just a few:
Must be granted to an employeeUnder a written ISO AgreementAt a price equal to or greater than the “fair market value” at the time of grant (see 409A slides) Via a written Plan specifying the total number of shares that may be issued and the eligible employeesThe Plan must be approved by the stockholders within 12 months either before or after the plan’s adoptionEmployee must not, at the time of grant, own stock representing more than 10% of the voting power of all stock outstandingThe option must be exercised within 10 years of grantThe aggregate value of any ISO stock exercised for the first time cannot exceed $100,000 in any given year
ISOsKey Provisions
Employee may buy stock at a specified price which is in compliance with Section 409A (not less than 100% of fair market value) for a given period of time (10-year maximum)
Options may be exercised in any sequence
The annual value of ISOs which become exercisable in any one year cannot exceed $100,000 per individual
Appreciation from grant to sale qualifies for capital gain treatment provided holding period requirements are met (stock must be held at least 2 years after grant and 1 year after exercise)
6
ISOsTax Consequences for Employee and Employer
Employee:An employee receiving ISO realizes no income upon its receipt (at grant) or exerciseThe employee is taxed upon a qualifying disposition (one held for the holding period) at capital gains ratesDisqualifying dispositions are taxed at ordinary incomeAlternative minimum tax can kick in depending on circumstances
Employer: Employer is not entitled to a deduction with respect to the issuance of the option or its exerciseIf the disposition of the stock is qualifying, the employer receives no deductionIf the employee causes the option to be disqualifying (by disposing of the stock prior to the end of the holding period), the employer generally may take a deduction for the amount recognized by the employee as ordinary income in the same year as the employee recognizes the income
ISOsSummary: Advantages and Disadvantages
AdvantagesEmployee’s tax liability is deferred until stock is soldLong exercise period allows employee flexibility and can be retentiveEmployee may defer taxes or may sell the stock earlier in a disqualifying disposition
DisadvantagesEmployee investment is required at exerciseCompany loses tax deductionSpread at exercise is considered tax preference item for purposes of computing alternative minimum taxMore complicated instrument for administration
NSOsKey Characteristics
All options outside of ISOs, including ISOs that fail to meet the requirements or otherwise qualify as ISOs, are rendered NSOs
Employee may buy stock at exercise price for a given period of time so long as the valuation is in compliance with Section 409A of the Internal Revenue CodeAppreciation from grant date to exercise date taxed at ordinary income rates
NSOs differ from ISOs in a number of ways including:They are far more flexible and easier to administerThey can be given to anyone – partners, consultants, board members, advisorsThey are typically taxed at exercise at ordinary income tax ratesThey provide the employer with an accompanying compensation tax deduction equal to the income recognized by the employee
7
NSOsTax Consequences for Employee and Employer
If, as is almost always the case with non-publicly traded companies, the NSOs do not have a readily ascertainable fair market value at the date of grant, there is no taxable event at the time of grantThe tax event occurs at the time the employee exercises the optionThe employee will be taxed at the ordinary income rates for the amount equal to the difference between the fair market value of the stock at exercise and amount paid for the option The employer has a corresponding deduction in the same amount at the same time as the ordinary income is recognized by the employeeIf the stock is held after exercise, any additional gain to the employee is generally treated as capital gain
NSOsSummary: Advantages and Disadvantages
AdvantagesCompany receives tax deduction at exerciseNo limitations on the amount that may be exercisedOffers potential for long-term appreciation as company grows
DisadvantagesEmployee investment is requiredEmployee incurs tax liability at exercise
ISOs v. NSOsTax Consequences
The preferential tax treatment available via ISOs include: ISOs are taxed when the employee sells the stock (not at the time of grant or exercise) while NSOs are taxed on the date of exerciseTherefore, with ISOs, paying taxes on unsold but exercised option stock is avoided (which potentially could become worthless) and profit is not realized unless and until the stock is sold
ISO shares may receive long-term capital gain tax treatment
If the holding period is met – i.e., the later of 1 year after the stock is transferred to the employee or 2 years after the option is granted – the ISO stock is taxed at the lower long-term capital gains rate, which is currently 15(20)%NSOs are taxed at ordinary income rate which can go up to 39.6%
Note: Alternative Minimum Tax requirements may apply in certain situations, thereby reducing the tax benefits of ISOs
8
ISOs v. NSOsTax Implication Comparison Chart
ISO NSOEmployee exercises option No tax Ordinary income tax (up
to 39.6%)Employer gets tax
deduction?No deduction Tax deduction upon
employee exercise
Employee sells options after holding period
Long-term capital gains tax at 15(20)%
Long-term capital gains tax at 15(20)%
1000 shares @ $10 exercise price
20% capital gain tax
ISO NSO
Employee exercises when market value is $20/share
and 28% tax bracket
No tax paid Tax = ($20 - $10) * 1,000 * (0.28) = $2,800
Employee sells at $30/share after holding
period
($30 - $10) * 1,000 * (0.20) = $4,000
($30 - $20) * 1,000 * (0.20) = $ 2,000
Total tax paid $4,000 $4,800
Restricted StockDefinition
Restricted stock refers to stock in a company with limitations attached, such as:
Requirement that a certain amount of time passesCertain goals be achieved prior the stock being transferrableSubject to forfeiture if employment is terminated
Upon satisfaction of the conditions, the stock vests and becomes transferable
Restricted StockKey Provisions
Outright grant of shares with restrictions as to sale, transfer and pledging
Restrictions lapse over a period of time (e.g., three to five years)
As restrictions lapse, employee has unrestricted shares which he may sell, transfer or pledge (subject to limitations in corporate documents such as stockholders’ agreement)
If employee terminates employment, all unvested shares are forfeited
During restriction period, employee receives dividends and can vote the shares
9
Restricted StockTax Consequences for Employee and Employer
Tax Impact on Employee (absent 83(b) election)At grant – no taxAs restrictions lapse – the current market value of vested shares taxed as ordinary incomeDividends received during restriction period taxed as ordinary income
Tax Impact on Company (absent 83(b) election)At grant – no tax deductionAs restrictions lapse – company receives tax deduction equal to employee’s ordinary incomeAt sale – no tax deductionDividends paid during restriction period are deductible by company when paid
Restricted StockSummary: Advantages and Disadvantages
AdvantagesNo employee investment requiredPromotes immediate stock ownershipRecognizable to most employeesOffers employee potentially long-term appreciation as company grows
DisadvantagesImmediate dilution of EPSEmployee may incur tax liability before shares are sold
Restricted Stock83(b) Election
AdvantagesAllows employees to pay tax at the time of receipt of stock at the then current fair market value (FMV) and thereby lock in the low value of the stockCapital gain holding period begins at grant and not at vesting
DisadvantagesAccelerated payment of taxes (must be filed within 30 days of receipt of the stock)Overpayment of taxes in case the value of the stock decreasesIf the FMV is set high due to venture capital funding, substantial income tax may be paid on stock which may or may not be valuableIf the stock is forfeited, there is no loss deduction
10
Phantom Stock
Phantom Stock refers to a type of incentive grant in which:
A promise to pay a bonus based on some formula or allocation
Recipient is not issued actual shares of stock on the grant date, but rather receives “hypothetical” stock (the company gives the employee the benefits of owning stock in the company without actually granting stock)
Phantom stock increases or decreases in price and pays “dividends” as if it were real
Eventually, the phantom stock is settled and cash is distributed to the employee
Phantom stock distributions are not “qualified” and are taxed as ordinary income at distribution
Stock Appreciation Rights (SARs)
A Stock Appreciation Rights ("SARs")Contractual arrangement between a company and an individual, usually an employee The recipient has the right to receive an amount equal to the appreciation on a specified number of shares of stockOver a specified period of timeNormally paid out in cash, but it could be paid in shares
Generally, a recipient's ability to exercise a SAR is subject to a contractual "vesting" provision that expires after a specified period of time, either all at once or in incrementsMay be granted in conjunction with options - to pay for their purchase at exercise
How SARs Differ from Stock Options
SARs differ from stock options in the following ways: Recipient is not required to pay an amount to exercise the SARsRecipient only receives the appreciation in the value of the stock between the date of grant of the SAR and the date of exercise (generally, the recipient controls the timing of exercise)Recipient generally does not receive any shares of stock of the granting company (the amount received by the recipient is payable in cash)
11
Phantom Stock and SARSTax Consequences for Employee and Employer
Employees are taxed when the right to the benefit is exercisedAt that point, the value of the award, minus any consideration paid for it (there usually is none) is taxed as ordinary income to the employee and is deductible by the employerIf the award is settled in shares (as might occur with an SAR), the amount of the gain is taxable at exercise, even if the shares are not soldAny subsequent gain on the shares is taxable as capital gain
Special Considerations in S Corporations and LLCsGeneral
S CorporationLimit of 100 shareholders None of the shareholders may be a nonresident alienTreated as corporate entities and ISOs are availableUpon filing of 83(b)/exercise of options the holder is considered a stockholderPhantom stock and SARs are a possibility if they don’t create a second class of stock
LLCHigh administrative cost and complexity in pass through LLCsISOs are not available except where LLC has elected to be taxed as a C corporationValue of unrestricted capital interests granted (less anything paid) is ordinary income and deduction is available to companyRestricted capital interest is taxed at time of vesting and deduction is available83(b) election is available
VI. The Importance of Fair Market Value Section 409A of the Internal Revenue Code
Congress enacted Section 409A of the Internal Revenue Code as part of the American Jobs Creation Act of 2004 in response to perceived abusive compensation practicesSection 409A applies to non-qualified deferred compensation (NQDC) plansDeferred compensation plans which do not meet the specific requirements of 409A are treated as “current income” and subject to a significant excise taxes plus penaltiesSection 409A of the Internal Revenue Code applies to employees, directors and “other service providers”Section 409A contains very specific rules governing the timing of deferrals, timing of distribution, funding methods and various other aspects of deferred compensation
12
409A Penalties for Non-Compliance
If there is a violation, affected service providers owe:Current tax on deferrals for current year and all prior years (to the extent not subject to a substantial risk of forfeiture)Interest at underpayment rate +1% from original deferral dateAdditional tax of 20% of the taxable compensation
If the plan is not drafted correctly, all plan participants could be “affected” and all post-2004 deferrals taxable
Exceptions to 409A Coverage
Section 409A defines deferred compensation broadly to include elective deferred compensation plans as well as non-elective arrangements
Exceptions to Section 409A coverage include the following equity compensation instruments:
Non-discounted stock optionsRestricted StockStock Appreciation Rights (SARs)
In order to fall into the 409A exception, however, the equity compensation instrument MUST be valued at “fair market value” at the time of grant
How Does 409A Affect Stock Options and SARs?
Non-discounted options are not subject to Section 409ASimilar treatment now extends to all SARs
Private and public companiesCash and stock settled arrangements
Exercise price may not be less than the “value” of the “service recipient stock” on the “grant date”Tax on vesting for discounted stock options & SARsConcepts apply to LLCs and partnerships
13
How is Value for a Private Company Determined under 409A?
Value is determined “by the reasonable application of a reasonable valuation method” – what does that mean?Unreasonable to use:
Previously calculated value that fails to reflect all material informationCalculation that is more than 12 months old
Two primary safe harbors:Written valuation report for illiquid stock by a person with significant knowledge and experienceIndependent Appraisal (which can cost a cash strapped start-up $5,000 to $7,000)
IRS Guidelines for 409A Valuations
“Reasonable method, reasonably and consistently applied”
The value of tangible and intangible assets The present value of future cash-flows The market value of stock or equity interests in similar companies and other entities engaged in businesses substantially similar to those engaged by the corporationRecent arm’s length transactions involving the sale or transfer of the stockOther relevant factors, such as control premiums or lack of marketability
VI. Which Plan is Right for Your Company?
Administrative complexity (ISOs and LLCs) Tax consequences for service providers and
employers Size of compensation pool Pre-IPO considerations Vesting patterns Paying for the stock Signing the stockholders agreement at exercise Repurchase rights
14
Incentive Stock Options Sample Calculations - 1
Assumes the capital gain rate is 15%
Incentive Stock Option Grant Exercise Sale
Fair Market Value: $2 $6 $9
Employee Investment: $0 $2
Employee Gain: $0 $0 $7 (Capital Gain)
Employee Tax: $0 $0 $1.05 Tax Due($7x.15)
Employee Net Gain: $0 $5.95 Net Gain(After Tax)
Incentive Stock OptionsSample Calculations - 2
Assumes the capital gain rate is 15%
Incentive Stock Option Grant Exercise Sale
Fair Market Value: $5 $10 $12
Employee Investment: $0 $5
Employee Gain: $0 $0 $7 (Capital Gain)
Employee Tax: $0 $0 $1.05 Tax Due($7x.15)
Employee Net Gain: $0 $5.95 Net Gain(After Tax)
Non-Qualified Stock OptionsSample Calculations - 1
Assumes the capital gain rate is 15% and ordinary income tax rate is 35%
Non-Qualifed Stock Option Grant Exercise Sale
Fair Market Value: $2 $6 $9
Employee Investment: $0 $2
Employee Gain: $0 $4 $3Ordinary Income Capital Gain $7.00
Employee Tax: $0($4x.35 = $1.40) $1.85
Employee Net Gain: $0 Total Net Gain(After Tax) $2.55 $5.15
Total Gain
Total Tax Due
$2.60
($3.00 x.15 = .45)
15
Non-Qualified Stock OptionsSample Calculations - 2
Assumes the capital gain rate is 15% and ordinary income tax rate is 35%
Non-Qualified Stock Option Grant Exercise Sale
Fair Market Value: $5 $10 $12
Employee Investment: $0 $5
Employee Gain: $0 $5 $2Ordinary Income Capital Gain $7.00
Employee Tax: $0($5 x.35 = $1.75) ($2 x.15 =.30) $2.38
Employee Net Gain: $0 Total Net Gain(After Tax) $1.70 $4.95
Total Gain
Total Tax Due
$3.25
Restricted StockSample Calculations - 1
This example assumes the employee is subject to an ordinary income tax rate of 35%. If an 83(b) election were made within 30 days of the award, the employee would be taxed on the fair value of the stock at grant as ordinary income, with subsequent appreciation treated as a capital gain. 83(b) elections are sometimes not made because the employee cannot recover taxes paid at grant if he or she forfeits the shares if the shares decrease in value.
Restricted Stock Grant Restrictions Lapse
Fair Market Value: $2 $10
Dividends $0 $1.00
Employee Investment: $0 $0
Employee Gain: $0 $11 (Ordinary Income)
Employee Tax: $0 $3.85 Tax Due($11.00x.35)
Employee Net Gain: $0 $7.15 Net Gain(After Tax)
Restricted StockSample Calculations - 2
This example assumes the employee is subject to an ordinary income tax rate of 35%. If an 83(b) election were made within 30 days of the award, the employee would be taxed on the fair value of the stock at grant as ordinary income,
with subsequent appreciation treated as a capital gain. 83(b) elections are sometimes not made because the employee cannot recover taxes paid at grant if he or she forfeits the shares if the shares decrease in value.
Restricted Stock Grant Restrictions Lapse
Fair Market Value: $5 $10
Dividends $0 $1.00
Employee Investment: $0 $0
Employee Gain: $0 $11 (Ordinary Income)
Employee Tax: $0 $3.85 Tax Due($11.00x.35)
Employee Net Gain: $0 $7.15 Net Gain(After Tax)
16
Motivating Employees Through Company Equity
Alan R. S ing le ton
Single ton Law F i rm, P.C .
R e s e a r c h P a r k a t t h e U n i v e r s i t y o f I l l i n o i s2 0 0 1 S . F i r s t S t . , S u i t e 2 0 9C h a m p a i g n , I L 6 1 8 2 0 - 3 6 5 4
( 2 1 7 ) 3 5 2 - 3 9 0 0 p h o n e
s i n g l e t o n @ s i n g l e t o n l a w f i r m . c o mww w. s i n g l e t o n l a w f i r m . c o m
1
Motivating Employees Through Company Equity - Scenarios
Alan R. S ing le ton
Single ton Law F i rm, P.C .
R e s e a r c h P a r k a t t h e U n i v e r s i t y o f I l l i n o i s2 0 0 1 S . F i r s t S t . , S u i t e 2 0 9C h a m p a i g n , I L 6 1 8 2 0 - 3 6 5 4
( 2 1 7 ) 3 5 2 - 3 9 0 0 p h o n e
s i n g l e t o n @ s i n g l e t o n l a w f i r m . c o mww w. s i n g l e t o n l a w f i r m . c o m
ScenariosI. Start Up/Formation
Several foundersNot much money to start the companySweat equity component for some of the foundersIP contribution
Restricted stock with vesting schedule
Considerations Beware of immigration issues Beware of Illinois Wage Payment and Collection Act No unpaid interns unless stockholders 83(b) election likely appropriate
ScenariosII. A Little Further Along
Founders already establishedNeed to attract some knowledgeable employees (perhaps post doc level people)No significant outside investment that has set a valuation on the company
Restricted stock with vesting schedule Stock options with vesting schedule (implement stock
option plan)
Considerations 83(b) election likely appropriate Illiquid start up valuation method likely available Implement option pool
2
ScenariosIII. First VC Round
Post-money valuation of $1.5MInvestors have a lot of leverage
Stock options Restricted stock likely not optimum as it would generate
adverse income tax consequences
Considerations Workout size of option pool with investors Illiquid start up valuation method likely available
ScenariosIV. Later Stages
Stock options Restricted stock likely not optimum as it would generate
adverse income tax consequences
Considerations Size of option pool is set Approval of stockholders/investors is needed to increase
the size of the option pool Outside valuation most likely needed - illiquid start up
valuation method likely not available as the company is no longer a start up (older than 10 years) or company is “too big”
ScenariosV. “Rearranging” Founder Equity
Three founders each owning one-third of the company equityOne agreeing to leave Possibilities:
Restricted stock which is not vested is forfeited Fully vested stock may be: Repurchased by the company (redemption) Purchased by the other stockholders Gifted (gift tax provisions apply - $14,000 annual gift
exclusion in 2014) In all cases at FMV
3
ScenariosVI. Very Mature Stage – Sale to an ESOP
50M in revenueFounders seek to be bought out yet reward employees and keep the business runningStock is held in a trust for employees meeting minimum service requirements and allocated to employees
Champaign based companies Hobbico and Human Kinetics
Considerations ESOPs are funded by the employer, not the employees Potential beneficial tax treatment for seller Owner can stay with the business or retire FMV must be determined at least annually by an outside,
independent appraiser The company is making enough money to buy out an owner Management continuity must be provided Maintenance of ESOP is costly and complex
Motivating Employees Through Company Equity - Scenarios
Alan R. S ing le ton
Single ton Law F i rm, P.C .
R e s e a r c h P a r k a t t h e U n i v e r s i t y o f I l l i n o i s2 0 0 1 S . F i r s t S t . , S u i t e 2 0 9C h a m p a i g n , I L 6 1 8 2 0 - 3 6 5 4
( 2 1 7 ) 3 5 2 - 3 9 0 0 p h o n e
s i n g l e t o n @ s i n g l e t o n l a w f i r m . c o mww w. s i n g l e t o n l a w f i r m . c o m
BUSINESS LAW
Tax exemptions for not-for-profit corporations --
understand which may apply
By Alan Singleton
CIBM Contributor
Published: Dec. 2008
Not-for-profit corporations provide a wide range of valuable services to Champaign
County, from afterschool programs offered by local boys and girls clubs to emergency
medical services provided by the local hospitals. Incorporation as a not-for-profit is a
logical step for a variety of charitable, religious and other endeavors. However, there are
certain important distinctions and requirements which prospective founders should keep in mind.
First is the commonly blurred distinction between a not-for-profit corporation and a tax exempt
organization. A not-for-profit corporation is an independent business entity formed by filing articles of
incorporation with the Illinois secretary of state. Not-for-profits are governed by the Illinois Not-For-
Profit Corporation Act and must have as their stated purpose one of the accepted purposes under that Act.
However, incorporation as a not-for-profit does not make the organization a tax exempt organization. For
that matter, there are several distinct forms of tax exemption, each of which carries its own requirements
and application process.
Generally, the first tax exemption sought by a not-for-profit is relief from federal income tax.
Qualification for this exemption is recognized by the Internal Revenue Service upon application by the
not-for-profit. Section 501(c) of the Internal Revenue Code provides a list of 28 types of entities which
qualify for exemption from federal income tax. The most commonly relied upon exemption is found in
section 501(c)(3) and applies to entities "operated exclusively for religious, charitable, scientific, testing
for public safety, literary or educational purposes, or to foster national or international amateur sports
competition or for the prevention of cruelty to children or animals." This broad sweeping exemption is
relied upon by churches, sports leagues, schools and any other organizations that share the stated
purposes.
An advantage of a 501(c)(3) designation over some of the other exemptions listed in Section 501(c) is the
fact that not only is the entity exempt from income tax, but also any donations made to the organization
are tax-deductible for the donor on his personal income tax return. However, a 501(c)(3) exemption also
carries two important restrictions. First, no portion of the income of the organization may go to any
private shareholder or individual. Employees, directors and officers of a 501(c)(3) organization may be
paid for their services, but care must be taken to avoid any payments to individuals beyond fair market
value for the services actually performed. Such overpayment could be found to be "private inurement"
and may jeopardize the organization's tax exempt status. A second restriction has been particularly
relevant during the recent election cycle and prohibits any "substantial portion" of a 501(c)(3)
organization's activities from attempting to influence legislation or intervening in any political campaign
in support or in opposition to any candidate.
A second commonly used exemption, and one of particular interest to the business community, is
501(c)(6), which applies to business leagues and chambers of commerce. Donations made to a 501(c)(6)
are not tax deductible for the individual donor. However, for the most part, businesses will be members of
these organizations and will pay membership fees, which are then deductible as an ordinary business
expense. Like 501(c)(3) organizations, no part of the earnings of a 501(c)(6) entity may inure to the
benefit of a private shareholder or individual. However, 501(c)(6) organizations are not prohibited from
engaging in political or legislative activities.
In addition to the exemption from federal income tax, the state of Illinois offers exemptions from real
estate taxes for certain charitable organizations. These exemptions apply to property owned by schools,
religious organizations and orphanages, as well as certain other types of property as long as the property
is "actually and exclusively used for charitable or beneficent purposes." This exemption has been the
subject of considerable attention recently as the courts work to determine whether our two local hospitals,
Provena and Carle, qualify for an exemption.
Finally, certain organizations may be eligible to receive an exemption from sales tax, depending on the
circumstances. Organizations may apply to the Illinois Department of Revenue for such an exemption.
However, this exemption is fairly narrow and often more difficult to meet than either the real estate or
income tax exemptions. Still, it could provide a substantial advantage to a not-for-profit and should be
considered.
The list of business and charitable purposes that can be supported by a not-for-profit corporation is fairly
broad. However, incorporation as a not-for-profit is only the first step, and founders should consider the
multiple exemptions from taxes that may be available. Qualifying for exemption at one level does not
guarantee exemption at any other level, since the standards are different, but each exemption helps toward
serving the organization's charitable or business purpose.
Alan Singleton is a corporate and intellectual property law attorney with Singleton Law Firm, P.C. in
Champaign. He can be reached at (217) 352-3900 or [email protected].
Alan R. Singleton, Esq.
2001 South First Street, Suite 209, Champaign, IL 61820 phone 217-352-3900 fax 217-352-4900
Not For Profit and Tax Exempt Entity Organization and Maintenance Checklist
I. Initial Organization
A. Organizational Documents
1. Articles of Incorporation - NFP 102.10 a. Corporate Name b. Registered Agent c. At least three directors d. Statement of Purpose e. $50 Filing Fee
2. Bylaws – Official rules of how the organization will be run a. Organizational Purpose b. Voting c. Meetings d. Members, Directors and Officers e. Salaries f. Committees g. Amendments h. Indemnification
3. Organizational Minutes a. Initial election of directors and officers b. Ratification of organization c. Adoption of initial documents, such as Bylaws and Conflict of Interest Policy
B. Registration as Charitable Organization
1. Illinois – Pursuant to Charitable trust and Solicitation for Charity Acts – Forms CO-1&2 a. Must register if you are based in, solicit contributions from, or hold over $4,000
for a charitable purpose in Illinois i. Information about the organization and copies of organizational documents
ii. Director and Officer information iii. Methods of Solicitation iv. Financial Statements v. $15.00 Filing Fee ($200.00 if not filed within 10 days of initial solicitation)
2. Other States – Most other states require registration if you solicit contributions from its citizens
C. Application for Federal Employer Identification Number (EIN) – SS-4
II. Tax Exemptions
A. Federal Income Tax –
1. §501(c) of the Internal Revenue Code – 28 types of entities eligible – most common are 501(c)(3) organizations, which are entities, “operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes, or to foster national or international amateur sports competition or for the prevention of cruelty to children or animals.”
2. Benefits can include both exemption from federal income tax and tax deductibility of certain contributions
3. Typically must apply for the exemption by filing Form 1023 a. Information about and copies of the organizational documents: specific language
required b. Narrative description of activities and copies of any printed materials c. Compensation of directors, officers, employees and independent contractors d. Disclosure of family or business relationships e. Conflict of interest policy f. Material leases, contracts, loans and other arrangements g. Benefits to organization’s members h. Statements regarding certain specific activities, such as political support, gaming,
methods and areas of solicitation, affiliations, intellectual property, connection to foreign countries and organizations and other specific activities
i. Detailed financial statements j. Public charity or private foundation status k. Specific information regarding churches, schools, hospitals, supporting
organizations, homes for the elderly, handicapped or low income residents, successor organizations and/or provision of scholarships, fellowships or other educational loans or grants
l. Filing Fees i. Gross Receipts < $10,000 = $300.00
ii. Gross Receipts > $10,000 = $750.00
B. Illinois Sales and Use Taxes 1. Available to any corporation, society, association, foundation, or institution
organized and operated exclusively for charitable, religious or educational purposes, nor to any not-for-profit corporation, society, association, foundation, institution or certain senior citizens organizations.
2. Must apply for an exemption number with the Illinois Department of Revenue a. Copies of organizational documents and printed materials b. Narrative of Activities c. Financial statements
d. IRS exempt organization determination letter, if applicable
C. Illinois Property Taxes 1. To qualify for a property tax exemption, the organization must:
a. be an exclusively beneficent and charitable, religious, educational, or governmental organization
b. own the property that is used exclusively for charitable, religious, educational, or governmental purposes and not leased or used for profit
2. Must apply for exemption at the county level a. IDOR Form PTAX-300 (PTAX-300R for religious organizations) b. Photo of the property c. Copy of the deed or other proof of ownership d. Notarized affidavit of use e. Copies of any leases of the property
III. Basic Maintenance
A. Annual Meetings/Consent Minutes
1. Annual a. Elect directors and officers b. Ratify actions of previous directors and officers
2. Special a. Major decisions, including those specified in the General Not-For-Profit
Corporation Act should be recorded in minutes from special meetings or consent minutes
B. Annual Report – Illinois Secretary of State’s Office
C. Return of Organization Exempt from Income Tax 1. Form 990 – Gross Receipts > $100,000; or Total Assets > $250,000 at year end 2. Form 990-EZ – Gross Receipts between $25,000 and $100,000; and Total Assets <
$250,000 3. Form 990-N - Gross Receipts < $25,000 4. Form 990-PF – Private Foundations
D. Federal and State employment taxes and unemployment insurance, if applicable
E. Charitable Organization Annual Reports
1. Illinois – Form AG990-IL, with the Attorney General’s Office 2. Other States as Necessary
Alan R. Singleton, Esq.
*$200.00 if not filed within 10 days of initial solicitation. Dependng on the location of the organization's activities additional registrations may be required in other states.
$39.25 $39.25IL annual report/franchise taxIL Charitable Organization annual report filing
Notes:
$850.00
$987.75$537.75
$54.25$54.25$15.00
All fees are based on 24-hour filing.
The above information is accurate to the best of our knowledge and based on numbers published on the Illinois Secretary of State & Attorney General websites as of 03/30/2012. Actual numbers may vary based on individual situations.
Information provided on this chart is intended to be general information only, in the nature of advertising. You should consult your attorney when making legal or business decisions and should not rely upon the content of this chart. Alan Singleton is licensed to practice law in the state of Illinois and is a patent attorney registered to practice before the U.S. Patent and Trademark Office. © 2009 Alan R. Singleton - www.singletonlawfirm.com
Gross Receipts > $10,000
$122.75
$15.00
$122.75
Annual fees:
$15.00
Articles of IncorporationIL Charitable Organization Registration *
IRS Tax Exempt filing
Based on minimum filing fees.
$400.00
$15.00
2001 South First Street, Suite 209, Champaign, IL 61820 phone 217-352-3900 fax 217-352-4900
Not For Profit Formation Basic Filing Costs
Initial Setup:
Gross Receipts < $10,000
Alan R. Singleton, Esq. [email protected]
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 phone 217-352-4900 fax
Information provided is intended to be general information only, in the nature of advertising. You should consult your attorney when making legal or business decisions and should not rely upon the content of this article. Alan Singleton is licensed to practice law in the state of Illinois and is a patent attorney registered to practice before the U.S. Patent and Trademark Office. © 2011 Alan R. Singleton ‐ www.singletonlawfirm.com
L3C - Bridging the Gap between Nonprofits and For-Profits
Effective January 1, 2010, Illinois became the fifth state to recognize the low-profit limited liability company (L3C). As of this writing, 64 L3Cs have been formed in the state. An L3C is a hybrid business structure that combines the financial advantages of LLCs with the social advantages of nonprofit organizations with respect to funding, distributions to owners, return on investment and achievement of social goals. Like nonprofits, an L3C is organized to further one or more charitable or educational purposes. However, unlike nonprofits, the L3C has owners and may in fact have different classes of investors - individuals, nonprofits, for-profits, and even government agencies. As a variety of LLC, it generally shields owners and investors from liabilities of the enterprise.
The opportunity for L3Cs lies in PRIs (program-related investments). PRIs are loans or investments private foundations can make for charitable or educational projects, even if those projects are run by for-profit entities. Federal tax law requires that private foundations distribute at least 5% of their assets (estimated at more than $23.5 billion only in Illinois) every year to social programs or PRIs. PRIs may involve high risk, low return, or both, but are nonetheless made by foundations because they are intended to achieve charitable purposes. The key to PRI funding is the foundation’s motivation in making the investment. PRIs can be recovered, along with earnings, by the foundation and reinvested in qualifying PRIs.
However, for-profit’s access to PRIs is restricted because investment in PRIs is complicated and the private foundation may be fined if IRS does not view the project as adequately charitable. L3Cs facilitate access to PRIs because, while the IRS does not automatically recognize L3Cs as eligible to receive PRI, the very structure of these entities may serve to facilitate the charitable nature of the investment. To ensure the L3C is properly structured, under Illinois law, specific language has to be included in the articles of organization. However, until PRIs in L3Cs are formally recognized, foundations will have to rely on private letter rulings by IRS or an opinion of counsel regarding the PRI treatments.
An L3C enjoys a flexible ownership structure and can have different classes of investors with distinct investment goals and affinity for financial risk. Unlike nonprofits, L3Cs are allowed to distribute profits to their owners/investors as long as the company continues to pursue its charitable purpose and production of income is secondary. Also, unlike nonprofits, at dissolution, the company is not required to distribute its assets to other nonprofits; there are no provisions that limit the sale of an L3Cs by the owners. If at any point the company ceases to satisfy the L3C requirements, it will be treated as an LLC and is required to amend its articles.
Even though similar to the tax-exempt nonprofits, an L3C is subject to taxation on its income. Just like an LLC, an L3C is taxed as a partnership if it has more than one member and as a disregarded entity if it has only one member. To reduce its tax burden when wholly owned by a nonprofit, the L3C may also opt in for corporate tax treatment.
The L3C will often be a great fit for social entrepreneurs, i.e., those seeking to do well while furthering social goals and seeking innovative solutions to pressing social problems.
For-Profit L3C Nonprofit
Exempt from income tax No No Yes, if 501(c) entity
Donor receives charitable deduction No No Yes, if 503(c)(3) entity
Tap into private foundations PRIs Only with difficulty Likely easier Easier; set up to access these funds
At wind down assets are distributed to Owners Owners Other charitable organizations
Fiduciary duty to maximize profit for owners Yes No No, there are no owners
Alan R. Singleton, Esq.
At a Glance
Patents Trademarks Copyrights Trade Secrets
Process, machine, manufacture,
composition of matter, or improvement
thereof.
Any distinct word, name, symbol, or
device used to identify a source of goods or
services.
Original work of authorship fixed in a tangible medium of
expression.
Commercially valuable information not generally
known or readily ascertainable, if
reasonable efforts are used to keep it secret.
Inherently distinctive if arbitrary, fanciful, or
suggestive.
Fixed if it is sufficiently permanent (written
down, recorded, painted, saved
electronically, etc.)
Disclosure to one person without confidence may destroy a trade secret.
Action RequiredU.S. Patent and
Trademark Office. Application required.
U.S. Patent and Trademark Office for
federal protection. Secretary of State’s
office for state protection.
Registration advised but not required.
U.S. Copyright Office within the Library of
Congress. Registration advised but not
required.
NONE.
Research Park at the University of Illinois, 2001 South First Street, Suite 209 Champaign, IL 61820-3654 217-352-3900
More efforts required for more valuable secrets.
Rights
Property Protected
Intellectual Property Protection
Also distinctive if descriptive with
acquired secondary meaning.
Originality requires some amount of
creativity by the author.
Right to exclude others from making, using,
selling, or offering for sale in U.S. or
importing to U.S.
Right to stop others from using confusingly
similar marks in commerce.
Exclusive right to reproduce, prepare derivative works,
distribute, perform publicly, and display
publicly.
Right to sue others from improperly acquiring the
trade secret or breaching confidence regarding the trade
secret. Does not prevent reverse engineering.
Must be useful, novel and non-obvious. Recently passed
America Invents Act of 2011 amended
statutory provisions of novelty. New
provisions rendering the US a first-inventor-
to-file system take effect March 16, 2013.
Patents Trademarks Copyrights Trade Secrets
Pat. Pending.TM or SM if not
registered with USPTO.
“Copyright” or ©, year of first publication,
author’s name.
Registered: No limit as long as you continually
use it and file appropriate renewal
papers.
Work for hire: the earlier of 95 years from
publication or 120 years from creation.
Infringer’s mark causes a likelihood of
confusion with your mark.
Infringer has copied your work without
permission.
If your mark is famous, then you can also sue
if another dilutes or tarnishes your mark.
Infringer’s work is substantially similar to
yours.
© 2007 Alan R. Singleton - www.singletonlawfirm.com
Information provided on this chart is intended to be general information only, in the nature of advertising. You should consult your attorney when making legal or business decisions and should not rely upon the content of this chart. Alan Singleton is licensed to practice law in the state of Illinois and is a patent attorney
registered to practice before the U.S. Patent and Trademark Office.
Notice to show confidential nature to
employees and anyone else with access to the
information.Pat. No. ######. ® if registered with
USPTO. © 2007 Joe Smith.
No limit as long as it still qualifies as a trade
secret.
Infringement
Every claim limitation in the patent is found,
literally or equivalently, in the accused device
or method.
Another has knowingly misappropriated your trade secret for his or
her own gain or to harm you.
Duration
Generally, 20 years from the earliest US filing date for which priority is claimed.
Provisional applications are excluded in this
calculation.
Non-registered: No limit as long as you continually use it.
Life of the author plus 70 years.
Public Notice
1
Alan R. SingletonSingleton Law Firm, P.C.
R e s e a r c h P a r k a t t h e U n i v e r s i t y o f I l l i n o i s2 0 0 1 S . F i r s t S t . , S u i t e 2 0 9C h a m p a i g n , I L 6 1 8 2 0 - 3 6 5 4
(217 ) 352 -3900 phone(217 ) 352 -4900 fax
s ing le ton@sing le ton lawf i rm.comw w w.s ing le ton law f i rm.com
© 2 0 1 3 A l a n R . S i n g l e t o n
IP Protection
Importance of IP to a Company
Increasingly important as a business asset May constitute the most valuable asset in
early stage tech companies
1
Why do Companies Care about IP?
Freedom to Operate—Ensure that someone else’s IP will not prevent your company from carrying out its business objectives
Competitive Advantage—Protect your company’s IP to acquire a competitive advantage in the marketplace by precluding others from using it
2
2
Common IP Mistakes Made By Entrepreneurs
Failing to secure IP rights from founders by assignment or license
Failing to address how jointly-owned patents are to be licensed and utilized in joint development situations
Failing to file a U.S. patent application within one year of public disclosure or other statutory bar
Failing to consider international patent protection prior to disclosure (no one year grace period)
Failing to use nondisclosure agreements Failing to properly register trademarks
3
Patent—Anything man-made that is “new,” “useful,” and “non-obvious”o E.g., new scientific instrument, chemical process, software
coupled with operation on a computer Trademark—Any distinct word, name, symbol, or device used
to identify a source of goods or serviceso E.g., company logo
Copyright—Original work of authorship fixed in a tangible medium of expressiono E.g., a novel, software, website content
Trade Secret—Commercially valuable information not generally known or readily ascertainable, if reasonable efforts are used to keep secreto E.g., the Coca-Cola secret formula
Contracts—Protect IP by entering into agreementso E.g., Non-Disclosure and Employment Agreements
Ways to Protect IP4
Hershey’s Kisses Protected by Five Types of Intellectual Property Protection
Patent for its method of reducing fat levels in cocoa used (#5,464,649)
Trademark for its shape (#1,038,025) and the term Kisses® (#2,416,701)
Copyright for commercial advertisements (PAu-697-741)
Trade secret on its recipe for producing the milk chocolate candy
Contracts, e.g., nondisclosure, employment, and supplier agreements
5
3
Patents—Rights & Duration
A patent gives its holder the right to excludeothers from making, using, offering to sell, or selling the patented invention in the U.S. or importing the invention into the U.S.
A patent does not grant its owner the right to make, use, offer to sell, or sell the patented invention; as such, one can have a patent but not be able to use the patented invention if it would infringe on an existing patent
Generally, U.S. patents last 20 years from the date the application is filed with USPTO
6
Patents
An invention must fit into one of the following categories of subject matter in order to be patented:o Machine, manufacture, process, composition of matter,
biological plant, ornamental design Anything man-made that is “new,” “useful,” and “non-
obvious” may be patented.o Useful—The easiest test to meeto Novel (New)—The invention must not already be known
by the public or in public useo Non-obvious—The invention must not be obvious in view
of the prior art and the knowledge of a person having ordinary skill in the art
7
Patents—Obtaining Protection
To secure a US patent, one must file a patent application with the USPTO
A patent application must be filed within one year of any commercial use, offer for sale, or public disclosure of an invention in order to be patentableo There is no one year grace period in most foreign jurisdictions
Before applying for a patent, consider the following:o The prosecution and enforcement of a patent can be very time
consuming and expensive― Determine whether the life span of the invention and its value justifies
a patento A patent requires a disclosure of the invention
― Determine whether disclosing the invention would provide competitors with an advantage, or if other forms of protection, such as a trade secret are preferable
8
4
Patents—Other Considerations
First to File v. First to Invento EFFECTIVE March 16, 2013, the U.S., like most foreign jurisdictions,
uses a First to File system, meaning that the first person to file may be awarded a patent.
o PRIOR TO March 16, 2013, the U.S. used a First to Invent system, meaning that the first person to invent may be awarded a patent.― Laboratory notebooks and invention disclosure forms were used to
document the date of the invention, i.e. the time of conception and the time of reduction to practice.
Use nondisclosure agreements to prevent public disclosure. A patent application may only be filed by an individual in the
U.S. Make sure that you have agreements in place to assign
ownership of any patent applications or patents to a company.
9
Patents—U.S. Provisional Patent Applications
A provisional patent application (“PPA”) can temporarily delay the need to file a utility patent application o E.g., an article containing an enabling disclosure of the invention will be published
in a scientific journal Must file a regular application within one year of the
provisional filing date or lose the filing date and the ability to obtain a patent if a public disclosure made or other bar occurs
Does not count against the 20 year term A PPA is less formal than a utility patent application,
but you need to ensure that what is disclosed in the PPA is sufficiently detailed so it will support a later utility application
10
Patents—Public Notice
“Pat. Pending” may be applied to goods for which a PPA or utility patent application has been filed and which is in prosecution
“U.S. Pat. No. #######” may be applied to goods once a patent has been issued
Marking increases the likelihood of obtaining damages should a patent be infringed
False marking may result in liability for statutory damages
11
5
Patents—Infringement
A patent claim is infringed when every claim limitation in the patent claim is found, literally or equivalently, in the accused device or methodo Example:
― A claim from Patent 1 claims a method comprising (a) scanning a barcode and (b) placing an item in a plastic bag.
― A claim from Patent 2 claims a method comprising (a) scanning a barcode, (b) placing an item in a plastic bag, and (c) carrying the plastic bag outside.
― The claim from Patent 2 contains every claim limitation found in the claim from Patent 1, and therefore infringes Patent 1, even though the claim from Patent 2 contains additional limitations.
12
Trademarks—Definition Any distinct word, name, symbol, or device used to identify a
source of goods or serviceso A mark is distinctive if it is:
― Fanciful—Made-up term, e.g., KODAK for cameras― Arbitrary—Term that has no connection to the product with
which it is associated, e.g., APPLE for computers― Suggestive—Term that suggests a connection to the
product with which it is associated, e.g., MICROSOFT for computer software
― Descriptive + secondary meaning—Term that describes the product with which it is associated and that has become associated with the product in the minds of the consuming public, e.g., PARK N FLY for airport parking lots
o A mark is not distinctive if it is generic. A mark is generic if consumers associate the mark with the product rather than the producer, e.g., CAR for a car
13
Trademarks—Marks That Can Be Protected
Examples of protectable marks:o Product names and logos
― E.g., DU PONT and o Sales slogans
― E.g., LET’S DO AMAZING for HPo Container shapes and distinctive packaging
― E.g., the shape of a Coca-Cola bottleo Sounds
― E.g., Intel “Chimes”o Colors
― E.g., Owens Corning’s pink insulation
14
6
Trademarks—Obtaining Protection
1. Brainstorm several potential marks—Better to create more than one in case some are incapable of being trademarked.o Best practice—Avoid generic or descriptive marks, and instead
create fanciful marks or choose arbitrary marks, which have the best chance of surviving the registration process.
2. Perform a clearance search—Ensure that you have the freedom to use the mark and to minimize the likelihood of any issues in the prosecution of a trademark application
3. Use the mark in connection with your goods or services—Use is an integral part of trademark law. If not registered, use the TM symbol. Once registered, use the ® symbol. Although trademark rights normally attach when the mark is used, it is possible to file an intent to use application with the USPTO prior to using the mark.
4. Register the mark—Registration with the USPTO provides important benefits and puts the world on notice that you are using the mark as a trademark
15
Trademarks—Rights & Duration
The owner of a trademark enjoys the right to stop others from using confusingly similar marks in commerceo Although trademark rights can be acquired without
registration, registration provides important benefits, including: constructive notice, prima facie evidence of validity, federal jurisdiction, and statutory damages
Trademark rights last indefinitely as long as the trademark is being continuously usedo For registered marks, renewals must also be filed
from time to time to show that you continue to use the mark
16
Trademarks—Infringement & Other Causes of Action
Infringemento An existing trademark is infringed when an infringer’s
mark causes a likelihood of confusion with the existing trademark.― E.g., MACROSOFT for software
Other remedies for “famous” markso Dilution by blurring—Unauthorized use of a famous
mark on unrelated goods― E.g., a company that tries to sell KODAK shoes
o Dilution by tarnishment—Unauthorized use of a famous mark on inferior or unwholesome goods― E.g., using a CATERPILLAR mark to sell shoddy car parts
17
7
Copyrighted Works—Definition
Original work of authorship fixed in a tangible medium of expressiono Original—A work is “original” if its author
used some amount of creativityo Fixed—A work is “fixed” if it is sufficiently
permanent, e.g., written, recorded, painted, saved to a hard drive
Examples—Textbooks, software, photographs, movies, this presentation
18
Copyrighted Works—Obtaining Protection
Protection exists from the moment a work is “fixed” in a tangible medium of expression—publication, registration, and notice are not required for the five exclusive rights to attach to a work
For maximum protection, notice and registration suggestions should be followed:o Marking a work with “©” or “Copyright,” the year of first
publication, and the author’s name provides notice to the world that the work is protected― E.g., © 2013 John Smith
o Registering a work with the U.S. Copyright Office within certain time periods provides the highest degree of protection, allowing, for example, the copyright owner to recover statutory damages, attorney’s fees, and injunctive relief
19
Copyrighted Works—Exclusive Rights
Copyright owners enjoy the exclusive right to:1. Reproduce the copyrighted work
― E.g., make copies of copyrighted software2. Prepare derivative works of the copyrighted work
― E.g., film a movie based on a copyrighted novel3. Distribute the copyrighted work
― E.g., sell DVDs of a copyrighted film4. Perform the copyrighted work publicly
― E.g., perform a copyrighted play 5. Display the copyrighted work publicly
― E.g., hang a piece of copyrighted art in a public place
20
8
Copyrighted Works—Duration
In general, copyrights exist for the life of the author plus 70 years
In the case of a work for hire, the copyright lasts for the earlier of 95 years from publication or 120 years from creation
21
Copyrighted Works—Ownership of the Work of Others
Employer/Employee—If certain tests are met, an employer becomes the owner of the copyright in a work created by an employee if the work was created within the scope of the employee’s employmento Employee v. Independent Contractor
Works for Hire—A company commissioning a third party to create a work may or may not become the owner; this is a fact-based inquiry
Prudent to document these issues in a signed agreement that also contains language addressing assignment of copyright
22
Trade Secrets—Definition
Commercially valuable information not generally known or readily ascertainable, if reasonable efforts are used to keep secret
Any formula, pattern, device or compilation of information used in a business that gives the trade secret owner an opportunity to obtain an advantage over competitors who do not know it. The trade secret cannot be public knowledge.o Examples—Coca-Cola formula, proprietary blend
of chemicals
23
9
Trade Secrets—Obtaining Protection
If information is secret and reasonable measures are taken to keep it secret, it will be protected by law; there is no registration process
The law does not create a monopoly for use of the secret like other protections of intellectual property; it only protects the secret from being improperly appropriated
Unlike patents, trade secrets may be “reverse engineered,” thereby destroying the trade secret
24
Trade Secrets—Obtaining Protection
Businesses must take proper steps to ensure the security of their trade secrets, including:o Security within the plant or office;o Contractual safeguards, such as non-competition
agreements and confidentiality agreements, with employees and business partners; and
o Workplace controls to prevent the dissemination of trade secrets to individuals that do not need access to them—disclosure to one person, without confidence, may destroy a trade secret.
The more valuable the secret, the more security required for protection
25
Trade Secrets—Rights, Duration, & Misappropriation
Rights—The owner of a trade secret has the right to sue others for improperly acquiring the trade secret or breaching confidence regarding the trade secret. There is no right to prevent reverse engineering.
Duration—No limit as long as it qualifies as a trade secret
Misappropriation—The owner may sue if another has knowingly misappropriated the trade secret for his or her own gain or to harm the owner
26
10
Licensing Issues
Exclusive vs. Nonexclusive One or a few fields of use vs. all fields of
use Territory—Worldwide vs. geographic
restrictions Right to sublicense Royalty rate and sharing of sublicensing
revenues Term or duration
27
Licensing Issues in a University Setting
Inventor in University setting is required to disclose invention to University
University will evaluate and decide whether to patent
If University pursues patent it will become the owner of the patent
Inventor must then license the technology from the University in order to commercializeo Typically the University receives 40%, the Inventor
receives 40%, and Inventor’s Department receives 20%
28
Licensing Issues in a University Setting
University will frequently license a patent of a startup company owned by an inventor if the startup is serious about commercializing the technology:o Be a company rather than an individual inventoro Be capable of meeting market demando Have a written plan to commercialize the
technologyo Address conflicts of interest, such as time
constraints for faculty, influence over students, influence on junior faculty, effect on research
29
11
Licensing Issues in a University Setting
Due Diligence milestones Minimum royalty payments Repayment of patent costs advanced by
University Equity in startup to be taken by University? Issue fee License of trademarks otm.illinois.edu
30
Hot Topic—IP Agreements
It is important to execute agreements between a company and its founders, employees and independent contractors to ensure that any IP is either owned or assigned to the company
Key Termso Assignment of IPo Works Made for Hireo Confidentiality
Shop Right – Without proper agreements in place, an employer’s rights in an invention may be limited to a “Shop Right,” meaning the employer receives a royalty free right to practice the patent, but the employee would own the patent
31
Hot Topic—Open Source Software
Open Source software may reduce a company’s costs and increase revenues, but has many pitfalls
“Open Source” does not have a single definition, and includes many variations:o GPL, LGPL, Apache, BSD, MIT
Benefits of using open source software:o Reduce costs; develop user communities; create revenue
streams from servicing; “dual licensing” Risks of using open source licenses
o Use of small parts of open source software in a larger program may require you to license the larger program under a specific open source license; loss of control of your IP; some investors and acquirers disfavor the use of open source
32
12
Hot Topic—SBIR/STTR SBIR and STTR funds are an excellent resource for tech
companies, but proper IP management is important The following considerations should be taken:
o STTR – negotiate favorable IP terms with University partnero SBIR/STTR – negotiate favorable IP terms with any prime or sub
contractorso Proposals – identify and mark any confidential information or it
may be disclosedo Deliverables
― Review relevant FARs and DFARs― Identify eligible data and assert any restrictions on data rights― Maintain records to justify any restrictions
o Proper procedures can increase the likelihood of a sole-source Phase III award
33
Hot Topic—EULAs
EULA provides the terms under which the customer may use the softwareo Sale v. License
Generally “Shrink-Wrap” and “Click-Wrap” licenses are enforceable, but the following should be considered, depending on the circumstances:o Allowing the purchaser to have the option of returning
the software if it does not agree with licenseo The terms of the license should be visible prior to
acceptance (i.e., do not link terms)o Use of language such as “By clicking this button I
agree to the terms” should be used as opposed to “download”
34
Why do Companies Care about IP?
Freedom to Operate—Ensure that someone else’s IP will not prevent your company from carrying out its business objectives
Competitive Advantage—Protect your company’s IP to acquire a competitive advantage in the marketplace by precluding others from using it
35
13
IP Protection
Alan R. SingletonSingleton Law Firm, P.C.
R e s e a r c h P a r k a t t h e U n i v e r s i t y o f I l l i n o i s2 0 0 1 S . F i r s t S t . , S u i t e 2 0 9C h a m p a i g n , I L 6 1 8 2 0 - 3 6 5 4
(217 ) 352 -3900 phone(217 ) 352 -4900 fax
s ing le ton@sing le ton lawf i rm.comw w w.s ing le ton law f i rm.com
© 2 0 1 3 A l a n R . S i n g l e t o n
Patent Reform As of 8/17/2015
Alan R. Singleton, Esq. [email protected]
Research Park at the University of Illinois 2001 S. First St., Suite 209 Champaign, IL 61820 217-352-3900
1
Judicial:
Issue Case Prior Law Holding Effect
Permanent Injunctions
eBay v. MercExchange,
547 U.S. 388 (2006)
Irreparable damage is presumed in cases of
patent infringement, and a permanent injunction is
warranted absent exceptional
circumstances.
The general four-factor test for determining whether a
permanent injunction should issue outside the patent infringement context is
applicable to patent infringement cases. The factors courts
consider are: (1) irreparable injury, (2) insufficient remedies in law, (3) balance of hardships,
and (4) public interest.
It is more difficult to obtain a permanent injunction following
a finding of patent infringement. Lower courts have interpreted the case as
eliminating the presumption of irreparable damage, and some courts have refused to issue
permanent injunctions unless the patent owner manufactures a product and the infringer is a
competitor.
Declaratory Judgment Suits by
Licensees
MedImmune v. Genentech, 549 U.S. 118 (2007)
In order to bring a declaratory judgment action concerning the
validity or enforceability of a patent, a licensee must first terminate or
breach the license agreement.
A licensee is not required to terminate or breach a license agreement prior to bringing a declaratory judgment action.
Allows licensees to “pay and sue” and may encourage
litigation. Because of the low bar, patentees should be aware that a claim of infringement is likely sufficient to afford the alleged accused declaratory
judgment jurisdiction.
Obviousness KSR v. Teleflex,
550 U.S. 398 (2007)
Obviousness is determined by
application of the Teaching, Suggestion, and Motivation (TSM)
Test.
Although the TSM Test is relevant, obviousness is to be
considered in light of the more flexible Graham factors, and
requires: (1) a determination of the scope and content of prior art, (2) ascertainment of the
differences between the prior art and the claims, (3) a
determination of the level of ordinary skill in the pertinent art,
and (4) consideration of secondary factors such as
commercial success, long felt but unresolved needs, and failure
of others.
KSR lowers the burden that a PTO Examiner must meet to establish obviousness, which
makes it more difficult to both obtain a patent in the first
instance and defend against invalidity challenges after
issuance.
Extraterri-torial
Enforcement of U.S. Patents
Microsoft v. AT&T, 550 U.S.
437 (2007)
§ 271(f) of the Patent Act provides that, in
derogation of the general rule, infringement occurs
when one supplies a patented invention’s components from the U.S. for combination
abroad.
Software, in the abstract, is not a component under § 271(f),
although copies of software are. Therefore, because Microsoft
only supplied a master disk from which copies were made for
installation, it did not infringe on AT&T’s patent.
By narrowing the scope of §271(f), the Court has made it more difficult for holders of
U.S. patents to allege infringement for uses in foreign jurisdictions in which the U.S.
patent holders do not hold patent rights. This decision
may increase the need for U.S. patent holders to apply for
patent rights abroad.
2
Issue Case Prior Law Holding Effect
Scope of Patent
Exhaustion Defense
Quanta Computer v. LG Electronics,
553 U.S. 617 (2008)
The doctrine of patent exhaustion, which
provides that a patented item’s initial authorized sale terminates all patent rights to that item, does
not apply to method patents.
The patent exhaustion doctrine applies to method patents when either of the following occurs:
(1) an authorized license is agreed upon or (2) a sale of
items that substantially embody the patent occurs.
By eliminating the exception of method patents from the patent
exhaustion doctrine defense, the ability of method patent
holders to enforce their rights against downstream infringers
is reduced. Method patent holders must rely on robust
protections through contracts for the sale or license of
products embodying their patents.
Willfulness Standard
In re Seagate, 497 F.3d 1360 (Fed.
Cir. 2007)
Willful infringement requires a showing of
failure to exercise “due care.” When a potential infringer has notice of another’s patent rights, he has an affirmative duty of due care to
determine whether he is infringing (e.g. by
obtaining competent legal advice).
Willful infringement requires a showing of “objective
recklessness” by clear and convincing evidence, i.e. the
infringer acted despite an objectively high likelihood that
its actions constituted infringement of a valid patent.
By raising the standard for willful infringement and
reducing the need to obtain an exculpatory opinion of counsel, the court made it more difficult
for patent holders to prove willful infringement.
Patentable Subject Matter
Bilski v. Kappos, 561 U.S. __ (June
28, 2010))
A method or process is patentable under § 101 of the Patent Act if it is
tied to a particular machine or apparatus, or it transforms an article from into a different
state or thing. This is the machine-or-
transformation test.
The “machine or transformation” test is not the sole test for patent
eligible subject matter.
A method or process can be patentable even if it does not
pass the machine or transformation test. A method or process is not patentable if it
is an abstract idea.
Ownership of Inventions Made With
Federal Grant
Stanford v. Roche, 563 U.S. __ (June
6, 2011)
The Bayh-Dole Act allowed federal
contractors, i.e. research institutions and
universities, to “elect to retain title” to inventions
generated through federal funding.
Patent rights initially vests in the inventor and the Bayh-Dole Act
has not changed this.
For federal contractors such as research institutions and
universities to have title to an invention of an employee, there must be an actual assignment of
the invention rights. A contractual duty to assign is not
enough.
Patent Invalidity;
Standard of Proof
Microsoft v. i4i Limited
Partnership, 564 U.S. __ (June 9,
2011)
A patent is presumed valid, and the
presumption of validity can only be overcome by showing that the patent is invalid by clear and convincing evidence.
An invalidity defense must be proven by clear and convincing
evidence even where the defense is based on prior art not
considered by the Patent Office during examination of the patent
application.
The Court affirmed that when claiming patent invalidity as a
defense the defendant must prove invalidity by clear and
convincing evidence.
Patentable Subject Matter
Mayo Collaborative
Services v. Prometheus
Laboratories, 566 U.S. __ (March
20, 2012)
A method or process can be patentable under §
101 of the Patent Act if it is tied to a particular
machine or apparatus, or it transforms an article into a different state or
thing.
A claim that recites a law of nature or natural correlation, in
combination with additional steps that are well understood, routine, conventional activity
previously engaged in by researchers in the field, is not
patentable.
A method or process claim that recites a law of nature or
natural correlation should have additional features or steps that are more than well understood, routine, conventional activity
previously engaged in by researchers in the field.
3
Issue Case Prior Law Holding Effect
Patentable Subject Matter
Association for Molecular
Pathology v. Myriad Generics, 569 U.S. __ (June
13, 2013)
Nonnaturally occurring manufactures and
compositions of matter are patent-eligible under § 101 of the Patent Act, but naturally occurring
phenomena are not.
An isolated DNA segment is a naturally occurring phenomenon and is not patent-eligible, but a
synthetically created complementary DNA molecule
is patent eligible.
Patent claims in the field of molecular biology should not claim isolated DNA segments, but may claim synthetic DNA molecules, innovative methods
of manipulating DNA molecules, etc.
Fee Shifting
Octane Fitness, LLC v. Icon Health and
Fitness, Inc., 572 U.S. __ (April 29,
2014)
In “exceptional” patent cases, courts may award
attorney fees to the prevailing party;
standards for finding cases to be “exceptional”
are high and rigorous.
Standards for finding patent cases to be “exceptional” are
now lowered; “exceptional” cases are those that stand out with respect to strength of a party’s litigating
position, or unreasonable manner of litigation.
Courts now have greater discretion to shift attorney fees in patent cases on a case-by-
case basis.
Invalidity for
Indefinite Patent
Claiming
Nautilus, Inc. v. Biosig
Instruments, Inc., 572 U.S. __ (June
2, 2014)
A patent claim cannot be invalidated for
indefiniteness as long as a court can reasonably
construe the meaning of the claim.
Current standard overturned; to meet the definiteness
requirement, a patent claim must inform those skilled in the art
about the scope of the invention with reasonable certainty.
The degree of clarity required in patent claims has been
heightened, and also depends on the specification and
prosecution history of the patent.
Patentable Subject Matter
Alice Corp. Pty. Ltd. v. CLS Bank Intern., 573 U.S.
__ (June 19, 2014)
Rulings on the patent eligibility of computer-implemented methods
are conflicted and inconsistent, particularly on appeal at the Federal
Circuit.
An abstract idea that is not patent-eligible by itself does not become patent-eligible solely by
implementation on a “generic computer.” Reiteration of Mayo
test for patent-eligibility.
A patent for a computer implementation of an abstract
idea must claim not just applying the idea to a “generic
computer” but also include some additional feature, like
improving the computer’s function or solving a
technological problem.
Claim Construction
in Patent Litigation
Teva Pharmaceuticals
USA, Inc. v. Sandoz Inc., 574 U.S. __ (January
20, 2015)
When a trial court makes rulings on the meaning
and scope of patent claims, no deference is
given to those rulings on appeal.
Claim construction is a question of law and remains subject to no deference on appellate review;
however, when the claim constructions are supported by
subsidiary factual findings based on extrinsic evidence, those
findings are entitled to greater deference, and can only be
overturned if made in clear error.
It may now be more difficult for patent claim constructions
by a trial court to be overturned on appeal under some
circumstances, but only if the trial court relied upon extrinsic
evidence to arrive at those claim constructions.
Liability for Inducing
Third-Party Infringement
Commil USA, LLC v. Cisco Sys., Inc., 575 U.S. __ (May
26, 2015)
A defendant cannot be held liable for inducing patent infringement if
the defendant believed in good faith that the patent
is invalid, even if that belief was incorrect.
If a defendant’s belief that a patent was invalid was incorrect,
this belief does not serve as a defense to induced patent
infringement.
A business that sells products that may infringe a patent when
used by a customer cannot insulate itself from
infringement liability by preparing an invalidity opinion.
Patent Infringement
Akamai Technologies Inc.
v. Limelight Networks, Inc., No. 2009-1372
(Fed. Cir., August 13, 2015)
Even if a defendant does not perform all of the
steps of a patent method claim, it can be liable for direct infringement if the
remaining steps were performed through an agent, a contractual
relationship, or a joint enterprise.
A defendant can also be liable for direct infringement if it instructed another party to
perform the remaining steps as a condition of receiving some
service or benefit.
A business can now be liable for patent infringement as a
result of the actions of customers under the business’s
instructions or directions.
4
America Invents Act, September 16, 2011:
The Patent Reform Act of 2011, also known as the Leahy-Smith America Invents Act (H.R. 1249), became law on September 16, 2011. The Act introduced many important changes to U.S. patent laws, some of which became effective upon enactment, while others did not take effect until at least one year after enactment. Below is a brief overview of some of the important provisions of the Act.
• First to File – The first inventor to file an application for patent on an invention is entitled to a patent. This is a change from the old law, which allowed a subsequent applicant to show that she is the first inventor and therefore entitled to a patent on the invention. The Act also establishes a Derivation Proceeding to allow an applicant who is not the first filer to challenge the claims of the first filer on the basis that the first filer derived the invention from the challenger. This provision applies to any application having an effective filing date on or after March 16, 2013.
This change in the law brings the U.S. patent system more in line with the majority of industrialized nations. It provides an incentive for an inventor to file earlier rather than later and to file before any disclosure of the subject matter of the invention is made to others. A first-to-file system can work to the disadvantage of a small business or independent inventor who may not have the financial resources to compete with larger companies, which may have the resources to file earlier and more prolifically. On the other hand, the change to a first-to-file system provides clarity and will perhaps reduce the need for costly inventorship disputes.
• Prior Art Exception – The Act provides inventors with a narrower one-year grace period to file a patent application where the subject matter of the application has already been disclosed to the public. This Prior Art Exception is narrow and only applies where the subject matter was disclosed by the inventor or someone who obtained the subject matter from the inventor. In contrast, the previous law provided a one-year grace period not only for disclosures originating from the inventor, but also for any disclosure (any patent or publication, any public use or sale in the United States), as long as it is made within one year of the date of filing. The narrower Prior Art Exception results in a broadening of the universe of prior art that can be applied against a patent application, thereby providing further incentive for an early filing.
Under the previous law, a sale or an offer for sale also provided for the one-year grace period. Under the current law, it is generally understood that sales or offers for sale (by the inventor or someone who obtained the subject matter from the inventor) still provide the one-year grace period, although some believe that this distinction may require clarification by courts.
• Post-Grant Review – Any person who is not the inventor can request that the patent office review the validity of an issued patent, within nine months of patent issuance, on any grounds of patentability. This is effective one year from the date of enactment and applies to all patent applications.
• Inter Partes Review – Any person who is not the inventor can request that the patent office review the validity of an issued patent, after nine months from patent issuance, for novelty and non-obviousness based on prior art patents and printed publications only. This is effective one year from the date of enactment and applies to all patent applications.
• Third Party Pre-Issuance Submission & Comment – Any third party can submit to the Patent Office a publication thought to be relevant to a pending patent application. Only patents, published applications or other printed publications can be submitted. Submissions must be made within a certain time period. This is effective one year from the date of enactment and applies to all pending patent applications.
This provision enables the public to have an effect on the examination of a patent application, with the intended result being improved patent quality and reduced patent litigation expenses.
5
• Supplemental Examination – This allows a patentee to request that the Patent Office consider, reconsider or correct information in a patent if the patentee has information that raises a substantial new question of patentability. This is effective one year from the date of enactment and applies to all patents.
• Micro-entity – A new class of applicants are eligible for further reduced fees. A micro-entity must: (1) qualify as a small entity, (2) the inventor must have no more than four previously filed patent applications, (3) have a gross income below a designated level and not have transferred ownership to an entity with income exceeding this limit. This provision is effective on the date of enactment.
• Best Mode – The failure to disclose the best mode is no longer a basis to establish that a claim is invalid or unenforceable. This provision is effective on the date of enactment and applies to proceedings that commence on or after the date of enactment.
• Prior User Rights – Any party using an invention before another files a patent application will have a patent infringement defense based on prior use.
• Markings – Virtual marking, i.e. a marking that directs the public to a freely accessible website showing a patented article and its patent number, can now be used to give the public notice that an article is patented. This provision is effective on the date of enactment and applies to all cases pending on the date of enactment or commenced on or after the date of enactment.
• False marking – Only the U.S. government can bring a lawsuit seeking a penalty for false marking, and only a person who has suffered a competitive injury from false marking can file a civil action to recover damages.
Alan R. Singleton, Esq.
Large EntitySmall Entity (paper filing)
Small Entity (electronic
filing) Micro Entity
$1,600.00 $800.00 $730.00 $400.00
$960.00 $480.00 $480.00 $240.00
$1,600.00 $800.00 $800.00 $400.00
$3,600.00 $1,800.00 $1,800.00 $900.00
$7,400.00 $3,700.00 $3,700.00 $1,850.00$15,160.00 $7,580.00 $7,510.00 $3,790.00
$420.00 $210.00 $210.00 $105.00
$80.00 $40.00 $40.00 $20.00
$260.00 $130.00 $130.00 $65.00$260.00 $130.00 $130.00 $65.00
Information provided on this chart is intended to be general information only, in the nature of advertising. You should consult your attorney when making legal or business decisions and should not rely upon the content of this chart. Alan Singleton is licensed to practice law in the state of Illinois and is a patent attorney registered to practice before the U.S. Patent and Trademark Office. © 2012 Alan R. Singleton - www.singletonlawfirm.com
2001 South First Street, Suite 209 Champaign, IL 61820 217-352-3900
USPTO Patent Filing Fees (Effective Jan. 1, 2014)
Maintenance Fee – 3.5 yrs.
Maintenance Fee – 7.5 yrs.
Total Fees
Total Fees
Maintenance Fee – 11.5 yrs.
Utility Patent Application, Issuance, and Post-Issuance:
Provisional Patent Application:
Filing Fee (Including Search and Examination Fees)
Additional Claims Fees (per independent claim beyond first 3)Additional Claims Fees (per claim beyond first 20)
Filing Fee
Issue Fee
Note: The above information is accurate to the best of our knowledge and based on numbers published on the USPTO website as of 1/8/2014. Actual fees may vary based on individual situations.
Alan R. Singleton, Esq.
Application Under 1(a)
Intent to Use Application Under 1(b)
$375.00 $375.00
$325.00 $325.00
$275.00 $275.00
$225.00 $225.00
$100.00
$150.00Minimum Filing Fees $225.00 $325.00
$100.00 $100.00
$100.00 $100.00
$300.00 $300.00
$100.00 $100.00
3 The §8 Affidavit and Renewal Applications may be filed up to six-months after their respective deadlines with the payment of the late fee.
Renewal Fees
Request for Six-month Extension of Time to File Statement of Use
Statement of Use
2 Must be filed within one year of each ten year anniversary of registration, e.g. years nine and ten, nineteen and twenty, and so on, provided that the mark is still being used in commerce.
Basic USPTO Trademark Filing Fees (effective Jan. 17, 2015)
Application and Prosecution Fees
Application per International Class (electronic filing, TEAS)
Application per International Class (paper filing)
Information provided on this chart is intended to be general information only, in the nature of advertising. You should consult your attorney when making legal or business decisions and should not rely upon the content of this chart. Alan Singleton is licensed to practice law in the state of Illinois and is a patent attorney registered to practice before the U.S. Patent and Trademark Office. © 2009 Alan R. Singleton - www.singletonlawfirm.com
2001 South First Street, Suite 209, Champaign, IL 61820 phone 217-352-3900 fax 217-352-4900
Application for Renewal Late Filing Fee3
Application for Renewal2§8 Late Filing Fee3
§8 Affidavit of Use1
Application per International Class (electronic filing, TEAS Reduced Fee)
Notes: The above amounts represent only the USPTO Filing Fees, and do not include professional time necessary to prepare and prosecute trademark applications. The above information is acurate to the best of our knowledge and based on numbers published on the USPTO website as of 1/12/2015, and is subject to change. Actual fees may vary based on individual situations
1 Must be filed between the fifth and sixth year anniversary of registration, and therafter within one year of each successive ten year anniversary of registration, e.g. between years nine and ten, nineteen and twenty, and so on, provided that the mark is still being used in commerce.
Application per International Class (electronic filing, TEAS Plus)
1
Al an R . S i ng l e t on
S i n g l e t o n L a w F i r m , P. C .
R e s e a r c h P a r k a t t h e U n i v e r s i t y o f I l l i n o i s
2 0 0 1 S . F i r s t S t . , S u i t e 2 0 9
C h a m p a i g n , I L 6 1 8 2 0 - 3 6 5 4
( 2 1 7 ) 3 5 2 - 3 9 0 0 p h o n e
( 2 1 7 ) 3 5 2 - 4 9 0 0 f a x
s i n g l e t o n @ s i n g l e t o n l a w f i r m . c o mw w w. s i n g l e t o n l a w f i r m . c o m
The Small Business Innovative Research (SBIR) Program:Intellectual Property & SBIR Awards
Presentation Outline
I. The SBIR Program― General Information
II. Qualifying for SBIRIII. The SBIR Process
― Proposals― Phase I― Phase II― Phase III & Sole Source Awards
IV. IP Rights in Government Contracting GenerallyV. IP Rights & SBIR
― Types of Data Rights Unlimited Data Rights SBIR Data Rights Limited Data Rights Restricted Data Rights
― Protecting IP within the SBIR Program
I. The SBIR Program
The SBIR Program provides funding for early stage R&D that serves a need and has the potential for being commercialized in the private sector.
Participating Agencies Include:―USDA, DoC, DoD, ED, DoE, NSF, HHS, DHS,
DoT, EPA, & NASA
2
SBIR- Objectives
The objective of the SBIR Program is to increase the participation of small businesses in meeting federal research and development needs.
The SBIR Program is also meant to increase small business commercialization of technology through the use of federal research and development funds.
Small Business Administration
The SBIR Program is administered by the U.S. Small Business Administration (SBA).
The SBA is an independent government agency whose mission it is to aid, counsel, assist, and protect the interests of small business concerns, to preserve free competitive enterprise, and to maintain and strengthen the overall economy of our nation.
The Small Business Technology Transfer (STTR) Program
Involves a small business cooperating with a non-profit research institution (usually a public University).
Most of the information applicable to the SBIR program is likewise applicable to STTR.― Intellectual property rights between the small
business and the research institution must be governed by private agreement between the parties.
3
SBIR - Benefits
Awards are grants, not loans. Significant opportunity due to number of
agencies that participate in the program. Alternative to venture capital funding. Establishes credibility for small business, which
can, in turn, attract future venture capital funding.
Establishes a position from which it is possible to become a sole source provider.
Small businesses generally retain IP rights.
Agency Differences: Grants v. Contracts
Grant Contract
Agencies USDA, ED, DoE, HHS, & NSF DoC, DoD, ED, HHS, DHS, DoT, EPA, & NASA
Mission Promote R&D to benefit society and the economy of
the nation.
R&D is meant to satisfy a specific need of the contracting agency.
Control Business has control over thrust of the R&D and
approach taken.
Agency defines the plan, protocols, and objectives
of R&D itself.
Commercialization Opportunities usually come from outside of the agency itself, often in the private
sector.
Opportunities usually come from the contracting
agency itself.
Agency Differences
Some agencies (non-DoD) use FARS and others (DoD) use DFARS.
It is important to check agency websites for individual SBIR programs and the rules governing such.
All agencies are different!
4
II. Qualifying for SBIR
In order to qualify for an SBIR award, a small business must meet certain required criteria-― Business must be independently owned and
operated, and organized for profit.― Business, including its affiliates, must have fewer
than 500 employees.― Business’ principal place of business must be
located within the United States. ― Business must be a minimum of 51% owned and
controlled by one or more persons who are citizens of, or permanent residents in, the United States.
Qualifying for SBIR Cont’d
― In the performance of an SBIR award all R&D must be performed in the United States.
― Small business must perform at least 67% of the work under SBIR Phase I, and at least 50% of the work under Phase II.
― The Primary Researcher must be at least 51% employed by the small business receiving the SBIR award, and must work a minimum of three hours per week, and at least one calendar month total on any Phase I award.
III. The SBIR Process- Proposals
Participating agencies solicit proposals regarding research and development topics that they are interested in.―Unsolicited proposals are NOT accepted
Proposals are judged in two stages-― Required Qualifications― Evaluative Process
Typically, about one in five proposals wins an SBIR Phase I award.
5
The SBIR Process- Phase I
SBIR Phase I is the Potentiality/Feasibility study stage.
Phase I is typically a period of six months or less.
Phase I awards typically range from $75,000 to $150,000 depending upon the agency providing the award.
The SBIR Process- Phase II
SBIR Phase II is the concept development stage.
Phase II is an outgrowth of Phase I.Awards are typically for a period of up
to two years.Awards generally range from $300,000
to $1,000,000.
The SBIR Process- Phase III
SBIR Phase III is the commercialization stage.
Phase III is work that derives from, extends, or logically concludes effort(s) performed under SBIR funding agreements.
Funding must come from outside of the SBIR Program.
6
Advantages of SBIR Phase III
No limits on: number of Phase III awards, duration or amount of the funding agreement, amount of time that can elapse between Phases I or II and Phase III, amount of time that can elapse between one Phase III award and another Phase III award, type of funding agreement, or size of the business receiving the award.
Phase III may be funded by a different federal agency than funded Phases I or II.
SBIR Phase III & Sole Source Awards
Sole Source Awards are contracts for the purchase of supplies or services that are entered into by an agency after soliciting and negotiating with only one source.
SBA encourages the agency to award Phase III to the small business that completed Phases I or II as a sole source award, but the agency is not required to do so.
SBIR Phase III & Sole Source Awards Cont’d
Sole source awards under Phase III are still considered SBIR awards, which is very important due to the implications this has on protecting IP rights.
By properly marking their IP the small business can increase the likelihood of receiving a Phase III award due to the technological monopoly they may have as a result.
If the Government wishes to use the technology they must contract with the owner of the IP, usually in the form of a sole source award.
-Govt can’t use SBIR Data for procurement.-Must deal with the holder of the SBIR Data Rights.
7
SBIR Phases- Summary
SBIR Phase I SBIR Phase II SBIR Phase III
Funding $75,000 -$150,000
$300,000 -$1,000,000
No limit on funding amount. Must come from outside of the SBIR Program
Duration 6 Months 2 Years No limit on duration.
Purpose / Stage
Feasibility / Potentiality
Concept Development
Commercialization
IV. Intellectual Property and the Federal Government
General Rule-―When IP is created with federal funding, whether
through a grant, contract, or cooperative agreement; the contractor will retain title to the IP and the Government will receive a nonexclusive, royalty-free license to use the IP for governmental purposes.
FARS & DFARS govern IP allocation between the Government and private contractors.
V. Intellectual Property Rights & SBIR
Under SBIR the Government has several different types of data rights depending upon which category of data the material falls into.―Unlimited Data Rights―SBIR Data Rights―Limited Data Rights―Restricted Data Rights
8
Unlimited Rights Data
In certain qualifying data, known as Unlimited Rights Data, the Government has the right to use, modify, reproduce, release, perform, display, or disclose technical data or computer software, in whole or in part, in any manner and for any purpose, and to have or authorize others to do so.
If possible, the small business should attempt to categorize their data as anything except Unlimited Rights Data
Unlimited Rights Data Cont’d
FARS DFARSUnlimited Rights Government receives
Unlimited Rights to all data that is not SBIR Data, Limited Data, or Restricted Data
Government automaticallyreceives Unlimited Rights in-OITM Data, Changes/Corrections to technical data or computer software provided by the Government, FFF Data, Data to which the Government already has unlimited rights, Publicly available data, & Expired SBIR Data
SBIR Data Rights
SBIR Data - Govt, including its support service contractors, obtains a royalty-free license to use, modify, reproduce, release, perform, display, or disclose technical data or computer software generated and delivered under the contract for any Government purpose (except procurement).
Does not prevent the Government from disclosing data to its support service contractors who could conceivably be the small business’ competitors.
- Anyone to whom the data is disclosed is bound by the SBIR Data Rights, however, and must also sign a non-disclosure agreement. - Can only use the data for governmental purposes, not
commercial purposes. - Government cannot disclose data for procurement purposes.
- Small business retains all rights to commercial applications but may potentially be placed in competition for future Government contracts, such as Phase III awards.
9
SBIR Data Rights Cont’d
Technical Data in the SBIR context is defined as-―Any recorded technical information
developed in the performance of the SBIR award. Reports Diagrams, Drawings, and Charts Invention disclosures Software documentation Probably does not include prototypes/samples
SBIR Data Rights Cont’d
FARS DFARSSBIR Rights Government receives SBIR
Data Rights in data that is not generally known or made available to othersand is first produced by a contractor under an SBIR award.
Government receives SBIR Data Rights for all technical data generated under the contract and not among the data to which the government automatically receives Unlimited Rights.
Duration 4 years after the completion of the last SBIR award.
5 years after the completion of the last SBIR award.
Acquiring/Selling SBIR Data Rights
If another business acquires the SBIR business, the acquiring business then owns the SBIR Data Rights provided that the SBIR Data Rights were part of the overall acquisition.
The SBIR business can sell its Data Rights without selling the company and the acquiring business can then assert the SBIR Data Rights themselves.
10
Limited Rights Data
Under both FARS and DFARS Limited Rights Data is technical data that is developed exclusively at private expense.
Limited Rights only allow the Government to use and disclose the Limited Rights Data within the Government, with few exceptions.
Restricted Computer Software (FARS)Restricted Rights Data (DFARS)
Non-commercial computer software developed exclusively at private expense.
Restricted Rights only allow the Government to use and disclose the Restricted Rights Data within the Government with few exceptions.
Government Data RightsUnlimited Data Government has the right to use, modify, reproduce, release, perform,
display, or disclose data, in whole or in part, in any manner, and for any purpose, and to have or authorize others to do so.
SBIR Data
<will convert to Unlimited Data 4 (FARS) or 5 (DFARS) years from completion of last SBIR >
Does not prevent Govt from disclosing data to its support service contractors who could be the small business’ competitors.- Anyone to whom the data is disclosed is bound by the SBIR Data Rights, however, and must also sign a non-disclosure agreement.- Can only use the data for governmental purposes, not commercial purposes.- Government cannot disclose data for procurement- Small business retains all rights to commercial applications but may potentially be placed in competition for future Government contracts, such as Phase III awards.
Limited Data Government can only use and disclose data outside the government in certain exceptional circumstances. (developed at private expense)
Restricted Data Government can only use and disclose data outside the government in certain exceptional circumstances.
Government Data Rights- Summary
11
FARS v. DFARS- Summary
FARS DFARSUnlimited Rights All data not specifically excluded
by other provisions of FARS; Data that is not SBIR, Limited, or Restricted Data
OTIM Data, Changes/Corrections to Government data, FFF Data, Publicly available data, Expired SBIR Data
SBIR Rights Data that is not generally known or made available to others and is first produced by a contractor under an SBIR award.
Technical data generated under contract and no among the data to which the Governmentautomatically receives Unlimited Rights
Limited Rights Technical data developedexclusively at private expense.
Technical data developedexclusively at private expense.
Restricted Rights Non-commercial computer software developed exclusivelyat private expense.
Non-commercial computer software developed exclusively at private expense.
Protecting Intellectual Property
In order to protect IP, a business must mark all proprietary data that is protectable before it is delivered to the agency.
Correctly marking data as proprietary is absolutely essential to maintaining IP rights over such data.
Protecting IP - Night Vision (Case Study)
Night Vision v. United States is a perfect example of why properly protecting proprietary data is so vital.
Night Vision involved a SBIR Phase II award for night vision goggles (NVG).
Upon delivery Night Vision marked its data as proprietary but failed to do so in accordance with DFARS provisions.
USAF provided competitors with data during solicitation of bids to produce NVG.
12
Protecting IP - Night Vision Cont’d
One of Night Vision’s competitors was Insight Technology, a subcontractor during the Phase II award.
By improperly marking their proprietary data the Government obtained Unlimited Data Rights as a result.
Government was within its rights to provide Night Vision’s competitors with the data and Insight ended up getting the Government contract.
The court refused to create an exception to strict compliance with the marking requirements of FARS & DFARS.
Protecting IP - Proposals
It is important for a business considering making an SBIR proposal to take steps to protect their IP throughout the proposal process.
In order to protect IP contained within the proposal, the small business must correctly mark such material as proprietary, in accordance with the agency’s rules, FARS, or DFARS.
Protecting IP – Proposals Cont’d
When making a SBIR proposal a small business grants the Government the right to reproduce and use the material provided in the proposal for the sole purpose of evaluation.
If the agency decides to grant the business an SBIR award, the Government then has the right to use, modify, reproduce, release, perform, display, or disclose the material provided in the proposal within the Government
13
Protecting IP - Deliverables
The culmination of an SBIR Phase is when the small business delivers the final product/data to the agency.
In order to properly protect their IP businesses must first identify the types of data that it is delivering to the agency, and then properly mark protectable data as proprietary.
Protecting IP- Deliverables Cont’d
FARS DFARSDeliverable Data Business must
furnish agency with UnlimitedRights Data, SBIR Data, and any other data specifically required by the contract.
Business must provide the agency with all data, regardlessof which category the data falls into.
Protecting IP- Subcontractors
If a subcontractor is used in the performance of an SBIR award another relationship is created and IP must be allocated between the parties through private agreement (FARS and DFARS do not apply to the relationship).
Private IP Agreements must address several important issues-― IP Ownership― Right to conduct follow-up research― Right to any awards stemming from that research― Responsibility for expenses― Confidentiality and non-disclosure provisions
14
Protecting IP – Additional Protections
Agencies may not make the issuance ofan SBIR award, including Phase III,conditional on the small business waivingtheir data rights.
Links to SBIR Resources/Websites
SBA Resources (www.sba.gov) SBA Proposal Handbook
(osbdc.org/Documentmaster.aspx?doc=1036) USDA (www.csrees.usda.gov/funding/sbir/sbir.html) DoC (oar.noaa.gov/orta) (nist.gov/sbir) DoD (dodsbir.net/) (www.acq.osd.mil/osbp/sbir) ED (ed.gov/programs/sbir) DoE (http://science.energy.gov/sbir) HHS (http://grants1.nih.gov/grants) DHS (https://sbir2.st.dhs.gov/portal/SBIR) DoT (www.volpe.dot.gov/sbir) EPA (es.epa.gov/ncer/sbir) NASA (sbir.gsfc.nasa.gov/SBIR) NSF (nsf.gov/eng/iip/sbir)
Al an R . S i ng l e t on
S i n g l e t o n L a w F i r m , P. C .
R e s e a r c h P a r k a t t h e U n i v e r s i t y o f I l l i n o i s
2 0 0 1 S . F i r s t S t . , S u i t e 2 0 9
C h a m p a i g n , I L 6 1 8 2 0 - 3 6 5 4
( 2 1 7 ) 3 5 2 - 3 9 0 0 p h o n e
( 2 1 7 ) 3 5 2 - 4 9 0 0 f a x
s i n g l e t o n @ s i n g l e t o n l a w f i r m . c o mw w w. s i n g l e t o n l a w f i r m . c o m
The Small Business Innovative Research (SBIR) Program:
Protecting Intellectual Property During SBIR Awards
Section: Table of Contents
INTELLECTUAL PROPERTY AUDIT CHECKLIST Alan R. Singleton
Singleton Law Firm, P.C.
Contents
Establishing the Goals of Your Audit ............................................................................... 2 Identification of Potential Intellectual Property ................................................................. 3 Classification of Intellectual Property............................................................................... 5 Identification of the Documents Relating to Intellectual Property .................................... 8 Examination of the Documentation ................................................................................. 9 Identify Owners ............................................................................................................. 11 Confirming Validity ........................................................................................................ 12 Retrospective Protection of Identified Intellectual Property ........................................... 14 Prospective Protection of Intellectual Property .............................................................. 21 Methods for Conducting the Audit ................................................................................. 27 Final Product ................................................................................................................. 28
1 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Establishing the Goals of Your Audit
Establishing the Goals of Your Audit Why are you conduction an audit?
□ Establishing procedures? □ Preparing for a sale, purchase or license? □ In contemplation of litigation? □ Making sure all IP is “in the box.”
What will the scope be? What assets will be involved?
□ Broad Overall review of procedures and policies Developing an index of all intellectual property
□ Narrow Focus on a specific asset for purposes of sale, purchase or license
□ Generic Overview of IP Sources
What do you want the final product of the audit to be?
□ Comprehensive snapshot of your intangible assets and related procedures? □ List of new procedures to be implemented? □ Index of catalogue of all intangible assets? □ Phone call or in person meeting for items where it would be better not to
reduce the findings to writing.
2 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Identification of Potential Intellectual Property
Identification of Potential Intellectual Property Identify all potential intangible assets; each element of the Company’s:
□ Inputs Independent contractors Suppliers Vendors Customers Third party research
□ Resources and processes
Identify the source(s) of each of the Company’s: • Processes & production information, know-how & negative
know-how • Machines & manufacturing information • Customer lists & confidential customer information, reports &
analyses • Operation & design manuals • Designs, drawings diagrams & artwork • Ideas & plans • Technology information • Formulas & calculations • Compounds • Prototypes • Laboratory notebooks & experiments • Experimental, analytical & design data • Vendor & supplier information • R&D information, reports, know-how & negative know-how • Cost, price, profit, loss & margins data, reports & analyses • Quality control information, procedures, manuals & records • Maintenance know-how & negative know-how • Sales & marketing information, reports, forecasts & plans,
advertising materials • Financial information, documents, budgets & forecasts • Computer printouts, operating reports • Administrative & managerial information, key decision
makers, internal organization • Computer software & source code • Creative individual works & collaborative works
3 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Identification of Potential Intellectual Property
□ Outputs Identify all potential marks for company products/services by
reviewing packaging, marketing literature and advertising. Identify all creative works. Identify all potentially proprietary information reports, data &
analyses resulting from processes, R&D, management, marketing and customer relations.
□ Relationships
What inputs and internal sources are related to the corresponding outputs?
4 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Classification of Intellectual Property
Classification of Intellectual Property Intangibles can be protected if they fit under any one of the following categories:
□ Trade Secret Is it generally known or readily ascertainable?
• If yes, then there is no trade secret as trade secret law only protects information that is not generally known and not readily ascertainable
Trade secret generally must also be the subject of reasonable efforts to maintain secrecy and must have commercial value.
Public disclosure to one person may destroy the secret if it becomes generally known.
Reverse engineering, independent development and availability in public materials can make the information readily ascertainable.
□ Copyright
Is it a fixed and original work of authorship? • If yes, then there is copyright as copyright law only protects
fixed and original works of authorship Copyright protection is generally available for the life of the author
plus 70 years for individuals, or the shorter of 95 years from the date of publication or 120 years from date of creation for corporations or works for hire.
Copyright protection is not available for de minimis contributions (words, titles, short phrases and ornamentation), facts (including research and history), forms (format, layout and style), color, typeface, photographic subjects, athletic events, scenes a faire (common themes and plots), ideas procedures, processes, systems, methods of operation, concepts, principles, discoveries and government works.
Originality requires some amount of creativity from an original author.
Copyright protection is unavailable for useful pictorial, graphic or sculptural works when the form and function of the article are inextricably intertwined such that the utilitarian aspects of the design are not physically or conceptually separable from the artistic expression.
• Pictorial, graphic, and sculptural works include two-dimensional and three-dimensional works of fine, graphic, and applied art, photographs, prints and art reproductions, maps, globes, charts, diagrams, models, and technical
5 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Classification of Intellectual Property
drawings, including architectural plans. Such works shall include works of artistic craftsmanship insofar as their form but not their mechanical or utilitarian aspects are concerned; the design of a useful article, as defined in this section, shall be considered a pictorial, graphic, and sculptural work only if, and only to the extent that, such design incorporates pictorial, graphic, or sculptural features that can be identified from, and are capable of existing independently of, the utilitarian aspects of the article. 17 U.S.C. §101.
• An architectural work is the design of a building as embodied in any tangible medium of expression, including a building, architectural plans, or drawings. The work includes the overall form as well as the arrangement and composition of spaces and elements in the design, but does not include individual standard features. 17 U.S.C. §101. The copyright in an architectural work that has been constructed does not include the right to prevent the making, distributing, or public display of pictures, paintings, photographs, or other pictorial representations of the work, if the building in which the work is embodied is located or ordinarily visible from a public place. 17 U.S.C. §120.
A work can be fixed in a number of ways, including being painted on a canvas, written on a piece of paper, stored on a hard drive or recorded on a tape, video cassette, CD or DVD.
□ Trademark & Trade Dress
Is it a distinctive source identifier used on goods or services? • If yes, then there is a trademark as trademark law protects a
source identifier on goods or services. Trademark and trade dress protection can last forever, but they do
not extend to protect a non-reputation related disadvantage based on use, cost quality or efficiency.
A mark that is arbitrary (Apple for computers, Red Baron for pizza, Starkist for tuna and Dutch Boy for paint), fanciful (Exxon for gasoline, Kodak for film and Colgate for toothpaste) or suggestive (Greyhound for bus, Pepsi for soda, Snap-On for tools, Velveeta for cheese and Windex for glass cleaner) is protected upon its first use in interstate commerce; whereas, a mark that is merely descriptive (Apple for a fruit grower and Puppy Chow for dog food) of the product or services requires establishing secondary meaning in order to gain distinctiveness. A generic mark (Zipper for zippers, Aspirin for aspirin, Thermos for thermos or vacuum packed bottles,
6 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Classification of Intellectual Property
Cellophane for cellophane and Cola for cola) is never protected; a mark can become generic through common use as a noun or verb.
Trade dress in the form of product packaging can be inherently distinctive, but product design requires establishing secondary meaning in order to gain protection.
□ Patent
Is it a new, non-obvious and useful idea? • If so, it may be eligible for a utility patent
Is it a new, original and ornamental design for an article of manufacture?
• If so, it may be eligible for a design patent Is it a distinct and new variety of plant that the inventor or
discoverer has asexually reproduced? • If so, it may be eligible for a plant patent
□ Utility patent
A utility patent protects a new, non-obvious and useful idea that is a process, machine, article of manufacture, composition of matter or improvement of any of the previous.
Laws of nature, physical phenomena, abstract ideas, copyrightable works are not patentable subject matters.
The invention is not new if: • The invention was in a printed publication, in public use, on
sale or otherwise available to the public anywhere in the world before the filing date of a patent application;
• The invention was abandoned; or • Then invention originated with someone else.
The invention is obvious if the difference between the claimed invention and the prior art are such that the claimed invention as a whole would have been obvious before the effective filing date of the claimed invention to a person having ordinary skill in the art to which the claimed invention pertains.
□ Design patent
A design patent protects a new, original and ornamental design that is applied or embodied in an article of manufacture.
□ Plant patent
A plant patent protects a distinct and new variety of plant that the inventor or discoverer has asexually reproduced.
7 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Identification of the Documents Relating to Intellectual Property
Identification of the Documents Relating to Intellectual Property
Identify all agreements between the Company and any third party □ License agreements □ Assignment agreements □ Maintenance agreements □ Distribution agreements □ Government agreements □ Employment agreements □ Consulting agreements □ Joint development agreements □ Technology transfer agreements □ Sponsored research agreements □ Non-disclosure agreements □ Non-competition agreements □ Work for hire agreements □ Contracts with independent contractors
Identify Filings and Registrations
□ All U.S. state and foreign IP applications □ Registration and recordation materials
Identify any other documents relating to IP rights
□ Contracts with suppliers and customers □ Correspondence relating to IP rights □ List of computer software owned by the company; including all versions
and source and object code, flow charts, other development documents □ Hiring and exit interview materials □ Publications and other documents □ Federal registration documents □ State commercial code filings □ Journal articles □ Published papers □ Competitive analysis documents □ Marketing files □ Confidential procedure documents and manuals
8 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Examination of the Documentation
Examination of the Documentation For each agreement, identify:
□ The parties to the agreement □ The rights being transferred □ The owner of any technology developed under the agreement □ The holder of any right to file a patent application on any technology
developed under the agreement Verify that:
□ Employees and others obtaining confidential information, secrets or inventions have signed confidentiality or non-disclosure agreements.
□ Employees and others in R&D have signed invention assignment agreements. Be sure that each assignment references the Illinois Employee
Patent Act (765 ILCS 1060/et seq.) and has the following language: “[This] agreement does not apply to an invention for which no equipment, supplies, facilities, or trade secret information of the employer was used and which was developed entirely on the employee's own time, unless[:]
• the invention relates o to the business of the employer, or o to the employer's actual or demonstrably anticipated
research or development, or • the invention results from any work performed by the
employee for the employer.” □ Employees and others obtaining confidential information, secrets, or
inventions which can be used by competitors have signed non-competition agreements. In Illinois, non-competition agreements are enforceable when the
limitations as to time and territory are not unreasonable, enforcement will not be injurious to the public or cause undue hardship to the employee, and the restraint imposed is not greater than is necessary to protect a legitimate business interest of the employer.
Illinois law now requires employers to offer consideration additional to mere employment, such as additional salary, bonus, promotion, or 2 years of continuous employment, before non-competition agreements can be made enforceable. Fitfeld v. Premier Dealer Services, Inc.
9
Alan R. Singleton Singleton Law Firm, P.C.
Research Park at University of Illinois 2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Examination of the Documentation
□ Agreements have arbitration or other dispute resolution language as appropriate to avoid costly litigation.
10 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Identify Owners
Identify Owners For each piece of intellectual property, identify the owner(s):
□ The company? □ Customers? □ Vendors? □ Independent contractors? □ Employees? □ Corporate owners? □ Competitors? □ Joint works? □ Co-inventors?
Search for Indicators of Clouded Title:
□ Filed financing statements □ USPTO and Copyright Office title searches □ State filings □ Foreign filings □ Filings with domain name registrar (i.e., Network Solutions, Inc.)
Search for Assignment of Intellectual Property Rights
□ USPTO assignment database (for Trademark and Patent information) Trademark assignments must assign the goodwill along with the
mark itself. Patent assignment must be recorded to bind later innocent third
party purchasers. □ Copyright Office (for Copyright Assignments)
The author of a work other than a work made for hire generally has the right to terminate any license or assignment 35 years after the grant was made. The termination right cannot be waived in advance. If the author dies before the termination period begins, the termination right can be exercised by the author's heirs. 17 U.S.C. § 203.
11 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Confirming Validity
Confirming Validity Trade Secret
□ Not generally known? □ Not readily ascertainable? □ Subject of reasonable efforts to maintain secrecy? □ Commercially valuable?
Copyright
□ Fixed in a tangible medium of expression? □ Original work of authorship?
Not an unauthorized derivative work? Modicum of creativity?
□ Not expired? (life plus 70 for individuals and at least 95 years for corporations and works for hire)
□ Not a useful pictorial, graphic, or sculptural work with the form and function of the article inextricably intertwined such that the utilitarian aspects of the design are not physically or conceptually separable from the artistic expression?
□ Not a de minimis contribution, fact, form, color, typeface, photographic subject, athletic event, scenes a faire, idea, procedure, processes, system, method of operation, concept, principle, discovery, or government work?
Trademark & Trade Dress
□ Source identifier? □ Distinctive?
Not generic? If descriptive, then secondary meaning? If product design, then secondary meaning?
□ Used on goods in interstate commerce? □ Not used to protect a non-reputation related disadvantage based on use,
cost, quality, or efficiency? □ Not abandoned?
Still in use? Renewal fees paid?
Utility Patent
□ New? No anticipating reference before filing date? No public disclosure by inventor one year before filing date?
12 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Confirming Validity
Not abandoned?
True inventor? □ Non-obvious?
Consider scope and content of the prior art, difference between the invention and the prior art, and level of skill in the art.
Also consider commercial success, long felt but unsolved needs, failure of others, copying of patent, licensing, unexpected results, and disbelief of experts.
□ Useful? □ If patent is issued or in prosecution:
Sufficient disclosure to support the claims? No inequitable conduct before the patent office?
• All known relevant and non-cumulative references disclosed during patent prosecution?
• No fraud on the patent office? No double patenting? Application not abandoned? Expired for failure to pay maintenance fees? Expired due to its limited duration now typically but not always 20
years U.S. filing date? Design Patent
□ New? □ Original? □ Ornamental? □ Design for an article of manufacture? □ Expired due to its limited duration (currently 14 years from grant)?
Plant Patent
□ Distinct and new variety of plant? □ Successfully asexually reproduced by inventor or discoverer? □ Expired due to its limited duration (typically but not always 20 years from
the U.S. filing date)?
13 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Retrospective Protection of Identified Intellectual Property
Retrospective Protection of Identified Intellectual Property Patents
□ A U.S. patent application must be filed if at all within one year of any public disclosure of an invention.
□ Check the availability of international rights. Most countries bar the right to a patent if there is any publication before the filing date. Also, check any PCT applications to see if a U.S. application is due.
□ Inform patent owners of their rights and encourage owners to license, market, and use the invention.
□ Discovery of new prior art, errors in inventorship, confusing typographical errors, and other errors should be corrected on any pending patent application. A correct inventor or co-inventor is anyone who contributed to the
conception of a single claim. □ Verify that the patent owner’s rights (exclusive right to make, use, sell, and
offer for sale in the U.S., and to import into the U.S.) are not currently being infringed by performing a search of products on the marketplace.
□ Advise the client of the infringement and the benefit of negotiating with the infringer, and the consequences of not immediately suing for infringement (a six year presumption for laches and a six year limitation on damages under the statute of limitations). 35 U.S.C. § 286.
□ Verify that the proper prior art references have been disclosed, including real products in the marketplace, publications, and other evidence of knowledge, use, or sale of the invention in the U.S. (keeping in mind there is no duty to do a search of prior art).
□ Verify that the practice of a patented or patent-pending invention does not infringe any of the prior art patent references for that invention.
□ Verify that outgoing products are properly marked so that purchasers will have imputed knowledge of the underlying patent. To mark a patent, fix the word “patent” or the abbreviation “pat.”,
together with the number of the patent, or when, from the character of the article, this cannot be done, by fixing to it, or to the package wherein one or more of them is contained, a label containing a like notice. 35 U.S.C. § 287.
In the event of failure so to mark, no damages shall be recovered by the patentee in any action for infringement except on proof that the infringer was notified of infringement and continued to infringe thereafter, in which event damages may be recovered only for infringement occurring after such notice. Filing of an action for infringement shall constitute such notice. 35 U.S.C. § 287.
14 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Retrospective Protection of Identified Intellectual Property
□ Inform inventors of the need to diligently reduce their currently conceived inventions to practice.
□ Timestamp or ask the inventors to date any documents or objects showing a possible date of conception or reduction to practice.
□ If possible and practical, use direct language instead of means-plus-function language or step-plus-function language in claims. Functional claiming is limited to the specification and equivalents at the
time of filing; whereas, direct claim language is entitled to the claim language and equivalents, including after-arising technology.
□ Verify that pending applications cover, if possible, later conceived competing products.
□ Consider any narrowing amendments to a patent application made during prosecution history. If the claim is amended and narrowed, then the patentee loses the
entire scope and equivalence between the amendment and the original unless the changes fall under a few narrow exceptions.
□ Verify that all new, useful, and non-obvious ideas disclosed in the patent application are claimed.
□ Verify that the inventor or owner documents any and all experimental use. □ Address any long delays (multiple continuations, continuations-in-part, and
requests for continued examination) for patent applications currently in prosecution.
□ Pay any maintenance fees due, and respond to any pending office actions. Maintenance fees are due three times after the patent issues, and they
cannot be paid early. These fees may be paid without surcharge between 3 years and 3 ½ years after issue (first maintenance fee), between 7 years and 7 ½ years after issue (second maintenance fee), and between 11 years and 11 ½ years after issue (third maintenance fee). 35 U.S.C. § 41(b).
Maintenance fees may be paid with a surcharge between 3 ½ years and 4 years after issue (first maintenance fee), between 7 ½ years and 8 years after issue (second maintenance fee), and between 11 ½ years and 12 years after issue (third maintenance fee). 35 U.S.C. § 41(f); 37 C.F.R. § 1.20.
Failure to pay the current maintenance fee on time may result in expiration of the patent. It may be possible to pay the maintenance fee after expiration where the delay is shown to the satisfaction of the Director to have been unavoidable or unintentional. 37 C.F.R. § 1.20.
Maintenance fees are not required for any plant patents or for any design patents. 37 C.F.R. § 1.362.
□ Document profits and sales figures for products based on the patent.
15 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Retrospective Protection of Identified Intellectual Property
Trademarks □ Verify that trademarks for company products or services have been
registered at: Federal level (USPTO) State level (Secretary of State’s Office) (not necessary to sue in federal
court) Foreign (USPTO via Madrid Protocol) Verify that the class or classes in which the mark is requested matches
the marks correct use □ Verify that the Company’s trademarks are being properly used. The latest versions of the marks are being used. Any licensees of the mark are supervised for quality control.
□ Determine whether and in what manner others are using the Company’s trademarks. Conduct searches on the Internet (Google or Bing are recommended)
to investigate how the Company’s marks are being used. Determine whether this use exposes the Company to risk of loss of
value of the trademark by it becoming generic or being otherwise misused.
□ Conduct the following trademark searches: Federal level - USPTO database State level - Secretary of State’s Office Common Law Usage - Google, Bing, and other search engines Commercial Databases such as TRADEMARKSCAN in Westlaw Outside search firm such as Dialog or Thomson CompuMark
□ Verify that the ™ or SM (common law notice) or ® (notice of federal registration) notice is properly displayed on all: Company literature displaying or discussing the product or service Promotional/marketing materials displaying or discussing the product
or service Advertisements for the product or service Websites displaying or discussing the product or service In-house publications displaying or discussing the product or service. Products or services
□ Verify that there are licensing agreements in place with any parties that may need to use company trademarks, such as distributors, suppliers (for example, putting logos on shopping bags).
□ Verify that the Company has received permission to use the marks of others and is using them properly.
□ Verify that sales figures are available for the amount of goods or services sold under each mark.
16 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Retrospective Protection of Identified Intellectual Property
Copyrights □ Verify that copyrighted material is properly marked to put others on notice
of copyright (e.g., © 2007 Joe Smith or Copyright 2007 Jane Jones). □ Verify that important copyrights have been properly registered or that
registration has been sought with the Copyright Office (e.g., instruction manuals for products, drawings, books, etc.).
□ The use of a copyright notice was mandatory on all published works before March 1, 1989. Verify that such notice was present.
□ Verify that employment agreements stipulate that all work by employees is done on a “work for hire” basis and all copyrightable work belongs to the Company and that the employee will create any assignments requested by the company.
□ Verify that written work for hire agreements accompany any copyrightable work created by independent contractors for use as a contribution to a collective work, as a part of a motion picture or other audiovisual work, as a translation, as a supplementary work, as a compilation, as an instructional text, as a test, as answer material for a test, or as an atlas.
□ Verify that all copyrightable work created by independent contractors has been assigned to the company and that the assignment has been filed with the Copyright Office.
□ Verify that any assignments over 35 years old have been re-assigned to the Company by the author. 17 U.S.C. § 203.
□ Verify and document the Company’s permission to use the copyrightable material of others’: Graphics Artwork Photographs Character drawings Other original & fixed expression
Trade Secrets □ Physical Security Measures & Notice What are the facility’s physical security precautions, such as a fenced
perimeter of the Company premises, limited entries and exits, alarms and self-locking doors, and after-hours security personnel?
Are there “KEEP OUT” and “AUTHORIZED PERSONNEL ONLY” signs at the access points to sensitive areas of the facility, and is there a policy of enforcing these restrictions?
What keeps visitors from obtaining confidential information? Are ingredients or data secretly coded or encrypted? Are drawers or areas for secret documents and drawings separated
and locked? 17
Alan R. Singleton Singleton Law Firm, P.C.
Research Park at University of Illinois 2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Retrospective Protection of Identified Intellectual Property
Are there physical barriers that prevent unauthorized viewing of proprietary process technology?
Are there sign in and sign out procedures for accessing and returning sensitive materials?
Are sensitive documents reproduced in only a limited number, and is there a policy to collect all copies after use?
Are authorized codes and passwords used for access to copying machines and computers?
Is computer data stored and transmitted in an encrypted, secure manner?
Are there policies and procedures to destroy (shred) sensitive documents rather than discarding them in whole?
Are confidential drawings and documents marked as confidential with a stamp, watermark, or confidentiality legend?
Employee Policies
□ Are employees subject to non-competition agreements? Scope reasonable (length of time, geographical area)? Would enforcement of the non-competition agreement be injurious to
the public or cause undue hardship to the employee? Is the restraint imposed greater than necessary to protect a legitimate
business interest of the employer? Is the non-competition agreement supported by consideration
additional to mere employment? Has each employee signed a confidentiality agreement or a non-
disclosure agreement? What are the company’s oversight policies and procedures that
prevent the inadvertent disclosure of trade secrets in written publications, seminars, speaking engagements, or at trade shows, by employees?
Are Company departments separated so that each employee does not have access to unnecessary confidential information?
Are components of trade secrets separated between or among departments so that each has only “a piece of the puzzle?”
Is the Company using confidential or proprietary information from a competitor brought in by an employee?
Are there written rules and regulations that prohibit employees from remaining in the plant after hours without express permission from properly authorized personnel?
Are there rules and regulations requiring employees to stay in controlled areas around their work stations?
18
Alan R. Singleton Singleton Law Firm, P.C.
Research Park at University of Illinois 2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Retrospective Protection of Identified Intellectual Property
Are employees required to wear identification badges or carry identification cards?
Is there a policy and practice for advising employees on a regular basis regarding the Company’s trade secrets and confidential business information?
Does the Company hold “exit interviews” to ensure return of company documents and to remind ex-employees of their obligation not to use confidential information of the Company for their own benefit or the benefit of others?
□ Third Party Communications Have trade secrets been disclosed on public material, including
advertisements, the Company’s website, and posters or billboards at the front of the office?
Have trade secrets been disclosed in patent or copyright applications? Has each third party recipient of confidential information signed a
confidentiality agreement or a non-disclosure agreement? Have trade secrets been maintained on a “need-to-know” basis only? Review the relationships with suppliers and customers
Purchase order terms and conditions Sales terms and conditions Forms used for receipt, disclosure or exchange of
proprietary/confidential information Protocol for receipt of unsolicited ideas Documents containing info relating to confidential
information
Domain Names □ Compile a list of all domain names that are: currently registered and active inactive and no longer used list of domain names the Company is considering using in the
immediate future □ Determine whether there have been any assignments made with respect
to domain names □ Search major domain name registries to verify ownership of each domain
name listed by the Company □ Search for domain names confusingly similar to any of the Company’s
mark. Determine whether any such domain name was acquired before or
after the Company acquired rights in the mark. Determine whether any such domain name was acquired with a bona
fide noncommercial or fair use of the mark in the domain name. 19
Alan R. Singleton Singleton Law Firm, P.C.
Research Park at University of Illinois 2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Retrospective Protection of Identified Intellectual Property
Determine whether any such domain name was acquired with an intent to divert consumers from the Company’s online location in a manner that could harm the goodwill represented by the Company’s mark.
Determine whether any such domain name is for sale, and whether the sale price is reasonable.
Determine whether any such domain name was acquired through the provision of misleading contact information.
Determine whether any such domain name was purchased along with other domain names that were confusingly similar to the Company’s marks or the marks of others.
Evaluate the distinctiveness and fame of the subject mark.
20 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Prospective Protection of Intellectual Property
Prospective Protection of Intellectual Property Review of Policies and Procedures
General
□ Verify that confidentiality agreements/non-disclosure agreements are required for: All employees Only certain employees Consultants Independent contractors Distributors Suppliers Visitors and maintenance workers
□ Verify that those incapable of consenting to a confidentiality agreement are not allowed to receive confidential information (i.e., children under the age of 18).
□ Verify that exit interviews are required for all employees. □ Require dated Inventor/Lab notebooks for all potential inventors. □ Determine whether there is a communication process for
inventors/developers to share research developments with counsel □ Determine whether there is a system in place that encourages employees
to report infringement, misappropriation, or theft.
Patent □ Determine whether there is a process that ensures inventors and relevant
decision-makers know that a patent application should be filed within one year of any public disclosure of an invention and that any publication before filing could destroy international rights.
□ Determine whether there is a process for informing patent owners of their rights and encouraging owners to license, market, and use the invention.
□ Determine whether there is a process for inventors and others involved in patent prosecution to report new prior art, errors in inventorship, and other errors in the patent application process.
□ Determine whether there is a periodic procedure for assessing whether the patent owner’s rights (exclusive right to make, use, sell, and offer for sale in the U.S., and to import into the U.S.) are being infringed.
□ Determine whether a procedure is in place to notify the inventor and others involved in patent prosecution about the scope of prior art that should be disclosed.
21 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Prospective Protection of Intellectual Property
□ Determine whether there is a procedure to design around existing patents and published patent applications so that the Company’s patented product does not infringe any other patents.
□ Identify the procedure for marking outgoing products. □ Ensure that there is a process to inform inventors of the need to diligently
reduce their currently conceived inventions to practice. □ Ensure that there is a procedure to inform inventors to timestamp any
documents or objects showing a possible date of conception or reduction to practice.
□ If possible and practical, use direct language instead of means-plus-function language or step-plus-function language in claims.
□ Identify a procedure for ensuring that amendments to pending applications ensure that pending applications cover, if possible, later conceived competing products.
□ Avoid, when possible, narrowing amendments to a patent application made during prosecution history.
□ Ensure that all disclosed new, useful and non-obvious ideas are claimed in new applications.
□ Determine whether there is a procedure for inventors to document any and all experimental use.
□ Ensure that the Company keeps track of profits and sales figures for specific products based on the patent. Damages for infringement can be based on a reasonable royalty or on
the patent owner’s lost profits. Evidence of profits and manufacturing capability can be important in a determination of damages.
□ Determine whether there is a process for monitoring pre-filing disclosures of patentable information.
□ Determine whether there is a process for reviewing sales literature to ensure that nothing is disclosed in the marketplace to potential customers.
□ Determine whether invention assignment forms are required for new hires. □ Determine whether there is a Patent Review Committee in place to handle: Invention selection criteria – patent v. trade secret Cost benefit analysis in determining whether to file applications Foreign filing strategy Application process and procedures Periodic patent search process in key areas to keep abreast of efforts
by competitors. Determine whether there are education programs to teach employees
about the patent process and their role in protecting patentable intellectual property.
22 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Prospective Protection of Intellectual Property
□ Examine the in-house docketing system for monitoring deadlines regarding: Any maintenance fee payments Renewal filings
Trademark
□ Determine whether there is a procedure for promptly registering trademarks for company products or services.
□ Verify that there is a procedure that ensures notices are properly displayed on all: Company literature displaying or discussing the product or service Promotional/marketing materials displaying or discussing the product
or service Advertisements for the product or service Websites displaying or discussing the product or service In-house publications displaying or discussing the product or service. Products or services
□ Verify that there are policies and standards in place for granting licensing agreements with any parties that may need to use company trademarks, such as distributors, suppliers.
□ Verify that there is a system for calculating the sales figures and the amount of goods or services sold under each mark.
□ Determine whether there is a licensing manager and a quality control system in place to protect the goodwill associated with the trademarks
□ Determine whether there is a process in place for phasing out marks that are no longer in use
□ Identify and evaluate any guides for proper mark usage, specifying Proper typeface Color specifications Mark placed in a consistent location on product or package
□ Determine whether there is a system in place for monitoring the registration and use of possible infringing marks or of the subject mark in an infringing manner.
□ Determine whether there is a policy in place outlining the process for dealing with infringement and whether cease and desist letters have been drafted
□ Examine the in-house docketing system for monitoring upcoming renewal deadlines
23 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Prospective Protection of Intellectual Property
Due dates between the fifth and sixth year after registration and at the end of every successive ten year period after registration (between years nine and ten, payable up to six months late for a fee of $100 per class).
Copyright
□ Verify that procedures are in place to properly mark copyrighted material □ Determine whether there is a disconnect between valuable creative
expression and the registration process, and suggest procedures that encourage the registration of important copyrights
□ Verify that standard employment agreements stipulate that all work by employees is done on a “work for hire” basis and all copyrightable work belongs to the Company.
□ Ensure that there is a procedure to obtain a written work for hire agreement from independent contractors working on a contribution to a collective work, a part of a motion picture or other audiovisual work, a translation, a supplementary work, a compilation, an instructional text, a test, answer material for a test, or an atlas.
□ Verify that there is a procedure for obtaining assignment agreements from independent contractors for copyrightable work.
□ Verify that there is a process for obtaining a re-assignment from the author after 35 years.
□ Determine whether there are “Clean Room” procedures in place that bar access by unnecessary employees during development of copyrightable material
□ Examine whether employees are respecting the copyrights of others and the Company’s policy for: Monitoring employee computer/laptop use to prevent unauthorized
software distribution Monitoring employee computer use to ensure that there is no illegal
downloading of movies, music, other copyrighted materials □ Examine the copyright policies and education programs to train
employees about protecting company copyrights
Trade Secrets □ Physical Security Measures & Notice Verify that the facility or business has physical security precautions,
such as a fenced perimeter of the Company premises, limited entries and exits, alarms and self-locking doors, and after-hours security personnel.
Verify that there “KEEP OUT” and “AUTHORIZED PERSONNEL ONLY” signs at the access points to sensitive areas of the facility, and that there is a policy for enforcing these restrictions.
Review visitor policies to determine whether: 24
Alan R. Singleton Singleton Law Firm, P.C.
Research Park at University of Illinois 2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Prospective Protection of Intellectual Property
Visitors are required to wear temporary ID badges. Visitors are required to sign in and enter and exit through only one
door. Bags are searched by security upon exit of the building. Escorts are required for visitors. Visitors do not have access to any confidential information without
signing a confidentiality or non-disclosure agreement. Visitors are required to be 18 years of age or older.
Verify that there is a policy to encode or encrypt ingredients or data. Verify that drawers or areas for secret documents and drawings are
separated and locked. Verify that there physical barriers that prevent unauthorized viewing of
proprietary process technology. Determine whether there are sign in and sign out procedures for
accessing and returning sensitive materials. Ensure that sensitive documents are reproduced in only a limited
number, and is there a policy to collect all copies after use. Verify that authorized codes and passwords are used for access to
copying machines and computers. Verify that computer data is stored and transmitted in an encrypted,
secure manner. Be sure to check: Laptops Internet/Email PDAs/Blackberrys
Verify that there are policies and procedures to destroy (shred) sensitive documents rather than discarding them in whole.
Determine whether there is a procedure to require that confidential drawings and documents be marked as confidential with a stamp, watermark, or confidentiality legend.
□ Employee Policies Ensure that there is a policy to require all new employees to sign
enforceable non-competition agreements. Verify that each employee is required to sign a confidentiality
agreement or a non-disclosure agreement. Ensure that the company has oversight policies and procedures that
prevent the inadvertent disclosure of trade secrets in written publications, seminars, speaking engagements, or at trade shows, by employees.
Determine whether Company departments are separated so that each employee does not have access to unnecessary confidential information.
25 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Prospective Protection of Intellectual Property
Determine whether components of trade secrets are separated between or among departments so that each has only “a piece of the puzzle.”
Ensure that the Company is not using confidential or proprietary information from a competitor brought in by an employee.
Determine whether there are written rules and regulations that prohibit employees from remaining in the plant after hours without express permission from properly authorized personnel.
Determine whether there are rules and regulations requiring employees to stay in controlled areas about their work stations.
Verify that employees are required to wear identification badges or carry identification cards.
Determine whether there is a policy and practice for advising employees on a regular basis regarding the Company’s trade secrets and confidential business information.
Ensure that the Company holds “exit interviews” to obtain return of company documents and to remind ex-employees of their obligation not to use confidential information of the Company for their own benefit or the benefit of others.
□ Third Party Communications Determine whether there is a procedure to prevent trade secrets from
being disclosed on public material, including advertisements, website, and posters of billboards at the front of the office.
Verify that each third party recipient of confidential information is required to sign a confidentiality agreement or a non-disclosure agreement.
Verify that trade secrets are maintained on a “need-to-know” basis only.
26 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Identification of Potential Intellectual Property
Methods for Conducting the Audit
Interviews of management and technical staff Questionnaire to all employees who use or develop IP Physical inspection of employee workspaces Observation of building security procedures Inspection of handbooks, policy manuals and other guidance documents Searches of databases including USPTO, Google Patents, Google, UCC Filings,
Copyright Office
27 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Section: Identification of Potential Intellectual Property
Final Product
Telephone call or face to face meeting for sensitive issues better not put in writing
Written report, including: □ Catalog of IP assets □ Development history of the identified IP Date of acquisition/creation Creator/owner
□ List of actions required to maintain each asset □ Any IP defects uncovered during the audit
List of filings to be pursued □ Copyright, trademark and patent applications to be filed □ Affidavits of continued use of trademarks □ Litigation and negotiation options for discovered potential infringement by
third parties □ Maintenance fees required to keep patents in force
List of procedures to be implemented □ Prioritized to-do list to be used as a starting point for subsequent audits
28 Alan R. Singleton
Singleton Law Firm, P.C. Research Park at University of Illinois
2001 S. First St., Suite 209, Champaign, IL 61820 217-352-3900 [email protected]
www.singletonlawfirm.com
Alan R. Singleton, Esq.
2001 South First Street, Suite 209, Champaign, IL 61820 phone 217-352-3900 fax 217-352-4900
USING INTELLECTUAL PROPERTY TO GAIN A COMPETITIVE ADVANTAGE
IN THE MARKETPLACE
There are many ways to gain a competitive advantage in the marketplace. For example, a company might be the “first mover,” have superior channels of distribution or the ability to manufacture at a lower cost. Intellectual property (IP) protection, which includes patents, trademarks, copyright and trade secrets, can likewise provide a competitive advantage in the marketplace.
One form of IP protection is the U.S. patent, which applies to an invention that is new, useful and non-obvious. In order to be considered new for patent purposes the invention cannot have been used commercially, offered for sale or disclosed publicly more than one year before the patent application was submitted. The United States Patent and Trademark Office (USPTO) accepts and reviews patent applications. Once a patent is issued, it gives the owner the right to prevent others from making, using, selling, offering for sale or importing the invention to the U.S. for 20 years from the date of filing. If the owner discovers that someone may be infringing upon the patent, the owner may take steps to prove infringement and enforce the patent. For a patent to be infringed upon, every element listed in a patent claim must be found, literally or equivalently, in the infringer’s device or method.
Another form of IP protection is the trademark, which functions to protect any distinct
word, symbol or device used to identify the source of goods or services. This category includes company names, brand names, logos and even some colors and sounds. The USPTO receives and processes applications for federal registration of a trademark. In addition, a trademark can be registered with the Secretary of State’s Office for state protection. Unlike a patent, a trademark does not need to be registered to be enforced, though it is recommended. Registration with the USPTO provides nationwide protection, whereas a non-registered trademark would enjoy protection only a limited geographic area and only in certain cases. Trademarks also differ from patents in that there is no time limit to how long they can be enforced. As long as the trademarked name, phrase, logo, etc. is used continually it remains protected. In addition to continual use, registered trademarks require renewal with the USPTO or Secretary of States Office from time to time to maintain the registration. Similar to patents, trademark protection gives the owner the right to prevent others from infringing on the mark. Since the trademark serves as an identifier of the source of goods or services, trademark infringement occurs when another mark is similar enough to an existing mark that the public is likely to confuse the two. If the rightful owner of the trademark is able to prove the infringing mark is likely to be confusing, then the infringing mark may no longer be used.
Copyrights are another formal means of protecting intellectual property. A copyright can be applied to any original work of authorship fixed in a tangible medium of expression. A work is fixed if it is written down, recorded, saved, etc. Property protected by copyright includes books, songs, software and articles like this one. As with trademarks, registration of a copyright is not required, but it is recommended. The United States Copyright Office within the Library of Congress handles the registration of copyrights. A copyright gives the holder the exclusive right to reproduce, distribute, perform publicly and display publicly the copyrighted work. Typically, this right lasts for the life of the author plus seventy years, unless the work was done for hire. Copyrights on works for hire typically last the earlier of ninety-five years from the date of publication or one hundred twenty years from the date of creation. A copyright is infringed if the author’s work is copied without the author’s permission or is substantially similar to the copyrighted material.
Trade secrets are a type of intellectual property held by virtually all companies in some form or another. A trade secret can be any valuable information not generally known or easily obtained. However, in order for the information to qualify as a trade secret, the company must use reasonable efforts to keep the information secret. For example, if a trade secret is disclosed to employees then the company must give notice to those employees that the information is confidential and is not to be disclosed. The more valuable the secret is, the more effort is required to keep it secret. Trade secrets can be as common as a company’s client lists or as famous as the secret recipe for Coke and the Colonel’s Original Recipe for KFC. There is no formal system for registering company secrets; they are simply held and protected by companies. As long as the information is kept secret there is no time limit on how long it can be enforced. Companies have the right to sue others who improperly acquire the trade secret or those who breach confidence regarding the trade secret. However, trade secret protection does not prevent the practice of reverse engineering.
As businesses strive to identify and create competitive advantages, they should be sure to carefully examine their intellectual property. Intellectual property that is adequately protected and effectively utilized can provide a powerful competitive advantage in the marketplace.
-Alan Singleton is a corporate and intellectual property law attorney with Singleton Law Firm,
P.C.
He can be reached at 217-352-3900 or [email protected].
Alan R. Singleton, Esq.
2001 South First Street, Suite 209, Champaign, IL 61820 phone 217-352-3900 fax 217-352-4900
QUESTIONS TO ASK IN THE DEVELOPMENT OF A SOFTWARE LICENSE
1. General Issues
a. License v. Sale b. Does the Licensor have sufficient rights to license or sell the software?
i. Software developed entirely by Licensee ii. Software or portions developed by third parties
1. Work Made for Hire 2. Assignment 3. License
a. Right to sublicense? 4. Open-Source
a. Type of open-source license? c. Types of Licenses
i. “Off the Shelf” Software ii. Custom Software
iii. Software as a Service (Saas) iv. For distribution
2. The License
a. Licensee i. Who is the licensee, does it include affiliates and subsidiaries?
ii. Restrictions? 1. Specific hardware, operating systems, locations, users, or number of
users iii. Is licensee the U.S. Government?
1. If so, certain language must be included or terms of license will be subject to Federal Acquisition Regulations
b. License Grant i. What is licensed?
1. Software 2. Hardware 3. Documentation 4. Other proprietary information/systems
ii. Exclusive or Non-Exclusive? iii. Transferable or Non-Transferable? iv. Right to Sublicense?
1. Royalties 2. Licensor approval 3. Terms of sublicense or EULA
v. Term vi. Geographic Scope
c. Scope i. Is USE defined?
1. Internal, business purposes only 2. As a service provider to third parties
d. Rights to Copy i. For what purposes?
1. Back-up 2. Production 3. Testing
ii. Number of copies? iii. Medium?
e. Restrictions? i. Reverse engineering and disassembling?
ii. Licensee modification? iii. Transfer to third parties? iv. Export? v. High risk activities?
vi. Use with other software? f. Rights in Software ?
i. Retention of all rights not licensed ii. Rights in derivative works and new ideas
1. Grant-back iii. Custom Software – who owns the final product
1. Developer or purchaser 2. Work made for hire/Assignment
3. Term
a. Term of Agreement v. Term of License b. Perpetual or Periodic?
i. Renewal procedure
4. Payments/Fees a. License Fees
i. Up-front or recurring? ii. Royalties?
iii. Calculation? b. Service and Support Fees c. Procedure
i. Invoices ii. Late payment
d. Taxes i. Who is responsible?
ii. Complex state laws regarding taxation of software and services
2
5. Delivery, Installation, Training, and Acceptance
a. Delivery i. What are the deliverables?
ii. Delivery location? iii. Delivery method?
b. Installation i. Who is responsible?
ii. Installation fees and costs? c. Training
i. Will the Licensor provide training? ii. Offsite or onsite?
iii. Costs of training? d. Acceptance
i. Metrics ii. Procedure
iii. Error correction iv. Acceptance date
6. Project Management
a. If Licensor will be developing custom software, how will the project management be structured?
7. Service Level Agreement a. If software offered as a service (SaaS), then Service Level Agreement should be
developed. i. Standards
ii. Credits 8. Maintenance and Support
a. Maintenance i. Bug/Error correction
1. Licensee notification 2. Urgency levels 3. Procedure and correction times
b. Improvements, Modifications, and Updates i. Distribution
ii. Definitions – difference from New Versions iii. Cost
c. Support i. Types of support
1. Onsite 2. Offsite
ii. length of support iii. Separate support agreement iv. Cost v. Right to discontinue support after release of new version
3
9. Source Code
a. Ownership b. Escrow
10. Disabling Devices
a. Does the software contain disabling devices? i. In what circumstances may they be used?
11. Confidential Information
a. Will Confidential Information Be Exchanged? b. Definition of Confidential Information? c. Identification of Confidential Information? d. Use of Confidential Information? e. (Non-) Disclosure of Confidential Information? f. Return of Confidential Information? g. Employees, Agents, and Independent Contractors? h. Remedies?
12. Warranties, Limitation of Liability, Indemnification
a. Warranties i. To whom do the warranties apply?
ii. Types of warranties 1. Authority to grant license 2. Non-Infringement on third party rights 3. Media on which software is stored 4. Free from material defects 5. Conformance to specifications and run-times 6. Free from viruses 7. No disabling devices 8. Free from minor defects or errors 9. Uninterrupted operation 10. Merchantability 11. Fitness for a particular purpose 12. Warranties related to third-party software
iii. Duration iv. Invalidation
1. Use on different equipment 2. Modification
b. Limitations on Liability i. Special, Indirect, Consequential, Punitive, and Indirect Damages
ii. Profits iii. Data Loss iv. Loss of Goodwill v. Specific Performance
vi. Limited to Specific Amount vii. Time Period for Cause of Action
4
c. Indemnification
i. Indemnifying Events ii. Notification and Procedure
d. Attorney’s Fees e. Insurance
13. Termination and Default
a. Termination i. Termination for Convenience
ii. Termination upon Default iii. Rights and Obligations upon Termination
1. Payment of all outstanding amounts 2. Return of software, documentation, and confidential information 3. Discontinue using software 4. Surviving obligations 5. Use of remote disabling devices
b. Events of Default i. Non-payment
ii. Filing of bankruptcy iii. Breach of provisions of agreement iv. Notice and cure
c. Dispute Resolution i. Informal
ii. Mediation iii. Arbitration iv. Litigation v. Attorney’s Fees
14. Export Controls
a. Federal regulations govern the export of certain software to certain countries
15. Assignment a. Is assignment permitted? b. Any limitations or restrictions?
16. Records and Audits
a. Must the Licensee maintain records relating to its use of the software? b. May Licensor audit Licensee’s records?
17. Non-Competition and Non-Solicitation
a. Non-Competition i. Are their restrictions on either party’s freedom to engage in competitive activity
with the other party? b. Non-Solicitation
i. Licensee may not solicit or hire Licensor’s employees
5
1
Alan R. SingletonSingleton Law Firm, P.C.
Research Park a t the Un ivers i t y o f I l l ino is2001 S . F i rs t S t . , Su i te 209Champaign , IL 61820 -3654
(217) 352-3900 s ingleton@singletonlawf i rm.com
www.singletonlawf i rm.com© 2 0 1 5 A l a n R . S i n g l e t o n
Mobile App Development: Intellectual Property Protection
Roadmap
What developers should know about IP protection Mobile Apps and Trademarks
― Mobile Apps and Trademarks: Overview ― Mobile Apps and Trademarks: Candy Crush Saga Example
Mobile Apps and Copyrights― Mobile Apps and Copyrights: Overview ― Mobile Apps and Copyrights: Work-for-Hire Agreements― Mobile Apps and Copyrights: Enforcement
Mobile Apps and Patents ― Mobile Apps and Patents: Overview― Mobile Apps and Patents: Subject Matter Eligibility― Mobile Apps and Patents: Enforcing your Intellectual Property
Rights Other Legal Issues You Should be Aware of
2
2
What Developers Should Know About Intellectual Property Protection
As an app developer, the intellectual property of your business is your main asset― You are developing your new app, and someone claims
that they have ownership rights to the app. What do you do?
― You have an app and users identify its logo with your business. That is a great selling point for you. What happens if another developer starts using your logo?
― A competitor steals your mobile app’s name. You spent time and effort on choosing that name. What can you do?
3
Mobile Apps and Trademarks: Overview
App owners should always consider protecting the brand name of the app by filing a trademark application― Trademark lies at the core of brand identity ― Trademarks constitute element of your mobile app that
identify the source of your products or services (e.g., logo and title of the app) Trademark is not the app functionality or code
4
3
Mobile Apps and Trademarks: Overview
What is the difference between the ™ symbol and the ® symbol?― ®: registered trademark U.S. trademark registration establishes legal presumption of
ownership and right to use trademark nationwide― ™: trademarks used in connection with goods or services
without registration – it’s free! However: ™ means common law protection applies and
trademark rights are limited to geographical areas where the trademark is used
In case of litigation, an unregistered trademark is generally at a disadvantage compared to a registered trademark
5
Mobile Apps and Trademarks: Overview
There is no “one size fits all” for trademark application― It is important to understand how your mobile app works
as a product or service and explain it to your IP attorney― A trademark registrable for one product or service might
be unregistrable for another All apps might include registrable trademarks:― An app name, icon, or logo used consistently and
prominently to identify your product or service― To be registrable, an app name should not merely
describe the function or nature of the app itself
6
4
Mobile Apps and Trademarks: Overview
Before registering the name of your software or app program, you should consider two preliminary issues with your attorney:― Is it worth it to commit expenses to one or more federal
trademark registrations?― Has someone else already registered a similar trademark
for software or related goods or services?
7
Mobile Apps and Trademarks: Candy Crush Saga Example
Candy Crush Saga― In many countries, including the U.S., King has asserted
trademark rights for the words CANDY and SAGA in the field of software and video games
― However, King’s CANDY and SAGA trademark applications worldwide have been abandoned, refused, or contested by third parties
8
5
Mobile Apps and Trademarks: Candy Crush Saga Example
How would it work for King? If an app developer releases a similar game and name it, for instance, Candy Star or Great Candy Casino Slots, King may demand that they change the name based on similarity to the trademark CANDY CRUSH SAGA― However, King is not entitled to a claim against each and every
game that uses the words CANDY or SAGA Trademarks are more about protecting a brand as a
whole and less about owning a word ― The "senior user": King would not prevail in a lawsuit against a
company that made a game with the word CANDY in its title if it dates back to before Candy Crush Saga
― King, as the plaintiff in a lawsuit against an app developer, has the burden to prove that a reasonable consumer in that market would be confused into thinking that the defendant's product originates from King, or is endorsed/sponsored by King
9
Mobile Apps and Trademarks: Candy Crush Saga Example
What did King do right?― Filed trademark applications on a timely basis to establish
priority in countries where it operated― Monitored trademark usage in the field of its operations and
took prompt action against possible infringers― Agreed to coexistence agreements against third parties
ultimately determined to not infringe What did King do wrong?― Claimed overbroad trademark rights – trademark registrations
are not granted for individual words in a trademark― By making highly publicized and broad trademark claims,
effectively invited interested third parties to contest their trademark applications
― Generated bad publicity by targeting small developers on the basis of controversial trademark claims – to the public, appeared to be attempting to “own a word”
10
6
Mobile Apps and Copyrights: Overview
Your mobile app is a work protected under the United States Copyright Act (Title 17)― The Act protects “original works of authorship” Examples: text, software, images, graphics, film, user-
generated content Copyright protection grants the author the
exclusive right to distribute, display and duplicate the work to the public ― In general, copyright protection lasts for the life of the
author plus an additional 70 years
11
Mobile Apps and Copyrights: Work-for-Hire Agreements
Generally, a person who creates the copyright work is the author for copyright purposes
However, when the work is created by an employee within the scope of the employment and employee sign a work-for-hire agreement, the employer owns the work for copyright purposes ― Work-for-hire agreements only apply to copyrights
For companies: without the work-for-hire agreement, the app developer who writes the source code, design, or other aspect of the company’s app, holds the copyright to that material
12
7
Mobile Apps and Copyrights: Work-for-Hire Agreements
For developers: if a developer signs the work-for-hire agreement and was promised a stake in the company for the work, he or she may have a written agreement with the company’s owners that details the terms of the equity grant in the company
13
Mobile Apps and Copyrights: Enforcement
You cannot sue for copyright infringement unless the work is registered― An app copyright registration makes you eligible for
statutory damages up to $150,000.00
Copyright protection may prevent competitors from releasing an app that is identical to yours, or take a “substantial part” of your mobile app, in creative content or look and feel― However, it cannot stop competitors from using your
idea to create a program with similar function
14
8
Mobile Apps and Patents: Overview
Patents are the best way to protect your idea/invention
U.S. patent laws provide for patenting of systems, devices, and methods, including ones relating to mobile apps― Software itself cannot be patented in its intangible form,
unless it is at least disclosed and claimed in the context of methods of interacting with a computer or mobile device
― Recent court cases have raised the bar further
15
Mobile Apps and Patents: Overview
Patents provide the greatest commercial benefit where:― The expected lifespan of the technology exceeds 3 years― The technology has general application and broad
general interest― There is scope for competitors to use the technology in
the own apps
16
9
Mobile Apps and Patents: Overview
For an invention to be patentable it must be:― Statutorily eligible subject matter― Useful― New― Non-obvious
An app is patentable, or patent-eligible subject matter if falling into a statutory category: Process, machine, manufacture, or composition of matter Certain subject matter is excluded from patentability, even
if the inventions are novel and non-obvious: laws of nature, natural phenomena, and abstract ideas
17
Mobile Apps and Patents: Subject Matter Eligibility
Patents directed to inventions implemented on computers may be rejected for lack of patent subject matter eligibility
Software patent claims could be rejected if found to constitute an abstract idea implemented on a computer
Alice Corp. Pty. Ltd. v. CLS Bank Intern., 573 U.S. __ (June 19, 2014) – the Supreme Court applied a two-part test ― 1. Determine if the claim is directed to an abstract idea― 2. If so, determine whether the claim specifies additional
elements that add “significantly more”― A claim found to be abstract under part 1 must pass part
2 in order to survive
46
10
Mobile Apps and Patents: What Is an Abstract Idea?
Rather than a general rule, courts rely more on comparisons to established examples of abstract ideas from past cases
Examples include:― Fundamental economic practices – “business method patents”― Certain methods of organizing human activities― An idea “of itself”― Mathematical relationships or formulas
However, an application of such an abstract idea “to a new and useful end” remains patent-eligible
47
Mobile Apps and Patents: What Is “Significantly More”?
If a claim is directed to an abstract idea, it must specify additional features that embody a meaningful application of the abstract idea
Examples include:― Improvements to another technology or technical field― Improvements to the function of the computer where the idea is
implemented― Implementation on a particular computer rather than a generic
computer― Causing a transformation of an article to another state or
another article― Adding steps beyond the performance of generic computer
functions that are well-understood, routine and conventional
48
11
Mobile Apps and Patents: Lower Court Decisions Since Alice
A computer system for managing a bingo game― The claims recited basic computer functions such as
storing, retrieving, and verifying a set of bingo numbers against winning numbers
― Each step only requires generic computer― Every step can be carried out manually― Claims found to constitute the abstract idea of
organizing human activity, without more― Claims were not subject matter eligible
49
Mobile Apps and Patents: Lower Court Decisions Since Alice
An e-commerce system that combines visual elements of a host website and the products or services of a third-party merchant to create a composite webpage with the look and feel of the host website― The claims identify a solution to a problem specific to
the Internet― The claims identify steps involving the execution of
particular algorithms― The claims were found subject matter eligible
50
12
Mobile Apps and Patents: Enforcing your Intellectual Property Rights
What else should you consider:― You have one year from the date of sale, offer to sale or
public disclosure to file a patent application to protect your rights
― Freedom-to-operate searches for NPEs (patent trolls) and third-party rights are recommended
23
Mobile Apps and Patents: Enforcing your Intellectual Property Rights
Diligent monitoring – most apps can be found online. You may:― Create internal tracking of apps and platforms ― Target specific app stores and platforms― Engage third-party vendors that monitor brands ― Alternative: take action only after receiving a complaint
Takedown notice― Notice request may be sent to a platform operator and the app
may be deactivated A deactivated app may still be found in a user’s mobile device,
and every time the user opens the app, there is an infringement― More commonly, notices may be sent to the developer instead
24
13
Mobile Apps and Patents: Enforcing your Intellectual Property Rights
Consider informing the user with statements and notices in marketing materials to establish your apps
Use digital watermarks and tags for online work Consider effects on public relations before
taking aggressive actions― For instance, sending legal notices or submitting a
complaint or notice to a platform operator before considering contacting the app developer
25
Other Legal Issues to be Aware of…
26
14
Privacy Laws
Privacy is a key legal consideration when developing a mobile app
If the mobile app collect data, general federal and state privacy laws apply covering entities that collect, use, share, store personal information
Some types of collected data have special treatment:― Financial― Health― Programs that target children
27
Privacy Laws: Federal
Federal Trade Commission (FTC) Act §5― Prohibits and makes unlawful “unfair methods of
competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce”
The FTC may bring charges against app developers and companies― Make sure you know and follow your own privacy
practices― Inform consumers about your actual privacy practices
28
15
Privacy Laws: State
States authority and laws are similar to the FTC authority and the FTC Act (mini “FTC Acts”) ― Most states have data security breach notification laws that
require entities holding personal data to provide notices in case of breach
― Location of the consumer is a key factor to the applicability of state laws Illinois: Personal Information Protection Act (815 ILCS 530) The Act defines breach of the security of the system data as
"unauthorized acquisition of computerized data that compromises the security, confidentiality, or integrity of personal information maintained by the data collector”
“Any data collector that owns or licenses personal information concerning an Illinois resident shall notify the resident that there has been a breach of the security of the system data following discovery or notification of the breach” (815 ILCS 530/10)
29
Privacy Laws: The Children’s Online Privacy Protection Rule
Children’s Online Privacy Protection Act (COPPA) apply to mobile apps that collect information from children under 13
If you target children, you need to provide additional services and information Parents must be notified before collecting information from
their kids The privacy policy must clearly and comprehensively describe
how information collected online from kids is handled Procedures shall be implemented to protect kids’ personal
information
30
16
Privacy Laws
In developing privacy practices, app developers and companies should take into account:― Specific legal requirements that may apply based on the
type of information being collected― Special legal requirements for regulated industries or
sensitive information (e.g. kids)― Industry guidance and best practices
31
Alan R. SingletonSingleton Law Firm, P.C.
Research Park a t the Un ivers i t y o f I l l ino is2001 S . F i rs t S t . , Su i te 209Champaign , IL 61820 -3654
(217) 352-3900 s ingleton@singletonlawf i rm.com
www.singletonlawf i rm.com© 2 0 1 5 A l a n R . S i n g l e t o n
Mobile App Development Intellectual Property Protection
1
Alan R. Singleton
Singleton Law Firm, P.C.
R e s e a r c h P a r k a t t he U ni ve r s i t y o f I l l i no i s
2 0 0 1 S . F i r s t S t . , S ui t e 2 0 9
C ha m pa i gn, IL 6 1 8 2 0 - 3 6 5 4
( 217) 352 -3900 phone
(217) 352 -4900 fax
s ing le ton@sing le ton l aw f i rm.com w w w.s ing le ton law f i rm.com
© 2 0 1 0 Al a n R . S i ng l e t o n
Joint Ventures, Joint Development Agreements,
Strategic Alliances
Definitions
Joint venture:
-independent business entities
-getting together for a common commercial purpose of defined scope and duration
-by contract or in the form of a new business entity
-pool resources and share risks, rewards, and control
-can take a variety of forms – no ―standard deal‖
-joint development program, contract development, strategic alliance
What is contributed?
Intellectual property (patents, copyright, trade secrets, trademark) – may be too complex, difficult or risky to develop on your own
Background IP
Foreground IP
Capital
Testing capability and access to technical expertise
―Built in‖ end customer or purchaser
Manufacturing capacity
Sales and distribution networks
Possibly, products outside of the core business area
2
Stages
Formation
- who contributes what
- start with NDA and then non binding term sheet
Operation
-split of profits and IP
Winding down
-by agreement
-bankruptcy (snapshot license)
-breach of agreements
-merger and acquisition events
-wind down operations but continue as IP holding company
Preliminary Questions
Why do you want to form a joint venture?
What outcomes do you envision from the joint venture?
Are there other ways of achieving these goals?
What makes the other party an attractive joint venturer?
Are your goals compatible with those of your joint venture partners?
Are you and your joint venture partners a good match?
o Business culture
o Background
o Experience
o Organizational values
Contractual Joint Ventures
o Attributes ― Joint venturers establish and form the joint venture through a
contractual agreement ― No separate legal entity is created
o Why use ― Preferred when the collaboration between the joint venturers is
expected to be of narrow scope and finite duration ― Best when the parties’ business or technology sphere are distinct
enough that they are not competitors of one another nor likely to become competitors in the future
o Legal consequences ― Parties have only limited fiduciary duties to each other ― Tax issues are usually simplified ― IP ownership can be more ambiguous if not adequately addressed in
advance
o ―Joint Development Agreement‖ – common for early stage tech companies to enter into JDA with large company
3
Entity Joint Ventures
o Attributes
― Joint venturers establish a separate jointly owned business entity (such as an LLC or a corporation)
o Why use
― Preferred when the collaboration between the joint venturers is expected to be multi-faceted and continuing over the long-term
― Often used when the parties anticipate developing completely new product lines or commercializing new markets
o Legal consequences
― Parties have a great deal of freedom to limit their exposure to liability or to engage in tax planning by choosing the entity’s form
― IP ownership is simplified since the entity can own IP rights and license them back to the joint venturers
Contractual followed by Entity
The choice of joint venture type is not fixed o Two-Stage Model
― First stage is a contractual joint venture
― Second stage is the creation of a joint venture entity
― More complex and less commonly encountered
― Useful when the joint venturers want a limited initial collaboration to determine the viability of continuing the joint venture as a longer-term, freestanding entity
Example: Stage one is to determine the technical and commercial viability of a proposed new product; if that viability is demonstrated, the parties will form a separate entity to bring the new product to market in stage two
Allows the parties to set tech, business, or financial benchmarks upon which the formation of the new entity will be conditioned
Suppose that two parties collaborate on technology development absent an agreement regarding IP rights. What result? o Patent: Any person who contributed to the conception of one
claim is a joint owner of the patent
― Doesn’t require the joint owners to physically work together or to work simultaneously
― Doesn’t even require a general intention to jointly invent
o Copyright: Similar to the patent scenario
― Like patents, doesn’t require the authors to work together or simultaneously
― Joint ownership will result only if the creators intend to jointly author the work and their contributions must be ―inseparable or interdependent.‖
Without a Written Agreement
4
Without a Written Agreement
Therefore, collaboration without an agreement regarding IP rights tends to create scenarios of joint ownership
Parties can also agree to jointly own IP
Joint ownership sounds like a fair outcome, but it is fraught with peril
Patent Joint Ownership
Patents
o Each joint owner can freely practice and can (nonexclusively) license the patent to a third party (including one of the other joint owners’ competitors)
o No duty to share profits with the other joint owners
o A suit for infringement can typically only proceed if all joint owners participate in the suit
― Any joint owner can cut off the infringement action by granting a license to the alleged infringer
o Astute would-be licensee can play the joint owners off one another to get the best deal
Copyright Joint Ownership
Copyright
o Each copyright joint owner can freely license the work without consultation with or consent from the other owners
o Unlike the case with patents, joint owners have a duty to share profits from the copyright with other owners (―duty to account‖)
o A suit for infringement does not require all parties to join
― Nevertheless, the court can require it if it chooses
― A court will also permit intervention by anyone with an interest in the copyright
5
International Joint Ownership
If you plan to commercialize your jointly developed technology in other countries, you face different laws (but similarly unsynchronized systems for different kinds of IP!) that must be accounted for
Choice of law provisions in agreements that indicate US law will apply will not override the default rules of another country with respect to enforcement and exploitation of jointly owned IP
When Created
What Who Developed
Ownership Licenses
Prior to Joint Venture
Preexisting Background IP
Individually Developed
Developing joint venturer
Nonexclusive to the other joint venturer(s) within the joint venture field of use
While Joint Venture is in Place
New Background IP
Individually Developed
Developing joint venturer
Nonexclusive to the other joint venturer(s) within the joint venture field of use
Foreground IP
Derivative IP wholly derived from only one joint venturer’s Background IP
Individually or Jointly Developed
Whichever joint venturer owns the underlying Background IP
Nonexclusive license to other joint venturer(s). Possible field-of-use limited.
Nonderivative Any other Foreground IP
Individually or Jointly Developed
One joint venturer only: to be negotiated in advance. Could be ―blanket‖ allocation of ownership (i.e., always to one joint venturer) or by pre-defined area of technology. Joint ownership could be problematic
Exclusive license to other joint venturer(s) in agreed field of use
Possible IP Allocation for a Contractual Joint Venture
When Created
What Who Ownership Licenses
Prior to Joint Venture
Preexisting Background IP
Individually Developed
Developing joint venturer OR --------------- NewCo
Exclusive or nonexclusive for NewCo in field of use -------------------- Nonexclusive grantback outside NewCo’s field of use
While Joint Venture is in Place (NewCo)
New Background IP Individually Developed
Developing joint venturer OR --------------- NewCo
Exclusive for NewCo in field of use to prevent joint venturers from competing with the joint venture; could be nonexclusive -------------------- Exclusive or nonexclusive grantback outside NewCo’s field of use
Foreground IP
Derivative IP completely derived from only one joint venturer’s Background IP.
Individual Joint Venturer, Multiple Joint Venturers, or NewCo
Whichever joint venturer owns the underlying background IP.
Nonexclusive to NewCo in field of use
NewCo Exclusive to joint venturer who owns the underlying IP outside NewCo’s field of use, possibly with further restrictions
Nonderivative Any other Foreground IP
Individual Joint Venturer, Multiple Joint Venturers, or NewCo
NewCo Exclusive or nonexclusive to joint venturer(s) in defined field(s) of use; could be royalty-free or royalty-bearing
Possible IP Allocation for an Entity Joint Venture (NewCo)
When Created
What Who Developed
Ownership Licenses
Prior to Joint Venture
Preexisting Background IP
Individually Developed
Developing joint venturer
Nonexclusive to the other joint venturer(s) within the joint venture field of use
While Joint Venture is in Place
New Background IP
Individually Developed
Developing joint venturer
Nonexclusive to the other joint venturer(s) within the joint venture field of use
Foreground IP
Derivative IP wholly derived from only one joint venturer’s Background IP
Individually or Jointly Developed
Whichever joint venturer owns the underlying Background IP
Nonexclusive license to other joint venturer(s). Possible field-of-use limited.
Nonderivative Any other Foreground IP
Individually or Jointly Developed
One joint venturer only: to be negotiated in advance. Could be “blanket” allocation of ownership (i.e., always to one joint venturer) or by pre-defined area of technology. Joint ownership could be problematic
Exclusive license to other joint venturer(s) in agreed field of use
Possible IP Allocation for a Contractual Joint Venture
When Created
What Who Ownership Licenses
Prior to Joint Venture
Preexisting Background IP
Individually Developed
Developing joint venturer OR --------------- NewCo
Exclusive or nonexclusive for NewCo in field of use -------------------- Nonexclusive grantback outside NewCo’s field of use
While Joint Venture is in Place (NewCo)
New Background IP Individually Developed
Developing joint venturer OR --------------- NewCo
Exclusive for NewCo in field of use to prevent joint venturers from competing with the joint venture; could be nonexclusive -------------------- Exclusive or nonexclusive grantback outside NewCo’s field of use
Foreground IP
Derivative IP completely derived from only one joint venturer’s Background IP.
Individual Joint Venturer, Multiple Joint Venturers, or NewCo
Whichever joint venturer owns the underlying background IP.
Nonexclusive to NewCo in field of use
NewCo Exclusive to joint venturer who owns the underlying IP outside NewCo’s field of use, possibly with further restrictions
Nonderivative Any other Foreground IP
Individual Joint Venturer, Multiple Joint Venturers, or NewCo
NewCo Exclusive or nonexclusive to joint venturer(s) in defined field(s) of use; could be royalty-free or royalty-bearing
Possible IP Allocation for an Entity Joint Venture (NewCo)
6
Your IP and Your Partners’ Employees
Not only do joint venturers have to worry about third parties gaining access to proprietary information; they also need to think about their joint venture partners and what employees may be able to do with that information
The information the employees learn cannot be erased at the end of the joint venture. Two potential hazards result from this:
1. An employee may leave your joint venture partner for a new position with one of your competitors
― Especially problematic if your joint venture partner doesn’t have a non-disclosure agreement with the employee
2. Your joint venture partner may form a joint development relationship with one of your competitors
Your IP and Your Partners’ Employees
Fortunately, by planning ahead, some of these risks can be minimized
o Joint venture partner agrees to limit the type of future work they assign to their employees who were exposed to your proprietary information, for a limited time
― In particular, have these employees excluded from working on other joint ventures that your partner might form in the future with your competitors
o Joint venture partner agrees to have a written confidentiality agreement with its employees naming you as a third-party beneficiary
― As a third-party beneficiary, you will be entitled to enforce the confidentiality agreement yourself, without having to rely on your partner filing a lawsuit
Questions
Is your interest in the venture/alliance primarily strategic or financial in nature?
What consequences would stem from a sale of your interests in the venture/alliance?
Why does it make sense for you to partner on this project rather than go it alone?
What opportunities will you forgo by entering into the venture/alliance?
What is the scope of the noncompetition and exclusivity provisions that are envisioned?
7
Questions
What are the strengths that each party brings to the table?
What are the parties’ bargaining powers, both up front and over time?
How much money do you wish to invest in the venture, both up front and over time?
What are the expected exit strategies and do all parties have a shared view of the likely exit scenarios?
Have you adequately considered all that could go wrong with the venture/alliance and how to adequately protect its interests in such various downside scenarios?
Structuring the Deal
What will the governance structure be?
What assets will be conveyed to the venture and by whom?
What will the economic rights of the parties be?
What is the ideal structure from a tax perspective?
What corporate approvals are required? Is shareholder approval needed?
What regulatory filings are needed? Is a Hart-Scott-Rodino or foreign antitrust filing required? Are there any significant anticompetitive consequences to the venture?
Are any third-party consents needed?
Has due diligence been completed? What does it reveal?
What timeframe is desired for completing the deal? What intermediate benchmarks/deadlines exist?
Forms of Entity Joint Ventures
TYPES OF BUSINESS ENTITIES
The oldest forms are partnerships and corporations (or more specifically, C corporations)
Partnerships arise when two or more persons or entities join to run a business together and split profits. There is no tax at the partnership level (what is called "pass-through tax treatment") and partners are fully liable for all claims against the partnership
C Corporations offer limited liability, but it comes at price: profits are taxed first at the corporation level and then again as an individual's income when paid out as a dividend
8
Forms of Entity Joint Ventures
The S corporation and the LLC were created to combine the best features of each of these two older forms. S corporations feature the limited liability of C corporations with the pass-through tax treatment feature of partnerships. However, S corporations face strict limitations on who and how many can be shareholders. The shareholders cannot number more than 100 and, with the exception of certain trusts and tax-exempt organizations, must be natural persons who are U.S. citizens or residents. Furthermore, only one class of stock is allowed, although differences in voting rights are permitted.
Finally, the newest form is the limited liability company (LLC). Like the S corporation, it also combines limited liability with pass-through tax treatment. Unlike the S corporation, the LLC is exceptionally flexible with respect to who and how many members (the LLC analogue to the S corporation's shareholder) may have. In particular, there is no upper limit to the number of members, all types of entities may be members, and different classes of ownership are permitted.
Joint Venture Form and Tax Treatment
One principal consideration in choosing between a contract-based joint venture and an entity-based one (including which kind of entity) is the tax treatment associated with the choice.
It is important to keep in mind that the IRS looks to the functional realities of the venture and not merely the legal designations that the venturers have used.
o For instance, a partnership can be formed simply by agreeing to go into business with another and splitting the profits; an explicit choice of the partnership form isn’t always required.
o Consequently, the IRS has regulations that allow them to recharacterize some contractual joint ventures as partnerships if they are too close in function to a partnership.
Joint Venture Form and Tax Treatment
On the other hand, the IRS gives businesses a great deal of freedom under its ―check the box‖ regulations.
Business entities composed of two or more members and which are not organized as corporations under state and federal law may choose to be taxed as a partnership or as a corporation.
o Default rules govern entities that do not file a ―check the box‖ election. Typically, the rules classify them as partnerships.
o Once an election has been made, it cannot be changed for five years---unless there is a more than 50% change in ownership
Note: This only pertains to federal tax. State taxation and liability issues are not altered by this system.
9
Joint Venture Form and Liability Issues
A second key consideration in choosing the joint venture form is exposure to liability. o As mentioned, one of the most desirable features of corporations
(both C and S) are their limited liability. In general, shareholders stand to lose only as much as they have invested
o Partners, on the other hand, face unlimited personal liability for claims against the partnership
o A limited liability company, as its name indicates, shares the limited liability feature of corporations
o Contract-based joint venture parties may face liability from activities undertaken in pursuance of the joint venture
Joint Venture Form and Access to Capital
Venture Capital - while LLCs are attractive because they feature limited liability and pass-through tax treatment, most venture capital firms will not invest in an LLC
IPO - if the joint venture were to go public, it would need to be converted from an LLC to a C corporation or at least elect to be taxed as a C corporation
Joint Venture Exit Strategies
Merger or Acquisition of Joint Venture
- licensed IP should be freely transferable upon change in control; BUT minority contributor to JV may insist that some IP not transferable to a competitor of the minority contributor
Dissolution of Joint Venture
-protect member’s right to use vs. prohibiting member’s right to use
- many of the same considerations that apply to apportioning IP rights during the JV apply to apportioning IP rights at its termination (in particular, avoidance of joint ownership)
- prohibitions or limitations on the members’ rights to IP after dissolution can serve to discourage prematurely dissolving the joint venture
10
Joint Venture Exit Strategies
Bankruptcy
- clauses that say a license terminates in bankruptcy generally unenforceable; better to terminate based on other factors – inability to pay bills, etc.
- bankruptcy courts have broad powers to authorize assignments or rejection of the bankrupt’s contract; in the joint development context, this has two consequences:
• to protect the members, ensure that the IP they license to the JV cannot be assigned away to a competitor by emphasizing the importance of the identities of the parties to the licensing transaction
• to protect the JV, ensure that the IP licensed to it meets 11 U.S.C. § 365(n), a provision of the Bankruptcy Code that restrains the court from approving IP license termination
Distributorships & Sales Representatives
Distributors — Purchase merchandise from manufacturers at a discount (typically larger than the value of a sales commission), profit is made from selling the items at a markup.
Sales representatives — Solicit offers to purchase from consumers, relay these to manufacturers who fill the order, profit is made by earning a commission on sales they procure.
In other words, there are two characteristics that distinguish these roles:
1. Who owns the merchandise? — Distributors purchase the goods and are responsible for storing, protecting, and selling them once they have ownership. Sales reps ordinarily do not have these obligations.
2. Who bears the risk? — Distributors bear the risk of carrying inventory for which there is no demand as well as the risk of a defaulting purchaser. Sales reps do not, although the sales representative agreement can specify that no commissions will be due when the customer fails to pay.
Distributorships & Sales Representatives
11
Distributorships & Sales Representatives
Q: What factors might manufacturers consider when deciding to use a distributor or a sales representative?
A: There are two key considerations that enter into the decision: credit risk and control.
Distributorships & Sales Representatives
Credit risk
Local distributors may have better information about the creditworthiness of local potential buyers. Where the typical potential buyer is a small unknown business, a manufacturer may find offloading the credit risk to a distributor attractive
When the typical potential buyer is large, well-known, and well-capitalized, using a sales representative will be a less costly way doing business
Distributorships & Sales Representatives
Control
Unlike distributors, sales reps only solicit offers and own no merchandise. Therefore, the manufacturer retains control over:
order acceptance: sales reps cannot accept orders, they only relay them to the manufacturer
price: the sales rep does not own and resell the merchandise as distributors do, the manufacturer keeps absolute control over price
customer relationship: manufacturers typically work more closely with customers when there is no distributor as a middleman
12
Distributorships & Sales Representatives
Exclusive versus Non-Exclusive Arrangements
Procuring Cause Rule (applicable to sales reps only)
Extremely important to specify that commissions are payable only on sales procured by the sales rep (indeed, the agreement should use that very word). Otherwise you might have to pay a commission to a sales rep who had nothing to do with the sale!
Toll Manufacturing
Toll manufacturing, also known as toll processing, tolling, toll conversion, or custom manufacturing, can be defined as performing a service on a customer's raw material or product, for a fee (toll). Toll manufacturers provide a manufacturing/processing service for other companies and receive a volume-based fee
Traditionally used for prototypes, marketing studies, and small-scale specialty products, and is a means to expedite manufacturing and marketing
Tolling also reduces capital expenditures and the need to hire and train temporary personnel
Toll Manufacturing
Toll manufacturing agreements demonstrate a large variety of terms. In many ways, the agreement is limited only by what one is capable of negotiating. The relationship can be continuing or on an as-needed basis. The toll manufacturer and its client can cooperate intensively on the fabrication process or remain quite distant
Given the open-ended nature of the toll manufacturing field, it is important to have considered all possible terms and conditions and to know where you need to be insistent and where you can be flexible
o In addition to the obvious terms of cost, volume, and turn-around time, be sure you know what you need in terms of confidentiality, meeting regulatory requirements, quality control protocols, distribution/shipping costs, risk management and beyond
13
Toll Manufacturing
Some of these additional considerations include:
Economics. Lower operating cost must be weighed against the extra cost of negotiating toll agreement and monitoring performance
Confidentiality. Ensuring that intellectual property and commercial secrecy are not compromised is particularly critical. If you and the toll manufacturer jointly develop a product or process as a result of your relationship, how will you split that reward?
Government regulations. Dealing with regulations, particularly those of distant states or foreign nations, can involve uncertainty, red tape, and delays that can be costly
Time zone difference. Consider the implications in terms of the on-call availability of personnel. Consultation with an expert in the home office may be required outside that person's normal working hours. An alternative is to temporarily relocate a technical representative at the facility
Manufacturing practices. This is particularly important in industries where adherence to current good manufacturing practices (cGMPs) is essential.
Conflicts of interest. Potential conflicts of interest may arise if the toller is an ex-employee of a competitor or of your own company
Contracts and the 5Ws
One of the most important functions of a written contract is to document the intentions and expectations of the parties
Remember the 5Ws of telling a story—contracts are no different
o Who are the parties to the contract? Who are any third parties that will play a role in the contracted relationship?
o What do the parties promise to do for each other? What conditions will make these promises come due or excuse them?
o When are the obligations to be performed? When will the contract expire?
o Where is the contract applicable? What territory is envisioned? Which jurisdiction’s laws will govern?
o Why is the contract being created? Use a recitals section to contextualize the contract.
o How much is at stake? Not just dollars, but also volume of merchandise or numbers of licensed users.
―Integration‖ or ―Merger‖ Clause
Paragraph that states the written contract is the entire agreement between the parties and that there have been no other representations or promises made
Typically appears at the end of the contract
The use of an integration or merger clause means that any prior promises made by the parties (whether oral or written) would not usually be enforceable unless there has been fraud
Consequently, the parties should not rely on any ―side promises.‖ If they’re integral to the deal … ―Get it in a signed writing.‖
14
Alan R. Singleton
Singleton Law Firm, P.C.
R e s e a r c h P a r k a t t he U ni ve r s i t y o f I l l i no i s
2 0 0 1 S . F i r s t S t . , S ui t e 2 0 9
C ha m pa i gn, IL 6 1 8 2 0 - 3 6 5 4
( 217) 352 -3900 phone
(217) 352 -4900 fax
s ing le ton@sing le ton l aw f i rm.com w w w.s ing le ton law f i rm.com
© 2 0 1 0 Al a n R . S i ng l e t o n
Joint Ventures, Joint Development Agreements,
Strategic Alliances
Singleton Law Firm, P.C. is dedicated to serving the legal needs of business and individual clients of east central Illinois and beyond with an emphasis in the areas of corporate, intellectual property (including patent) and real estate law. The firm was founded by attorney Alan R. Singleton and paralegal Elizabeth C. Kellner following Mr. Singleton’s practice at another local firm as an associate and then shareholder. Ms. Kellner’s experience includes work at the University of Illinois business incubator and then service as the coordinator and then executive director of techCommUnity. Both Mr. Singleton and Ms. Kellner are active in their efforts to grow the local business community. Both maintain contacts in the local business community and beyond which allow them to serve as a team to meet the needs of business and individual clients through the provision of value added quality legal services.
ALAN R. SINGLETON SINGLETON LAW FIRM, P.C.
Research Park at the University of Illinois 2001 S. First St., Suite 209
Champaign, IL 61820 217-352-3900
www.singletonlawfirm.com [email protected]
Mr. Singleton provides legal services to business clients in corporate, intellectual property, securities, and real estate law areas. He has frequently assisted entrepreneurs select and organize an appropriate entity and obtain capital. He has formed limited liability companies, subchapter S corporations, subchapter C corporations, professional corporations, L3Cs, and not-for-profit corporations, including publicly supported organizations and private
foundations. Mr. Singleton has also assisted clients with mergers and acquisitions and with implementing stock option programs.
A member of the patent bar, Mr. Singleton has represented clients in patent prosecution, trademark registration, negotiation of licenses, research and development agreements and joint development agreements. He is familiar with the University of Illinois policies on technology transfer and has negotiated licenses of University technology. Mr. Singleton’s real estate law experience includes purchases and sales, leases, installment contracts, like kind exchanges, and zoning and land use issues.
Mr. Singleton is active in both the business and educational communities. He has served on the Advisory Councils of numerous technology companies and served on the list of advisors at the Illinois Technology Center. He is a member of the business plan review group Second Saturday and has served as a judge for the Academy for Entrepreneurial Leadership Innovation Teams Competition and V. Dale Cozad Business Plan Competition. He currently serves as an Entrepreneur in Residence at EnterpriseWorks.
Mr. Singleton maintained an adjunct faculty appointment with the University of Illinois College of Medicine for roughly 20 years. He has given guest lectures for the University of Illinois MBA course on technology commercialization, the Senior Capstone Design Course in the Department of Agricultural and Biological Engineering, the Academy for Entrepreneurial Leadership Idea to Enterprise Workshop, the Technology Entrepreneur Center, the Advanced Invention to Venture workshop, Enterprise Works, the SIU Carbondale business incubator, the University of Illinois College of Veterinary Medicine and for medical residency programs throughout the state.
The recipient of the 2008 Entrepreneur Advocacy Award and, as an undergraduate, of the Chemical Rubber Company Chemistry Award, Mr. Singleton earned a Bachelor of Science Degree in Geology from the University of Illinois in 1988 and a Juris Doctorate from the University of Illinois College of Law in 1991. Following law school and prior to founding Singleton Law Firm, P.C., he practiced with Webber & Thies, P.C. as an associate and then shareholder.
Mr. Singleton is currently a member of the American Bar Association Sections on Business Law, Intellectual Property Law and Science and Technology Law, the Illinois State Bar Association Sections on Corporation and Securities Law (Prior Member, Section Council) and Intellectual Property Law (Prior Member, Section Council), the American Intellectual Property Law Association, American Chemical Society, Association of University Technology Managers and has previously been a member of the Intellectual Property Law Association of Chicago and Midwest Business Brokers and Intermediaries.
Mr. Singleton has chaired the EDC/techCommunity Mentoring Program, has served on the board of the Don Moyer Boys and Girls Club and Mahomet Area Youth Club, and serves on the boards of the Mahomet Area Kids Endowment Foundation and Mahomet Seymour Soccer Club.
1
Alan R. SingletonSingleton Law Firm, P.C.
Research Park a t the Un ivers i t y o f I l l ino is2001 S . F i rs t S t . , Su i te 209Champaign , IL 61820 -3654
(217) 352-3900 s ingleton@singletonlawf i rm.com
www.singletonlawf i rm.com© 2 0 1 5 A l a n R . S i n g l e t o n
Exit Strategies for the Technology Company
Roadmap
Intro-Big Picture (slides 3 – 8) Sample M&A data (slides 9 – 14) Sample of local M&A (slides 15 – 23) Acquisition Criteria (slides 24 – 31) Nondisclosure Agreement (slides 32 – 33) Buyer Visit (slides 34 – 36) Letter of Intent (slide 37) Due Diligence (slides 38 – 47) Deal Structure (Stock Sale, Asset Sale, Merger) (slides 48 – 59) Preferred Stock in M&A Setting (slides 60 – 62) ESOPs (slides 63 – 67) M&A Agreement and Common Terms (slides 68 – 96) Additional local M&A events (slides 97 – 120) Example Study of M&A events in a specific industry (slides 121 – 145) Big dollar tech exits (slides 146 – 155)
2
2
Big Picture - Commonly Used Terms
Merger: a transaction in which two or more corporations combine under state corporation law resulting in all but one of the participating corps losing their identities
Acquisition: a broader term that can mean any general purchase of all or part of a business- can be stock or asset purchases
Consolidation: two or more organizations are combined into one new legal entity
Liquidation: disposition of assets of a business to raise cash; covers a spectrum of business transactions; can include a Chapter 7 bankruptcy
Restructuring: generally, any transaction in which a company’s ownership, assets, or operations are rearranged to increase profitability; can include Chapter 11 bankruptcy reorganization
3
Big Picture - Strategic Buyers vs. Financial Buyers
Strategic Buyers― Typically in a similar line of business― Objective is to “buy low and hold”― Generally, the strategic buyer is a large company that has the
capital and managerial know-how to take the target to the next level of corporate development; this synergy is what makes the deal attractive
Financial Buyers― Often what people think of when they hear “M&A” objective is
to “buy low and sell high”― Perform the function of putting target’s assets to their most
profitable use― Targets are attractive not because of synergies with acquirer’s
business, but because of the target’s financial characteristics
4
3
Big Picture - 10 Exits (John Huston)
1. Grand Slam HomerunExceeds a 10X in five years (>58% IRR)
2. A Lucrative Exit<58% IRR, but at least a 1-10X return
3. The Harry HoudiniEscaped with a 1X return; No loss
4. Lost a LittleDidn’t lose it all (<1X but not a 0X)
5
Big Picture - 10 Exits from John Huston
5. My Grandkids’ CompanyCompany is successful but there’s no exit in sight. Maybe it will occur after my grandchildren inherit the portfolio?
6. The ZombieA walking dead venture which will never become a great company, nor will it die so I can declare the loss
7. Deductible LossIt died without a tail and I got to declare the loss (or sold my shares for $1.00 to record the loss)
6
4
Big Picture - 10 Exits from John Huston
8. Funeral ExpensesNot only did I lose all my original investment, but I had to also cover the costs of winding down the venture, plus pay accountants to provide the final accounting needed so I could take my tax deduction
9. The Worst Gets Worst“The loss that keeps on losing” due to ongoing litigation expenses even after the company has no value
10. Angel HellIn addition to losing all my investment and a considerable amount of my time, media coverage tarnished my reputation, plus damaged my relationship with co-investors
7
Big Picture - 10 Exits from John Huston
The Perfect Loss: I merely lose 100% of my investment; take the tax deduction; suffer no on-going tail of litigation; no wind-down expenses, no media coverage, no damage to my reputation or my relationships with co-investors… and it was a “productive failure” because the entrepreneur, the management team and the investors all learned lessons which will increase their likelihood of success in their next venture
8
5
Sample M&A Data
The following slides summarize recent data and exits in the tech industry
9
ExitRound 2014 Report
The ExitRound Report focus on M&A exits below $100 million― 88% of tech M&A deals happen below $100 million― Used data from more than 200 exits that have happened
between 2006 and 2014
10
6
ExitRound 2014 Report
Key Findings:― Companies that generate substantial exits are usually at
least 4 years old Companies below 4 years generally did not show a substantial
variation in price Those more than 4 years old increased substantially in price
Source: Exit Round (2014 Report)
11
ExitRound 2014 Report
Key Findings:― Raising more capital does not necessarily result in a larger
exit price for the company― Exit prices varied among companies in different sectors -
cloud and mobile showed the best return on invested capital
Source: Exit Round (2014 Report)
12
7
ExitRound 2014 Report: Exit Curve
Source: Exit Round (2014 Report)
The Exit Curve shows the best exits from a return-on-capital perspective form a pattern
13
ExitRound 2014 Report: Exit Curve
It was found that the best average exits tend to be around companies with total capital raises of between $2 million to $3 million and between $5 million to $10 million ― Exit prices tend to drop after companies raise more than $3 million and $10
million
Source: Exit Round (2014 Report)
14
8
Sample Local M&A
15
American Analytical Chemical Laboratories, Inc
Inception ― 1994: American Analytical Chemical Laboratories (AAC Labs)
founded by biologist Charlie Li in Savoy, IL― 2004: AAC Labs moves to Champaign’s Mattis Commercial
Park Core Technology― Analysis and testing of nutritional supplements for presence
of residues, pesticides, antibiotics, and verification of nutritional content
Market― Dietary Supplement Health and Education Act (2006) requires
supplement testing to ensure identity, potency and safety ― As a result, AAC Labs does testing for ~ 500 customers in the
United States and worldwide ― Major clients include a nutritional supplement company in New
York, and two sizeable customers in Salt Lake City
16
9
American Analytical Chemical Laboratories, Inc
Growth― 1994: AAC Labs opens in Savoy― Revenue increased every year since inception Grew 11% in 2010, during height of economic downturn
― 2004: larger facility, 15 employees― 2010: 23 employees
Exit (2011)― Acquired by Intertek Group for $6.9 million cash― Strategic Buyer ― Founder Charlie Li to remain in charge of Champaign lab,
which expects to grow employee count by 50% to about 35 employees within next 2-3 years
Sources― The News Gazette and London Stock Exchange RNS
17
iCyt Mission Technology, Inc.
Inception― 1995: Cytometry Services, Inc. founded in
Champaign/Urbana― Renamed iCyt Mission Technology, Inc. in 2002
Core technology― Advanced flow cytometry analysis and sorting
technology for use in life science research Market― Private and public research institutions― Pharmaceutical and biotechnology companies― Large medical centers
18
10
iCyt Mission Technology, Inc.
Growth― 2000: first full-time employees hired― 2004: 30 employees― 2005: larger facility, 44 employees― 2007: first commercial instrument system
Exit (2010)― Acquired by Sony Corporation― Wholly owned subsidiary, with founder as executive― A strategic acquisition
Source:― Company website and Sony press release dated 2-10-2010
19
Isotech Laboratories, Inc.
Inception― 1985: founded by Dennis Coleman, Jerry Benson and Kerry Riley ― Based in Champaign, IL
Core technology― Isotope testing for the oil and the gas industry: helps reduce risk
in oil and gas exploration and checks integrity of underground storage fields
― IsoTube®, IsoJar®, IsoBag® and IsoPak™ Growth
― 42 employees― Sales: from $1.1 in 2001 to $4 in 2006 and almost $9 million in
2008 ― Now operates three satellite labs in Cairo (Egypt), Rio de Janeiro
(Brazil) and Perth (Australia), in the process of setting up another one in Oman
― Works with almost all oil and gas companies
20
11
Isotech Laboratories, Inc.
Acquisition― Isotech reached the point where going forward on its own would
be too risky as its technology was becoming widely used and competitors were emerging
― 2011: acquired by Weatherford Laboratories, subsidiary of Switzerland-based Weatherford Laboratories
― SEC filing by the buyer implies a sale price of $28 million― Weatherford employs more than 50,000 employees worldwide,
and operates in more than 100 countries― Weatherford entered the isotope analysis market through this
acquisition Remains local― Isotech remains in Champaign and operates under same
management Source― News Gazette, SEC
21
Carle Foundation Hospital
Carle Foundation Hospital acquired Carle Clinic Association and its subsidiary Health Alliance― $ 250 million sale― Carle Foundation is a not-for-profit organization― Carle Clinic Association a for-profit, physician owned
multi-specialty group practice Strategic acquisition – creation of an integrated
system for health care― The deal positions Carle to remain under local control― Hospital had been seeking to acquire the Clinic off and
on for the past thirty years – parties’ familiarity with each other
22
12
Carle Foundation Hospital
Most of the actual purchase price was allocated to the Clinic’s subsidiary Health Alliance Medical Plans
80% of key employees (physicians) signed employment contracts to continue employment after the transaction
Purchase price paid through borrowing Required regulatory approvals included― Heath Facilities Planning Board― Federal Trade Commission― Department of Justice
Source― News Gazette, December 11, 2009
23
Players: Sell-side
At least three groups of people will be involved in the acquisition process—either because they are owners or because of their management role Exiting owners
― Often the founders; view the acquisition as a successful outcome for their entrepreneurship
― May also include angel investors and venture capital firms who made their investment with the goal of an exit
Continuing owners― Includes key equity-owning executives and other personnel,
including possibly the founders, whose continued management is desired by the buyer
Non-owner management― Includes managers whom the 1) buyer wishes to continue to
employ after acquisition and 2) those who will be replaced
24
13
Acquisition Criteria
An acquirer will generally formulate criteria regarding the type of business it is looking to purchase before beginning its search, for instance: Industry/Type of business Size of business Profitability Management/Board of Directors style Target’s market characteristics Product lines Tech/R&D activities Purchase price payment options
How acquisition can benefit the acquirer’s bottom lineKnowing these acquisition criteria can help a target identify legal and business steps to make the company more attractive to a potential buyer
25
Acquisition Criteria: Industry/Type of Business
The most easily understood of the acquisition criteria
The usual acquirers of early-stage tech companies are much larger conglomerates― It could also be the end result of a successful joint
development agreement or joint venture Nevertheless, there are legal issues to be
mindful of: will the acquisition give rise to any antitrust or anticompetitive concerns?― Unusual in the context of early-stage tech companies
26
14
Acquisition Criteria: Size and Profitability
Size― Metric: annual sales or annual revenue― Companies will look for targets within a specific range,
neither too small nor too large Profitability― Return on equity― Price-earnings ratio― Return on sales― Sales growth trends― Early stage tech company may not yet be profitable but
may still be an attractive target for a strategic buyer
27
Acquisition Criteria: Management Style
Management/Board of Directors style― Has the target been well-managed so far, and is that
likely to continue? Are there middle-rank management who are ready to
succeed following the departure of owners and high-level executives?
What system is in place to continue to recruit and train qualified management candidates?
Does management match the acquirer’s desired attributes, such as for business aggressiveness or conservative management?
Will management be replaced upon closing of the acquisition?
28
15
Acquisition Criteria: Market Characteristics
Are there any peculiarities to the target’s market characteristics that need to be considered?― Does a single customer account for a large proportion of
the target’s sales? This may not be especially problematic if the customer is a
government agency― Has the target developed a business niche that sets it
apart from it competitors?― Similarly, has the target developed a geographic niche
that makes it attractive to the potential acquirer?
29
Acquisition Criteria: Product Lines and R&D
Product Lines― Some acquirers may not consider single product line
companies for acquisition; strategic buyer may roll the product line into its existing company and be very comfortable with one product line
Research and Development― What are the prospects for the tech it has developed?― What legal protections for its IP are in place? Will there be any difficulties in transferring the IP to a new
owner?― Who drives innovation at the target? If it is a small number of
employees, what would happen if they left the company?― What has the target’s R&D track record been like?― What are the projections for R&D expenditures in the short-
term and the long-term?― See IP audit checklist
30
16
How Acquirers Identify Targets
Internal― Some acquiring companies have an internal department whose role (or one
of its roles) is to identify potential acquisition targets - commonly called “Corporate Development”
― Often the companies know each other through trade shows, a joint development arrangement or some other preexisting relationship – the ________ industry is a “small world”
External― Selling companies may retain external professionals to help with the sale― Brokers or finders sometimes handle smaller acquisitions – “main street”
businesses – these often sell through word of mouth without a broker ― M&A advisory firms or investment banks may advise on very large deals― Fees for these groups might range from a 2% “finder’s fee” to the more
complicated “Lehman formula” - 5% on the first million, 4% on the second million, 3% on the third, 2% on the fourth, and 1% on the remainder over four million dollars, although Lehman formula fallen in disfavor
31
Nondisclosure Agreement (NDA)
• Often the first agreement to be entered into and an early first step in M&A transaction
• Use a nondisclosure form that is specifically drafted for M&A activity
32
17
Some areas of the NDA that may be unique to M&A
• Confirms language clarifying that discussions between parties about the transaction are confidential, for instance:• identity of the parties • terms of any bid if the recipient is the acquiring company (if recipient is
the acquiring company and needs financing for the transaction, obtain a carve out allowing information to be disclosed to financiers)
• Limits use of the confidential information to evaluation of the specific transaction and for no other purpose
• Non-solicitation/Employment of Disclosing Party’s Employees (important to provider/seller)
• Sets the terms of the NDA (limited or perpetual) (consider unlimited term for trade secrets)
• Privilege – confirms disclosure is not deemed to have waived or diminished attorney-client privilege, attorney work-product protection, etc
33
The Buyer Visit
Typically occurs very early in the acquisition process Discretion is important― No need to tip off customers, vendors, employees, competitors,
and others that an acquisition is being contemplated Preparation is important― Buyer is looking for hidden risks and unexploited opportunities― First question buyer will ask is “Why are you selling the
business?” — Make sure you have a good answer The best answer typically focuses on what the buyer brings to
the table that the seller doesn’t have (greater capital, larger sales and distribution networks)
Positions the company as ready to take-off once those advantages are brought to bear
34
18
The Buyer Visit
Know your company inside and out― Know your costs, your margins, and your ratios― Be able to explain the market your company operates in and
provide a forecast for your operations How to handle the company’s weaknesses― Part of knowing your company is knowing its strengths and
weaknesses― Naturally seeming forthright will build more confidence in the
buyer than appearing cagey― Position the company’s weaknesses as capable of easy
correction — a weakness then appears to be an untapped opportunity Example: A company has an 8-week backlog on orders, which
causes lost sales. The acquirer has the resources to handle order fulfillment more
efficiently and recapture the lost sales
35
The Buyer Visit
Remember that the buyer visit is a two-way exchange of information― Seller should also question buyer― Seller should use buyer’s responses to identify what
matters to the buyer — and weave this information into making the case for acquisition and drive up your perceived value to buyer
― Seller should get a sense whether the buyer understands your business and the industry and market it operates in Many acquisitions involve earn-outs Need to be confident that buyer has the capability of
meeting the earn-out benchmarks
36
19
Letter of Intent (“LOI”) / Term Sheet
Sets forth key business terms before definitive legal documents are prepared
Legally binding vs. non binding vs. binding only as to particular terms (confidentiality, no shop)― Best to avoid “no shop” provision, which would prohibit
any discussion with another possible buyer― If “no shop,” cannot be removed, negotiate a better
purchase price, break fee, or limit it to a “window shop” - cannot solicit buyers but can talk to them if they come to you
37
Conducting Due Diligence
Due Diligence: What is it?― Fundamentally, it is the investigation of a business in
connection with a possible transaction― Usually performed by someone who is considering
whether to purchase or make a significant investment in a business (buy-side due diligence)
― Sellers can and should engage in (sell-side) due diligence to uncover any problems that may be presented by a sale to a suitor
― Although both parties should engage in due diligence, because of the seller’s information advantage, buy-side due diligence tends to be much more intensive
38
20
Conducting Due Diligence
Due Diligence: What does it cover?― Legal issues This is only a small portion of due diligence
― Valuation issues Financial data Market and industry forecasts
― Due diligence is not designed only to uncover risks (although it is meant to do at least that), it can also help uncover untapped opportunities Due diligence can drive a buyer away when unacceptable
problems are found or it may encourage a buyer when it appears that the problems are solvable
39
Conducting Due Diligence
Due Diligence: How is it conducted?― Traditionally, lawyers for the buyer would prepare a list of
documents required from the seller Usually, this list would encompass all the subject areas of due
diligence, not just the legal due diligence Depending on the bargaining position of the parties, due
diligence demands may (or may not) be negotiated― Seller would then be given a generally short amount of time to
assemble the requested documentation and present it for buyer’s examination in an on-site (seller) “data room” The data room is a famous feature of the M&A process, but the
online data room is replacing the physical data room― Buyer’s M&A team would then review the requested material at
the data room over the course of a few days or longer and make a report to the buyer concerning their assessment
40
21
Conducting Due Diligence
Due Diligence: What are its objectives?― As mentioned, one objective of due diligence from the
buyer’s perspective is to uncover latent risks in the acquisition
But it is also meant to provide insight on other questions as well, such as …― Can seller effectively integrate the newly acquired
business?― Have the representations that have been made been
accurate?― What is the true value of the business, both stand-alone
and as a unit of the potential acquirer?
41
Conducting Due Diligence
Due Diligence: The seller’s team Clearly, a due diligence can be disruptive to seller’s
business― The additional administrative burden of meeting due diligence
requirements― The risks of disclosures
Minimizing this disruption begins with the formation of a due diligence team― Team leader from the company― Operations personnel― Accounting personnel (internal and/or external)― Legal personnel (internal and/or external)― Other experts from within the company or external consultants
(valuation experts, environmental consultants, risk managers), as needed
42
22
Conducting Due Diligence
Due Diligence: The seller’s objectives― Uses its initial information advantage to obtain better
terms and less burdensome representations and warranties
― Minimizes the adverse effect of due diligence mandated disclosures
― Controls the marketplace’s knowledge of the pending deal and perform effective damage control if the deal falls through
43
Conducting Due Diligence
Due Diligence: How seller achieves its objectives― Impose certain conditions on the due diligence process Only responds to written due diligence requests Uses staggered due diligence to prevent premature disclosure;
more sensitive disclosure occurs later in the process Imposes distribution restrictions — agree that material
designated as “Attorneys’ Eyes Only” will only go to buyer’s lawyers and not their operations personnel
― Addresses adverse facts Remedies defects before closing Notifies buyer; carries the risk that indemnification will be
sought Ignores them and sees if buyer discovers; as with any
negotiation, seller should be candid but does not need to fall on its sword
Sells off problem assets
44
23
The Data Room
The Data Room Defined― Before, due to the amount and sensitivity of the
documentation requested, seller’s responses to buyer’s due diligence requirements were kept on site at seller’s premises in a location known as the “data room” A customary component of the M&A process even as
technology alleviates some of the cost and confidentiality concerns
― The data room is part of the “beauty pageant” - if the data room is lacking or looks too hastily and unintelligently put together, the buyer’s confidence in the seller may take a serious hit
45
The Data Room
Creating a Data RoomWhile the data room is important for maintaining buyer’s confidence, it can be time-consuming and expensive to create
Here are some typical facts about putting a Data Room together:― Many of the documents will be located throughout the company’s
premises and offices; the personnel charged with locating them may have to ask persistently to ferret out the needed documents
― Due to time constraints, it may not be possible to review all documents before they are included in the data room
― Some sellers don’t index anything and let buyer figure it out; others provide comprehensive indexes. Because you don’t necessarily want to provide a map to embarrassing disclosures, the best result is probably to identify what top-level portion of the due diligence list a given document is responsive to
― Be prepared for follow-up requests and to determine how much access to your employees you will grant to buyer
46
24
The Data Room
Running the Physical Data Room― Whether you have one potential buyer or several, there
are some common rules to running a Data Room that help ensure confidentiality and responsiveness are maintained: Have a sign-in procedure for visitors to the data room Develop a check-in/check-out procedures for documents Determine whether copies will be allowed, and if so, how
copying will be performed and what restrictions will be imposed on use of the copies
Similar protections should be in place for an electronic data room
47
Deal Structure - Stock Sale
Stock sale – buyer buys the stock of the target― Target corporation realizes no gain and so there is no
corporate tax paid by target― Target shareholders pay only the capital gains tax rate
on the sale of their stock― All assets and liabilities are still the assets and
liabilities of the target― Buyer may leave target as a separate entity or
integrate it into buyer over time in by taking additional measures
48
25
Deal Structure - Stock Sale
Advantages― Target structure is not altered by the deal and remains
generally intact― Need for third-party consent (as to assignments of
contracts, leases, etc.) is reduced― Buyer can still get stepped up basis if the target is an S
corporation and 338(h)(10) election made
Disadvantages― Agreement of every selling shareholder needed― Buyer does not get stepped up basis in assets unless
338(h)(10) election made (limited to S corporations)― Target still has all of its liabilities
49
Deal Structure - Asset Sale
Asset sale -buyer purchases substantially all of the target’s assets― Buyers prefer this route because:
it has favorable tax implications (buyer gets a step up in basis in the underlying assets)
cuts off liability for existing target debts facilitates buyer hiring less than all of target’s employees and buyer
need not take on employee benefit plans― NOT favored by sellers structured as a C corporation (most VC
funded firms) because the target/selling corporation will realize a gain, pay tax on that, and the shareholders will pay tax again when the proceeds are distributed This adverse tax treatment mitigated for S corporations
― Both C corp. and S corp. still may prefer to avoid having to deal with leftover liabilities and so may prefer asset sales for this reason
50
26
Deal Structure - Asset Sale
Issues― Buyer and seller will need to agree how to allocate the purchase price
among different IRS categories― Non-assignment clauses in target’s contracts will be triggered so
buyer may have to renegotiate these contracts― Buyer may not end up with a standalone business― Stockholders of target may still be required to sign the sales contract
and be on the line personally for certain obligations under the contract
51
Deal Structure - Merger Types
Two-party merger― Acquiring corporation acquires the target by merging
target directly into acquiring corporation― Can be tax-free if the requirements of IRC §368 are met
Multi-party merger― Although the two-party merger is the simplest and most
frequently encountered, a company can acquire several independent targets
52
27
Deal Structure - Merger Types
Two-party merger diagram
Acquiring
Target
Target Shareholders
Merger consideration*
Merges into Acquiring
(Target ceases to exist following merger)
* Consideration is acquiring stock and possibly cash or other property (boot)
53
Deal Structure - Merger Types
Forward triangular merger― Acquiring corporation forms a subsidiary corporation
(“Sub”)― Sub acquires the target by merging target into Sub― Can also be tax-free if the requirements of IRC §368 are
met― Since Sub is a corporation, the acquiring corporation
(which is the sole shareholder of Sub) enjoys some limitation of liability—a feature not shared by the two-party merger
54
28
Deal Structure - Merger Types
Forward triangular merger diagram
Acquiring
Target
Target Shareholders
Merger consideration*
Merges into Sub(Target ceases to exist following merger)
* Consideration is acquiring stock and possibly cash or other property (boot)
Sub
55
Deal Structure - Merger Types
Reverse triangular merger― Acquiring corporation forms a subsidiary corporation
(“Sub”)― Sub is acquired by the target by merging Sub into target― Can also be tax-free if the requirements of IRC §368 are
met― Since target ends up as a wholly-owned corporate
subsidiary, the acquiring corporation enjoys some limitation of liability—a feature not shared by the two-party merger
― Because target continues in existence, assignment or transfer of contract rights and licenses can be less problematic
56
29
Deal Structure - Merger Types
Reverse triangular merger diagram
Acquiring
Target
Target Shareholders
Merger consideration*
(Sub ceases to exist following merger)
* Consideration is acquiring stock and possibly cash or other property (boot)
SubMerges into Target
57
Deal Structure - Hybrid Acquisition
The hybrid acquisition involves the larger company taking a large, but not complete, stake in the smaller company, together with the right to purchase the company at a later date according to agreed-upon valuation metrics― Sometimes used in the tech industry
Why acquirer’s sometimes like this approach:― Allows diversification; instead of acquiring one company for $30 million,
the hybrid buyer can take less-than-total stakes over several companies― Access to new products and technology is obtained at a smaller cost― Key personnel are likely to remain in place, but now they also have capital
infusion from the larger hybrid buyer to take company to its next level Owners of selling company may like this approach as it lets
them “take some money off the table” now (their entire net worth may be locked up in the company stock) while still owning a portion of the company going forward
58
30
Deal Structure - Recapitalization as an Exit Strategy
Recapitalization: company raises funds through taking on debt; this money is then used to either buy back stock from exiting shareholders or by paying a “super dividend”
Partial exit: usually, recapitalization represents a partial exit. The shareholding owners retain some equity in the company and managerial responsibility; these continued investment and management by the original owners makes the recapitalization deal attractive to the lender
Positive cash flows required: because a recapitalization will create a debt that needs to be serviced, it is a more appropriate strategy for mature businesses with a positive cash flow
59
Preferred Stock
Equity that has preferences over common stock Preferred stock holders may have the right to
receive dividends before common stock holders In case of liquidation, preferred stock holders
are paid before common stock holders― But after creditors
Preferred stock may be convertible― Convertible preferred stock can be exchanged for
common stock― Conversion is one-way
60
31
Participating Preferred Stock in M&A
Form of convertible preferred stock― Often the type of stock provided to VC investors
Provides investor with extraordinary rights if company is sold or liquidated― Investor receives return of its purchase price paid for the stock― Investor may also receive guaranteed return on investment― Investor receives pro rata share of remaining proceeds― Holders may enjoy additional benefits over common stock
holders Enhanced voting rights Dividend preferences
The liquidation preference has a greater effect proportionately in a “modest” exit
61
Participating Preferred Stock in M&ANon-participating preferred
Participating Preferred
Shares of common stock 8 million 8 millionShares of preferred stock 2 million 2 millionPreferred stock purchase price $10 million $10 million
Company sold for $20 millionCommon stock proceeds $16 million $8 millionPreferred stock proceeds $4 million $12 million (10 + .2x10)
Company sold for $50 millionCommon stock proceeds $40 million $32 millionPreferred stock proceeds $10 million $18 million (10 + .2x40)
Company sold for $100 millionCommon stock proceeds $80 million $72 millionPreferred stock proceeds $20 million $28 million (10 + .2x90)
62
32
Employee Stock Ownership Plan (ESOP)as an Exit Strategy
An ESOP is a kind of employee benefit plan, similar in some ways to a profit-sharing plan
Company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares
Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan
Company contributions to the trust are tax-deductible, within certain limits
Shares in the trust are allocated to individual employee accounts
63
Employee Stock Ownership Plan (ESOP)as an Exit Strategy
Why ESOPs are used as an exit strategy Owners of privately held companies can use an ESOP to create a ready
market for their shares. Under this approach, the company can make tax-deductible cash contributions to the ESOP to buy out an owner's shares, or it can have the ESOP borrow money to buy the shares.
ESOPs are unique among benefit plans in their ability to borrow money. The ESOP borrows cash, which it uses to buy company shares or shares of existing owners. The company then makes tax-deductible contributions to the ESOP to repay the loan, meaning both principal and interest are deductible.
Capital gains taxation on owners’ sale of stock to ESOP can be deferred if sale proceeds are reinvested in qualifying U.S. stocks and bonds
However, an ESOP requires a corporate form, either an S corporation or a C corporation― ESOPs in S corporations can be a little tricky—S corporations have limitations on the
number of shareholders and who is eligible to be a shareholder― ESOPs in S corporations have greater limitations on tax deferred capital gains than C
corporation ESOPs
64
33
CU Area Companies with ESOP Exits
At least three local companies have used ESOPs as exit strategies
Human Kinetics― 1973: Sports and leisure publishing firm founded by U of I
kinesiology professor Rainer Martens― 1985: Martens left the university to operate HK full-time― 2000: HK was doing $20 million in sales and employed about
250 people― 2005: Martens sold HK to his employees through an ESOP― 2008: The employees proved to be able stewards of Martens’
legacy: HK had revenues over $37 million and a work force of 320
65
CU Area Companies with ESOP Exits
Hobbico― World’s largest manufacturer and distributor of model
hobby products― Hobbico resulted from the 1986 consolidation of two
other model hobby companies that were founded in the early 1970s
― 2000s: Hobbico employs about 800 people in facilities of over 600 thousand square feet in Illinois and Nevada
― 2005: Clint Atkins, one of Hobbico’s owners, mentioned that the then 20-year-old company had “never had an unprofitable month”
66
34
CU Area Companies with ESOP Exits
SAIC― Federal contractor that works on military and security projects― 2005: Went public ― Before that, SAIC was one of the country’s largest employee-
owned companies … and the IPO in 2005 proved to be very lucrative for them IPO raised over one billion dollars, which was distributed as a
special dividend to employee and retiree shareholders Employees retained 80% ownership of company following the
IPO― Privately held companies have to repurchase the employee-
owned stock when employees leave the company; by going public, SAIC used the market to supply the buyers and the funds, rather than company cash
67
The M&A Agreement
The M&A Agreement (Stock Purchase Agreement, Asset Purchase Agreement, Merger Agreement) is the primary document that governs the terms and conditions detailing the merger of two companies or the acquisition of one company by another― It implements the LOI in more detail
There are many legal and business issues involved ― This presentation addresses just a few of them
68
35
M&A Agreement Key Provisions
Purchase Price and Purchase Price Adjustments Representations and warranties Buyer and seller covenants Indemnification provisions Closing conditions Termination provisions
69
Purchase Price - Determining the Sales Price
Best valuation is the one that comes in the form of a check (or better yet – a wire transfer)
Measure the value proposition in the acquirer’s terms― How will the acquisition benefit the acquirer’s bottom
line?
70
36
Purchase Price -Approaches to Business Valuation
Income approach― Present value of expected future cash flows
Market approach (comparable sales)― Transaction prices of similar companies― See industry specific sales summarized at end of these
slides
Asset approach― Market value of liabilities deducted from market value of
assets
71
Purchase Price - Post-Closing Earnout Provisions
Prospective parties to a M&A deal typically have different views as to the value of the subject company making agreement on the purchase price difficult
Sometimes buyer is unable to afford target company, but nevertheless remains very interested in doing so― One way to bridge the gap in the above situations is to have a
portion of the purchase price based on the future performance of the target company
― Such provisions, often referred to as “Earnouts”, entitle the seller to receive additional payments if the business meets certain contractual targets post-closing
72
37
Earnout Characteristics
Earnout provisions allow parties otherwise unable to agree to a purchase price to nevertheless reach a deal― Earnout provisions are important and often times represent a
substantial portion of the total consideration Achievement of the earnout necessarily depends
upon the buyer’s management of the business post-closing, and how the buyer accounts for the post-closing financial performance of the business
In light of this potential conflict between the buyer and seller, disputes often arise relating to earnoutprovisions
73
Inclusion of Earnout Provisions - SRS Study74
38
Average Periods of Earnout – SRS Study75
Typical Earnout Disputes
Two primary disputes that arise in relation to earnout provisions include:1. Disagreement as to whether the applicable target(s) for
the earnout payment were met (--i.e., whether the EBITDA target was met)
2. Disagreements as to why the earnout targets were not satisfied (--i.e., whether the buyer adequately supported the business after the closing)
These issues can be addressed within the earnoutprovisions themselves through a variety of covenants and provisions
76
39
Earnout Dispute Avoidance
The parties’ rights and obligations with respect to earnout provisions are contractual
The resolution of an earnout dispute often turns to the specific language negotiated by the parties― Courts will not rewrite the agreement in the name of
“fairness”, but will instead focus and enforce the “plain language” of the contract itself
Careful drafting of the contract is key - clearly define salient points with the agreement itself
77
Earnout Covenant to Run Business in Accordance with Past Practice
78
40
Covenant to Run Business so as to Maximize Earnout Payment
79
Earnout Dispute Example
Comet Systems, Inc. Shareholders’ Agent v. MIVA, Inc. presents a typical dispute relating to whether the earnout was met:
MIVA acquired Comet pursuant to a merger agreement The agreement included an earnout provision where the earnout payment was
based upon relative to performance goals When calculating performance, the agreement allowed for the exclusion of “one-
time, non-recurring expenses” , but did not further define this term Comet paid an approximately $800,000 bonus to its employees MIVA calculated the bonus payment as an ordinary expense resulting in revenue
targets not being met and therefore a significantly reduced earnout payment Comet calculated the bonus as a “one-time, non-recurring expenses” whereby
revenue targets were met and a much higher earnout payment due
The Court found the bonus to be a “one-time, non-recurring expense” Lesson: Parties would be well-served to carefully draft the agreement to
clearly define how the earnout should be calculated (and determine the earnout consistent with the agreement) in order to reduce the likelihood of litigation
80
41
Purchase Price - Closing Adjustment Provisions
Delays, sometimes significant, invariably exist between the Negotiation of the Purchase Price and the Closing of the Deal
During that period of time, numerous events can and do occur affecting the reasonableness of the negotiated Purchase Price
Closing Adjustment Provisions provide an opportunity to allocate risk during this time period
While the determination of the Closing Adjustment appears straightforward, it is not
Closing Adjustments can have a significant impact on the Purchase Price
Disputes often arise surrounding Closing Adjustments
81
Net Working Capital Adjustment― Targets a closing balance sheet net working capital
amount― Usually based on an interim net working capital, average
annual net working capital or forecasted net working capital amounts
― To the extent the actual closing net working capital value deviates from the target an adjustment to purchase price may come into effect
― These adjustments may be structured as one or two way adjustments to purchase price
Purchase Price - Net Working Capital Adjustment82
42
Purchase Price - Closing Adjustment Provisions
The 2013 Private Target Merger & Acquisitions Deal Points Study from the American Bar Association (ABA) found that 85% of deals analyzed included Adjustment Provisions― Working capital was the most common adjustment (in
91% of the relevant deals)― Other metrics used in calculating adjustments include:
earnings, debt, assets, cash or other
83
Sample Post-Closing Purchase Price Adjustment Provision (per ABA)
The “Adjustment Amount” (which may be a positive or negative number) will be equal to the amount determined by subtracting the Closing Working Capital from the Initial Capital. If the Adjustment Amount is positive, the Adjustment Amount shall be paid by wire transfer to Seller to an account specified by Buyer. If the Adjustment Amount is negative, the difference between the Closing Working Capital and the Initial Working Capital shall be paid by wire transfer to Buyer to an account specified by Seller.
… “Working Capital” as of a given date shall mean the amount
calculated by subtracting the current liabilities of Seller … as of that date from the current assets of Seller … as of that date. The Working Capital of Seller as of the date of the Balance Sheet (the “Initial Working Capital” was _______ dollars ($__________)
84
43
Purchase Price - Escrow
Escrow of a portion of purchase price can last in excess of 12 months
Percentage of purchase price varies but can run from five to fifteen percent
85
Representations and Warranties
Intended to disclose all material legal, and many material financial, aspects of the business to the buyer
Seller also gives assurances that the transaction itself will not have adverse effects upon the property to be conveyed, such as any limitations on transfer or assignment of rights
Lenders providing acquisition financing will require the buyer to make extensive representations and warranties about the target as a condition to funding
Like any other part of the deal, representations and warranties are negotiable. There are some representations that buyers typically try to include—but by no means does this mean that these provisions must be included
86
44
Representations and Warranties
Common representations and warranties include the following: Financial statements: closing audit is imperative to verify the
authenticity of all the items, particularly inventory, receivables, and payables. Then a post-closing adjustment is factored into the final floating payoff at closing
Assets: buyer wants to be sure he is gaining full title to the assets, particularly as it pertains to items such as intellectual property and patents. Also, the buyer wants assurances that the machinery and equipment are in good working order
Taxes: not only is it critical to verify any tax liability if it is a stock purchase, but in the case of an asset purchase, the owner wants to be sure there are no liens on assets due to failure to pay taxes
87
Representations and Warranties
Environmental: can be especially important because environmental liability can be difficult to limit. Liability follows the asset, so even that mode of transfer provides minimal liability protection
Pending and potential litigation: seller will want to place a time period or cap on his or her total responsibility. Usually, the buyer ends up sharing some of the risk for previously made products
Authorization: selling the company from stockholders, directors, or third parties such as the bank the owner will require authorization. Seller will be expected to ensure to the buyer that all liabilities are represented; all contracts are disclosed; all wages, taxes, and insurance are current; and all bonus plans are disclosed
88
45
Pre-Closing Covenants
Apply after signing the M&A Agreement and before closing― Seller generally required to operate the business in
normal fashion, with some restrictions― Buyer will have complete access to seller’s records― Seller required to notify buyer of certain developments
89
Post-Closing Covenants
Seller not allowed to compete with buyer or solicit buyer employees― Cooperate regarding assignment of contracts, transfer of
real estate, vehicle titles, etc.― Coordinate regarding accounts receivable collection― Earnout monitoring and payments
90
46
Closing Conditions
Not included in sign and close deals Bring down of representations and warranties― Qualifiers: materiality or MAE
Third-party consents― All required consents or agreed-upon list of material
consents Employment agreements with key employees
remain in place Real estate - no MAE Legal opinion
91
Indemnification
Indemnification is the follow up to representation and warranties― it establishes what remedies will be available for breach― Can be in the form of escrow or insurance policy
Indemnification provisions related to M&A transactions (mergers, asset purchases and stock purchases) are some of the most complex and heavily negotiated provisions in M&A agreements
92
47
Indemnification provisions can become a “contract within a contract” having its own term, payment provisions, notice provisions, governing law and dispute resolution
There are a few reasons for this complexity:― The indemnitor is always trying to limit indemnification liability
while the indemnitee wants as much indemnification protection as possible
― Parties attempt to anticipate every conceivable indemnification event
― Everything is negotiable, so there is no one “right” answer concerning indemnifications
Indemnification93
Indemnification parameters include: Time limitations: Establishing a period in which a claim for
indemnity must be raised Subject matter limitations: What counts as “material”? Whose
knowledge can be considered company knowledge? What warranties will have long post-closing periods and which warranties will end soon after closing?
Dollar limitation: What is the maximum seller will pay out? What minimum must be reached before any claims are paid (the “basket” or “deductible”)
Identities: Who precisely is indemnifying whom? Are they jointly and severally liable or not?
Defense of third party claims: If a third party sues, what obligation do seller and buyer have to assist in the defense of the suit?
Dispute resolution: Will claims go to court? Or to an expedited arbitration panel?
Indemnification94
48
Representation & Warranties
Only apply when closing is not held simultaneous with signing of the M&A agreement
Reps and warranties must be true as of date of closing
Third-party consents must be obtained or accounted for
No material adverse change in the business Employment agreements with key employees in
place
95
Termination of M&A Agreement
Sellers typically want to close quickly Buyers typically want to take enough time to
make sure they know what they are buying If buyer not ready to close on time, buyer can
typically terminate, subject to certain restrictions
Financing contingency sometimes included that allows buyer to walk if it cannot obtain financing
96
49
Additional Local M&A Events
More local M&A cases….
97
Caterva, Inc.
Inception ― 2008: Caterva, formerly known as Yottaclick, Inc., was
formed in Champaign, Illinois, by Hieu Li while he was a University of Illinois doctoral student
Core Technology― Caterva’s main product is the Mirror.me, a real-time
social media platform that looks at activity on online social networks
Market― People spend a quarter of their online time on social
networks and blogs, and companies with an online presence are interested in targeting their audience
― Mirror.me was the first online product to craft individualized social signatures for its users based on the interests they express on social media
98
50
Caterva, Inc.
Growth― 2010: 5 full-time employees and received funding from
IllinoisVENTURES in the amount of $600,000 ― 2011: Caterva received $1.2 million in seed funding ― 2012: Caterva secured a new funding round of $490,000
from an undisclosed venture investor Exit (2013)― Infochimps acquired the assets of Caterva, Inc. from
IllinoisVENTURES, RPM Ventures, Serra Capital Sources― The News-Gazette, and Clear Sight Advisors
99
TetraVitae Bioscience, Inc.
Inception ― 2006: TetraVitae Bioscience, Inc., formerly known as Advanced
Biofuels, Inc., was co-founded by Hans-Peter Blaschek, director of the UI’s Center for Advanced BioEnergy Research
Core Technology― TetraVitae is a leading developer of bio-butanol with a
patented bio-catalysis technology Market― The growth of renewable chemicals has been spurred on by a
volatile marketplace for oil― TetraVitae proprietary technology and expertise in the fields of
industrial fermentations, process engineering, microbiology, and cellulosic feedstocks aim to lower the costs of production
100
51
TetraVitae Bioscience, Inc.
Growth― 2008: funding from Harris & Harris Group, IllinoisVENTURES and
RPM Ventures totaling $6,300,100― 2010: funding from IllinoisVENTURES and RPM Ventures
totalling $2,869,000 Exit (2011)
― Eastman Chemical company acquired TetraVitae― Tetravitae operates as a subsidiary of Eastman ― Eastman serves customers in approximately 100 countries and
had 2013 revenues of approximately $9.4 billion. Eastman employs approximately 14,000 people around the world.
― Terms of the transaction were not disclosed Sources
― Eastman Chemical’s website, Bloomberg Businessweek, and The News-Gazette
101
ByteMobile, Inc.
Inception― 2000: founded by Constantine Polychronopoulos, a University
of Illinois Professor― 2002: by this year, it had already attracted nearly $30 million
in venture capital Core Technology― ByteMobile focuses on optimizing high-bandwidth data
services on wireless networks designed for low-bandwidth voice services
Market― Provides video and multimedia optimization software― ByteMobile uses its own Smart Capacity technology both its
Unison and T3000 series platafforms― By 2006, Bytemobile's products "touch three-quarters of a
billion mobile subscribers around the world”
102
52
ByteMobile, Inc.
Growth― 2001: customers included cellular operators Vodafone, Sprint and
Nextel― 2002: 100 employees ― 2005: Bytemobile acquired ProQuent Systems and absorbed its 30
employees― 2011: Joint Venture with China Comservice
Exit (2012)― ByteMobile was acquired by Citrix Systems for $435,000,000 ― Citrix plans to build on ByteMobile as the center of its go-to-
market strategy for 3G and 4G LTE wireless operators Sources
― Privo, Citrix’s website, and The News-Gazette
103
Volition, Inc.
Inception ― 1993: Mike Kulas co-founded Parallax Software with Matt
Toschlog― 1996: Parallax Software split into Volition Inc. and Outrage
Entertainment Core Technology
― Volition develops games, including the “Saints Row” line of videogames
Market― In 2012, total U.S. consumer spending on video game content
amounted to 14.8 billion dollars― In November 2014, physical video game software sales in the
United States amounted to 1.06 billion U.S. dollars― Volition makes games for the "core gamer" market, which are
intended to appeal to the avid player, include action, fighting, racing, shooting and strategy games. Its other areas are "online games" and "kids, family and casual games"
104
53
Volition, Inc.
Growth― 1998: Volition had grown to 30 employees― 2000: approximately 40 employees― 2004: approximately 100 employees― 2011: grows to 220 full-time employees
Exit (2000)― 2000: THQ Inc. acquires Volition for 1 million shares of
THQ of common stock― 2013: Koch Media, headquartered in Germany, wins a
bid by offering $22.3 million for Volition Sources ― The News-Gazette and Statista
105
Argus Systems Group, Inc.
Inception ― 1993: founded and headquartered in Savoy, Illinois, and
continues operation in Savoy until this date Core Technology― Argus operates the system enhancing software PitBull
Market― There is an increased reliance on internet-based business
architectures that support core business processed and require advanced security mechanisms
― International vendor of security software and engineering services, providing security solutions for servers
― Argus software is used by financial services companies, utilities and government agencies around the world
106
54
Argus Systems Group, Inc.
Growth― 2003: Argus filed for liquidation and its assets are
acquired by Open Prairie Ventures for $1.5 million― 2006: announced PitBull Foundation and PitBull
Foundation Suite for Linux― 2011: approximately 15 employees working in Savoy, IL
Exit (2011)― General Dynamics acquires Argus― Value of the transaction was not disclosed
Sources ― The News-Gazette and the Washington Post
107
Adrenaline Mobility, Inc.
Inception― 2012: Adrenaline, formerly named Valkyrie Computer
Systems, Inc. was founded by a team from the University of Illinois engineering school
Core Technology― Adrenaline uses military-grade end-to-end encryption to
protect user’s data before storing it on a mobile device and before sending it to cloud servers
Market― Adrenaline operates a platform for creating cross-platform,
pure HTML5, and enterprise-class applications― It also provides cloud-based application services that turn
distributed services into Web services, and enterprise services to host enterprise applications on mobile devices without vendor lock-in
108
55
Adrenaline Mobility, Inc.
Growth― 2012: seed investment from IllinoisVENTURES― 2013: investment Serra Ventures, and a National Science
Foundation Small Business Innovation Research grant Exit (2014)― Adrenaline joined Twitter
Sources― University of Illinois website and Business Week
109
RiverGlass
Inception― 2003: Formed to commercialize eight years of grant-funded
research at the National Center for Supercomputing Applications (NCSA) at the University of Illinois
Market― RiverGlass is the leading provider of advanced, intelligent web
information collection and analysis solutions― RiverGlass provides application solutions to government
agencies and commands in defense; intelligence; law enforcement; and major corporations
Exit― 2011: RiverGlass was acquired by Allen Systems Group (ASG)
110
56
Traco Labs
Inception― 1985: local company
Market― Bulk nutritional goods, including nutritional lipids
Exit― 2000: sale to publicly traded German company –
SKW/Degussa, renamed Degussa Bioactives Source― Company press release
111
Chromatin, Inc.
Inception― 2000: founded by University of Chicago professor
Daphne Preuss with post-docs Gregory Copenhaver and Kevin Keith
― Headquartered in Chicago, IL Core technology― Mini-chromosomes for simultaneous addition of
multiple genetic traits to plants Market― Agricultural, energy, chemical, nutritional, and
pharmaceutical sectors― Plant growers, seed producers, and bioprocessors
112
57
Chromatin, Inc.
Growth in part through an acquisition― 2007: License agreement with Monsanto Company― 2007 - 2009: License agreements with Syngenta
Biotechnology, Inc.― 2009: Technology alliance and license agreement with
Bayer CropScience― 2009: Research and license agreement with Dow
AgroSciences, LLC.― 2010: Research agreement with ACGT Sdn Bhd― 2010: acquired Sorghum Partners, Inc. and Milo
Genetics, LP
113
Biodisplay Technologies
Inception― Founded by U of I biochemistry professor David Kranz
and former U of I faculty member Dane Wittrup Market ― A “virtual company” with no physical location― Yeast display technology that shortens time to get
experimental drugs to clinical trials Exit― 2001: sold for $7 million to Abbott Labs
Source― The News-Gazzete
114
58
Kuck & Associates (KAI)
Inception― 1979: headquartered in Champaign, Illinois
Core Technology― Intel and KAI were leaders in the development of OpenMP™, the
industry standard for multithreaded software development Market
― KAI is a leading provider of performance-oriented compilers and programming tools used in the development of multithreaded applications
Exit― 2001: Sale to Intel― Resulted in Intel having presence in our community― Strategic acquisition
Sources― Intel News Release
115
Demaco
Sold to SAIC some time back Resulted in SAIC having a presence in the
Research Park Dennis Andersh continued as an executive with
SAIC after the transaction SAIC an ESOP for period of time, then went
public Strategic acquisition
116
59
Gill Athletics, Inc.
Exit:― Purchased assets of Porter Athletic Equipment Company― Both companies early innovators in sports equipment― Porter’s activities now moved to Champaign after
transition period Inception ― Gill is a local company; Porter had local ties but based in
Broadview, IL― Porter, founded in 1868, was one of first manufacturers
of basketball goals and gymnasium equipment
117
SourceGear, Inc.
Inception― 1997 founded by Eric Sink and Corey Steffen and based in
Champaign, IL Core technology― Programming tools for software development
Growth― 2002: 36 employees
Exit― 2009: Microsoft acquired the Teamprise division of
SourceGear― 2010: The main product was rebranded by Microsoft: Visual
Studio Team Explorer Everywhere― Rest of SourceGear still locally owned
118
60
A-1 Alarm Service, Inc.
Inception― 1968: founded by Cecil Byrnes and based in Champaign, IL
Market― Residential and commercial alarm/monitoring service― Customer base: 65% residential, 35% commercial
Growth― 2002: Diane Ruedi, the founder’s daughter, took over as president of
company after the founder’s death― 2010: 20 employees
Exit― 2009: Friendly acquisition by local competitor F. E. Moran Alarm
F. E. Moran Alarm had 130 employees, and 50% commercial customers All A-1 employees retained, to move to F. E. Moran Alarm’s HQ
― Customers of A-1 Alarm perceived no change Contact numbers not changed, familiar operators No change in fees for 15 months
A strategic acquisition
119
Intersymbol Communications, Inc.
Inception― 2001: founded by University of Illinois professors Naresh
Shanbhag and Andrew Singer and based in Champaign, IL Core Technology― High speed optical devices for digital communications
Exit― 2006: acquired by Kodeos Communications A strategic acquisition Operated as subsidiary of Kodeos
― 2007: Kodeos Communications acquired by FinisarCorporation Intersymbol continues as subsidiary of Finisar
120
61
M&A Activity in Specific Industry
The following slides summarize M&A activity in the coatings industry
121
Rust-Oleum Corporation
A leading manufacturer and marketer of specialty coatings in the United Kingdom Annual sales of approximately $45 million
M&A activity since 2006― 1994: Rust-Oleum acquired by RPM International, Inc. Purchase price of $178 million
― 2006: acquired Watco Group Based in Godalming, UK, a manufacturer and marketer of
industrial coatings and leading supplier of concrete floorings in the UK
Annual sales: approximately $20 million― 2007: acquired Tor Coatings Limited
122
62
Rust-Oleum Corporation
2009: acquired FibreGrid Limited― A supplier of fiberglass anti-slip safety products based
in the United Kingdom― Annual sales: approximately $3.5 million ― 2010: Rust-Oleum Netherlands BV acquired Chemtec
Chemicals BV― A manufacturer of specialty cleaning and maintenance
products based in Rotterdam, Netherlands
123
Akzo Nobel (AKZOY)
M&A activity since 2008― 2008: acquired Imperial Chemical Industries (ICI)― Purchase price approximately €11.5 billion (EUR)― 2010: acquired Dow Chemical Company’s powder
coating activities― Annual global sales: approximately several hundred
million dollars(USD)
124
63
Hentzen Coatings, Inc.
M&A activity since 2005― 2005: acquired Batavia, IL coatings manufacturing site
and non-core drum and pipe coatings business from BASF
125
Diamond Vogel Paint, Inc.
A Lincoln, NE based industrial-coatings producer M&A activity since 2004― 2004: acquired certain assets of David-Frost Paint Co. Assets associated with the industrial-coatings business and
based at the company’s operations based in Minneapolis, MN and Tulsa, OK
― 2004: acquired Four Seasons Paint
126
64
The Sherwin Williams Co. (SHW)
M&A activity since 2007― 2007: acquired Nitco Paints A Mumbai headquartered, privately owned manufacturer
and distributor of exterior specialty paints and coatings used in the construction of office buildings, high rise, apartments, shopping malls, hospitals, and schools.
Annual sales: approximately $18 million ― 2007: acquired Napko, an industrial-maintenance
coatings company in Monterrey, Mexico― 2007: acquired S.A. de C.V.― 2007: acquired Pinturas Industriales S.A., an industrial
paint company headquartered in Montevideo, Uruguay
127
The Sherwin Williams Co. (SHW)
2007: acquired M.A. Bruder, a Philadelphia based company with 132 paint stores
2007: acquired Columbia Paint & Coatings based in Spokane.
2007: acquired VHT Paint Lines, an aerosol coatings company in Scottsdale, AZ
2008: acquired Becker Powder Coatings, Inc., a producer of powder coatings applied to appliances, metal furniture, fixtures, and electronic products headquartered in Columbus, OH― Annual sales: approximately $14 million
128
65
The Sherwin Williams Co. (SHW)
2008: acquired the Liquid Coatings Subsidiaries of Inchem Holdings which produces coatings applied to wood and plastic products in Asia― Annual sales: approximately $30 million
2008: acquired Euronavy-Tintas Maritimas e Industrials S.A. of Portugal― A leading innovator of marine and protective coatings
applied to ships, off shore platforms storage tanks, steel, concrete, and flooring
― Annual sales: less than $25 million
129
The Sherwin Williams Co. (SHW)
2010: acquired the Industrial Wood Coatings business (Sayerlack) of Arch Chemicals, Inc.― A technology leader in polyurethane, water, and UV
coatings― Annual sales: $147 million – 2009
2010: acquired Becker Acroma Industrial Wood Coatings― A technology leader in water, UV, and other wood
coatings― Annual sales: approximately $300 million
130
66
Tennant Company (TNC)
M&A activity since 2006― 2006: acquired Hofmans Machinefabriek B.V. Annual sales: $7 million – 2005
― 2007: acquired Floorep Ltd. Annual sales: $5.6 million – 2006
― 2008: acquired Applied Sweepers—makers of Green Machines® brand cleaning equipment Deal valued at $68 million Annual sales: $40 million - 2007
131
Tennant Company (TNC)
― Mar. 2008: acquired Sociedade Alfa Ltda.—maker of Alfa brand commercial cleaning machines. Annual Sales: $9 million – 2007
― Aug. 2008: acquired Shanghai Shen Tan Mechanical and Electrical Equipment Co. Ltd. Annual sales: $1.6 million – 2007
132
67
The Valspar Corporation (VAL)
M&A activity since 2005― 2005: acquired Samuel Cabot Incorporated Annual sales: $60 million
― 2006: acquired 80% interest in Huarun Paints Holdings Company Ltd. Annual sales: $200 million – 2006 2008: owns 85.8% of outstanding shares
― 2006: acquired H.B. Fuller Company’s powder coatings busines. Net sales: $75 million – 2005
133
The Valspar Corporation (VAL)
― 2007: acquired majority voting shares in Tekno S.A. Annual revenue: $10.7 million – 2006 2008: acquired remaining shares of Teknos
― 2007: acquired Teknos Nova Coil TNC Oy Annual revenue: €31 million (Euros) – 2006
― 2007: acquired control of Aries Coil Coatings S.A. de C.V. (Aries) Annual sales: $40 million – 2007 2008: acquired remaining shares
134
68
Honda Motor Co., Inc.
Inception― 1948: Founded by Soichiro Honda ― 1959: Founded in the US, American Honda Motor
Company, Inc. Market― World’s largest manufacturer of motorcycles and internal
combustion engines, and 6th largest automobile manufacturer in the world
― Also manufactures garden equipment, marine engines, personal watercraft, power generators, robotics research
135
Honda Motor Co., Inc.
M&A activity since 2005― 2005: Suzuka Circuitland Co., Ltd., became wholly
owned subsidiary of Honda Motor Co., Ltd. Through summary exchange
― 2006: Honda Express Co., Ltd. and Komyo Co., Ltd. became wholly owned subsidiaries of the Company (Honda Motor), through acquisition of all shares of stock
― 2007: Yachiyo Industry Co., Ltd. Became a consolidated subsidiary of Honda Motor Co., Inc
136
69
Caterpillar Inc.
Inception― 1925: Founded in California, as Caterpillar Tractor Co.,
currently based in Peoria, IL. Market― World’s largest manufacturer of construction and mining
equipment and diesel and natural gas engines.― Worldwide network including 220 dealers in nearly 200
countries Growth― As of 2009: Caterpillar employs nearly 100,000
employees
137
Caterpillar Inc.
M&A activity since 2006― 2006: Caterpillar Inc. acquires privately held Progress
Rail in a $1 billion cash and stock deal― 2008: Mitsubishi Heavy Industries Ltd.and Shin
Caterpillar Mitsubishi Ltd. Signed definitive agreements that include a share redemption plan which will result in Caterpillar owning 67% of SCM First phase of the share redemption is estimated at 50 billion
JPY― 2010: Progress Rail Services signed definitive agreement
to purchase Electro Motive Diesel for 820 USD from Berkshire Partners LLC and Greenbriar Equity Group LLC Progress Rail Services is a wholly-owned subsidiary of
Caterpillar Inc.
138
70
PPG Industries, Inc.
Inception― 1883: Founded as the Pittsburgh Plate Glass Company.― Changed name to PPG Industries to better reflect its diversity
Market― Global supplier of paints, coatings, optical products, specialty
materials, chemicals, glass and fiber glass Growth― Net income of 336 million USD in 2009― Employed nearly 40,000 employees in 2009
139
PPG Industries, Inc.
M&A activity since 2006― 2006: Ameron International announced it will sell
its Performance Coatings and Finishes business to PPG Industries for 115 million
― 2008: PPG acquired SigmaKalon Group, a Dutch based coatings company, for 3.2 billion
140
71
United Technologies Corporation
Inception― 1929: founded as United Aircraft and Transport
Corporation by a multi-business merger Market― Researches, develops, and manufactures high-
technology products in numerous areas, including aircraft engines, helicopters, heating and cooling, fuel cells, elevators and escalators, fire and security, and industrial products
Growth― As of 2010: employs over 200,000 employees
141
United Technologies Corporation
M&A activity since 1999 ― 1999: United Technologies Corp. agreed to acquire
Sundstrand Corp., maker of internal systems for airplanes, for $4.3 billion
― 2005: Crowell & Moring LLP client, United Technologies Corporation’s Pratt & Whitney Division, has completed the acquisition of Boeing’s rocket engine unit, Rocketdyne Propulsion & Power for about $700 million
― 2010: United Technologies completes $1.82 billion acquisition of General Electric Co.’s fire detection and electronic security business
142
72
ArcelorMittal
Inception― 2006: formed by merger of Arcelor and Mittal Steel
Market― The largest steel company in the world― Leader in all major global steel markets, including
automotive, construction, household appliances and packaging as well as supplies of raw materials and distribution networks
Growth― 2009: employed over 280,000 employees with revenue
of 2009 being $65 billion
143
ArcelorMittal
M&A activity since 2006― 2006: merger of Arcelor and Mittal Steel― 2006: ArcelorMittal acquires Sicartsa, producer of
long steel, for $1,439 million― 2008: ArcelorMittal announced acquisition of Bayou
Steel, producer of structural steel products in the U.S for $475 million
― 2008: ArcelorMittal announced agreement to acquire the Kippers’ Monessen Coke Plant from Koppers Inc. for $160 million
144
73
Carboline Company
M&A activity since 2005― 1985: Carboline Company acquired by RPM
International, Inc. ― 2005: acquired AD Fire Protection Systems, An international provider of fireproofing products for
the protection of structural steel Annual sales: approximately $18 million (USD)
― 2006: acquired certain assets of Nu-Chem An international provider of fireproofing products for
the protection of structural steel― 2007: acquired the marine and industrial assets of
Finnaren & Haley A privately-held paint manufacturer and retailer
headquartered in Conshohocken, PA
145
Big Dollar Tech Exits
146
74
Top Tech Exits in 2014: MICROS Systems
Inception― 1977: founded in by Louis Brown, Jr, the son and grandson of Maryland
dairy farmer Core Technology
― MICROS Systems provides various cloud-based, mobile and on-premiseapplication tools for customers in the food and beverage, hospitality and retail industries
Growth― 1978: $1.4 million in revenue― 1981: first initial public offering ― Micros has more than 6,600 employees and its products are in use at
more than 330,000 sites around the world Exit
― 2014: sale to Oracle for $5.2 billion (largest deal of the year) Source
― Oracle Press Release and Funding Universe
147
Top Tech Exits in 2014: OpenTable
Inception― 1998: after founder, Chuck Templeton, observed the difficulty
his wife faced while trying to book a dinner reservation by phone
Core Technology― OpenTable allows users to search for restaurants and
reservations based on parameters including times, dates, cuisine and price range and it provides restaurant owners with a reservation management
Market― OpenTable helps restaurants to fill tables by offering online
reservation services to diners― OpenTable’s business caters to about 24,000 restaurants out
of its total customer base of 31,500
148
75
Top Tech Exits in 2014: OpenTable
Growth― 1999: the website began operations serving a limited selection
of restaurants in San Francisco. ― Today: it covers more than 30,000 restaurants in most
states as well as in several cities around the world. Exit― Open table was acquired by Priceline― Priceline has the resources and the expertise to grow
OpenTable globally. There is a lot of scope for cross-promotion and cross-selling activities Significant cost synergies from the merger of the two
companies Sources― Open table website and Forbes
149
Top Tech Exits in 2014: Trulia
Inception― 2005: founded originally only serving properties in
California Market ― Trulia provides price trend information by using listing
and public data showsing how the price of a home has changed over a period of time as well as comparing that house price with other homes
150
76
Top Tech Exits in 2014: Trulia
Growth― 2006: Trulia services offered nationally ― 2012: Trulia reported 22 million monthly visitors― 2013: approximately 437,000 active real estate professionals
Exit― Zillow announced a deal to buy Trulia for $3.5 billion― All stock deal― Together, the two will dominate the traffic for online home
listings and they expect to realize about $100 million in cost savings by 2016
Sources― Trulia’s website and The Mercury News
151
Top Tech Exits in 2014: Shopkick
Inception― 2009: created
Core Technology― Points program called “kicks”, which are usually awarded
when customer-users walk into the participating stores. Shopkick receives a fee for each kick a customer earns
Market ― Shopkick created a shopping app that offers customers
rewards for walking into stores
152
77
Top Tech Exits in 2014: Shopkick
Growth― 2010: Shopkick app was released, initially with 5 retail
partners (Macy’s, Best Buy, Sports Authority and American Eagle Outfitters) and reached its first million users within six months
― 2011: added Target, Crate and Barrel, Old Navy, and Gap― 2012: Shopkick drove $200M in revenue for its partners― 2015: Shopkick has 200 brand partners
Exit― 2014: acquired for over $200M in cash by SK planet, part of
SK Group and SK Telecom Sources― The New York Times & The Wall Street Journal
153
Top Tech Exits in 2014: Caviar
Inception― 2012: founded in San Francisco by 5 people
Core Technology― Mobile payments startup that partners with highly-rated
restaurants that don’t normally offer deliver – it offers a “premium delivery” service
Market ― Food delivery service ― Caviar allows buyers to get delivery from top-rated,
popular local restaurants that do not offer delivery
154
78
Top Tech Exits in 2014: Caviar
Growth― 2012: service in San Francisco ― 2014: Caviar's couriers have delivered more than 1
million meals― Today: offered in many cities such as Boston, Chicago,
New York, Seattle, Los Angeles, and Washington D.C. Exit― Square purchases Caviar for a reported $90 million
Source― Business Insider
155
Alan R. SingletonSingleton Law Firm, P.C.
Research Park a t the Un ivers i t y o f I l l ino is2001 S . F i rs t S t . , Su i te 209Champaign , IL 61820 -3654
(217) 352-3900 s ingleton@singletonlawf i rm.com
www.singletonlawf i rm.com© 2 0 1 5 A l a n R . S i n g l e t o n
Exit Strategies for the Technology Company
Singleton Law Firm, P.C. is dedicated to serving the legal needs of business and individual clients of east central Illinois and beyond with an emphasis in the areas of corporate, intellectual property (including patent) and real estate law. The firm was founded by attorney Alan R. Singleton and paralegal Elizabeth C. Kellner following Mr. Singleton’s practice at another local firm as an associate and then shareholder. Ms. Kellner’s experience includes work at the University of Illinois business incubator and then service as the coordinator and then executive director of techCommUnity. Both Mr. Singleton and Ms. Kellner are active in their efforts to grow the local business community. Both maintain contacts in the local business community and beyond which allow them to serve as a team to meet the needs of business and individual clients through the provision of value added quality legal services.
ALAN R. SINGLETON SINGLETON LAW FIRM, P.C.
Research Park at the University of Illinois 2001 S. First St., Suite 209
Champaign, IL 61820 217-352-3900
www.singletonlawfirm.com [email protected]
Mr. Singleton provides legal services to business clients in corporate, intellectual property, securities, and real estate law areas. He has frequently assisted entrepreneurs select and organize an appropriate entity and obtain capital. He has formed limited liability companies, subchapter S corporations, subchapter C corporations, professional corporations, L3Cs, and not-for-profit corporations, including publicly supported organizations and private
foundations. Mr. Singleton has also assisted clients with mergers and acquisitions and with implementing stock option programs.
A member of the patent bar, Mr. Singleton has represented clients in patent prosecution, trademark registration, negotiation of licenses, research and development agreements and joint development agreements. He is familiar with the University of Illinois policies on technology transfer and has negotiated licenses of University technology. Mr. Singleton’s real estate law experience includes purchases and sales, leases, installment contracts, like kind exchanges, and zoning and land use issues.
Mr. Singleton is active in both the business and educational communities. He has served on the Advisory Councils of numerous technology companies and served on the list of advisors at the Illinois Technology Center. He is a member of the business plan review group Second Saturday and has served as a judge for the Academy for Entrepreneurial Leadership Innovation Teams Competition and V. Dale Cozad Business Plan Competition. He currently serves as an Entrepreneur in Residence at EnterpriseWorks.
Mr. Singleton maintained an adjunct faculty appointment with the University of Illinois College of Medicine for roughly 20 years. He has given guest lectures for the University of Illinois MBA course on technology commercialization, the Senior Capstone Design Course in the Department of Agricultural and Biological Engineering, the Academy for Entrepreneurial Leadership Idea to Enterprise Workshop, the Technology Entrepreneur Center, the Advanced Invention to Venture workshop, Enterprise Works, the SIU Carbondale business incubator, the University of Illinois College of Veterinary Medicine and for medical residency programs throughout the state.
The recipient of the 2008 Entrepreneur Advocacy Award and, as an undergraduate, of the Chemical Rubber Company Chemistry Award, Mr. Singleton earned a Bachelor of Science Degree in Geology from the University of Illinois in 1988 and a Juris Doctorate from the University of Illinois College of Law in 1991. Following law school and prior to founding Singleton Law Firm, P.C., he practiced with Webber & Thies, P.C. as an associate and then shareholder.
Mr. Singleton is currently a member of the American Bar Association Sections on Business Law, Intellectual Property Law and Science and Technology Law, the Illinois State Bar Association Sections on Corporation and Securities Law (Prior Member, Section Council) and Intellectual Property Law (Prior Member, Section Council), the American Intellectual Property Law Association, American Chemical Society, Association of University Technology Managers and has previously been a member of the Intellectual Property Law Association of Chicago and Midwest Business Brokers and Intermediaries.
Mr. Singleton has chaired the EDC/techCommunity Mentoring Program, has served on the board of the Don Moyer Boys and Girls Club and Mahomet Area Youth Club, and serves on the boards of the Mahomet Area Kids Endowment Foundation and Mahomet Seymour Soccer Club.