Selling the Wisconsin Corporation — Good News for Directors

February 9, 2012

By: Michael H. Altman

On January 26, 2012, a three judge panel of the Seventh Circuit Court of Appeals determined that the directors of Ladish would not have liability for approving the $778 million sale of the company to Allegheny Technologies Inc., despite a plaintiff’s claim that Ladish directors failed to disclose material information in the proxy materials.  The plaintiff shareholder argued that Wisconsin’s business judgment rule does not apply to public statements and material omissions, because of a separate “duty of candor” outside the business judgment rule.  The appeals court panel rejected this argument.   

Under Wisconsin law, as in most states, a board’s decisions are governed by the business judgment rule, which recognizes that boards, rather than individual shareholders or the courts, are best positioned to make complex business decisions.  Therefore, as long as a board acts in a manner consistent with the exercise of honest discretion, its decisions will be given deference.  Wisconsin has codified this rule in a statute (specifically Wisconsin Statute §180.0828), which specifically shields directors from liability for failure to perform “any duty” that a director owes to the corporation or its investors, except only in limited listed situations involving a breach of a director’s duty of loyalty or willful or intentional misconduct.

Despite the Ladish plaintiff’s claim, the appeals court found that “any duty” as used in the statute is as applicable to a board’s “duty of candor” as it is to the general duty of care.  In other words, Wisconsin’s business judgment rule does not allow an award of damages to shareholders unless they allege willful or intentional misconduct or breach of the duty of loyalty, which the Ladish plaintiff failed to do (and which is, of course, much more difficult to claim or prove).

 Some states, including the common business state of incorporation Delaware, provide further exceptions to the business judgment rule in the context of a sale of the business (we lawyers sometimes call these “Revlon” duties, after a 1986 Delaware Supreme Court case, or in analyzing defensive measures, “Unocal” standards, after a 1985 decision).  The Court of Appeals panel in the Ladish case specifically rejected the plaintiff’s contention that Wisconsin would follow these Delaware decisions which would have provided a higher obligation than the simple business judgment rule in the sale context.  The panel’s decision reinforces that, when evaluating corporate merger transactions (other than those that implicate duty of loyalty concerns or willful or intentional misconduct), a board’s decision to enter into a merger transaction is governed by the business judgment rule and Wisconsin Statute §180.0828, plain and simple.   This is good news for directors of Wisconsin-incorporated businesses.

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Posted by rygray

Venture Capital and Private Equity: The Same, Only (Very) Different

February 3, 2012

By: Paul Jones

If you’ve followed Presidential politics of late – and as much as I want to look away I find myself gawking at a freeway pileup – you have no doubt heard a lot about private equity and venture/vulture capital. The good news is that much of what you have heard is not true; which, I suppose, is also the bad news. Herewith a brief attempt to provide a little clarity.

First, in a very technical sense, venture capital (VC) is a kind of private equity (PE). Both terms refer to pools of capital assembled by professional management/investment teams from wealthy individual and institutional investors in private offerings. However, in a practical sense, the VC business is fundamentally different from the PE business. As for “vulture capital,” the term is more of a slogan than a description of a business, but to the extent it somehow describes a business strategy it more often than not makes its appearance in the PE world.

Now, VC and PE investors are both out to make money; in fact, they are both out to generate returns that exceed the returns typically available in public securities markets. They both look to generate those returns by investing in businesses with higher risk/reward profiles than those that make up the vast bulk of securities on the major public stock exchanges. But as to how they expect to generate those returns, VC and PE are typically worlds apart.

Fundamentally, VCs make money by building new businesses. PE investors, on the other hand, generally make money by restructuring existing business. VCs are “clean slate” investors in the sense that they typically invest in young businesses with little or no track record with the expectation that those business will become “the next big thing.” Think Google, as an example of a VC deal that worked, and, say PetCo as a VC deal that failed. PE investors, on the other hand, generally invest in established businesses that have fallen on hard times, or are otherwise perceived as not performing to their potential. Think Hertz as a PE deal that worked and, say, Sears as a PE deal that (so far) has not worked very well.

Some more differences. VCs typically do not assume operating control of the businesses they invest in. They are active investors, to be sure, but fundamentally investors, not managers. PE investors, on the other hand, typically see themselves not as supporting but rather as taking over management of the businesses they invest in. VCs typically invest in businesses with no debt, or in later stage investments with limited debt. PE investors, on the other hand, usually leverage their equity investments by having the business take on debt that substantially exceeds the amount of equity the PE firm invested. Thus, most PE investments are in the form of “leveraged buyouts” or “management buyouts.” Finally, if and when a VC-backed company achieves an exit for its VC investors, the company will almost certainly employ more people, usually a lot more people, than when the first VC money was invested. In contrast, if and when a PE-backed company achieves an exit for its PE investors, the business will more often employ fewer people than it did when the PE investors first entered the picture.

While I have spent most of my career in and around the venture capital world, I am not going to argue that VC investing and investors are somehow better or worse than PE investing and investors. They both have their place, which, I think, can be summarized as follows: VC is about creating new value in new vessels, while PE is about salvaging value otherwise locked up in old, deteriorating vessels. The strongest economies excel at both.

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Thinking About Dilution

January 19, 2012

By: Paul A. Jones

For most entrepreneurs, dilution is an ugly word. Being diluted, after all, is about giving someone else a piece of your business. All other things being equal, that’s not a good thing. That said, for entrepreneurs that need third party risk capital to fund their business, dilution is inevitable. And (the silver lining in the dilution cloud) not always as bad as it might seem.

Entrepreneurs facing dilutive events typically have two concerns, both related to a reduction in relative ownership of the business: loss of management control and a diminished share of the “upside” if the business succeeds. Let’s look at control issues first.

Fear of losing management control to investors is something that keeps a lot of entrepreneurs up at night. Too often, though, the fear assumes that there is some magic number – usually 50% ownership – around which control pivots. Alas, it is not anything like that simple. The (possibly disturbing) fact is, an owner of the smallest fraction of a company’s equity (indeed, a creditor without any equity stake at all, though that is a matter for another blog) can have de facto control of a company’s management. And, indeed, venture capital investors with minority ownership positions almost always have substantial management control, as for example rights to prohibit strategic transactions (e.g. sale or merger of the business), limit future sales of equity, etc. well beyond those rights they would enjoy from a simple “who has the most shares” analysis. The devil, in terms of management control, is in the fine print of the deal terms, not the gross percentage of equity owned. The take home here is that control in venture backed startups is more a function of the (hopefully thoughtfully negotiated) finer points of the deal terms than simply a function of who has the bigger/majority equity interest.

As for dilution reducing an entrepreneur’s share of the upside, by definition, an equity investment involves some grant of interest in future profits and/or exit value to the investor. (For purposes of this blog, we’ll assume that the investor’s stake is commensurate with its ownership stake, though it need not be: while an investor’s ownership stake is less likely to diverge significantly from the investor’s ownership share than its control rights, such discrepancies are not uncommon, if not usually as significant.)

Now it is fair enough to say that giving a third party any stake in the ultimate equity value created by the business necessarily dilutes the interests of the prior stakeholders. But the story is more complex than that. Taking on a new investor is a priori (if not always a posteriori) a classic win-win proposition. More specifically, the investor is investing because he believes that the investment will grow in value, while the entrepreneur is accepting the investment ( and dilution) because she believes that the value of her diluted share of the post-investment equity in the business will exceed the value of her (undiluted) pre-investment equity. Unless both parties anticipate a wealth enhancing proposition, there won’t be a deal.

The win-win story is most easily understood in the context of an “up” round: that is, where the new investor pays a higher price than the prior investors. So, for example, an entrepreneur who owns say 50% of a business where the previous investor paid $1.00 per share is demonstrably wealthier if she takes on an additional investor at $2.00 per share even if doing so dilutes her ownership down to 25%. In fact, her wealth (even if not her liquidity) has been doubled (she now owns the same number of shares, each of which is worth twice what it was before the investment).

The $1.00/$2.00 example above does not mean that an entrepreneur should always accept dilution if doing so would increase her wealth. It may be that while the $2.00 offer doubles her wealth, the ownership stake she is selling is worth more than $2.00 to some other investor. What the example does illustrate, though, is that a dilutive event can also be a wealth enhancing event. Indeed, even in a down round scenario (say the price goes from $1.00 to $0.50 per share) the entrepreneur should only accept the dilutive event if she feels that her diluted ownership stake after the investment will be worth at least as much as her undiluted stake if she forgoes the investment.

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Corporate Venture Capital: An Entrepreneur’s Perspective

January 16, 2012

By: Paul A. Jones

While never a dominant part of the venture capital industry, corporate-sponsored venture capital investors (think for example AOL Ventures) have long been an important part of the industry.  Entrepreneurs thinking about seeking venture capital should, preferably at the beginning of the quest, consider whether they want to seek, or will even consider, corporate venture capital.  For some deals, corporate venture capital is a priority; for most it is an option; and for some, it might be a last resort.  Herewith, some of the issues to consider.

Corporate Venture Capital as Deal Validation.  Generally, the more technology risk a deal has, the more attractive corporate venture money is, all the more so when the expected amount of pre-revenue capital needed and time to market are greater. Corporate venture capital is often a plus, for example, in biopharma deals, where technology risk, capital needs and time to market are huge.  Getting a corporate fund in a deal sends a powerful due diligence signal to all but the highest tier traditional funds (they are as a rule less impressed by third party due diligence) that the science passes the blush test.  On the other hand, deals where time to market, technology risk and risk capital requirements are not so great – say, a niche social networking concept – are not likely to get as great a validation enhancer across as broad a range of traditional funds.

Corporate Venture Capital as Lead Investor – Usually Not.  As a rule, corporate funds don’t make very good lead investors.  First, while a corporate fund can be a nice validator, getting too close to a corporate fund can make doing business deals with companies that compete with the corporate fund’s parent harder to do.  If “Competitor A” is your lead investor, “Competitor B” will be understandably more cautious about doing a deal – or even sharing information – with you than if Competitor A is only a follower in the deal.  Further, remember that most corporate funds (there are exceptions: ask) are not “pure return” investor, and thus is not in a good position to set the price – which is one of the important things the lead typically, well, takes the lead on.  (Traditional funds will – quite correctly – discount an entrepreneur’s assertion that a price agreed to by a corporate fund is a fair price, particularly if the corporate fund is not a pure return investor.)

 Corporate Venture Capital: The People Difference.  Not to say that there are not exceptions, and not to say that corporate venture capital professionals are not exceptional in their own corporate worlds, corporate venture capitalists are as a general rule not the brightest bulbs in the venture capitalist universe.  First, compensation at most corporate venture capital firms is generally not as generous/aggressive as at traditional funds that don’t have to “fit in” to a broader corporate compensation system.  If traditional venture capital firms pay more, you would expect they would attract the best people.  Second, corporate venture capitalists, while needing, of course, to earn the confidence of senior corporate managers, don’t have to go through the hurdle of successfully selling themselves to a typically fairly large group of sophisticated investors who specialize in evaluating venture capital professionals as traditional venture capitalists do.  Finally, most traditional venture capitalists – certainly the stereotypical venture capital professional – are folks with big egos who like to make others fit to their rules rather than vice versa.  That’s a personality profile that doesn’t generally fit very well in  below C-level jobs in big business management cultures.  

Corporate Venture Capital:  Here Today, ….  Whether considering a relationship with a traditional or corporate venture firm, one criteria, of course, is how long a fund team  has been around: generally, fund teams that have managed several funds across several investing cycles are more desirable investors than less experienced funds. While there are notable exceptions, corporate venture capital funds don’t as a rule have the staying power of more traditional funds, as in addition to the performance hurdles all funds must overcome to stay in the business over the long haul, corporate funds have some of their own longevity issues.  For example, being pieces (usually small ones at that) of much larger enterprises, corporate funds are subject to the whims of senior management teams that at most companies blow hot and cold on venture capital investing, depending on short-term earnings pressures and more broadly shifting management priorities over the corporate cycle and as senior managers come and go.  Entrepreneurs considering venture capital should, to the extent possible, try to focus on corporate funds that have demonstrated both some staying power and some real success (which, of course, are also good criteria for evaluating competing proposals from traditional venture funds, too).

As noted, corporate venture capital is an important if relatively small part of the broader venture capital industry.  There are, as with traditional venture capital funds, good corporate venture investors and not-so-good corporate investors.  The ideas noted above are offered not as hard and fast rules – for all of them there are exceptions – but rather as a framework for analysis.  An analysis that entrepreneurs are wise to undertake before launching a campaign for venture capital funding.

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It Takes More Than Grey Hair

December 13, 2011

By: Paul Jones

One of the more pernicious mistakes many less experienced entrepreneurs make is assuming that successful “big business” executives are as a rule well suited to managing smaller high impact businesses.  It’s a pernicious mistake because few things can derail an otherwise promising startup faster than putting the reins in the hands of a poorly suited, even if highly decorated, big company manager.  It is a mistake I once made at one of my own startups, and one that I have seen others make too many times.

There are several reasons big company executives – not all of them, but a lot of them – fail when they transition to the startup world.  Most are related to the notion that managing a startup typically involves making “bet the company” decisions more often (as often as daily, and seldom less often than monthly), with less information, in less time, and with less input from appropriately experienced colleagues, than managers of larger, more established businesses.  Another startup attribute that can flummox big company executives is a culture that places much more emphasis (and reward) on rapid identification of mistakes, and much less on assigning blame for them.  Finally, most big company executives come from a world where the risk reduction paradigm is based on diversification, while for most startups risk reduction is based on focusing limited resources on a very narrow front (albeit one that can change overnight: see above re “bet the company” decisions).

None of this is to say that good big business managers are as a rule not well suited to be good managers of startups.  The point, rather, is that the demands of the jobs – and thus the skill set for doing them well – are different in the two worlds.  Some folks can transition from one world to the other, some folks can’t. 

Of course, figuring out whether a particular big company manager can succeed in the startup world is the real trick.  On that score, I have yet to find a sure fire test.  In my experience, one good approach is, once a candidate has passed the blush test and knows a little bit about the opportunity at hand, to ask her “so, tell me, if you were to start tomorrow what would you do first?”  Look for an answer that focuses on action, not analysis.  Look for a “take charge” attitude: avoid, at all costs, a candidate that looks like a deer caught in the headlights.  Another good approach is to emphasize how, well, broke the company is, or will be soon, without new capital or new/accelerating revenue – and how little the company spends on support staff and services.

If my suggestions seem inadequate, well, they come from experience as an entrepreneur hiring my replacement as CEO.  He had all the right industry experience and networks, and the grey hair to go with it.  If only we had asked him what he would do on his first day at the office, we might have learned about his need for an Executive Assistant, and his passion for good HR policies – as, for example, a standard, monthly process for recognizing the birthdays of the various members of the team.  If we had, we might have avoided making a fatal mistake.

 

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IRC 409A: Good Faith is Good, but not Good Enough

November 1, 2011

By: Paul Jones

From very early on, one of the distinguishing features of the Silicon Valley school of innovation was the notion that virtually every one on the team – from the receptionist at the front door to the founders in the corner office – should have a stake in the success of the venture.  While founders and in some cases other very early employees often acquired their “sweat equity” in the form of common stock, most later employees got their “upside participation” in the form of options to purchase common stock – typically at a price substantially less than the price paid for shares of preferred stock by more or less contemporaneous venture capital or other sophisticated investors.  How much less?  Well, therein lies a tale; alas, an increasingly frightening tale in recent years.

By way of background, in the good old days of sweat equity pricing – say, before 2004 (more on that later) – the task was in principal more or less what it is today.  The option exercise price was supposed to be set at the fair market value of the common stock on the date the option was granted.  The “technical” problem of figuring out fair market value was as much ritual as science: the process typically culminated in a boilerplate board resolution that implied a timely, exhaustive, good faith effort by the board – that in reality was mostly driven by rules of thumb.  Among those rules, the “common is worth 1/10th the preferred at the time of a first round venture financing” was one of the most popular.  Life was more or less good for founders, employees and investors alike.  As for the IRS, well, if you stuck to the rules of thumb and backed it up with the appropriate boilerplate, the IRS generally looked the other way.

And then came 2004, and Internal Revenue Code Section 409A, and the game was up.  Valuation rules of thumb were out (bad enough) and the cost of getting it wrong went way up (much worse).  Whereas in the good old days a board could be pretty confident that using a rule of thumb to set the valuation (albeit dressing it up in the board resolutions) would keep the IRS agents away, these days a board often does considerably more than that if it wants to sleep well at night, IRS-wise.  First, because 409A essentially eliminated using rules of thumb to determine fair market value in favor of some very particular – in terms of factors to be considered in setting a valuation and who should do the considering and how often – guidelines.  Second, because the cost of getting it wrong (in the old days mostly theoretical if occasionally somewhat problematic from an accounting perspective in an exit transaction) went up.  Way up.  For the employee, the company, and potentially even the individual members of the company’s board of directors.

Okay, first to the valuation question.  409A provides (in broad substance: this blog is a business heads up, not a comprehensive or even summary legal analysis) a specific list of factors that must be considered in making a valuation determination.  It also provides specific criteria as to who can do the valuation analysis if you want the IRS to take it seriously.  Alas, for most venture-backed companies the folks that qualify under the criteria are generally independent,  appropriately experienced, and expensive (say $5k to $50k depending on stage of development of the business and complexity of the capital structure) professional appraisers.  Follow the rules (i.e. absorb the expense) and you can be reasonably (if not totally) certain that the IRS will find better ponds to fish in than yours.  Don’t follow the rules, and ….

What can happen if you mess up a 409A valuation?  It’s not pretty.  Let’s take a hypothetical, and to make it both simple and less scary, let’s start with what happens if an employee is granted a vested option to purchase a single share of common stock at an exercise price of $1.00, and that the IRS later (say 12 months later) decides the fair market value was $3.00.  Well, first the employee is on the hook for not paying federal and state taxes on the $2.00 difference between the option exercise price of $1.00 and the IRS determined fair market value of $3.00.  Oh, and on top of that a 20% penalty tax and likely interest.  (And in some states, like California, an additional 20% penalty.)  And the company – and if the company can’t come up with the money, the various directors of the company personally – are on the hook for the unwithheld withholding taxes on the $2.00 – over and above the cost of redoing the accounting books to reflect the added compensation expense.  Ugly, indeed.

And, of course, it gets worse.  Because in most cases stock options vest over time; that is, an award of say 1,000 option shares might vest over four years.  At each vesting date, figure out the difference between the exercise price and the then fair market value and repeat the calculation for the shares that vested.  Even uglier.

So it looks like directors of venture backed companies that want to sleep well at night need to comply with 409A, such compliance most likely to include spending scarce corporate cash resources on periodic (at least every 12 months, and in many cases more often than that) professional appraisals of their common stock.  Among the prices we pay, I guess, for living in a post-Sarbanes-Oxley world.

An important footnote.  Some entrepreneurs and investors take the view that the fair market value exercise price problem posed by 409A can be avoided by simply setting the option exercise price at least equal to the then preferred price.  That’s true, if perhaps too clever.  If you live someplace where likely employees don’t understand the value of having an option exercise price below the current investor preferred price, well, good for you (not really, but that is another story).  Except that if you ever find yourself needing to bring on board a key player who does understand the difference you are going to have a problem figuring out how to explain to everyone else why their options are priced higher than the new guy’s.

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Convertible Debt Financing: Thoughts on the Default Conversion Price

October 25, 2011

By Paul Jones

Convertible debt financing structures, with or without equity kickers, are a popular choice for many seed stage entrepreneurs and investors.  (Disclaimer: this blog is about first money in seed investments, and not about the many other situations where convertible debt structures can be profitably employed.)  The ability to punt on the contentious and often problematic valuation issue until some combination of greater opportunity visibility and/or attracting larger post-seed investors to the table can be very attractive to the entrepreneur and seed investor alike.  However, while the concept is based on the notion that a valuation will ultimately be established in the context of a future, larger round of equity financing, what happens if no such round ever takes place?  Presumably, the seed investor will want to have the option to convert at some valuation (to participate in the upside) – without being obligated to convert to equity at any valuation (to protect on the downside).  It thus seems that while convertible debt financing makes the valuation issue at the seed stage less contentious than it might otherwise be, it doesn’t completely remove valuation from the negotiating table.  The entrepreneur and seed investor will still have to agree on a default conversion valuation if the anticipated post-seed “conversion trigger” financing doesn’t, for whatever reason, happen.

Before talking about the default conversion valuation, let’s consider when it comes into play.  A typical seed convertible debt financing anticipates that there will be a larger downstream “conversion trigger” financing, with the valuation in that financing serving as well as the valuation for conversion of the seed debt.  Usually, entrepreneur and seed investor alike put a lot of thought into how big the future finding has to be to trigger conversion of the debt.  While each party may have its own ideas on what the trigger valuation needs to be, those ideas are more often than not relatively easy to bridge.  Both sides will want a trigger financing to be big enough (particularly if there is an equity kicker associated with the convertible debt) to assure that the “convertible tale does not wag the trigger investment dog” so to speak.  And both parties will presumably have some more or less similar ideas on at least the minimum amount of next round capital the business will need to get to the round after that (or exit, if you are an incurable optimist). 

But there is a more subtle piece of the trigger financing question.  How long does the company have to pull it off?  Put differently, besides defining the amount of capital that must be raised to trigger conversion of the seed convertible debt, you also have to set an outside time limit on that financing: a time after which, if no trigger financings has occurred, the seed convertible debt will have the option to convert at the default conversion valuation.  On that score, sooner is better for the seed investor and later is better for the entrepreneur – but at the end of the day, the entrepreneur should not rush into a short fuse no matter how certain she is that the trigger financing will happen sooner rather than later.  In my experience, most seed investors will accept a 12-18 month time frame for the trigger financing, and, well, the longer the better.

Finally, we get to the heart of this blog.  Given that higher is always better for the entrepreneur, and lower is always better for the seed investor, how should the parties approach setting the default conversion valuation?

Let me cut to the chase and then circle back on the rationale.  In my experience, a good default conversion valuation is one that will, if the seed investor decides to convert at that time/price, result in a fully-diluted ownership stake in the 10-20% range.  If that sounds arbitrary, well, it is.  But capricious it is not.  Here’s why.

Lets start by predicting the future of the entrepreneur’s business, focusing on just those futures that are most likely if you assume that no conversion trigger financing ever takes place.  It seems to me that the vast majority of such futures will fall into one of two buckets.  Either the business the business tanked without ever getting additional financing, or the business took off without needing additional financing, or.  In the later case, the seed investor will not want to convert, it being all but certain that remaining in their creditor position will maximize the amount, if any, of their investment that is recoverable.  And this should be fine with the entrepreneur (who, of course, was wise enough not to sign any personal guarantees (which, if you think about it, makes sense – but that is a digression).

So what about the case where the business became wildly successful, without ever needing to raise additional equity capital?  Shouldn’t, in that case, the entrepreneur fairly expect a very high valuation for the conversion of the seed debt?

In theory, yes, but lets look at the practicalities of the assumed outcome.  The entrepreneur will, in my 10-20% dilution scenario, find themselves with 80-90% ownership of a business that, short of an exit transaction (or perhaps bank or other non-dilutive financing), by definition does not need additional equity capital.  Sure, at a higher default conversion valuation, they would own an even bigger piece of the pie.  But at some point, shouldn’t the entrepreneur ask herself something like the following question: “Just how rich does the seed investor have to make me before I will be satisfied – given that the seed investor’s money is what got me all the way home, and that my expectation going into the seed round was that there would ultimately be a lot more than 10-20% dilution before we got home?”

Now, every situation is different, and there are situations where my 10-20% default conversion rule of thumb may not be the “right” answer (whatever that is).  But it does seem to me that an entrepreneur who hits a home run so much faster, and with so much less risk capital than even she thought possible, well, she ought to be able to share a little of her good fortune with the seed investor who made it possible.

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Steve Jobs: Concept Precedes Design

October 11, 2011

By: Paul Jones

Among the many tributes to Steve Jobs on his passing, perhaps the most common theme is the man’s prowess as a designer.  And, indeed, from the Mac to the iPod to the iPhone to the iPad (if not so much Newton, or Lisa, or iTV, or …) Jobs’ talent for matching form to function was nothing short of astounding.  Asking his successors at Apple to maintain the standards he set is asking a lot.  But for arguments’ sake, let’s assume they can do it.

Unfortunately for Apple, meeting the design challenge will only get them part way home in terms of living up to their now departed leader’s legacy.  Because as good as Jobs may have been as a designer, he was even better as a conceptualizer: which is to say, his conceptual prowess was at least the equal of his design flair, and while I can – well, sort of– imagine that Jobs’ successors at Apple can design a better iPod, iPhone and iPad, I really struggle with the idea that they will be able to conceive of the next, well, iNext.  And, ultimately (which is to say probably within a year or two or maybe three at the outside) Apple will have to come up with a compelling iNext to keep the Apple juggernaut on top of the tech world for the next few years after that.

Design, ultimately, is a craft, and Jobs was a superb craftsman.  The ability to conceive something utterly new in function as well as form, on the other hand, is the mark of true genius.  Making a better iPad is a big task, but not as remotely challenging as conceiving the notion of the iPad in the first place.  Even conceding that Apple has the talent to live up to Jobs’ standards in the design of the next iPhone, it strains credulity, I think, to believe that anyone at Apple can match Jobs standards and timing in conjuring the iNext.

Look at it this way.  Suppose you had to rank three teams in terms of how likely each was to conceptualize a blockbuster iNext.  Team one was the Apple team with Jobs.  Team two was Jobs, and team 3 was the Apple team without Jobs.  Go ahead, rank them.  Doesn’t your ranking (we all came up with the same ranking, right?) tell you something about Apple’s likely longevity as the center of the consumer technology universe – or at least as the most valuable company on the planet?

 

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What’s in a Name? Protecting Your Start-Up Trademarks

September 28, 2011

By: Jeff Peterson

Most new business ventures are started around a new idea.  The business focuses on a new product, a new service, something that will set the business world alight with the new idea and creativity that the business will bring to the marketplace.  The initial focus of new companies, rightfully so, is on the development of these new products and services and how to best to commercialize them in a competitive marketplace.  Unfortunately, businesses often tend to neglect another key aspect of their company’s property, namely, the intellectual property they have in the name of their company or products themselves.  Oftentimes, the initial inquiry around a new company’s name in today’s markets is whether the domain name is available for the name.  Companies often fail to do more in-depth trademark clearance searches on both the company name and any new product names which will be used in the marketplace.  Just because a domain name is available for use does not mean the company is free to use that name as the name of their business and/or their products.  Other parties may have trademark rights in that name, even if they do not have the domain name registered.  Selecting a trade name for a new company that is both available and strongly protectable can lead to an invaluable asset for the company as it grows in the marketplace.  If a new company does not do the appropriate due diligence on the selection of their name it can lead to painful and expensive name changes of either the company and/or products down the road if problems arise. 

Choosing a name
Oftentimes, a new company will choose a name which is somewhat descriptive of the new goods and services that they will bring to market.  For instance, “Quality Lenses”, or “Optic Technologies” may provide the commercial impression to consumers that the company is related to optical lenses but the marks themselves are so descriptive that any proprietary enforceability around such trademarks would be relatively weak.  This is because, in general, descriptive marks are not available for trademark protection.  Only when a mark has  been used for a long period of time and acquired so-called “secondary meaning” will courts find that descriptive marks, i.e., marks which describe a characteristic of the product or services, are afforded trademark protection.  The term “secondary meaning” stands for the principle that even though the mark is descriptive, the mark has been so widely used for such a long period of time that consumers recognize that the mark has another meaning beside the descriptive one, namely, it is an indicator of a specific source for the good or service associated with the mark.  Therefore, some of the best marks for choice of the name are fanciful or arbitrary marks that do not relate to the product or good themselves.  “Apple” for instance has nothing to do with computers or electronics.  Another good choice for a mark would be a mark that is suggestive of the good or service associated with it.  “Greyhound” for bus transportation is suggestive because a consumer may envision that the bus travels as fast as a greyhound dog.  Selecting a mark that is either arbitrary, fanciful or suggestive, but is not directly descriptive, can provide a business name or product name in which a company can strongly enforce if any competitors enter the marketplace using the same or similar brand.

Clearing the proposed name
It is important for any new company to make sure that the proposed name they are choosing to do business as is free and clear to use.  This clearance must not only be considered for the goods and services the business is planning on offering immediately but for any future expansions either in goods or services and/or geographical areas that the business is planning on expanding to in the future.  Certainly, checking domain name and corporate name availability at the corporate name registration level is appropriate.  Additionally, a company should make sure no other state trademark registrations or federal trademark registrations have been filed or registered on the same or similar mark.  Additionally, a search should be done to determine if any local businesses in the geographic area the company is operating in have been conducting business or offering products using the same or similar mark.  If such pre-existing companies have been conducting business under the same or similar mark, they may have common-law protection for the mark, even if they don’t have a trademark registration.  Working with legal counsel to perform a legal clearance search of the names is something that should strongly be considered by any new company to make sure that their proposed business and product names are available for use. 

Protecting the trademarks
Once a company has selected their business and product names, and have cleared them in a search, the next step is for the company to decide how to protect their new brands.  Fortunately, unlike patent protection, some level of trademark protection is available without undertaking any additional legal filings or expenses.  Just the mere act of using a business or product name in public, in association with marketing goods or services, is enough to obtain common law trademark protection for the mark.  Common law trademark protection is a right under state law and gives a company proprietary rights to prevent others from using the same or similar mark in the same geographical areas that the company uses the mark.  Obviously, the weakness of common law protection is that the protection would only encompass the geographical areas that a company has actually done business in.  In order to obtain more robust protection, a company can register their trademark with either the state or the federal government.  The rights granted with state trademarks vary from state to state, but generally provide the registrant similar protection to common law protection.  Federal trademark registration, however, gives presumptive nationwide rights in the use of a company’s trademark once it is registered.  Once a trademark has been registered with the United States Patent and Trademark Office the owner of the registration is, with few exceptions, the only one who may use the mark in the United States in conjunction with the goods and services for which it is registered for.  Trademark registration may be applied for at any time – even before the mark is in use.  This allows the company to reserve rights to the mark before the associated company name or product is introduced.  Before a final registration can be secured, however, the mark must pass through the registration process and be used.  The registration process can take upwards of eighteen months.  If a new company has enough financial resources it is always a good idea to try to establish a federal trademark registration at least in the company’s name to provide ample opportunities for that company to expand on a nationwide basis while preserving their right to use the mark and enforce it against other parties.

Best practices
No matter how small a new business is, they should always take the time to perform a clearance search in some aspect of the business name to make sure that there are no overlapping domain names or trademarks which would place restrictions upon how the company gets to use its name in commerce.  By performing a clearance search and picking a strong distinctive name, a new company should not run into any major issues which prevent them from using their brand in the future and will provide adequate protection to prevent others from using any brands developed by the company.  No company ever wants to have to change its business name and being forced to change something as important as the company’s name or the name brands of that company can easily spell the end of a new business.

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Posted by jdpeterson2

Navigating Wisconsin State Income Tax Credit Incentives

September 14, 2011

By: Hamang B. Patel

A business executive can be excused for not knowing which of the various state income tax credit incentives is appropriate for his or her company.  At first blush, the various tax incentives all seem to be similar.  The following summarizes the various income tax incentives available to a company to expand operations in Wisconsin, and explains how a company would want to choose from among these programs.

Four Main Programs
There are four Wisconsin income tax incentives available to companies that seek to expand activities inWisconsin, which are the following: 

1.         Economic Development Tax Credits;

2.         Jobs Tax Credits;

3.         Relocation Tax Credits; and

4.         Enterprise Zone Tax Credits.

Many business owners are familiar with the Wisconsin Angel Investment Tax Credits (commonly known as “Act 255 Credits” after the statute creating the program several years ago) and the Early State Seed Investment Tax Credits.  A key thing to remember is that these two investment tax credit programs provide tax credits to investors seeking to invest in a company, which is a good way to assist a company to raise capital from investors.  However, these two programs don’t directly provide tax incentives to the company itself. 

There are also other tax credit programs that are specific to certain industries (e.g., credits for dairy, meat processing, food processing, woody biomass, film production manufacturing, etc.).  For the moment, let’s focus on the four major programs described above that can directly incentivize a company’s expansion plans without regard to industry type.

Economic Development Tax Credits
In 2009, Wisconsin(recognizing that simplicity is welcome in the business community) condensed five overlapping tax credit programs into the Economic Development Tax Credit program. This program provides a nonrefundable state income tax credit for certain types of economic development projects.  This program provides tax credits for companies that: (i) create jobs, (ii) invest in equipment or real estate, and/or (iii) train employees.  For job creation, the credit ranges from $3,000 to $7,000 per job depending on the salary paid to the full-time employee.  For capital investment, the credit can be up to 3% of the investment in equipment and 5% of the investment in real property.  A credit for employee training is up to 50% of the training costs.  These credits are typically less $3M per company, unless special approval is provided by the state.  In 2011, the state increased the aggregate amount of tax credits that may be allocated to all applicants by $25M.  Further information is available here. 

Jobs Tax Credits
Available for the first time last year, Wisconsinprovides a refundable state income tax credit specifically for creating jobs in Wisconsin pursuant to the Jobs Tax Credit program.  The credits are up to 10% of new full-time employee wages.  New jobs must pay annual wages of at least $20,000 ($30,000 depending on the classification of the county or city) but not more than $100,000.  The total amount of these credits available to all applicants per year is $5M.   Further information is available here . 

Relocation Tax Credits
In 2011, Wisconsincreated a new nonrefundable state income tax credit known as the Relocation Tax Credits program.  These credits are available for a company that moves at least 51% of its workforce payroll or at least $200,000 of wages toWisconsin from another state or country.  The credit equals the company’s totalWisconsin income tax liability (after taking into account all other credits, deductions and exclusions).  The credit can be claimed for two consecutive years, beginning in the year the business relocates toWisconsin. 

Enterprise Zone Tax Credits
In 2011, Wisconsinexpanded the Enterprise Zone Tax Credit program to allow up to 20 “zones” (up from the existing 12 zones).  The zones are created at the discretion of the Wisconsin Economic Development Corporation (the “EDC”), taking into account the area’s economic need.  Although not self-evident from the statutes, in practice a “zone” has been the area around a particular company’s facilities rather than a broad area.  So in practice, this program should be thought of as an incentive for a particular company’s expansion plans.  A company receiving these credits should make a significant investment in jobs and/or capital.  Our discussions with EDC staff suggests that projects that would receive these credits are for those that create or retain 800-1,000 jobs in Wisconsin and/or invest $80M – $100M of capital investment.  Several refundable state income tax credits are available under this program.  For job creation or retention, the credit is up to 7% of wages in excess of $20,000 ($30,000 depending on the classification of the county or city).  For job training, the credit is up to 100% of the training costs.  For capital investment, the credit is up to 10% of expenditures.  A final credit is equal to 1% of purchases of goods or services fromWisconsin suppliers.

Certification
To obtain any of the credits described above, a company needs to get certification from the EDC prior to starting the job creation or capital investment upon which the credits will be computed.  Certification is a competitive process and depends on the allocation constraints of the EDC (i.e., how much of the limited credits remain available).  Our experience with the EDC is that certification for a credit also depends on the quality of jobs created (i.e., whether the jobs are low-wage or transitory) and, for nonrefundable credits, whether the company has taxable income to use such credits.  The EDC has also told us that while there is no statutory prohibition against double dipping to obtain multiple credits, the EDC would never in practice certify a company to receive multiple credits for doing the same thing.  For example, the EDC wouldn’t certify a company to receive the Jobs Credit and the Economic Development Credit for creating the same jobs.  On the other hand, the EDC has told us that it might be possible for a company on a case by case basis to be certified, to get the Jobs Tax Credits for creating jobs and also to be certified to receive the Economic Development Tax Credits for other activities (e.g., capital investment or employee training). 

Choosing Among Programs
The EDC will ultimately choose among the above described incentives that are available/offered to a company.  Nonetheless, a company would need to know which incentive to push for.  The following lists some of the factors that should be taken into consideration from the perspective of the company.

1.         Tax Appetite.  The obvious difference among these programs is that the Jobs Tax Credit program and the Enterprise Zone Tax Credit program provide for refundable credits.  Thus, if a company doesn’t have taxableWisconsin income that can be offset by these credits, the state will literally send a check in the mail to the company for the unused portion.  In contrast, the Economic Development Tax Credit program and the Relocation Tax Credit program offer nonrefundable credits.  If the company doesn’t have taxableWisconsin income that can absorb the credit, it would have a preference for the Jobs Tax Credit or Enterprise Zone Tax Credit.

2.         Size of Project.  Based on our discussions with EDC staff, the Enterprise Zone Tax Credits is not for small projects.  Thus, unless a company is planning a major job creation or capital investment program, the company is unlikely to be certified to receive Enterprise Zone Tax Credits. 

3.         Quality of Wages.  For some programs, the level of wages for new jobs created must be above a certain threshold (e.g., Jobs Tax Credit and Enterprise Zone Tax Credit programs) due to statutory requirements.  Unless the expected jobs exceed this threshold, such programs can be disregarded.  For the Economic Development Tax Credit program, which allows tax credit solely due to capital investment activities, our experience is that if the jobs resulting from or saved by the capital investment are not well paying jobs (e.g., migrant workers earning minimum wage), then the EDC is unlikely to certify the program for credits.

The economic value of these tax credit incentives can be powerful.  A company considering a business expansion would be advised to spend some time evaluating the various state incentives and contacting the EDC to see if any of these incentives are available.

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Posted by hamangpatel

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