RESQBug.com – Geek Speak to English

Today, my partner Seth wrote a great piece on the merits of early-stage startups raising convertible debt rounds versus traditional preferred stock equity structures.  The piece was inspired by Paul Graham’s recent tweet that said:  “Convertible notes have won. Every investment so far in this YC batch (and there have been a lot) has been done on a convertible note.”

Seth’s piece is a must read in this debate that is only gaining more participants, including a nice follow up from Mark Suster about his thoughts.  I can’t do justice to either Mark’s or Seth’s pieces trying to summarize them, so I strongly encourage you to read them.

I’m going to go out on a limb and break out my old law bar card and bring up one issue that I don’t think is getting enough focus in the debate:  the use of debt fundamentally changes the fiduciary duties of managers and board member of the company.

If a company raises cash via equity, it has a positive balance sheet.  It is solvent (assets are greater than obligations) and the board and executives have fiduciary duties to the shareholders in the efforts to maximize company value.  The shareholders are all the usual suspects – the employees and venture capitalists.  Life is good and normal.

However, if a company is insolvent, the board and company now owe fiduciary duties to the creditors of the company.  By definition, if you raise a convertible debt round, your company is insolvent.  You have cash, but your debt obligations are greater than your assets.  Your creditors include your landlord, anyone you owe money to and folks that you might owe money to you, like former disgruntled employees and founders who have lawyers.

How does this change the paradigm?  To be fair, I have had no personal war stories here, but it’s not hard to construct some weird and scary situations.

Let’s look at the hypothetical:

Assume the company is not a success and fails.  In the case of raising equity, the officers and directors only own a duty to the creditors (landlord, etc.) at such time that cash isn’t large enough to pay their liabilities.  If the company manages it correctly, even on the downside scenario creditors are paid off cleanly.  But sometimes it doesn’t happen this way and there are lawsuits.  When the lawyers get involved, they’ll look to try to establish the time in which the company went insolvent and then try to show that the actions of the board were “bad” during that time.  If the time range is short, it’s hard to make a case against the company.

However, if you raise debt, the insolvency time is forever!  Not just when cash got below the ability to pay liabilities like the equity situation, because the company has never been solvent.

What does this mean?  It means that if your company ends up failing and you can’t pay your creditors, landlords, etc. that their ability for a plaintiff lawyer to judge your actions has increased dramatically.  And don’t forget, if you have any outstanding employment litigation, etc., all of these folks count as creditors as well.

The best part of all of this is that many states impose personal liability on directors for screwing up things while a company was insolvent.  Read this to be:  “some states will allow creditors to sue directors personally for not getting all of their money they are owed.”

Now I don’t want to get too crazy here.  We are talking about early-stage / seed companies and hopefully the situation is clean enough that my doomsday predictions won’t happen, but my bet is that few folks participating in convertible debt rounds are actually thinking about these issues.  And no, I don’t know of any actual cases out there, now.  But I’ve been around this business long enough to know that there is constant “innovation” in the plaintiff’s bar as well.

With thanks to jasonmendelson.com  To see the original article please click here.

Remember, that the only dumb question is the one never asked. If you have any questions or comments, I look forward to them, please email or call me.

Cheers.

Allan

RESQBug.com Technical Services and PRAD Enterprise

“Managing Your Technology for Improved Workplace Performance”

c: 416.464.1508

e: allan@resqbug.com

t: http://twitter.com/resqbug

Visit us on the Web at http://www.resqbug.com

This article is for information purposes only.  It is recommended that individuals consult with an IT professional before acting on any information contained in this article. The opinions stated are those of Allan Waddington and not a reflection of any company he currently works with or has in the past.

“If you think it’s expensive to hire a professional to do the job, wait until you hire an amateur.” -Red Adair

There are many, many reasons why it’s smart for an entrepreneur to learn about intellectual property law.  Here are ten of my favorites:

1.  To keep the intellectual property that you create for your new company free of ownership claims by your former employer

Watch out if you’re working on your new venture while employed by another company in the same industry.  Later claims by your former employer to your startup’s IP can land you in court and ruin your new company.

Knowing how to carve out and keep the intellectual property rights to what you create for your new company can be critical for your success.  It’s important to learn about trade secret law and what you can use from your prior jobs.

There are key steps you can take to narrow the net of what your former employer may claim, especially if you live in California.

2.  To increase the odds that you can use your company and product names without being stopped by another trademark owner

After picking names that you love for your business, products and services; incorporating your company; building a website; and working hard to promote your brand,

IT SUCKS TO HAVE A TRADEMARK OWNER CLAIM THAT YOU ARE INFRINGING!

Warning.  Just because the dot com domain is available, it doesn’t mean that you can freely use the name.

Just because the Secretary of State for one state allows you to use a business name, it doesn’t mean you can freely use the name nationally or on the Internet.

And no, your corporate lawyer probably didn’t check for conflicting trademarks.

Learning about trademark law and doing some basic groundwork before starting  your business can save you from big headaches and expenses down the road.

If you love your name, think about registering your mark so you can increase the odds of being able to use it.  Few people want to start over from scratch.

3.  To make sure your startup owns the intellectual property created by its founders, employees, vendors, and independent contractors

This is where many startups screw up if they don’t understand basic IP law.  Some of the legal rules about IP ownership are counterintuitive and complicated.

You should be aware that you may not own what you pay others to create for your new company if you don’t take precautions.

It seems so wrong but it’s true.

I’ve spent years doing intellectual property ownership clean up.  Some startups were able to make some basic changes and turn things around.  Others got burned — to the ground.

4.  To own the rights to your logo

Your logo is the symbol of your company.  Your hard work and promotion make it valuable and it’s usually worth the trouble to protect it.  If you don’t have a written copyright assignment by the person or company who designed it, you don’t own the copyright.  You need an assignment to register a copyright or trademark.

Professional design studios will assign the copyright to you without a hassle.  Beware of designers who won’t do a copyright assignment or balk at the suggestion.

5.  To own your company website

This is similar to number 4.  If you don’t have a written, signed copyright assignment for the design of your website, you don’t own the copyright to the site.  This may create problems in the future and it will prevent you from registering your website with the Copyright Office.

Bizarrely, if you don’t own the copyright and you change your site,  you may be guilty of copyright infringement.

If you already have a site, check on the footer to see if the design company is claiming the copyright.  Does their name appear after the copyright symbol?

Pragmatically, caring about IP ownership to your website depends in part on how much you spent for the design; the complexity of the design; your commitment level to the look of your site; your type of relationship with the designer; and how hard it would be to build a new site.

If it was expensive, design intensive, hard to replicate and you love it, pay attention to copyright ownership.

Further, to avoid infringement, make sure you have a license to use or own the copyright to every element on your website.

If your site is expensive, it’s important to be aware of what software was used as the foundation for your site and the related licenses.

6.  To minimize the chance of liability for IP infringement

Ignorance is not bliss.  It can get you sued.  And as some unfortunate software developers have learned, trade secret misappropriation can land you in jail.

7.  To get legal protection for intellectual property that is created for your startup

Different laws have different requirements for obtaining legal protection.  To get protection, you must follow the rules and take specific actions.  You don’t want to blow it and lose protection for your million dollar invention or product because you didn’t know what you needed to do.

8.  To understand open source licenses

Many technology companies incorporate open source software into their products.  What you can do with the new work you create that incorporates the open source code can vary dramatically.  Some open source licenses prevent you from selling your new product.  Beware unless you plan to give your product away for free.

9.  To protect your IP when you are doing a joint venture

When you work with another company or developer on a joint project or product, it is important to use more than a handshake.  It’s important to know what to do to keep the lines of IP ownership clear or you may end up with the default legal rules that create a mess you never intended.

Arguments because of an initial lack of clarity can ruin even the best friendships.

10.  To not scare off potential investors because the ownership of your startup’s intellectual property is a mess

The core assets of many technology startups are based on intellectual property.  I’ve done due diligence for venture capitalists and other types of investors and I’ve seen some horrible, dirty messes.  Don’t scare off potential investors because you haven’t taken the time to do what you need to do to have clear lines of intellectual property ownership.

Right now, you may not care about potential investors or buyers.  But if your startup is wildly successful, you may care when it’s too late to fix things.

Later posts will explain each category above in detail.  I will share valuable information about intellectual property law and some concrete steps that you can take to help your business succeed and increase the value of your work.

P.S.  You may want to subscribe to make sure you catch what you need to know most.

With thanks to www.iplawforstartups.com.   To see the original article please click here.

Remember, that the only dumb question is the one never asked. If you have any questions or comments, I look forward to them, please email or call me.

Cheers.

Allan

RESQBug.com Technical Services and PRAD Enterprise

“Managing Your Technology for Improved Workplace Performance”

c: 416.464.1508

e: allan@resqbug.com

t: http://twitter.com/resqbug

Visit us on the Web at http://www.resqbug.com

This article is for information purposes only.  It is recommended that individuals consult with an IT professional before acting on any information contained in this article. The opinions stated are those of Allan Waddington and not a reflection of any company he currently works with or has in the past.

“If you think it’s expensive to hire a professional to do the job, wait until you hire an amateur.” -Red Adair