Copyright © 2012 by K&L Gates LLP. All rights reserved.

Startups 101

Chung-Tung University Alumni Association – NCTaiwanese American Industrial Technology Association

June 19, 2012

Fred Greguras, K&L Gates LLP(650) 798-6708fred.greguras@klgates.com

Charles Holland, K&L Gates LLP650-798-6710charles.holland@klgates.com

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K&L Gates Law Practice We have offices in major cities around the U.S.

and across the globe, including 6 offices and 100 lawyers in Asia We advise start-up and established technology,

renewable energy and other types of businesses

We work with global and U.S. venture capitalists and private equity investors

Cross border M&A and IPO exits in the U.S., Hong Kong, Taipei and AIM in London

Mandarin and Cantonese speaking attorneys throughout the firm

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Overview

Making a clean break from a prior employer Choice of legal entity Why, when and where to incorporate Conventional capital structure Founders shares allocation and vesting Stock option plans China and offshore corporations

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Making a Clean Break underCalifornia Labor Code 2870

“Any provision in an employment agreement which provides that an employee shall assign, or offer to assign, any of his or her rights in an invention to his or her employer shall NOT apply to an invention that the employee developed entirely on his or her owntime without using the employer’s equipment, supplies, facilities, or trade secret information EXCEPT for those inventions that either:

1. Relate at the time of conception or reduction to practice of theinvention to the employer’s business, or actual or demonstrably anticipated research or development of the employer; or

2. Result from any work performed by the employee for the employer.”

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What Are The Implications? “Clean break” will be tested in due diligence in a financing -

employee has burden of proof “Relate” to the employers business will be construed broadly

according to court decisions - covers employer’s scope of business not just employee’s job scope

No time limit on the prohibition on using the employer’s trade secrets

Working completely outside an employer’s premises and not using an employer’s resources is not enough to avoid a taint

Overlapping employment (“moonlighting”) by a founder Use of consultant – who does he/she work for? Does not apply to general skills or knowledge but where is the

dividing line Conception is not just thinking about a problem needing a solution

but is the new product based on a generally known market need oran undisclosed vulnerability in the employer’s product?

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Avoid Doing the Following(Assuming Same Business Space)

Any overlap in employment Filing a provisional (or utility) patent application a few days

after you leave your old company Assigning IP and technology to purchase your shares in the

new company Reducing any ideas about a possible invention to any

tangible medium while at your prior company Developing the product in the new company at “super

human” speed Taking anything from your prior employer even paper clips

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Choice of Legal EntityLimited Liability Company (LLC)

Used for consulting and other small businesses One or more owners (members) Formalities of a corporation are not required Members generally not personally liable for

obligations of the business (unless guaranteed) Can elect to be treated as a corporation or

partnership for tax purposes Regulatory filing is required to establish an LLC

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Choice of Legal EntityC-Corporation

State corporation – C tax status is the default if no S corporation election

One or more owners (shareholders) Management by a board of directors elected by

shareholders; officers elected by the board Shareholders not personally liable for obligations of the

business (unless guaranteed) if formalities followed A tax return is required at the corporate level,

corporation pays the taxes Regulatory filing is required to establish a corporation

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Why and When to Incorporate Most start-ups seeking investment incorporate

Investor requirement and comfort Enables use of stock options for service providers Corporation can be acquired tax-free with stock

(LLC cannot) Corporations are the best vehicle for going public

Incorporation requires more than filing articles of incorporation No one owns the corporation unless shares are purchased

When to incorporate? Document founders ownership Take actions that could create personal liability Sign a customer contract or even a NDA Grant stock options to “pay” for development services Receive investment – particularly one in which the company will be valued Need to hire employees

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Where to Incorporate California, Delaware, Cayman Islands, elsewhere

Geographical market focus Investor comfort or requirement Flexibility in exit strategy

Cannot avoid California taxes if the corporation is operating in California Delaware advantages are investor preference, ease of dealing with

regulatory authorities, flexibility in the law (such as number of board members), more precedent on corporate law. Disadvantages are being taxed by and subject to two states requirements.

California advantages are lower cost and being subject to only one state’s requirements, if operating here. Major disadvantage is difficulty of dealing with regulatory authorities.

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“Nuts and Bolts” of Incorporating

File Articles of Incorporation Incorporator resigns and appoints initial board of

directors Organizational consent of the board in which:

By-laws adopted Founders stock purchases approved Equity incentive plan approved Initial stock option grants approved

Founders buy shares under the stock purchase agreements

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Conventional Capital Structure Keep it simple and conventional “1X” pattern

Fully diluted concept: outstanding shares + outstanding options + option reserve

OutstandingAuthorized or Reserved

______________________________________________Common Stock 10M 3-5M Founders

1-2M Stock Option Plan

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Capitalization Example

● Founders 4M

● Stock Option Plan 1M

All Common Stock Outstanding Reserved

Fully-diluted is 5M shares (4M +1M) Founders own 100% of the company on an outstanding share basis 4M/4M) Founders own 80% of the company on a fully-diluted basis (4M/5M) Investors will calculate their ownership on a fully-diluted basis

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Financing Valuation CalculationExample

$4M pre-money valuation, $2M investment in Series A Fully-diluted pre-money is 5M shares of common stock 4M shares of common stock issued to founders

1M shares of common stock reserved in stock option plan. SeriesA price is $4M/5M (fully-diluted) = $0.80 per share. $2M buys 2.5M Series A shares

Resulting cap table is:

100%7.5 M33.33%2.5 MInvestors13.33%1MPlan53.33%4MFounders

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Founders’ Shares Allocation and Purchase

3-5M shares of common stock Buy common stock at a nominal price

Timing of purchase – avoid being near the Series A financing for tax reasons

Payment is by cash, assignment of technology or other property. Need to purchase shares in order to own the corporation. Company must own its technology and intellectual property

but avoid 2870 taint Transfer all property at the same time under IRC § 351 – not

applicable offshore

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Founders Vesting Issues

What is stock vesting? Company right to repurchase shares on termination,

at original purchase price, that lapses over time Right is exercisable if founder stops providing

services to the company 83(b) filing/consequences – within 30 days after

purchase Why impose vesting pre-financing? Provides incentive for founder to continue to provide

services to the company Avoids “free-rider” problem if a founder leaves

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Founders Vesting Issues

How much vesting up front for founders? Work done in past Value of intellectual property/other contributions Stickiness – most important factor

Time vesting 3 or 4 years Cliff, no cliff Monthly, quarterly, annually after a cliff

(monthly after the cliff is more common)

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Founders Vesting Issues

Vesting acceleration for founders – set up at founding in founders stock purchase agreements Trigger events

Upon termination without “cause” or for “good reason”(outside of an acquisition)

Acquisition of the company with “double trigger” on acquisition – stickiness

What is a “double trigger”? Trigger One - Company acquired Trigger Two – Termination within 12 months

(or other period)

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Stock Option Plans

Create and approve at time of incorporation so “currency” is available to attract and retain employees and other service providers

Option plan provisions and filings must comply with federal and state securities and tax laws

Difference between ISOs and NQSOs – when income must be recognized

Eligibility for each type of option Employee: ISO or NQSO Other service provider: NQSO only

Acquisition consequences in plan - stickiness Fair market value pricing for 409A purposes

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China and Offshore Corporations Test the waters for the business before building infrastructure

Start with U.S. or other domestic company? Local government investment is causing more startups to be China

domestic companies In general, reincorporating a company offshore is treated as a sale of the

company unless the transaction is a bona fide acquisition. Under IRS 7874, the tax consequences of reincorporation offshore is

either a sale of the company or the new company remains a U.S. corporation for tax purposes. Sale with no cash if former shareholders own 60-80% of new foreign

company Treated as U.S. corporation if former shareholders own 80%+ of new

foreign company China government approval (Ministry of Commerce) is required for

reincorporation.

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Exit Strategy Formation Considerations (I) Geographical market focus

China or global Nature of founders/investors

Domestic, foreign or both

Local government funding Global investor preference or requirement

China or offshore Restricted or prohibited industry status under Chinese law Media, telecom, internet,…**Catalogue of Industries for Guiding Foreign Investment (2011 Amendment)

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Exit Strategy Formation Considerations (II)

Foreign exchange restrictions on moving money out of China

Listing eligibility on stock exchanges Exit alternatives are restricted by where the company

is formed particularly if in China M&A rules in China, US and elsewhere (MOFCOM,

SAFE, etc.) restrict availability of suitors

China Securities Regulatory Commission (CSRC) approval required for domestic and offshore IPOs

Copyright © 2012 by K&L Gates LLP. All rights reserved.

Key Intellectual Property Issues for Startups______________________________________

June 19, 2012

Chuck Holland and Fred Greguras, Esq.K&L Gates LLP

(650) 798-6710 and (650) 798-6708

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Key Points

Get intellectual property into the company early Granted patents and trademarks

Get the intellectual property basics right –investors, acquirers, underwriters will carefully investigate

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Overview ofKey Intellectual Property Issues for Startups

Scope of intellectual property associated with your business

Ownership of rights to that intellectual property

Freedom of operation

Routine practices to further each of these

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Scope of IP – background info on types of intellectual property a company develops

Patents (utility, design, utility model) - inventions

Trade secrets and know-how – info. you developed

Trademarks/service marks/domain names

Copyrights

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Scope of IP – background info on some rights each type of IP provides

Patent – right to exclude others from making, using, selling, offering, importing what is claimed in the patent; expires 20 years from earliest priority claimed

Trade secret/know-how – right to stop others from using confidential information taken from you; available as long as you keep information confid’l

Trademark/service mark/domain name – right to stop others from using identifiers for your company in a confusing way; valid as long as you are using it

Copyright – various rights to stop others from using or reproducing an original work; lasts at least 70 years

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Scope of IP – background info on rights each type of IP does not provide

Patent – does not provide the right to freely make, use, sell, offer for sale, import what is claimed

Trade secret/know-how – does not provide the right to stop others from reverse-engineering or independently developing or learning information

Trademark/service mark/domain name – does not provide the right to stop others from using same or similar mark or namefor business in different business line

Copyright – does not stop someone from using the idea conveyed by your copyrighted info; only stops someone from using your expression of that idea

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Scope of IP – patents Decide whether trade secret or patent protection is appropriate

How easily can technology be reverse engineered?

Assess whether to file provisional or non-provisional application

How much development in next year

Exit strategy – patents matter more than applications; provisional app’s are not examined

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Scope of IP – patents (cont.)

Budget

Foreign filings are expensive – assess where patents are essential (key markets, manufacturing) and build into budget

Application drafting costs are the tip of the iceberg when compared with foreign costs Know the prior art to maximize claim scope Provisional applications misconception

Often little disclosure to keep cost low but may not meet statutory requirements or you may think you have more protection than you actually have

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Scope of IP – patents (cont.) Budget (cont.)

Cleaning up poorly-strategized portfolios can be expensive and rights can already be compromised

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Scope of IP – patents (cont.) Timing

US patent first Office Action roughly 2 years after filing non-provisional application, lucky to have patent grant in 3 years

Procedures to accelerate U.S. examination Prioritized examination - $4800 surcharge large entity

Petition to make special

Procedures to accelerate foreign examination Patent prosecution highway

PACE in Europe

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Scope of IP – patents (cont.) Develop and implement IP strategy in view of exit strategy

Claim scope in view of prior art

Draft applications and claims knowing the countries where applications will be filed

Decide on whether to file multiple applications in certain countries for same invention

Narrow v. broad patent claims

Different “inventions” under that country’s law

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Ownership of patent – common issues

University technology

Previous employer

Contractor or other outside contributor

Joint ownership and licensing implications

Employment agreement wording for employees

Resolve issues early – easier and less costly to fix problems

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Freedom of Operation – patents

Others have patent claims that you infringe in country in which you want to operate Potential defensive positions Opinions that claims are invalid or not infringed Procedures to invalidate granted claims Procedures to cite prior art during prosecution

Investment still possible despite potential freedom of operation issues Well reasoned positions Likelihood of designing around or product evolving

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Freedom of operation – patents (cont.)

Budget Search and analysis of patents and applications Comprehensive search and review is typically

expensive because you are analyzing many aspects of a product

Timing – well before diligence When to obtain freedom of operation analysis

depends on stage of product development Analyses may take a long time if many patents

and patent applications need to be reviewed

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What is a Trade Secret?

A trade secret is something that:

Derives economic value from not being generally known

The company takes reasonable steps to keep secret

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What is a Trade Secret? (con’t.)

Examples of possible trade secrets: Computer code “Know-how” “Negative know-how” Future production information New products Pricing

Combinations of “publicly available elements” Certain customer information

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What is Not a Trade Secret?

Examples: Publicly available/disclosed information Information available on the internet

Information disclosed to third parties without a non-disclosure agreement

Industry conventions Employee’s general skill, talent, experience

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Protect company from allegations of trade secret theft Instruct new hires: Don’t bring prior employer’s trade

secrets with you! Prevent new employee from:

Performing duties that would involve use or disclosure of prior employers’ trade secrets

Bringing documents/computer files that belong to prior employer

Employment agreement and policies

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Scope and ownership of trade secrets

Comprehensive trade secret program Take measures to limit access to confidential info

to those who need to know in company Keeping records of trade secrets Locking trade secrets

Employment agreements and policiesNo disclosure to those outside the company Nondisclosure agreements Raising capital Diligence

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Scope of IP – trade secrets

Discuss trade secret policy on hiring and on employee departureHave records to show your trade secret program for diligence - document these discussions and agreementsEnforce theft or breach to limit losses Ex-employees Breach of nondisclosure agreement

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Do Your Homework on Your Company Trade Name, Trademark and Domain Name

First visible aspects of your business and first legal exposure

Coordinate all types of protection – trademark, trade name, domain name

Trademark is the strongest protection Don’t go to your attorney the day before you

release your product Do the search and mark analysis in relevant

countries Often less expensive and timely to switch to

another name or mark than fight at startup time

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Mark Your Intellectual Property With Proprietary Notices

Credibility indicator

©, ®, ™, etc.

Confidentiality notices

Patent pending

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ProgramsPatents:1.Identify and document inventions2.Prioritize inventions (old and new) to

Pursue some in various countries Sell or drop old ones of no value

3.Searches to identify prior art and potential freedom of operation issues (especially competitors’ patent filings)4.Match prosecution strategy to business (exit) strategy

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ProgramsPatents (cont):5.Agreements assigning rights to inventions (founders, employees, contractors)6.Identify opportunities to license7.Stop infringers to protect market share

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Programs (cont.)

Trade secrets:1.Employment agreements and policies2.Discussions with employees on hiring and on separating confirming employee does not use trade secrets of others for company business and does not use or disclose company trade secrets3.Procedures and systems to limit access to and use of trade secrets4.Stop unauthorized use or disclosure

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Programs (cont.)

Trademarks and service marks:1.Search relevant countries for registrations2.Register marks in relevant countries to assure your use of marks3.Oppose issuance of confusingly similar marks4.Police unauthorized use or confusingly similar marks and stop infringers

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Thank you

Questions?

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Comparison of Patent, Copyright andTrade Secret Protection

Copyright Patent Trade SecretScope Narrow-images, form of

expression onlyBroad Broad if kept confidential

When does protection begin

Work is fixed in tangible medium of expression

Issuance of patent Work is created in a confidential matter

Duration of protection Generally life of author plus 70 years

20 years from filing Indefinite if kept confidential

Source of protection Work is fixed in a tangible medium of expression Enforceable upon registration with USCO

Issuance of patent by USPTO. Invention must be “useful, new and nonobvious”

Contract or trust relationship which maintains confidentiality

Cost to implement Minimal Expensive$5K-20K per application

Minimal

Time to implement Immediate but need to register with USCO to enforce

2-3 years Immediate but always need to protect secrecy

Strength of protection Weak Strong Strong

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Comparison of Patent, Copyright andTrade Secret Protection (con’t.)

Copyright Patent Trade Secret

Employer/Employee work ownership protection

Yes Get assignment of ownership

Get assignment of ownership

Corporation/Consultant work ownership protection

Need assignment of ownership

Need assignment of ownership

Need assignment of ownership

Mass market product distribution protection

Yes (statutory) Yes (statutory) No (contract)

Independent product development defense

Yes No Yes

Global protection Easy to implement Needs issuance in each country

Easy to implementin limited distribution

Infringing/ misappropriating acts

Copying, preparing derivative work, distribution, display of the work

Making, using or selling the invention claimed in the patent

Use or disclosure of the trade secret

How can I damage my own rights

Notice not required on work to protect but registration with USCO is required to enforce

Public disclosure or offer for sale more than 12 months before the application was filed

Disclosure of the trade secret