Tonight, the New Ventures BC seminar series presents Corporate Structure with Sean Hodgins of QC Docs and Steven Lukas of Fasken Martineau.

Steven Lukas, Fasken Martineau
When you put together a corporate structure, you’re bringing together a series of people for a common purpose. A company just sets out relationships of how they work together and what the responsibilities of them are.

A company is different from you. When you incorporate, you’re talking about being the owner of the business. As you bring in more shareholders, the company structure becomes more complicated.

The structural map of your company will include shareholders, directors, officers, employees and possibly an advisory panel.

Shareholders
Anyone can be a shareholder. Individuals, companies and partnerships can be shareholders. There is no limit on the number of shareholders.

There are rules on how people become shareholders and when you become shareholders. As well, the rules change once you bring in more than 50 shareholders.

The key to being a shareholder is that their liability is limited only to the money that they have invested. If the company goes under, shareholders are not responsible for those liabilities (though they may lose their investment).

There are an unlimited number of types of shares, classes, rights and restrictions. The key ones include, are they voting or non-voting, participating or non-participating, and coming with options, warrants or rights.

Shareholders have an exclusive right to elect directors, but by and large can’t make the company do anything. Shareholders rights are governed by very detailed contracts. Not all shareholder agreement contracts are equal.

Directors
Directors are elected by the shareholders. They can fill vacancies or potentially add a number of directors.

In practice, who makes the direction of who the director will be? Usually, it’s the CEO (though they don’t elect the directors).

There must be at least one director. In BC, there is no residency requirement and there are no qualifications for being a director.

If you’re looking at your exit involving sale to an American company, it may be easier to do it with a BC company, because of the lack of residency requirement for directors.

Directors have the power to manage the affairs of the company. They have a duty to the company and the shareholders as a whole to act fairly and diligently.

They may be personally liable for breaching duties, taxes or wages. For instance, they can be personally liable if they issue shares for less than what they’re worth. That said, you can be protected by doing due diligence and acting in good faith.

Officers
The power of any officer is set by the board of directors. They oversee the employees.

Employees
They do all the real work.

It’s important to understand the definitions of employee and contractor. An employee works for your company. A contractor works for themselves.

If the CRA second-guesses you determines that a contractor was actually an employee and he doesn’t pay his taxes, then the company can be liable for paying those taxes.

It can be complicated. One example — if you take twelve one month jobs, you’re a contractor. If you take a job and get fired after a month and that’s the end of it, you were an employee.

If the level of sophistication of the person representing themselves isn’t there, then the person is probably not a contractor (even if that is what they would like to be considered).

What does compensation look like? It can be cash, shares or options or any other combination thereof. There is no set model for paying employees.

The Advisors
These people advise the board or advise management from time to time, in their areas of expertise.

Officer Issues
Conflicts of interest ie. your role as a shareholder vs. director. These sorts of conflicts come up all the time in VC positions.

There are differences between being a private company and a public company. When you go public, you’ve got a whole new series of responsibilities.

Initial Corporate Structuring
Incorporation is favorable in Canada, because of:

Financing issues – investors don’t like offshore companies.
Government grants – in most cases, these are only available to Canadian companies
Taxation and employment issues are also simpler to deal with if incorporating in Canada.

Create a structure with unlimited common shares and unlimited “blank-cheque” preferred shares. If you don’t do it this way, you may have to go back to your shareholders to ask for permission.

Financiers dictate financing terms, such as debt vs. equity, price, preferences, terms of SHAG, etc.

If you can, avoid issuing secured debt, using shareholders’ loans, using multiple share classes and incorporating offshore.

NOTE: It’s almost impossible to start a business without creating shareholder loans. Before those investors come in, convert it to equity.

Founder Shares
Founder shares are large blocks of shares issued at a low price to position the founders. It recognizes their “sweat equity” contribution.

What class of shares should they be? Common shares. They can be preferred shares for sophisticated investors if you have a good reason (I’ve never come across one…).

Founder Shares should be issued to founders and senior officers, not employees or outside investors.

Common Mistakes in Allocating Founder Shares
* Not setting aside enough founders’ shares at time of incorporation.
* not setting aside some founders’ shares for future additions to the management team.
* Not vesting the Founders’ shares. In 2-4 years, or providing for “reverse-vesting”.
* Issuing them to the wrong people.

Preparing a Financing Plan
Determine a road map for financing

The company determines its developmental milestones. What are they? By when will they be met? How much funding is needed to meet them?

Sources of financing include government grants, friends and family, angel investors, VCs, investment backers, underwriters (ie. brokers). There’s money all over the place — it’s just a matter of who you can tap into and how.

If you distribute a security, you must file a prospectus or rely on exemption from prospective requirement.

There is no limit on the number of people you can approach for financing.

* What are stock options? The right to purchase a number of shares at a predetermined value.
* Companies must plan for growth an make a notional allocation of their options.
* Companies should vest all options within 2-4 years.

Don’t necessarily be afraid of reducing your percentage of shares so long as the value of shares keeps going up. It’s better to have a smaller percentage of a bigger pie than a bigger percentage of a smaller pie.

Your Capitalization Plan is your best guess, like a budget. Actual results may differ from your projections. If you figure out sooner what the end picture looks like, you can do better in picking the number of shares you need.

When VCs come in, they change the rules and apply new conditions. The easy part of the discussion is what is the value of your company. The hard part is dealing with contractual obligations while being able to do your job and manage your company.

Sean Hodgins, CA, CPA, Tandem Accounting Group Ltd., speaking on Financial Modeling

We deal day to day with a lot of technology startups. That’s our area of expertise.

In today’s presentation, we’ll look at structuring for success, BC Tech bootstrap structuring, Financial Modeling and a Case Study.

NVBC is a competition. To win, you need to be in a hot space, have huge potential and a great story! It’s a combination of timing and a few other things to hit and win the competition. Even for those who don’t win, businesses can learn a lot.

The Bootstrap Model
1 in 100 companies that apply get VC financing
2 out of 10 VC financed companies make it
Dragon’s den is entertainment, not to foster successful startups! (It pains me to watch that show). Listen and learn from what they’re saying, but I don’t know if it’s particularly healthy other than for that.
Focus on solving a real problem and making a profit.

If you only need one round of financing and can take home big paychecks and have a successful business, that’s where most enterprises are today.

Top 10 words of wisdom
1. Incorporate. Keep is simple and use reverse vesting common shares. It can be a disaster if this isn’t structured at the front end.
2. Raise your first $25,000 from friends and family. If you can’t raise money from those closest to you, how will you get financing from angel investors?
3. Get good at expense reporting (separate self from Inc.). For instance, you paid to travel here. Are you going to expense that to your company? Even if a company has no money and can’t pay you back, you recognize that the company owes you.
4. Register immediately to get your GST back!
5. Build real SR&ED and optimize Proxy rules. This is basically a tax incentive program for technology companies, allowing you to file a tax return, never having earned any money, and getting paid by the government for expenses for development of the product.

Proxy rules are an incentive to hire people as employees rather than contractors. You can gross up their salary and get a tax credit for the gross value. The Proxy comes in if you’ve incurred other expenses.

6. Register as an Eligible Business Corporation. This allows you to raise money from accredited or angel investors.

7. Leverage the NRC-IRAP and other Gov’t programs. NRC-IRAP is like pre-paid SR&ED. You get approved for a grant. Example, if you’re hiring youths, it’s definitely a place to look at.

8. Angel circuit-links to customers and maybe even money. They can develop great networks and create energy around what you’re building

9. Find “customers” who will “help” build your product.

10. Build partnerships and networks early.

Financial Modeling

What to include? (Historic + 3-5 year projection)
* Income statement (profit and loss). A year in time’s perspective.
* Balance Sheets – assets, liabilities and equity
* Cash flows and burn/runway
* Opportunity analysis
* List of assumptions. As you’re starting your business and are trying to develop your financial model, you must develop assumptions on how you are going to build your business.
* Capitalization table

Financial Modeling
* Focus on revenues
* Numbers are instrumental in telling the story
* Make it believable. Test using your network
* Test the angel networks and VC’s
* Costs should focus on R&D and sales and marketing.

Business Modeling
* Who’s going to buy what you’re selling?
* What price are you going to charge?
* How does this compare to competitors?
* When do the sales happen?
* Customer acquisition costs?
* Customer support costs?

Business Model (Eyeballs Model)
* Who’s going to visit your site and why?
* How fast is it going to grow?
* How does this compare to competitors?
* When do you get bought and by whom?
* Cost structuring for rapid growth?
* Customer support costs?

Business Model (Technical Model)
* What trend is hot?
* Who will acquire you and when?
* Need technical excellence!
* need investors in your field and with connections
* $1 Million+ per engineer

These types of companies are acquired for the people who are there.

Opportunity Analysis
* Calculate the size of your target market.
* Story to Market Take Ratio (how good is your story?)
* Rate of growth analysis – key metrics, customer acquisition costs (don’t guess)
* Valuation analysis – support your value

Case Study: QCDocs Systems Inc.

Numbers are a key to telling your story. Focus on the customer and generating revenue and don’t be afraid!

New Ventures BC seminar series continues, liveblogged for your real-time reading pleasure. Tonight’s seminar about “Managing Your Intellectual Property: Copyrights, Trade-Marks, Trade Secrets and Patents” is brought you you by Roger Kuypers and Doran Ingalls with Fasken Martineau.

*Quick note: Deadline for NVBC competition round 1 is April 19!*

Roger Kuypers
Disclaimer: This is not legal advice!

Topics We Will Cover on Intellectual Property
1. Main types of IP
2. IP commercialization models
3. Assignments and licenses

IP Management Considerations
1. IP identification
2. IP ownership.
3. IP protection. (once you’ve straightened out ownership, what are you going to do to protect it?)

* Four pillars of intellectual property
- copyrights
- trademarks
- trade secrets
- patents

NOTE: Roger likes questions as he goes through the presentation. Ask away!

Software is covered by copyrights, trademarks, trade secrets and patents.

Trademark: Eg. it will be called Word or Office and will have protection in the marketplace.
Copyright protects the code created and the layout of what you see on the screen.

Copyright
protects the expression of an idea, not the ideas themselves. A great idea may be patentable, but not copyright-able.

Eg. a song about love lost, that idea can’t be copyrighted. But the lyrics can be.

Copyright is the sole right to produce or reproduce a work, or a substantial part of a work.

“Work” includes books, songs, computer programs, instruction manuals and website designs. These are protected. But software doesn’t fit so squarely…

Requirements
Originality – the exercise of skill and diligence, but not necessarily creativity (eg. telephone listings are not protected by copyright. The cover will be, though. Mere compilation of industry is not copyrighted.

Fixation – must be expressed to some extent in a material form. Eg. interpretive dance would not be copyrighted — it would exist for a moment and be gone. But if it were to be captured on videotape, that could be copyrighted.

Another example. A hockey game is not copyrighted. The video of the hockey game can be.

As a general rule, the author or creator of a work is the first owner of copyright. If you’re an employee of a company creating code on instructions of your employee, your code is copyrighted to the owner. If you’re an independent contractor creating the code and don’t have an employee relationship, the contractor owns the copyright. This can be addressed in a contract.

Classic example is a website. The web developer creates what you see. If your contract doesn’t say you own it, you don’t own it (you just have license to use it). Something to be mindful of.

Moral Rights
These give the author of a work the exclusive right to be associated with the work and the integrity of the work.

Moral rights can only belong to people. Moral rights cannot be assigned, only waived.

Example. Toronto Mall shows sculpture of geese. Mall put Christmas decorations on the geese. Creator of sculpture put them to court. They had to remove the decorations.

Imagine how this might apply to tech. Software programmer says you can’t do an upgrade because it violates his moral rights(?). It’s possible…

Copyright Protection
- arises automatically
Copyright symbol notices should be used.
Registration enhances rights
- simple and inexpensive to register
- registration in US is more significant.

Registration in Canada does not enhance your rights significantly. Main benefit is when you send cease and desist letters, you can say it’s been registered and that has some weight.

Copyright in the USA is different. Statutory damages are accrued per violation.

Eg. If you took something and copied a lot (eg. some paragraphs of Harry Potter) it would be for a few thousand dollars per copy of a book sold. Could amount to a huge sum.

Copyright Management
Focus on ownership and rights
How are works developed?
What do your contracts say about copyright?
- Employment agreements
- Service contracts
- Licenses

QUESTION
Sometimes, you see “all rights reserved”. Does this provide any extra protection?

ANSWER
Just assume you don’t have rights to use this. A good thing to have if you have something that is prone to being copied. Eg. Educational materials constantly being copied, people go off and provide courses on their own using this material.

The notice doesn’t give you something you wouldn’t have had otherwise.

QUESTION
Is it risky to use open source software?

ANSWER
There is a fair amount of open source software. The problem is some types of open source software that you agree to by using that software that have consequences that are bad. Eg. Web developer was using open source, told us what they were using.

Some licenses had very robust language: “If you use this software to create software, this software will be free too”. The company had to write own software modules to replace the open source software.

QUESTION
I’ve been working with a graphic artist creating designs for a company. I created a concept which the designer executed. Who would own the rights to the logo?

She’s given me a certain type font that matches my concept. I might want to change the font in the future. Can I?

ANSWER
You have joint ownership. In Canada, this means you can use it as you wish. But to modify it, that could complicate things. You could have a partial waiver of moral rights to eachother.

QUESTION
If you have a contract and the contractor assigns copyright to you, does that include moral right?

ANSWER
Moral rights are in the Canadian copyright act, not the US one. Moral rights can only belong to people. Cannot be assigned, but can be waived (possibly for compensation).

QUESTION
Copyright and blogging. I write a blog that’s interesting to my user base. I’m re-posting parts of an article.

ANSWER
Often with blogs you have to accept certain terms before you’re allowed to post. If you want to be sure about what you post and submit, you need to be clear about those terms… There are concepts of fair use. You are allowed to use parts of works if you credit them, depending on what they’re used for. Such as education.

At the end of the day, you are running some risk in re-posting part of an article.

If you’re copying Harry Potter and selling it, that’s obviously infringement. But copying a few sentences for a Harry Potter fan blog and crediting it should be fine.

Trademarks – the Rodney Dangerfield of the legal world. They’re great, but they get no respect.

Why are Trade-Marks important?
- The goodwill associated with the product and companies reside in their respective trade-marks
- consumers make decisions based on trade-marks

Eg. Imagine McDonalds lost its trade-mark. Suddenly, it’s restaurants don’t “look” like McDonalds. Confusion would occur in the marketplace and customers would go elsewhere.

Managing Trade-Marks (Best Practices)

A. Picking a Good Trade-Mark
1. Distinctiveness
2. Searching and Clearance
3. Assessing Risks

B. Registration

C. Enforcement

IMPORTANT ADVICE - when starting out, focus on one distinctive trademark rather than a whole bunch. Distinguish your wares and services from those of others.

Two things kill distinctiveness. If Trademark is too descriptive or too much like competitors.

Eg. Kodak wasn’t associated with anything before the Kodak company came along.

Another good example is Apple. Before the Apple company, apples were not linked to computers. They gave that trade-mark meaning.

Trade mark owners should not monopolize words that describe wares or services
eg. “safe” cars or “fresh” bread. It’s anti-competitive.

Avoid confusion with other trademarks. It creates confusion in the marketplace and infringes the rights of others that have come before. Last thing you want to be doing is wasting money on litigation fees. You want to focus on developing your product and selling it.

Prior to choosing a trade-mark, search the trade-marks register and marketplace.

You may want to come up with two or three options re: brand as there is likely to be one choice already taken. Rank according to preference.

Types of Trade-Mark Rights
Common Law rights
- arise from use of trade-mark in the marketplace.
- need to search the marketplace to find them
- limited geographically

Eg. open a restaurant here, someone in Toronto can open a restaurant with the same name. But they can’t do it if you have statutory rights.

Knock-out searches
- CIPO, USPTO and other Trade-marks registry databases. Won’t show phonetically similar examples, though. Be careful!

Assessing Risks
Most searches reveal some measure of risk in proceeding with a trade-mark.
- You can use exact same trade-mark if you’re in a completely different area of business.

Eg. Barbie Barbecue company — consumers just aren’t going to be confused.

Think about the resources and expected vigilance of the other party. ie. Don’t try to go toe to toe with Coca Cola

QUESTION
Mike Rowe went up against Microsoft. He lost and had to give up his personal domain name. Was this legitimate?

ANSWER
They get upset easily… and they have a lot of money.

Registration of Trade-Mark
Registration is by country (except EU)
Canada
- One and a half years average for registration
- $2,500 (no objections, oppositions)
- 15 year renewable registration period.

Enforcement
Keep an eye out for possible infringement of your rights. Monitor your market.
Monitor trade-mark registries

Take action against infringements and potential infringements with cease and desist letters, legal action.

In common law jurisdictions, you get rights through use. If you wait to register, there’s some risk someone may try to register it.

QUESTION
Is trade-mark for life?

ANSWER
If you renew your registration, it can go on for life. You also have to keep using it. Commercial use is key.

Why Get a Patent?
- gives you the right to prevent others from making, using, selling the claimed invention
- lasts 20 years
- in exchange, you have to disclose your idea and eventually it will become public domain.

Secrecy — KEEP THE SECRET!
- public disclosure of invention prior to filing may be used against the application
- Use NDAs etc prior to filing. After filing, can disclose contents of application.

Not everything is patentable
requirements for invention to be patentable
- the invention is “new”
- non-obvious – the invention is not a minor tweak on what’s been done before
- utility – the invention does what it is described to do (This blocks time machines, perpetual motion machines, etc).
- subject matter

eg. replacing a nail with a screw is not going to get you a patent

Places to search for patent – USPTO

Obviousness
- test: invention can’t have been obvious to someone skilled in the art.

Subject Matter
- traditional: pharmaceuticals, electronics, chemicals
- less traditional: games, software, business methods

You may be surprised what IS patentable.

Higher life forms aren’t patentable, nor are mathematical algorithms.

The First Filing
Preparing the application
- provide detailed description
- remember you know this area of technology better than they do.

If cost is an issue, consider a provisional application
-first to file wins patent

Where to file?
- Patents are territorial

Problem: filing in multiple jurisdictions gets very expensive. However, your own applications and disclosure may work against you.

Claiming Priority
- International Treaties allow an applicatnt to file a first application, then file applications up to one year later and backdate the later filed applications

PCT Applications
- Closest thing to a “world patent” application (covers most major industrial countries).
- Treated as a pending application in countries

Provisional Applications
- only serve as an initial filing for the purposes of claiming priority. They will never become a patent
- can be less expensive than a regular application.
- useful when invention is in development
- BE CAREFUL – need to ensure provisional contains enough to preserve priority claim.

Common Strategy (about cost deferral)
- file provisional application
- one year later, file PCT application
- two and a half years from provisional application, enter national phase in selected jurisdictions
- THIS DELAYS getting patents

Patents as an asset
- value varies. Many are worthless. Some are valuable.
- sometimes allows early stage company to be taken more seriously
- investors may insist on filings

Defensive portfolio
- hold large portfolio of patents
- don’t litigate with patents unless defending self
- large budget for filing/prosecuting, less for litigation

Apple vs. HTC example.

Licensing
- toll collection eg. IBM
- they have thousands of patents they are quite happy to license. They make billions from it.
- some companies do nothing else (They are called “trolls”).

Patent Problems
- Cost: expensive to obtain, maintain and enforce
- publication
- limited duration: 20 years and then your idea becomes public domain (For software, that may be longer than it needs to be…)

QUESTION
If you have a patent, could you make enough changes to it to get another 20 years?

ANSWER
Changes would have to be patentable in their own right

QUESTION
Patent for mobile applications. Examples?

ANSWER
Patents for managing wireless networks. In a more abstract sense, there’s information flow, there has to be a way of managing the data. You can also get patents for applications (eg. a new way of using GPS in a novel feature).

QUESTION
How do you deal with a clearly invalid patent?

ANSWER
You want to be prepared. Be sure you can prove it was invalid. Eg. something was published in a book somewhere before the patent was filed.

QUESTION
If some parts of claim are invalid, does that make whole patent invalid?

ANSWER
Each claim is examined independently re: its validity

TRADE SECRETS
- information of commercial value not disclosed to the public

Eg. tech
- formulas, recipes,
- client, customer info
- “know-how”

Reasonable Efforts to Maintain Secrets
- Contracts! Everyone who knows secret should be under a contractual obligation to keep it secret.
- use NDAs

Advantages of Trade Secrets
- they never expire
- no filings required
- can be very successful (eg. Coca Cola, KFC).

Disadvantages
- not everything can be protected (eg. technology can be reverse-engineered)
- if the secret is exposed, it’s no longer a secret
- can be expensive to maintain (eg. KFC mixing its secret recipe of spices in different locations)

QUESTION
Let’s say you have a business plan and you’re entering a contest. In many business plans, there are trade secrets. How do you keep it secret?

ANSWER
- Don’t give away the “secret sauce”. Eg. we’ve got this great tasting drink (but we’re not telling you what’s in it).

Commercialization Models
- How will you commercialize your IP?

1. Integrator
2. Orchestrator
3. Licensor

Integrator: you do everything. development, manufacturing, sales, etc. So many potential pitfalls. Still, remarkably popular.
- capital intensive

Orchestrator: focus on some steps, but rely on others to carry out the rest.
- requires strong project management
- quicker to market
- balances control with need to leverage resources

Licensor
- license the technology to others to take it to market (ie. sell the license and sit back and collect checks).
- low capital and capability requirements
- requires strong IP protection
- requires good contracting skills
- allows innovators to focus on what they do best

Assignments and Licenses
- two ways of dealing with IP, like buying or renting

Assignments
- preferred to a license by IP purchaser, investors and acquirers. Eg. You’re an inventor and want to hang on to the IP. You sell a license, but retain control over the IP.
- IP becomes an asset of the assignee
- not affected by assignor bankruptcy

Investors don’t like this.

Licenses
- creative agreements

Licenses: Main Provisions

* Term: length of time of the license should be specified. Could be for duration of patent or copyright. Trap alert: Know-how license term

eg. negotiate a short-term license, then you have to pay more when it’s time to renegotiate the license if the commercial value is proven.

* Exclusivity – must be in writing. Represents and extra value (monopoly). Only sign an exclusive license agreement if you know and trust the licensee.

* Scope of Use. Many techs have different applications. You can find a number of partners who can use the techs in different fields. Maximize the use of that asset. eg. license use of mechanical device in one industry but not others. Movie adaptation of copyrighted work, but not for play.

* Territory. License can be worldwide or limited by country. Common approach to have a partner in North America, Asia and Europe.

Section 2.1: Article 1 is the definition. Want to see the portion of the agreement that grants the rights.

Perpetual, exclusive, worldwide right…

* Fees
- fixed fees
- milestone payments
- royalties
- shares in the capital of the licensee
- consider cash flow needs and risk/reward calculations to determine the right risk!

Need to balance compensation that meets your needs. Eg. If it’s your first deal and in a tertiary market, maybe you’ll take more cash up front. You’ll take more royalties when you deal with your main markets.

* Modifications and Improvements
- is the licensee entitled to modify the IP?
- If modifications are permitted, who owns them?

Case Study
Biotech Inc Licensor goes to three markets: Asia Pharmaco, North America Pharmaco, Europe Pharmaco. Each region may create improvements. You can try to have a provision in license agreement that everyone gets to use each other’s improvements. But you must contemplate this up front.

* Transferability by License
- is it possible for the licensee to transfer or sublicense its rights to a third party?
- Licensor might want to control who can receive a transfer or sublicense
- Licensor might want to control the form of sublicense agreement

These will affect how your investors see your company. What’s your exit strategy?

* Indemnification
- they are promising that if you promise some loss, they will pay for it. “The Licensor shall indeminify and hold harmless the Licensee against…”

Or “The Licensee shall indemnify and hold harmless the Licensor against”… eg. you don’t want to get sued for using software. Make sure you’re covered.

* Applause by a satisfied audience. We’re done! Have a good night, everyone *