What's in a Name (Part 2)

This article from Harvard law gives an excellent overview of Trademark Law including the following excerpt that pertains to the strength of the IP protection that may be afforded a mark, such as a brand name. (For a summary of brand naming from a marketing perspective, please refer to this post.)

"In order to serve as a trademark, a mark must be distinctive -- that is, it must be capable of identifying the source of a particular good. In determining whether a mark is distinctive, the courts group marks into four categories, based on the relationship between the mark and the underlying product: (1) arbitrary or fanciful, (2) suggestive, (3) descriptive, or (4) generic. Because the marks in each of these categories vary with respect to their distinctiveness, the requirements for, and degree of, legal protection afforded a particular trademark will depend upon which category it falls within.

An arbitrary or fanciful mark is a mark that bears no logical relationship to the underlying product. For example, the words "Exxon," "Kodak," and "Apple" bear no inherent relationship to their underlying products (respectively, gasoline, cameras, or computers). Similarly, the Nike "swoosh" bears no inherent relationship to athletic shoes. Arbitrary or fanciful marks are inherently distinctive -- i.e. capable of identifying an underlying product -- and are given a high degree of protection.

A suggestive mark is a mark that evokes or suggests a characteristic of the underlying good. For example, the word "Coppertone" is suggestive of sun-tan lotion, but does not specifically describe the underlying product. Some exercise of imagination is needed to associate the word with the underlying product. At the same time, however, the word is not totally unrelated to the underlying product. Like arbitrary or fanciful marks, suggestive marks are inherently distinctive and are given a high degree of protection.

A descriptive mark is a mark that directly describes, rather than suggests, a characteristic or quality of the underlying product (e.g. its color, odor, function, dimensions, or ingredients). For example, "Holiday Inn," "All Bran," and "Vision Center" all describe some aspect of the underlying product or service (respectively, hotel rooms, breakfast cereal, optical services). They tell us something about the product. Unlike arbitrary or suggestive marks, descriptive marks are not inherently distinctive and are protected only if they have acquired "secondary meaning." Descriptive marks must clear this additional hurdle because they are terms that are useful for describing the underlying product, and giving a particular manufacturer the exclusive right to use the term could confer an unfair advantage.

A descriptive mark acquires secondary meaning when the consuming public primarily associates that mark with a particular producer, rather than the underlying product. Thus, for example, the term "Holiday Inn" has acquired secondary meaning because the consuming public associates that term with a particular provider of hotel services, and not with hotel services in general. The public need not be able to identify the specific producer; only that the product or service comes from a single producer. When trying to determine whether a given term has acquired secondary meaning, courts will often look to the following factors: (1) the amount and manner of advertising; (2) the volume of sales; (3) the length and manner of the term's use; (4) results of consumer surveys. Zatarain's, Inc. v. Oak Grove Smokehouse, Inc., 698 F.2d 786 (5th Cir. 1983).

Finally, a generic mark is a mark that describes the general category to which the underlying product belongs. For example, the term "Computer" is a generic term for computer equipment. Generic marks are entitled to no protection under trademark law. Thus, a manufacturer selling "Computer" brand computers (or "Apple" brand apples, etc.) would have no exclusive right to use that term with respect to that product. Generic terms are not protected by trademark law because they are simply too useful for identifying a particular product. Giving a single manufacturer control over use of the term would give that manufacturer too great a competitive advantage. Under some circumstances, terms that are not originally generic can become generic over time (a process called "genericity"), and thus become unprotected."

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Deal of Lifetime

THE DEAL OF A LIFETIME

LEGAL ASPECTS OF BUYING OR SELLING A BUSINESS

By: Anthony Cerminaro

The purchase of a residence may be the single largest transaction in which most individuals will ever be involved. For an entrepreneur or small business owner a similar statement can be made about the buying or selling of a business. In short, it is often the deal of a lifetime.

Legal considerations affect even the most basic aspects of such a transaction. For example, the risk of assuming unwanted environmental or employee benefits liabilities may rule out a particular structure for a transaction or prevent the transaction from going forward at all. Consultations between client and counsel at an early planning stage are essential to (1) close the deal in a timely manner, (2) ensure a smooth post-closing transition, (3) avoid surprises about the value of the business, and (4) avoid the assumption of unwanted or unknown liabilities.

This Article briefly summarizes some of the major legal considerations involved in the buying or selling of a business. While the article focuses on corporate transactions and is oriented to the buyer's viewpoint, similar considerations apply to the seller and other types of acquisitions.

STRUCTURE

Several alternatives are available for the structuring of an acquisition. Among these are (1) statutory merger or consolidation, (2) asset purchase and (3) stock purchase.

In a merger or consolidation, two corporations are combined. In a merger, the stock of one is exchanged for the stock of the other, cash or other consideration. In a consolidation, the stock of both is exchanged for the stock of a third corporation, cash or other consideration. The surviving corporation carries on the business of the combined corporations and either or both of the original corporations ceases to exist.

There are certain advantages to a merger or consolidation. The acquisition can be structured as a tax-deferred transaction. In addition, there are no minority shareholders after the merger or consolidation. There are generally no sales tax or bulk sale problems. In relative terms, the documentation of a merger or consolidation can be simpler than that used to document other types of transactions.

Disadvantages include acquisition by the buyer of all liabilities of the target, whether fixed, contingent, disclosed or undisclosed. While this problem can be obviated somewhat by obtaining warranties, representations and indemnities from the target company and its major shareholders, warranties and representations made by the acquired company ordinarily do not survive the merger. In addition, target stockholders may have dissenters rights enabling them to receive cash for their stock at an appraised value set ultimately by a court.

In an asset purchase, an acquiror may purchase all, substantially all, or selected assets of the target in return for any combination of stock, cash, debt or property. The advantages of an asset acquisition include the ability to purchase selected assets free of liabilities not specifically assumed. As with a merger, after consummation of the transaction, there are no minority stockholders of the target with which to contend. Ordinarily, shareholders of the target do not have dissenters’ rights.

There are also disadvantages to an asset purchase. Identification of the assets to be acquired is of paramount importance. Consummation may also require obtaining consents to assignment of contracts and prepayment of debt. Deeds for real property transfers and other separate transfer documentation may be required for each asset, class of assets, license and permit to be acquired. More complex documentation and more time is therefor ordinarily required to conclude an asset purchase. Real estate transfer and sales taxes may also be incurred.

In a stock purchase, an acquiror may purchase all, substantially all or majority of the target's stock. Advantages include the preservation of the target's identity, franchises, licenses and permits. In general there are no transfer tax, sales tax or bulk sales problems. The contract rights of the acquired business are ordinarily not impaired. Less documentation may be required. Disadvantages include the fact that the transaction may leave minority shareholders in the target. All target liabilities are also acquired.

Variations and combinations of the foregoing are also possible, including the use of earn-out arrangements. In an earn-out, a formula based on the future perfor¬mance of the acquired business is used which results in additional purchase price payments. Problems with earn-outs abound, particularly as to the creation of the formula, measurement methods and verification. Invariably, if the maximum earn out is not achieved, disputes will result.

TAX CONSIDERATIONS

Sale of business transactions may be structured so as to defer the recognition of federal income tax. Analogous provisions generally apply to defer state income taxes. All such structures require the issuance of stock of the acquiror or its parent and that either the target's historic business be continued or a significant portion of its assets remain engaged in a new business.

In a tax-deferred transaction, the recognition of gain for the target and its stockholders is deferred. In such a transaction, the acquirer obtains a carryover basis in the stock or assets of the target and the tax attributes of the target are carried over to the acquirer. In a tax-deferred transaction, recapture of depreciation and invest¬ment tax credit, problems which can arise in a taxable transaction, are avoided.

Structures which require the recognition of taxable income and gain upon consummation of the transaction include a merger or consolidation where cash or debt securities are paid. In addition, a purchase of stock or assets for cash, debt securities, or a combination generally would be a taxable transaction, as would an installment sale of a business. Regardless of structure, the acquisition of a corporation with net operating losses, investment credit carry forwards or other carry forwards presents special problems which must be dealt with on a case by case basis.

FINANCING

A question frequently asked by a potential buyer of a business is, "Where will I get the money?" Sources of capital for payment of the purchase price range from self-generation from internal operations, to family and friends, to venture capitalists to banks, vendors, suppliers, employees and even the seller. If bank borrowing is involved, assets, such as real property, plant, equipment, inventory and accounts receivable usually serve as collateral. The interrelationships and priorities among financing sources can be intricate and require time-consuming negotiations and careful drafting to avoid later problems. For instance, fraudulent conveyance issues must be addressed when using the target's assets as collateral in a so-called leveraged buyout.

In addition, in many financing transactions, federal and state securities laws must be dealt with. In this area, ignorance of the law can be very painful to a business enterprise and its principals. All sales of securities are regulated under both federal and state securities laws. The term "security" for purposes of these laws is interpreted very broadly, and includes stock options, warrants and some forms of debt, along with common and preferred stock and convertible debt. The securities laws prohibit misrepresentations (whether by misstatement or omission) in connection with the purchase or sale of any security. The securities laws also require certain written disclosures about the financial and business status, prospects and management of the busi¬ness, the securities being sold, how the money raised in the offering will be used, the risks associated with the investment, and any other material facts that an investor should know before making an investment decision.

Misrepresentations or omissions of material facts in connection with the purchase or sale of a security may sub¬ject corporate officers and management personnel to personal liability for investor losses. Personal liability may extend to the outside directors, and to others who are involved in promoting the purchase or sale of the security. Misrepresentations may be intentional or only negligent, and may include incomplete statements as well as failure to disclosure important information.

DUE DILIGENCE INVESTIGATION

The objective of the due diligence examination is to evaluate the target's business. The examination should expose potential problems so that specific agreements can be reached to deal with them. Areas of particular concern include environmental, product liability, employee benefits, and other potential sources of contingent liabilities. A thorough due diligence investigation will also evaluate technology, proprietary rights, accounting systems and other aspects of the target's business and identify legal and contractu¬al impediments to completion of the proposed acquisition.

OTHER CONSIDERATIONS

Other considerations which often are critical in structuring or documenting the purchase or sale of a business include those regarding (1) environmental matters, (2) pension and other employee benefit plans, (3) intellectual property, (4) product liability matters, (5) state corpo¬rate law considerations, (6) federal and state antitrust laws, (7) regulation of foreign investment or ownership, and (8) industry regulation.

Perhaps no area holds as many traps for the unwary as potential environmental liability. Federal and state laws impose liability for clean-up of hazardous substances on present owners and operators of real property from which there has been a release of any hazardous substances. The continuation, knowingly or unknowingly, of a prior practice may give rise to liability, as may a release arising from past activities which occurs or continues at a site. Past violations of clean air and water acts and other regulations governing emissions, discharges and permits may also become the respon¬sibility of the new owner. Fines may be imposed, operations forced to shut down and expensive pollution control equipment required. The purchase transaction may also trigger reporting obligations which must be complied with in order to avoid later problems.

Both to take advantage of what is termed the "innocent purchaser" defense to an environmental claim, and to learn more about potential liability exposure, environmental audits are strongly advised in all transactions involving the transfer of real estate or the lease of industrial property. Typically, these are done in phases. In a "Phase I" study, employees are interviewed, records reviewed and the site inspected. Based on the results of the Phase I study, a "Phase II" study involving testing and ground water and soil sampling may be required. Appropri¬ate representations, warranties and in¬demnification of the buyer by the seller in the acquisition agreement (and occasionally, walking away from the deal) are essential to protect against unwanted liabilities.

As to pensions and other employee benefit plans, the acquirer may become liable for excess taxes or become subject to a lien on both its and the target's assets if the target's plans have not met minimum funding or other require¬ments of the Employee Retirement Income Security Act (ERISA). If the acquirer wishes to assume, freeze or terminate the target's plans, specific steps must be taken to ensure compliance with ERISA. Multi-employer pension plans, employee stock ownership plans (ESOPs), profit sharing and other plans holding employer securities, and other stock plans for employees, present special problems which must be addressed on a case by case basis.

Intellectual property concerns revolve around the treatment in the acquisition of such items as patents, trade¬marks, service marks, copyrights and trade secrets. In general such items are transferable. Alternatively, ownership of intellectual property can be retained by the seller and use rights licensed to the buyer in exchange for the payment of royalties. Clear identification of the target's intellectual property must be made and the adequacy of the steps the target has taken to protect its rights must be determined. To the extent the target has not taken proper protective actions, curative measures must be undertaken to ensure that good title is transferred to the buyer.

With respect to potential product liability problems, liability for injuries and damages caused by products distributed by the target company will be assumed upon the merger or acquisition of stock of the target company. A carefully drafted purchase contract may limit the liabili¬ties assumed in this area. Note, however, that particularly where the target's business is continued in much the same manner by the acquiror after the pur¬chase or where there is an overlap or commonality of ownership before and after the transaction, successor liability is possible regardless of contract protections.

Regarding state corporate law considerations, directors of both the target and the purchaser must be cogni¬zant of their fiduciary duties to shareholders and, in certain cases involving compa¬nies that are insolvent, potentially to the creditors of the insolvent company. While directors may take advantage of the business judgment rule and statutory protection which insulates them from liability for actions taken in good faith, after due deliberation and believed to be in the best interest of the company, special situations may require that specif¬ic steps be taken. For instance, where transfer of control of the target is contemplated, elimination of a minority own¬ership interests is an important consideration, or in other contentious situations, it may be advisable to obtain fairness opinions from an investment banking or other like firm prior to approval of a transaction.

Depending on the size of the acquisition, the involved industries and the concentration of competition within the involved markets, federal and state antitrust laws may be implicated in the sale of a business. For instance, both the Clayton Act and the Sherman Antitrust Act prohibit certain business combinations which lessen competition. In addition, prior to concluding certain deals, the parties must file what is known as a Hart-Scott-Rodino premerger notification and observe a statutory waiting period. During the waiting period, the government may object to the transaction. Obviously any governmental interference should be anticipated and appropriately dealt with in documenting and implementing the proposed transaction.

Another area of potential concern, is regulation of foreign investment or ownership of United States companies and real estate. For instance a filing with the Committee on Foreign Investment in the United States (CFIUS) and a waiting period may be required if a transaction involves a non-U.S. acquiror. Filings and approvals under other federal laws may also be required, particularly where the business of the target is defense related or involves cer¬tain key sectors, such as maritime, aviation, mining, energy, real estate, commu¬nications, banking, government contracting or financial services.

Similar considerations may apply regardless of foreign involvement, if the proposed acquisition involves regulated industries. These include electric, gas and other utilities, insurance companies, banks or bank holding companies, savings and loan associations, airlines and other transportation carriers or television, radio and other communications properties.

SUMMARY

Legal considerations permeate all aspects of the purchase or sale of a business. Because of the complexities involved, early consultation with counsel is advisable to ensure that the deal of a lifetime does not become a lost opportunity.

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Snapshot of Women Small Business Owners

From re:invention blog - for women entrepreneurs:

"An updated snapshot of women small business owners.

55% vote in every election
34% are Democrats.
39% are Republicans.
24% are Independents.
86% are white.
4% are black.
6% are Hispanic.
49% are 50 or older.
45% have college or post grad education.
25% say the economy and jobs are the most important factors in choosing a president.
86% say they are more likely to vote for a candidate who supports controlling health care costs.
57% are unable to provide health insurance for their employees.
54% don't provide health insurance because it is too expensive.

Source: Lake Snell Perry & Associates and American Viewpoint for Women Impacting Public Policy survey, November 2003."

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Blawger Bowl Week 4: The Update

Several of us blawgers are fighting it out in a fantasy football league. A quick snapshot of this week's results is available at Promote the Progress.

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How Antitrust Laws Affect IP

From Larta:

'Patent rights promote innovation and expression of new ideas and inventions for the public benefit. Patent rights give incentives to inventors to express their ideas by giving them assurance that these ideas will be protected so that others will not be able to profit from them. However, while patent protection provides economic incentives for inventors, this protection is not unlimited.

Antitrust laws impose important restrictions to ensure that inventors are not overstepping their boundaries by restricting competition. Some ways antitrust laws are able to promote competition are by strictly monitoring firms' actions by regulating potential mergers and preventing firms from forming monopolies."

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IRR Overstates Project's True Value

From The McKinsey Quarterly:

"Many executives use the internal rate of return as the measure of a proposed project's long-term value. This approach does have intuitive appeal, but the complicated model used to calculate the internal rate of return makes certain assumptions that exaggerate a project's true value. The higher the return, the worse the distortion...

Companies and their advisers use the internal rate of return at their peril. A modified version that sets more realistic interim return rates would be vastly preferable, but the best alternative measure is net present value."

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SBA Announces 7(a) Changes

From Law & Entrepreneurship News:

"Over the weekend the SBA announced changes to the 7(a) program that are effective as of October 1, 2004 and will remain in effect until November 20, 2004.

Beginning on Oct. 1, the guarantee fee on loans of $150,000 or less is 2% (up from 1%). For loans between $150,000-$700,000 the new guarantee fee is 3% (up from 2.5%). For loans over $700,000, the fee will remain at the prior level of 3.5%. "

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Got the Entrepreneurial Stuff?

From Business Week :

"To turn a business idea into a winner, you need a rare collection of character traits. Here's one professor's list "

1. You must be willing to take calculated risks.
2. You must move toward the edge and almost step over it.
3. You must truly utilize out-of-the-box thinking and rat-like cunning.
4. You must be ready to lead by example and empower your teammates to make decisions and handle crisis situations.
5. You must have a management style that is flexible and changes based on situations.
6. You must have 'passion' for what you are doing. If you do, then you will spend as much time at it as is required to be successful.
7. You must learn to come up with new and innovative ideas that produce meaningful and perceptive differences, and be able to communicate that idea.
8. You must surround yourself with a great team.
9. You must constantly reinvent your business.
10. You must always be ready to 'jumpstart your brain'

Via BusinessPundit

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Compensation Serves Multiple Purposes in Startups

In this excellent post from Digitalyst the multiple roles compensation plays in startups is examined. Among the topics covered are:

Aligning the goals of the individual and the company
Providing flexibility
Conserving cash
Motivation
Internal equity
External equity
Incentive compensation
Bonuses

The Bottom Line
"How the company compensates its employees says a lot about the company's philosophy and contributes to its culture. Everything management does in a startup is closely watched by employees who are always trying to read the tea leaves in an atmosphere of uncertainty. The more carefully architected and articulated your comp plan, the more comfortable your staff will be."

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Do These Mentalities Plague Your Company?

According to Naomi Moneypenny four mentalities block new learning and plague companies:

"- Not Invented Here - it didn't come from us, so it isn't any good
- Already Invented Here - we already do whatever the 'new' thing and can't learn from anyone else
- Analysis Paralysis - we'll study the thing that might cause change to death, but never actually do anything about it
- Head in Sand and March Right On - what change? Why change? Our way or the highway..."

Via Innovation Weblog

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FAQ about Software Reverse Engineering

This article from Chilling Effets Clearinghouse answers the following frequently asked questions about reverse engineering of software:

Q: What is reverse engineering?
Q: How does reverse engineering differ from other types of engineering?
Q: What stages are involved in the reverse engineering process?
Q: What is disassembly or decompilation of a computer software program?
Q: What is the difference between source code and object code?
Q: What is interoperability?
Q: What are the different uses of reverse engineering?
Q: Is reverse engineering legal?
Q: What 'copying' of computer programs is permitted under copyright law?
Q: Is the making of an intermediate copy in the reverse engineering process copyright infringement?
Q: What elements of a computer program are copyrightable?
Q: How does a court determine the difference between the ideas and expressions in a computer program?
Q: Are the functional elements of a software program protected by copyright?
Q: Is reverse engineering affected by patent law?
Q: Does trade secret protection of information contained within a product restrict reverse engineering?
Q: Should a reverse engineer worry about the original product manufacturer's trademarks?
Q: What kind of proof is necessary to show the copying of a computer program?
Q: What is UCITA?
Q: What is the difference between a license and a sale of a product?
Q: What are shrink-wrap, click-wrap, and browse-wrap licenses?
Q: Are licensing provisions prohibiting reverse engineering enforceable?
Q: Is the reverse engineering of a technological protection measure illegal under the DMCA?
Q: What are the limitations of the interoperability criteria for the DMCA's reverse engineering

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Patent Tips for a Small Business with Grand Ideas

From Patently Obvious comes these tips for a company embarking on a business strategy that may use patents to protect its IP:

"1. If someone at your company has an idea that may be patentable, act quickly. You can lose rights by disclosing the idea publicly or by offering it for sale before filing for a patent application. This type of disclosure can even occur before you make any engineering drawings or working models.

2. Try to keep records that help establish the novelty of the invention and the date of conception. This evidence may be important at a later date -- especially if there is any delay in filing for patent protection.

3. Before you retain a patent attorney, bone up on the subject -- Read the book “Patents and How to Get One.” It is very short and is a great book to read on your next business trip.

4. Retain a patent attorney to discuss your issues, to help you decide whether to file any patent applications, and then to help with the preparation and prosecution of the patent applications... Get references.

5. When thinking about your potential inventions, remember that you can obtain patents on devices as well as methods. Methods, for example, may include methods of manufacturing an item, methods of doing business, methods of using a device, and process flow methods that describe the flow of data in a piece of software. (Merely a few examples.)"

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Key VC Investment Criteria

This article from the Puget Sound Business Journal offers these three key criteria in today's market for successful funding VC funding:

1. The company must be cash-flow positive or will become cash-flow positive with a very high degree of certainty, post funding.

2. Seasoned management is a must. The ideal management team has done it before, preferably with a private equity fund partner.

3. High-growth potential must project out to a compounded annual growth that will enable the investor to achieve a targeted 40 percent internal rate of return over about a five-year holding period.

For more on this topic, please consider reviewing my article, Tech Startups Face New Reality

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Deleted Files Pose Legal Challenge

This Kansas City business journal article explains:

"A business that designs its data backup system without talking to a lawyer may be making a big mistake.

Court rules are changing, and judges are becoming less tolerant of litigants who can't produce electronic documents on demand. "

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Carnival of the Capitalists

The 52nd edition of the Carnival of the Capitalists is up at Drakeview and features many interesting articles including this post from Coyote Blog on how to buy a business.

For more on this topic consider reviewing my earlier post on this subject, here.

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Biotech's Harsh Lesson in New Zealand

This story from STUFF explains:

"Players in New Zealand's fledgling biotechnology industry - a key pillar of the government's economic development strategy - have learned a harsh lesson."

And the lesson is one that many companies may want to heed: "Focus on the 'Do-able.'"

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Is Your Growth Strategy Your Worst Enemy?

From Dispatches Weblog quoting from and commenting on an article from The McKinsey Quarterly:

""History is littered with companies that experience 'boom and bust' rapid growth followed by steep decline, often into oblivion...The challenge to finding a sustainable growth rate means striking a balance between growth drivers and constraints.'

The authors go on to describe six principles that are worth repeating:

Every action produces a reaction.
Structure shapes behavior.
Complex interrelationships make a system.
Time clouds the picture.
'Hard' and 'soft' factors interact.
Feedback reinforces and counteracts.

Business decisions made without due consideration of these principals are likely to result in unintended consequences. Young companies that are defined by scarce resources can ill-afford the cost of unintended consequences."

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IP Software Seller Strategies

From Holland & Knight:

"For many software companies, intellectual property just happens. Programmers write code. Sales staff find customers. Executives book revenues. The company may have a sales strategy and a long-range view of technology, but the legal protection of its intellectual property becomes an after-thought -- a strategic orphan. Big mistake.

Companies that do not identify risks early, if not immediately, pay dearly when the day comes that a potential buyer or investor tries valuing the company's core asset -- its software. The strategy need not harmonize with every syllable of the business plan. However, the software protection regime must be more than a three-line checklist of patent filing deadlines, or the occasional piece of hate mail threatening to sue over pilfered computer code."

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Small Biz News Nuggets

From Just For Small Business:

"Small business news from around the world just for small business owners.

NASA Selects Innovative Small Business Projects
US Small Business Administration Moves To Assist Victims Of Hurricane Jeanne
Small Business 'Creates The Jobs'
Oil Prices Dampen Small Business Outlook
Top Tips To Better Small Business Profit Margins (UK)
Big Lift For Small Business (AU)

This weekly post features key issues for small business owners."

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Friday Funny Business

Links for your enjoyment

A Night at the Opera a Day at the WeinerDogRaces

Cap'n Crunch and the other Cartoon Boat Veterans for Truth

Yinz need helped with yer Pittsburghese 'n'at? Fine aht up 'ere an' up air

Working hard and other surefire ways to get fired

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