Films as Startups: A Legal Guide for the Indie Filmmaker

By: Sammy Zand

The film industry is changing. We no longer see the days where writers shopped a script around Hollywood, hoping to catch the eye of a major production studio. Instead, that model has turned upside down. Films are aiming to captivate an audience first, without the assistance of studios. Technology and social media have made it feasible.

Instead of following a more traditional path of production, a writer may enter his feature-length script into a contest, or create a small teaser to get the premise of the film in front of a large audience. If the film is bought, it will then lead to a feature-length film. The teaser trailer acts like a short pilot that will reveal the numbers to potential investors and financiers up front.

Studios spend a tremendous amount of money in marketing the film, but independent filmmakers are now capable of distributing their content in even the smallest of budgets. Websites like Facebook, Kickstarter, and Twitter have changed the way films are now made.

For example, film director, actor, writer, and producer, Edward Burns has said that twitter has fundamentally changed the way he makes films. Thanks to social media, the independent film movement is in a renaissance. Burns created Newlyweds on a $9,000 movie budget in 12 days. Twitter helped Burns connect with people that really care about the work in the most effective way to get things seen. Since joining Twitter, Burns answers questions from fans, shares his filmmaking process and yes, uses his followers to promote his projects. While studios spend incredible amounts of money in raising awareness as to the digital and home availability of their films, Burns was able to accomplish that completely through Twitter.

Edward Burns is one of hundreds of independent filmmakers that have chosen this alternative route. Amazon and Netflix has made that even more possible. Last year, Amazon bought five independent films, including the Oscar-nominated film, Manchester by the Sea for a reported $10 million. Meanwhile, Netflix has picked up streaming rights for many other films and announced it will produce a slate of indie films. Technology is changing film production. More and more filmmakers are taking the independent film route.

For those that are beginning their “indie venture”, there are important legal issues that independent filmmakers must face. 3 major areas of concern are: business structure, crowdfunding, and intellectual property rights.

Business Structure

Just like any other business or when starting any new venture, the first question an entrepreneur faces is how to organize the business structure. The same goes for independent filmmakers when setting up a production company. The best choice of business structure will depend on the objectives of the filmmaker in balancing four considerations: control, financing, liability, and tax obligations. Often times, these four areas are in conflict. The filmmaker must determine the nature of the project early in its existence, because the planning choices may dictate some of the subsequent choices available to the filmmaker. But, business organizations can change as the situation evolves.

A Sole Proprietorship: Here, a single person is personally responsible for all aspects of a business. Unless the filmmaker works with a partner or adopts a more formal legal structure for his film company, he is considered a proprietor by default. A sole proprietor is never separate from its owner and all control stays with the business owner, including all liability like debts, promises, and obligations. Without a separate legal entity, there are few formalities. While the primary benefit is that of simplicity, the single biggest drawback is the personal liability the filmmaker takes. This model also does not accommodate fundraising. The filmmaker can take out personal loans, but the sole proprietorship is not suited for raising capital from third parties.

Corporations: An S or C Corp is managed by a board of directors, operated by its officers, and owned by its shareholders. The corporation provides the shareholders with limited liability for all acts conducted on behalf of the corporation and protect the officers, directors, and employees from many forms of personal liability. Yet one of the key features is separation of management from control. The shareholders (investors) control the corporation and operate by electing a board of directors. The board is then bound by operating rules established in the corporation’s bylaws. For many filmmakers, this complexity may seem extreme. But, most states (including MA), allow a single person to serve as the board of directors. Perhaps the biggest downside to operating a corporation is following the corporate formalities. An S Corp. can only have 75 stockholders or fewer, while the number of a C Corp.'s stockholders is unlimited, but the latter is subject to "double taxation" (first on the corporation, then on the individual level).

The LLC: For most independent filmmakers, a limited liability company is the best choice for forming a film production company. It can be taxed as either a corporation or a partnership, and its operating agreement is more flexible that corporate bylaws for structuring the film company’s operations. The personal liability shield is effectively the same as a corporation. Many filmmakers also hope to launch an ongoing film company with the hope of creating multiple projects but they need to keep investments of each film project separate in order to ensure that the profits from each film are distributed to the investors of a particular project. To accomplish both goals, a popular structure is to create one umbrella company formed as an LLC to be owned and operated by the production team or single film entrepreneur, and then that umbrella LLC will be the sole manager of a second LLC that is formed to finance, develop, and distribute a particular film. Investors of the movie are members of the second LLC. Nonetheless, a different structure may be preferred. It depends on the particular makeup of filmmakers and investors. For films that are heavily financed by outside investors, the traditional corporate form may be best. Investors can be often times reluctant to participate in an LLC, and may prefer a more traditional corporate structure to purchase shares that invest in an LLC.

Crowdfunding

Crowdfunding has become a popular choice for filmmakers who are unsure of the size of units they will need, or anticipate approaching a large swath of different investors. Each crowdfunding company has a different set of rules for fundraising, and, very often, you have to provide your contributors with "rewards" in exchange for their funding. Kickstarter is the most famous of these companies.

Kickstarter: projects must reach goal in order for project creator to receive funds. Kickstarter is free to sign up, 5% fee to funds raised, plus Amazon Payments processing fees.

Indiegogo: allows you to choose to get the funds earned for projects, whether or not the project reaches its goal. Indiegogo charges a 4% fee to funds if the project reaches its goal, 9% fee to funds if it does not, plus 3% credit card processing fee and $25 wire fee for non-US campaign.

RocketHub: is a lesser known crowdfunding site, but appealing for indie filmmakers. It allows you to get the monies raised for a project, even if you don't reach your goal. They charge a 4% fee to funds if the project reaches its goal, 8% fee to funds if it does not, plus 4% credit card processing fee. Side note: RocketHub has an affiliation with A&E Networks, which may be useful.

Intellectual Property Protection

Intellectual property rights refer to property rights over creations. This includes screenplays, motion pictures, sound recordings, and more. The types of intellectual property rights most important to independent filmmakers are those concerning copyright, which gives the copyright owner the rights to reproduce, adapt, arrange, perform, display, distribute, or sell copies of the work. Gaining a copyright over a screenplay is simple. It only requires that the idea be in a tangible form. Writing it into a screenplay will suffice. However, unless it is registered with the US Copyright Office, a lawsuit for damages in the event of infringement cannot be brought. Filmmakers should also be certain not only to protect their own work, but also to make sure they are not infringing on the copyright of others as they begin a project.

Patent Considerations For Start-ups And Small Businesses

By: Michael Thomas

Protecting intellectual property rights are a concern for many start-ups and small businesses. Patents, trademarks, copyright, and trade secrets are all forms of intellectual property protection available to start-ups and small businesses. Of these four types, patents generally raise the most questions and are the hardest to acquire. Knowing what exactly a patent is, if the invention qualifies for a patent, and information on how to file for a patent can help a start-up or small business decide if a patent is the right choice. 

The Basics: What Is A Patent?

A patent is a property right awarded to the inventor by the United States Patent and Trademark Office (USPTO). This right allows the owner to exclude others from making, selling, or using his or her invention. Much like other forms of intellectual property, the USPTO plays no role in enforcing this right and it is up to the inventor to ensure there is no unauthorized use of his or her invention. In most cases, this right to exclude exists for a period of 20 years from the date the inventor files for a patent. From a policy standpoint, this grant of exclusivity is offered in exchange for the inventor sharing his or her invention with the public. It is important to note that patent rights granted in the United States are only valid in the United States. If the invention is something that may be used globally, it is important to consider filing in different countries during the application process. Another thing to keep in mind is that the validity of a patent can be contested at any time. This means that even if a patent has been granted by the USPTO it can be challenged and found invalid before the 20 year period is up.

How Much Does It Cost To Get A Patent And How Long Will It Take?

            The cost of acquiring a patent can vary greatly depending on whether a patent attorney is used or the inventor decides to file on his or her own. The USPTO lists all of the current application fees on its website. For a basic patent application these fees will range from $280 for larger companies, down to $70 for small companies and individual inventors. Using a patent attorney to file the application will raise these costs but is recommended, as it will ensure the best chance for success. Filing an application on your own can be much cheaper but one should balance the cost savings with the time it will take to learn and work through the process.

            Although much of it is time spent waiting, the process of filing to ultimately receiving a patent can be a long one so patience is key. The USPTO keeps track of the estimated time to complete the application process, which currently sits at a little under three years. This timeframe can play a role in the choice of pursuing a patent, as the patent may not be as valuable in three years when it finally issues.

Is My Invention Eligible For A Patent?

While there are a number of statutory requirements that must be met, one of the basic requirements is that the invention must fall into one of the allowable subject matter areas. The Patent Act states that the invention must be directed towards a “new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof.” In many cases an inventor can see if they qualify by asking themselves which of the above categories their invention falls into. While these categories cover a large breadth of products and the processes for making those products, it does not cover things such as abstract ideas, laws of nature, and literary or artistic works.

Is My Invention Novel?

One of the most important requirements, and well-known ones, is that the invention must be novel. While this seems like a very straightforward concept there are a number of subtleties that can be unknown to someone unfamiliar with the patent system. The concept of novelty is covered in 35 U.S.C §102. In 2012 the America Invents Act was passed and changed the United States patent system to a first to file system, making the United States system consistent with the rest of the world. Under this system the inventor that files first with the USPTO is entitled to the patent even though another inventor may have developed the concept first.

A simple step that can be taken to determine if your invention is novel is to conduct a simple cursory search of current patents and pending patent applications. This can be helpful as it can save the inventor time and money if a quick search reveals that someone else has already considered the invention. Both the USPTO and Google offer patent specific search engines that are extremely easy to use. Google Patents provides a layout that will be familiar to most people and offers a very user-friendly format. In addition, Google Patents can search not only patents but also articles that may have addressed a particular invention or concept. For those a little more familiar with patent searches, Google offers an advanced patent search engine as well.

While a search is unlikely to reveal the exact invention, it can give the inventor an idea of what currently exists and presents an opportunity to think about what makes their product truly innovative. In many cases, an inventor has a truly novel product but hasn’t quite articulated what makes it worthy of a patent. This can be an important step in acquiring a patent because the USPTO will require a well articulated reason for what makes the product innovative compared to similar inventions. A patent attorney can be very helpful in crafting language that explains the invention in a way that increases the chances of acquiring a patent.

When Should I File For A Patent?

In some instances it may be advisable to wait before filing, for example if funds are low for a new business and other costs take priority. However, in most cases it is important to consider patenting your invention during development or soon thereafter because our patent system is a first to file system. This is also important because even though an inventor may have filed the application first and no one else has patented the invention, there are a number of requirements that can disqualify an invention. An important thing to remember is that any public disclosure of the invention prior to the filing date can disqualify the inventor from obtaining a patent. For example, a public sale of the product, use of a process to make a product, or even publishing a paper a year prior to the filing date can disqualify an inventor from receiving a patent.

To ensure an inventor has the earliest possible filing date the USPTO offers the option of a provisional application. A provisional application must describe the invention but it allows the inventor to file an application with the USPTO without many of the formalities associated with a full application. The provisional essentially allows the inventor to hold their place in line with an earlier filing date while they work out details of the invention. Upon filing a provisional application the inventor has one year to file a formal application with the USPTO. This is a worthwhile option in many cases but it must be used correctly. The provisional should be used when an inventor is perfecting their invention, not when they have a good idea and want to see where it goes. 

If a small business decides to file for an application they can do so themselves or with the help of a patent attorney. The USPTO will work with inventors filing their own application and offers a number of great resources to help an inventor through the process. However, it can be very helpful and is recommended to seek the advice of a patent attorney. The process of filing a patent and communicating with the USPTO has the potential to trip up those who are unfamiliar with the process. A patent attorney will give the small business or start-up the best chance for acquiring a patent and ensuring the patent offers the greatest amount of protection. Ultimately, a little research and familiarizing oneself with the patent system can help significantly in the decision on whether or not to file for a patent.

 

 

Establishing a Co-Founder Relationship

By: Maria Stracqualursi 

Finding a co-founder to help you launch and build your business can be a daunting task. However, working with a co-founder is a good idea both in terms of strategic business planning and your own mental health. This post examines the benefits of having a co-founder, how you can find a good match in a business partner, and how to develop and formalize the working relationship moving forward.

Importance of a Co-Founder

Starting a company is really hard. Having someone else by your side can be immensely helpful, not only to add different skills but also to share the stress that come with running a business. One report found that startups with two founders are able to raise 30% more in funding and increase their customer base three times as fast as startups with solo founders.

The reasons are many. First, having more than one set of eyes looking at the issues facing the startup generates not only more solutions, but also more creative solutions. A co-founder can help you see potential pitfalls you may not have noticed and hone your ideas. Combining multiple skills sets, experiences, and perspectives allow for more productive brainstorming sessions.

A co-founder can also be a valuable source of emotional support. She can take on some of the burden of stress and will understand exactly what you are going through because they are in it with you. Co-founders can motivate each other to keep moving forward. When the going gets tough, knowing that there is someone else who is committed to and invested in your business on whom you can rely is key.

Having a co-founder could make it much easier to raise funds for your burgeoning business. Venture capitalists repeatedly emphasize that they look for a quality team when investing in startups, and some may even require it as a condition of funding. This may stem from fears that the business will fail if a solo founder burns out or becomes incapacitated.

Number of Co-Founders

The general consensus seems to be that two cofounders is the sweet spot for a successful startup. Fewer cooks in the kitchen means the faster decisions and less equity split. As an individual’s share of the company becomes diluted, he has less of a personal investment and may become less incentivized to work hard and stick with the company through thick and thin. Although it is often preferable to have a co-founder with essential skills that will help the company grow, hiring independent contractors or employees can often be more cost-effective and efficient!

Where to Find a Co-Founder

It is often preferable to connect with a prospective co-founder through a friend, coworker, or even an industry acquaintance because they can personally vouch for their skills. You should certainly start spreading the word that you are seeking someone with a certain background or skillset, and check out Linkedin and other social networks to see if you can find someone who fits. However, if this is a no go, there many other alternatives to connecting with other innovators.

Finding a co-founder has become such an important step for startups that businesses have grown up around assisting entrepreneurs in meeting their perfect counterpart. Cofounderslab.com and founder2be.com allow its members to create profiles detailing their skills, business stage, and what they are looking for in a co-founder – complete with a picture of themselves, like a dating website for entrepreneurs! Startupweekend.org hosts weekend long workshops where entrepreneurs can network while working together on a project that culminates in a presentation at the end of the weekend. You can also attend coding boot camp or events thrown by Meetup or General Assembly. Don’t be afraid to ask individuals that you meet through these channels for a reference, and certainly feel free to do a little Googling!

Things to Look for in a Co-Founder

When trying to figure out what you are seeking in a cofounder, think SEPP: skills, experience, passion and personality fit. First, identify any gaps in your own skillset that are essential to getting the company up and running. Generally, co-founders should have complementary skills but some overlap is helpful for sharing work and bouncing ideas off each other. It is unlikely that you have design, finance, software development, AND marketing skills, all of which are crucial to launching almost any startup. You want to ask yourself whether the person can grow with your company and continue to contribute after the initial launch. Ideally, your prospective co-founder will have some experience working in startups or in the same industry. At the very least, she should be passionate about your product or services and share your drive to make the business a success. Finally, your co-founder should be someone that you can imagine spending long hours with and who won’t drive you nuts. Use the Pizza Test: can you picture yourself eating pizza with this person while working at 12am?

Co-Founder “Dating”

Choosing a co-founder is a huge decision and should not be rushed into. Before you give away equity, you will want to ask a lot of questions to ensure you and your potential co-founder are on the same page and avoid conflict as much as possible down the line. These include finding out about each other’s motivations, values and passions. For example, if you want your company to focus on advocacy and creating a social benefit, you will want to make sure that your potential co-founder agrees with managing the startup in such a way to achieve those goals.

You also want to feel comfortable speaking openly with each other. You will need to be able to give constructive criticism and disagree honestly but respectfully. Additionally, you should have an understanding of each other’s lifestyle and family commitments. For example, someone parenting young children may have a different financial situation and number of hours that they can work, and they may have different priorities or a different financial situation from a single young person with a full time job who just graduated with student loans.

Consider spending a weekend with your prospective co-founder engaging in some kind of intense activity that necessitates decision-making, such as a hackathon or camping trip. If all goes well, you should follow this with a trial period of whatever length you feel comfortable with.

The Co-Founder Pre-Nup

Committing to a co-founder is frequently described as a marriage without the romance. It is potentially a long-term relationship and the expectations should be clear before formalizing the relationship. If the commitment is similar to a marriage, the co-founder agreement is sort of like a pre-nup.

The co-founder agreement should first clarify the roles and responsibilities (including titles) of the parties. Second, it should lay out equity ownership and any vesting schedule. The decision on how to split equity is a process that may involve negotiation and should be done after determining what each party will contribute in terms of skills, time, and experience. Some research suggests that startups with equal equity splits among the founders may have more difficulty raising capital, as it may signal to investors that the team has trouble negotiating and handling difficult issues. Startups should also consider a vesting schedule, in which each founder has to earn his or her equity share by staying active in the company or hitting certain pre-defined milestones. The co-founder agreement should also outline any restrictions on transferring stock and any initial capital contributions made by the founders. The co-founder agreement should additionally require that co-founders assign their intellectual property rights to the company for any material that they develop on behalf of the company. That way, if a founder decides to leave the startup, he will not legally be able to take an essential piece of intellectual property with them. Of course, you should speak with a lawyer to help you draft a co-founders agreement and ensure all your bases are covered.

Finding a co-founder can be a long and demanding process, but ultimately it could be a major contributor to the success of your startup.

 

Equity Crowdfunding 101: Is It For You?

By: Ji-Su Park

Everyone has an idea. Everyone has a story to tell. But turning that story into a successful business takes commitment, know-how, and capital. Raising capital is challenging at any stage of a company’s growth but it is especially more difficult for startups that are at the earliest stages of development when the business model is still under construction.

Fortunately, for startups today, there are many options for raising funds. In the last year or two, ways to fund a business have significantly changed. More and more companies today are considering an online public offering, also known as “equity crowdfunding,” as a way to support their business in addition to more commonly known options such as debt, angel, or venture capital funding.

To help you decide whether or not equity crowdfunding is right for your business, this post looks into the background and history of crowdfunding and equity crowdfunding and analyzes the pros and cons of equity crowdfunding.

What is Crowdfunding?

Professor C. Steven Bradford, a leading scholar on the issue of crowdfunding at the University of Nebraska College of Law, defines crowdfunding as “rais[ing] money through relatively small contributions from a large number of people.”[1] Crowdfunding involves getting individuals to pool their resources to finance a project without a typical financial intermediary such as a bank or an underwriter.[2] The individual investors often do not engage in crowdfunding for financial gain; in fact, they often act more like donors. If the amount pledged is met by the investors, then the investors usually receive something in return, such as a product from the business (e.g. a DVD or CD from the film or album produced).

Today, in a typical crowdfunding transaction, an entrepreneur goes onto a crowdfunding website such as Kiva, Kickstarter, GoFundMe, and Indiegogo and proposes the amount needed for the project. Clearly, the Internet enables an entrepreneur to sell to millions of potential investors in real time with no incremental cost.[3] In other words, anyone who can convince the public to believe that he or she has a good business idea can become an entrepreneur, and anyone with a few dollars to spend can become an investor.

What is “Equity Crowdfunding”?

While the concept of the Internet-based crowdfunding itself is not so new, “equity crowdfunding” is a step beyond the earlier crowdfunding models. Because crowdfunding used to be limited to all but equity crowdfunding, the only way small businesses generally could access the capital of the masses used to be through an initial public offering (“IPO”).[4] However, for most small businesses, the average cost of going public was extremely expensive. The cost of going public for a small business in the United States is between $100,000 and $1.5 million in third-party fees. This naturally isolated the public from the small businesses.

When Congress finally decided to take action to cure this problem, it looked at the success of the traditional crowdfunding option popularized by websites such as Kickstarter, Kiva, GoFundMe, and Indiegogo and contemplated the use of equity-based crowdfunding, which was already being popularized in Europe. In April of 2012, President Barack Obama signed the Jumpstart Our Business Startups Act (“JOBS Act”), which received bipartisan support from the bill’s inception.[5]

By establishing new registration exemptions for equity crowdfunding under Title III, the JOBS Act eliminated the excessively restrictive requirements for small businesses to access capital. While drafting the JOBS Act, Congress theorized that equity crowdfunding would democratize the investment process and provide small businesses the necessary funds to survive through recession and eventually prosper.[6]

Equity crowdfunding allows startups to raise cash from non-professional investors who get a stake in the company. Non-professional investors invest in a project in exchange for equity: they give money to the venture and get shares in the venture. According to the Securities and Exchanges Commission (SEC) rules, investors with an annual income or net worth of at least $100,000 can invest up to 10% of the lesser of those, up to $100,000, in a 12-month period. Investors who fall below that mark can invest the greater of $2,000 or 5% of their annual income or net worth in a 12-month period. If the project succeeds, the value of the shares goes up and benefits the investors. If the project does not succeed, the investors lose as the value of their shares goes down.

What Are the Pros and Cons of Equity Crowdfunding?

Pros

●       Access to capital

○       A larger pool of investors: Both professional and non-professional investors have the chance to invest in your company. Given the wide reach of the Internet, you, the entrepreneur, have the chance to reach out to a larger pool of investors who might be looking for exciting young businesses.

○       Attracting additional sources of funding: Crowdfunding and other sources of funding are not mutually exclusive. You can pave the way for future funding by leveraging a successful campaign and making your company more attractive to big investors.

●       Control

○       Setting your own terms: You determine your company valuation, the number of shares to issue, and the minimum investment amount.

○       Retaining company control: You do not have to provide preferred stock or board seats.

●       Increased visibility and brand equity

○       Marketing: This modern, democratic approach to funding a company can increase visibility and brand equity through the marketing efforts of your campaign.

Cons

●       Legal issues

○       It’s new and complicated: There are a lot of new rules and regulations around equity crowdfunding. Making sure that you are following the law will take a lot of time and money, including getting the proper legal advice for your business.

○       Ongoing reporting requirements: Doing an online public offering requires filing with the SEC. It is important to consider any ongoing costs and annual reporting requirements.

●       Control

○       Keeping the investors happy: It is great to raise a lot of money from so many different people but remember that with equity crowdfunding, these people have ownership, too. That means that you need to keep these investors updated and satisfied, and eventually -- if all goes well -- paid, if your business succeeds in the future.

○       Facing angry investors: Furthermore, some investors may also be very vocal in their opinions about how you run the business. Taking money from investors can be stressful when you have to manage pretty demanding investors. It is definitely different when you are giving equity away as opposed to the traditional rewards-based model of crowdfunding.

●       Real effort required

○       Lack of expertise: Many investors you find from the crowd are unlikely to add value to your business beyond their cash. This means that you could be missing out on the experience and mentorship that sometimes come with other forms of funding such as angel or venture capitalists, most of who have been in your shoes in the past. Therefore, equity crowdfunding might not make sense for the entrepreneurs who need business mentors and advice to succeed, or who need industry expertise from investors to open doors to opportunities.

○       Cost: While there is no set amount that a campaign will cost you, there are some marketing costs to consider, such as costs of videowork or artwork to push your message out to the public.

Is Equity Crowdfunding Right For You?

Ultimately, this is a question you have to answer for yourself.

According to a report from The Forum of for Sustainable and Responsible Investment (USSIF), millennials, or the young generation born roughly between 1980 and 2000, “have shown particular interest in producing a positive impact on society through their investments.” As these millennials continue to age and start investing, there might be more potential in equity crowdfunding as a financing option for socially impactful startups. In fact, some of the most successful companies with equity crowdfunding have been companies in socially progressive areas such as cleantech, green tech, transportation, health and fitness, and healthcare. These companies already have had a pre-existing online footprint and established a like-minded community before jumping into equity crowdfunding.

It must be noted that equity crowdfunding is not just a U.S. innovation. Though equity crowdfunding may be new to the U.S., other countries -- especially the European countries such as Switzerland, Sweden, Italy, and the U.K. -- already have been using this model of crowdfunding for years.[7] Today, there is a global trend towards the legalization of equity crowdfunding: the equity crowdfunding legislation passed the Australian Senate in March 2017, and South Korea adopted the equity crowdfunding model in January 2016.

As we see equity crowdfunding legislation being considered and adopted across the world, it is likely that experiences from the success of equity crowdfunding will lead to further reforms in the future.

[1] C. Steven Bradford, Crowdfunding and the Federal Securities Laws, 2012 Colum. Bus. L. Rev. 1, 10 (2012).

[2] Andrew J. Sherman, Raising Capital: Get the Money You Need to Grow Your Business 95 (2012).

[3] Bradford, supra note 1.

[4] Christian W. Borek, Regulation a+: Navigating Equity-Based Crowdfunding Under Title IV of the Jobs Act, 47 Cumb. L. Rev. 143, 144-45 (2017).

[5] Id.

[6] Id.

[7] Id.

Fitness trackers & health information – I’ve walked 6,000 steps, but who else knows it?

By: Kathryn Pajak

It was the middle of the night, I was walking back and forth through my apartment determined to get to 10,000 steps.  Sound familiar?  The new fitness trend of wearables has taken the millennial generation by storm (and basically all other generations at that).  But – what does this fitness tracker really track?  The GPS measures how far I’ve walked, but does it track where I was? Where is that information stored?  Can a court subpoena the information?

Fitness trackers have swept the world. A Pricewaterhouse Coopers study found that one in five American adults owns a wearable device, and the research firm Canalys reported that eight million activity-tracking bands were expected to ship in 2014.  Fitness trackers hold great promise for public health policy and personal wellness.  The main contenders in the market are Jawbone (site and privacy policy), Fitbit (site and privacy policy), and Garmin (site and privacy policy).  The challenge fitness tracker and mobile health apps face is striking a balance between collecting necessary information and protecting consumers’ privacy.  Fitness tracker manufacturers require consumer trust to sell their products; they know they cannot sell their products if their customers don’t have confidence that the manufacturers have reasonable privacy protections and data security in place.

What Information is Collected?

Companies Collect Personal Fitness Information (“PFI”) – PFI consists of various types of sensitive information such as a user’s heart rate, number of steps taken, activity levels, sleep quality and duration, and calories burned.  Not only do these devices collect PFI, but also they collect a large volume of it. Data gathered from fitness trackers likely has broader public health implications for researchers and policy makers.  For instance, at some point, such data could be as detailed as a doctor’s medical records, and such information could be shared with employers, insurers and financial professionals. The sale of the aggregate PFI data may ultimately implicate HIPAA thereby imploring lawmakers to update HIPAA or pass new legislation.  It could even fall under the reach of the Fair Credit Reporting Act if it is used to make employment or credit offers.

How is it Collected?

Sensors and Algorithms – Fitness trackers function by collecting information via sensors that measure motion, specifically the acceleration, frequency, duration, intensity and patterns of your movement.  The data collected is transformed into steps and activity.

Fitness Trackers Function on Sharing – When using fitness trackers, individuals voluntarily share their private information.  This directly contrasts traditional privacy concerns of third-party surveillance, because users of fitness trackers voluntarily record and transmit their lives in granular detail. Therefore the privacy issue at hand is not whether users are being recorded, but rather what happens to the data collected.  There seems to be a general lack of awareness from users on how much, and how potentially harmful, the data collected is. 

Who has Access?

It isn’t Clear Who has Access to the Information Collected – Naturally companies and fitness brands, which collect this information, have access.  However, recently, these companies have been selling the information to the highest bidder. 

What are the Potential Legal Issues?

Fitness Trackers are Under Attack in Europe – The laws in Europe are traditionally stricter on privacy than the laws in the United States.  In fact, recently the Norwegian Consumer Council accused health tracker manufactures of violating European law because the Council is concerned that none of the companies give users proper notice about changes in their terms, all of the wristbands collect more data than what is necessary to provide the service, none of the companies fully explain who they may share user data with, and none of the companies state how long they will retain user data.  The United States has traditionally been more relaxed on privacy.  Nevertheless, in Katz v. United States, the Supreme Court established that individuals are entitled to a reasonable expectation of privacy. 

Privacy Policies are Subject to Change - Most brands have clauses stated that the terms of the privacy policy are subject to change.  For instance, Garmin’s privacy policy states “We will provide notice to you if these changes are material and, where required by applicable law, we will obtain your consent.”  Therefore, users do not have the ability to effectively control how their fitness data is used and shared.  In the past, Fitbit has shared users data in aggregate and de-identified.  For instance, in 2015, Fitbit used fitness information to measure and track its users’ excitement throughout the Super Bowl by examining users’ heart rates and distributed this information.  While aggregated and de-identified, some analysts have been able to re-identify the supposedly anonymous data.

FDA will not regulate fitness trackers – The FDA will not regulate products intended for general wellness, such as tools for weight management, physical fitness, or mental acuity.  While the FDA will not regulate fitness trackers in that arena, they will regulate medical devices, i.e. technology that makes a medical claim to treat or diagnose a disease or condition.  The FDA made this decision to strike a balance between unnecessary government red tape for applications trying to promote healthful activities and protection of private health information.  General wellness tools will still have to pass the Medical Electronic Data Technology Enhancement for Consumer’s Health Act (“MEDTECH”).  In contrast, HIPAA regulates Private Health Information (“PHI”).  HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act (“HITECH Act”), protects against the improper disclosure of private health information.

Tell Me More!

Additional Sources – If you find this topic interesting, here are a few fun reads for more information!

1.      Smart Watches and Weak Privacy Rules, N.Y. TIMES (Sept. 15, 2014), http://www.nytimes.com/2014/09/16/opinion/smartwatches-and-weak-privacy-rules.html?_r=0

2.      James A. Martin, Pros and Cons of Using Fitness Trackers for Employee Wellness, CIO (Mar. 24, 2014), http://www.cio.com/article/2377723/it-strategy/pros-and-cons-of-using-fitness-trackers-for-employee-wellness.html  

3.      Sophie Charara, If You Own a Fitness Tracker, Chances Are It’s a Fitbit, WAREABLE (May 22, 2015), http://www.wareable.com/fitbit/fitness-tracker-sales-2015-fitbit-1169

4.      Joseph Bradley, When IoE Gets Personal: The Quantified Self Movement!, CISCO BLOG (Sept. 10, 2013), http://blogs.cisco.com/zzfeatured/when-ioe-gets-personal-the-quantified-self-movement/

5.      Al Sacco, Fitness Trackers Are Changing Online Privacy--and It’s Time to Pay Attention, TECH HIVE (Aug. 15, 2014), http://www.techhive.com/article/2465820/fitness-trackers-are-changing-online-privacy-and-its-time-to-pay-attention.html  

6.      Stuart Dredge, Why the Workplace of 2016 Could Echo Orwell’s 1984, THE GUARDIAN (Aug. 22, 2015), http://www.theguardian.com/technology/2015/aug/23/data-and-tracking-devices-in-the-workplace-amazon  

7.      Jack Smith IV, Fitbit Is Now Officially Profiting From Users’ Health Data, OBSERVER (Apr. 18, 2014), http://observer.com/2014/04/fitbit-is-now-officially-profiting-from-users-health-data/#ixzz2zdt0LO2w  

8.      Emma Hutchings, Fitbit Users’ Sexual Activity Found In Google Search Results, PSFK (July 4, 2011), http://www.psfk.com/2011/07/fitbit-users-sexual-activity-found-in-google-search-results.html

9.      Kate Crawford, When Fitbit Data Is the Expert Witness, THE ATLANTIC (Nov. 19, 2014), http://www.theatlantic.com/technology/archive/2014/11/when-fitbit-is-the-expert-witness/382936/

10.  Should Companies Profit by Selling Customers’ Data?, The Wall Street Journal, https://www.wsj.com/articles/SB10001424052702304410204579143981978505724

11.  WHY SHOULD WE CARE WHAT FITBIT SHARES?: A PROPOSED STATUTORY SOLUTION TO PROTECT SENSITIVE PERSONAL FITNESS INFORMATION by Michelle M. Christovich published in Winter 2016. 38 Hastings Comm. & Ent L.J. 91

12.  YOU SHOULD BE FREE TO TALK THE TALK AND WALK THE WALK: APPLYING RILEY V. CALIFORNIA TO SMART ACTIVITY TRACKERS, by Katharine Saphner published in April 2016. 100 Minn. L. Rev. 1689

Leveraging Equity Incentive Structures for Third-Party Relationships: A Warrant-ed Alternative Security Structure for Angels and Advisors?

By: Jennifer Kay

Startup founders are typically willing to offer straight equity, in the form of preferred or common stock, to angel investors and advisers who agree to commit their capital or time to the venture. That said, founders often feel that they must offer a significant proportion of equity to early-stage contributors who may or may not be committed to actively contributing to the company’s long-term success. To incentivize early-stage contributors’ long-term commitment to their company’s growth, founders should consider offering stock purchase warrants, instead of or in addition to straight equity, to angels and advisers. That said, founders should beware that issuing warrants may complicate their accounting and flexibility in later financing rounds.

Not to be confused with search warrants, stock purchase warrants are financial instruments that provide holders with the contractual right to buy a certain number of a company’s equity shares directly from the company a fixed price during a defined time period. Accordingly, warrants are similar to employee stock options, as both provide the contractual right to later purchase an equity security. That said, employee stock options are only available to intra-company parties (i.e., the company’s officers), while warrants are available to parties external to a company (i.e., angel investors or advisers deemed to be independent contractors of the company). Additionally, while companies that issue employee stock options typically do so under universal terms for all employees, companies that issue warrants typically do so in the context of third-party transactions (i.e., in exchange for an investment) and the terms of warrant contracts are typically negotiated deal-by-deal.

As startup founders consider various financing structures for their venture, they should consider incorporating warrants into the toolbox of financial instruments that they use as consideration for angel investors or advisers. Specifically, founders should consider offering warrants to angels or advisers in order to incentivize early investment as the exercise price of early-stage warrants would likely be significantly lower than later share value. In this scenario, if the stock value goes at least as high as a warrant’s exercise price before the expiry date, the warrant is “in the money” and the warrant-holder may purchase commensurate shares. Thereafter, if the future stock value exceeds the warrant’s exercise price, the warrant-holder may want to purchase the stock and then immediately resell the shares at a profit or hold the equity until a later acquisition.

Founders should also consider issuing warrants as a means of compensating external parties like angels or advisers for bringing in new business to the company (i.e., by setting performance-based milestones as the trigger for warrant exercisability). That said, warrants received as compensation for performing services will be taxed just like compensatory employee stock options (see http://www.thetaxadviser.com/issues/2014/sep/tax-clinic-10.html http://www.thetaxadviser.com/issues/2014/sep/tax-clinic-10.html).

Further, if a startup wants to avoid having to register their securities with the SEC, the startup will have to ensure that warrants granted as compensation for advisors meet the requirements of SEC Rule 701, thus further complicating warrant-based consideration structures (see https://www.pillsburylaw.com/images/content/4/8/v2/483/RobbinsRule7012013.pdf: Adopted under Section 3(b) of the Securities Act of 1933, Rule 701 provides an exemption from the registration requirements of the Securities Act for certain offers and sales of securities made pursuant to the terms of compensatory benefit plans or written contracts relating to compensation by an issuer that is not subject to the reporting requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934 and is not an investment company registered or required to be registered under the Investment Company Act of 1940.)

In addition to the tax and securities law-related complications associated with warrants, the lack of shareholder voting rights associated with warrants may prompt angels or advisers to resist warrant-oriented consideration for their capital or time.

Accordingly, founders should understand, and weigh the benefits and drawbacks of, warrants as they structure angel and adviser equity grants. While warrants may provide a way to incentivize angels’ and advisers’ long-term commitment to a company, warrants may also provide accounting, tax, and securities law complications for both companies and warrant-recipients.

Sources

http://www.investopedia.com/articles/04/021704.asp#ixzz4dbn3vIdh   

http://www.startuplawblog.com/2009/12/16/what-is-the-difference-between-warrants-and-options/  

https://www.forbes.com/sites/mariannehudson/2016/12/22/what-the-heck-are-warrants-answers-to-questions-some-angels-are-afraid-to-ask/#5f07f90247e5  

http://www.vcdeallawyer.com/2009/08/30/lets-talk-angel-investors/    

https://www.angelcapitalassociation.org/data/Documents/Resources/AngelCapitalEducation/ACEF_BEST_PRACTICES_Deal_Structuring.pdf

https://seraf-investor.com/compass/article/stock-warrants-sweetening-deal-angel-investors  

http://www.investopedia.com/ask/answers/08/stock-option-warrant.asp  

http://www.investopedia.com/articles/04/021704.asp  

http://www.startuplawblog.com/2009/12/16/what-is-the-difference-between-warrants-and-options/  

https://www.allbusiness.com/warrants-what-they-are-and-how-to-use-them-15137265-1.html

 

 

 

Money, Money, Money: Traditional Financing or a New Wave of Crowdfunding?

By: Samantha Gross

Steve Jobs once said, “I’m convinced that about half of what separates the successful entrepreneurs from the non-successful ones is pure perseverance.”  Perhaps in avoidance of sounding cynical, Mr. Jobs does not address the other half of the equation – money.  The reality is that entrepreneurs need initial financing to get a business up and running.  In fact, about 80% of startups fail, mainly due to lack of capital.  With more and more startups vying to enter the market, investors are setting higher benchmarks to protect their money.  The result: great difficulty for first-time entrepreneurs without substantial personal resources and connections. 

Traditional paths for financing have included investments from personal savings, friends and family, the elusive angels, and the sophisticated venture capitalists.  In recent years, four different types of crowdfunding have paved a new path for raising seed capital.  Financial analysts all agree that the type of financing an entrepreneur accepts is extremely important and involves much thought; however, the best type of capital-raising method is still contested.  This blog post evaluates the benefits and risks of so-called “smart money” and “dumb money” for an average entrepreneur starting with absolutely no leads for financing.

“Smart Money”: The Value of Human Capital

            “Smart money” typically refers to investments from those, who are experienced, well-informed, and well-connected – popularly known as angel investors and venture capitalists.  Such investors often take active roles in their portfolio companies, as advisors, board members, or endorsers, which can open different doors for entrepreneurs.  In other words, “smart money” provides both financial and human capital.

Established business owners, experienced investors, and financial advisors all express the importance of finding the right fit, when entering into a financing deal.  There must be a covenant of honesty, trust, and transparency because the relationship between a seed investor and entrepreneur can last up to six or seven years.  Thus, a great benefit to obtaining money from friends and family, angel investors, and even venture capitalists is the support provided by the person backing an entrepreneur’s sweat and labor.  Nevertheless, such options are not always readily available, especially since the competition among startups is currently hot and heavy.  As a result, a new path for funding has emerged, referred to as crowdfunding.          

What Type of Crowdfunding?

            It is important for an entrepreneur to recognize that there are four different types of crowdfunding, and carefully understand the process of each before proceeding full speed ahead.

1.      Donation Based Crowdfunding

            In donation based crowdfunding, the contributing person gives money or other resources to the entrepreneur without anything in return, simply because they support the idea.  This type of crowdfunding has proven successful for social causes and charity organizations.  However, this option is not necessarily sustainable for a business, which needs a larger amount of capital at the initial stage.   

2.      Rewards Based Crowdfunding

            In rewards based crowdfunding, the contributing person gives money to the entrepreneur in exchange for a reward, typically some good or service.  A famous example of rewards based crowdfunding was Zach Braff’s campaign to raise money for his film “Wish You Were Here.”  He raised $3.1 million on Kickstarter, and gave his backers access to the film’s production in exchange.

3.      Equity Based Crowdfunding from Accredited Investors

            Entrepreneurs can raise money and issue shares over the internet from accredited investors, individuals who either have a net worth over $1 million (excluding a primary residence) or an income of at least $200,000 for the preceding two years.  However, entrepreneurs, who have yet to establish connections within the investor world, may face the same difficulty in raising funds from accredited investor crowdfunding as they would from angel investors or venture capitalists.

4.      Equity Based Crowdfunding from Unaccredited Investors

            On May 16, 2016, Title III of the JOBS (Jumpstart Our Business Startups) Act came into effect, making it possible for entrepreneurs to raise money in exchange for equity from the general public, not just accredited investors.  The idea behind the act was to allow more startups, which do not necessarily fit into the angel or venture capitalist model, to receive funding from a larger pool of investors.  Whether this relatively new option is actually beneficial and useful for entrepreneurs is still uncertain.

Benefits of Crowdfunding

            In 2015–2016, donation and reward crowdfunding raised a total of $5.5 billion, while equity crowdfunding under-performed in comparison, only raising a total of $2.5 billion.  The bottom line is that entrepreneurs, who may not be eligible among angel investors and venture capitalists, can access funds relatively quickly through crowdfunding.  Reaching a diverse investor pool from around the globe is an attractive advantage.

Disadvantages of Crowdfunding

            In contrast to the “smart money” of angel investors and venture capitalists, financial experts sometimes refer to equity based crowdfunding as “dumb money” – mainly because such financing does not provide the added expertise of a well-seasoned investor committed to advising his portfolio clients.  Rather, the relationship is reduced to an online portal of many investors, willing to make small investments in all sorts of businesses.

            Another major disadvantage is the rather heavy regulatory scheme.  For instance, the maximum offering amount is $1 million in a twelve-month period, the investors are subject to limits with regard to the amount of capital they can contribute in a twelve-month period, the companies are subject to disclosure requirements as well as restrictions in advertising, and the crowdfunding must be conducted through a registered portal.  It remains to be seen whether all this red tape is worth it or even feasible for an entrepreneur lacking in resources.

Debt Funding May be a Lifesaver

            While financial analysts are not convinced about the benefits of equity based crowdfunding from non-accredited investors, there may be some great potential from Title III debt crowdfunding.  For small businesses with cash-flow, debt crowdfunding works well because payments do not usually start immediately and are based on a percent of revenue; as a result, businesses are not burdened with fixed loan payments.  Ultimately, debt crowdfunding can be cheaper and faster than going to a bank with the added benefit of marketing exposure through a crowdfunding portal. 

            Financing options are distinct and numerous; nevertheless, it is up to the entrepreneur to find the best means for a happy start-up ending.