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Entrepreneurial Ventures Legal Services FAQ

These FAQ's answer questions about legal issues that startup companies often face.  They are divided into the legal areas of the clinics that work with the various issues: Basic Business Entities, Intellectual Property and Employment.

Basic Business Entities 

1. What are the basic business entities that startups often use?

The basic business entities are a “Sole Proprietorship”, “Partnership”, “Limited Liability Company”, and a “Corporation.” These entities have different tax and liability implications for owners. Sometimes there are several forms of an entity which has particular characteristics that are attractive to an investor or founder. For example, there are Limited Partnerships and Registered Limited Partnerships, as well as C Corporations and S Corporations. Almost all venture capitalists prefer a C-Corporation for investment purposes, whereas if financing is through founders might use a Limited Liability Company

2. What are some features of corporations that are important to investors?

  • Limited Liability: Financial liability for corporation liabilities is limited to a fixed sum – the value of a person’s investment in a company. This is an important advantage over some of the other business entities because investors in a corporation will not be personally liable for losses incurred by the company.
  • Perpetual Life: Corporations can exist indefinitely because the corporations existence does not depend upon the life of its employees, managers or shareholders. A sole proprietorship or partnership has a limited life and may be dissolved by the death, incapacity or withdrawal of the owner or partner. Those entities therefore do not provide the stability of a corporation as an ongoing concern.
  • Legal formalities and organizational paperwork: Sole proprietorships and partnerships have minimal set up and record keeping requirements. However corporations have legal formalities that must be adhered to including filing of formation papers (articles of incorporation) with the state and documented annual shareholder meetings. If corporate formalities are not followed the corporation risks losing the benefit of limited liability.
  • Centralized Management: Shareholders do not manage the day-to-day operations of a corporation. Instead, shareholders vote for the board of directors which is responsible for hiring officers and managers. Only the board of directors or an officer can make management decisions that legally obligates the company. In a general partnership every partner is an agent of the company, and unless a managing partner is appointed, all partners can make decisions which are legally binding on the business.
  • Deductibility of losses: Owners of a sole proprietorship or general partnership may use business losses to deduct from other income on individual tax returns. In a corporation shareholders may not deduct business losses unless the corporation is an S corporation.

3. What is limited liability?

Limited liability means that an investor in a corporation (or LLC) can generally only lose the amount of money paid for the investment and there will be no personal liablity for the corporation’s business debts or other financial obligations. If there was not this limitation, if a company were not able to pay its debts and financial obligations, creditors might be able to seize the investor’s home or other personal assets. This protection of limited liability is a big advantage of a corporation for investors. However, limited liability can be lost if the formalities of a corporation are not followed, and owners must maintain a formal separation between the business and personal finances.

4. What are some important differences between an S-Corporation and a C-Corporation

S-Corporations and C-Corporations are distinguished by the tax treatment of corporate profits and losses and also the flexibility of corporate structure. A C-Corporation itself is taxed on its corporate income, and has no limitations on the number of investors in the corporation or the residency status of those investors. S-Corporations, on the other hand, pass-through profits and losses to their investors who will be taxed individually on the corporate profits and losses. Limits on the number of investors who may invest in an S-Corporation, as well as residency requirements for those investors, preclude the election of an S-Corporation for many corporations. 

5. What is an Incorporator?

An incorporator is generally the individual responsible for the formal process of incorporation. Although incorporators are often attorneys, they may be a founder or anyone else somehow involved with the corporation. In California, a business will not be given corporate status until the incorporator signs and files the Articles of Incorporation with the Secretary of State. Incorporators, however, may play only a small role in the business, and their involvement as incorporator usually ends soon after the corporation papers are filed. Even though the incorporator appoints the first board of directors, the primary role of the incorporator, in California, is to prepare and sign the Articles of Incorporation and file the Articles with the California Secretary of State.

6. What is a corporate director?

A corporate director is a member of the corporation’s board of directors. This board is composed of one or more members and is responsible for managing the corporation, establishing policies and objectives for the corporation, selecting officers, approving budgets, and setting compensation for officers and others. The board of directors is accountable to the shareholders of the corporation and owes a fiduciary obligation to the corporation. Directors are legally bound to act within the scope of their authority and to exercise due care in the performance of their corporate tasks.

Directors are initially appointed by the incorporator and after that elected at the annual meetings of shareholders for one-year terms. Independent directors must have “no material relationship” with the corporation, while non-independent directors may be officers or employees of the corporation. The majority of the directors of a publicly traded company must be independent in order to ensure objectivity.

7. What is a corporate officer?

A corporate officer is an employee of a corporation who holds a management-level position, such as a President, Vice President, CEO, General Manager, Secretary or Treasurer. Corporate Officers are responsible for the day to day running of the corporation and have the actual or apparent authority to contract or otherwise act on behalf of the corporation. Officers are chosen by the board of directors and often serve at their pleasure. The board of directors sets the corporate officers’ salaries and can remove officers through the procedures listed in the corporation’s by-laws.

8. What does vesting of corporate stock mean?

Vesting may be a requirement of a stock plan that allows employees to conditionally acquire corporate stock. The condition(s) function as an incentives for employee productivity and loyalty by requiring time and/or performance conditions that must be met before the stock can be unconditionally purchased or owned by the employee. For example: a company may require an employee to have two years of service and deliver two projects on time for the employees stock options to belong unconditionally to (or “vest” in) the employee. Vesting can also involve a repurchase right that the corporation has for a founder’s stock. A vesting schedule determines the date at which an employee or founder obtains full and unconditional rights in the stock or stock option. 

10. What are some characteristics of Limited Liability Companies (LLC’s)

An LLC combines the limited liability feature of a corporation with the tax treatment and structural flexibility of a partnership. Some characteristics of LLCs include: limited liability, pass-through taxation, some ownership requirements, management flexibility, and inexpensive formation costs. LLC’s shield owners from personal responsibility for the LLC’s debts and other liabilities. Pass-through taxation means that the owners pay income taxes or take tax losses directly from their share of the LLC’s profits and losses. Management flexibility means that there is more flexibility in management structure and decision making for an LLC than is dictated by law for corporations and some other business entities. LLC “members” (owners) have the flexibility to structure and organize the LLC as they wish through a written “operating agreement”. 

Intellectual Property

1. What is a Trademark? 

A trademark is a word, name, symbol, device, or any combination that designates to a consumer the brand of the goods and/or services.  A trademark specifically serves the function of identifying the source of goods and/or services.

2. What is a Registered Trademark?

An individual or company may register a trademark with the USPTO based on existing use or intent to use the mark and obtain certain legal rights.  Registration provides a trademark owner with priority and nationwide rights, which means the trademark owner may legally assert exclusive use of the trademark anywhere in the U.S. for the goods and services stated in the registration.  Trademark registration requires information about the individual or company, the words or images appearing in the trademark, a description of the goods and services, and a source of payment.  This process is often completed by an attorney, who may provide additional services if there are any problems with registration, infringing uses by a third party, or maintenance of the registration.

In order to be able to register a trademark, a trademark must be distinctive, not in use by another party for similar goods or services and generally not descriptive of the trademark owners goods or services.

3. What is the United States Patent and Trademark Office (USPTO)?

The United States Patent and Trademark Office (USPTO) is a federal agency within the Department of Commerce that is responsible for examining and granting patents, and trademarks in the Untied States. The mission of the USPTO is to promote industrial and technological progress in the United States and strengthen the national economy by administering the laws relating to patents and trademarks 

The USPTO registers patents based on Article I, Section 8, and Clause 8 of the United States Constitution, which states in part, “to promote the progress of science and the useful arts by securing for limited times to Authors and Inventors the exclusive right to their respective discoveries.” The USPTO registers trademarks based on the commerce clause of the Constitution (Article I, Section 8, Clause 3 or also called the Commerce clause). The Commerce Clause, gives Congress the power to, “regulate Commerce with foreign Nations, and among the several States.”

4. Trademark Prosecution

Trademark prosecution is a process of applying (or registering) for nationwide rights to use a trademark exclusively. The applicant seeking to register the trademark, files a trademark application with the United States Patent and Trademark Office.  The trademark for which the applicant applies should already be in use in commerce or the applicant must intend to use it in commerce in the near future.   An “examiner” from the USPTO is assigned to determine, among other things, whether the trademark being applied for is distinctive, doesn’t cause confusion about source with another trademark that another is using for similar goods or services in commerce, is not descriptive of what the trademark identifies, and is not functional. Once an examiner determines that the trademark applied for meets the legal requirement, the trademark will be published in the “Official Gazette”, which is a weekly online publication, for public input.  If no problem or challenge arises during 30 days of publication, the mark will be registered and the owner will be granted certain rights.

5. What is a Patent?

A patent is an intellectual property right granted by a government to an inventor “to exclude others from making, using, offering for sale, or selling the invention or importing the invention into the country,” unless they have permission from the owner of the patent.  35 U.S.C. 154(a)(1). Patent rights are granted for a limited time.  In the US and many other countries, the period of  rights to a patent owner is 20 years.

6. What is a Copyright

A copyright gives certain exclusive rights to the author of the work, for a specified period of time. The word “author” includes creators of art, music, photographs, and even software. The basis for copyright protection is found in the U.S. Constitution and covers both published and unpublished works of original authorship that are fixed in a tangible medium of expression. 

A copyright grants five exclusive rights to copyright owners to do or authorize the following: 1) the right to make copies of the work, 2) the right to create derivative works based on the copyrighted work, 3) the right to distribute copies of the work, 4) the right to perform the work publicly, and 5) the right to display the work publicly. Generally, the owner of the copyright retains these rights upon the creation of the work and for a term of the life of an author plus 70 years. The author also has the exclusive right to license a portion, or all of these rights through a license or assignment to another individual or entity.

7. What is a Work Made for Hire?

When a work is made for hire, an employer is considered the author/owner of the copyrighted work even if an employee actual created/prepared the work. A work made for hire is often a work prepared by an employee within the scope of his or her employment. The employer might be an organization or an individual. 

A work made for hire may also be a work that is specifically ordered or commissioned from an independent contractor. This type of work made for hire requires the parties to agree to this in a signed written instrument.  

See. 17 U.S.C. § 101. 

8. What is the Digital Millennium Copyright Act (“DMCA”)?

The DMCA was enacted in 1998 to update portions of U.S. copyright law to meet the quickly growing and changing digital technology and to conform U.S. law to the requirements of the World Intellectual Property Organization (WIPO) and treaties signed by the U.S. in 1996. This act was divided into five different titles. Among its many complex provisions, the Act:

Imposes rules prohibiting the circumvention of technological protection measures (commonly known as digital rights management or DRM). 

Creates a safe harbor for online and internet service providers against copyright infringement liability, provided they meet certain requirements and guidelines. 

Modified section 117 of the Copyright Act so that those repairing computers could make certain temporary, limited copies of programs/software while working on a computer without infringing the copyright(s). 

Provided a significant updating of the rules and procedures regarding archival preservation

Mandated study on  distance education activities in networked environments and effects of anti-circumvention protection rules on the “first sale” doctrine, 

9. What is a domain name?

A domain name is a form of identification that represents one or more IP addresses. A domain name functions as a general and often memorable name that replaces a complicated and unmemorable numerical string that represents a specific destination on a computer network.  A domain name consists of a top-level and a second-level domain which combine to indicate the location of a website. 

Every domain name has a suffix that indicates which top level domain (TLD) it belongs to. There are only a limited number of such domains. A top-level domain label is located at the end of a domain name, behind the dot (.), and represents a category of services or an organization, including: .com, .gov, .edu, .net, .int, and .mil. A domain name also contains a second-level domain, located to the left of the dot (.) created to represent a company, organization, product, or service.  For example, in “usfca.edu” the “usfca” portion is the second level domain indicating USF as the organization name and “.edu” is the top-level domain that indicates the category of service offered by USF, in this case, education. 

10. What is ICANN?

The Internet Corporation for Assigned names and Numbers (ICANN) is an international non-profit organization formed in 1988 to oversee and coordinate the Internet domain name system (DNS)  ICANN serves as a central administrator of domain names, Internet related databases and Internet protocol (IP) addresses. ICANN’s primary principles of operation are accrediting domain name registrars, setting minimum standards for their performance and recognizing the persons and entities meeting those standards.  ICANN is also responsible for maintain the operative stability of the global Internet community by promoting healthy competition and developing appropriate regulatory policies

11. What is a Trade Secret?

A trade secret is any knowledge or information that a company or individual(s) possesses that typically gives it an economic advantage over its competitors. Trade secrets cannot be generally known or common knowledge, and must be actually kept secret. Protection of a trade secret ordinarily lasts as long as it is kept secret and trade secrets are protected by state statutes (usually based upon the Uniform Trade Secrets Act) and common law. The holder of a trade secret does not need to file or register for protection of the trade secret.   

Trade secrets can concern various subject matters, including formulas, patterns, compilations, programs, devices, methods, techniques, processes, and recipes.  One of the most famous trade secrets that continues to receive protection is the Coca Cola secret formula. 

To maintain a trade secret the owner should be careful that the secret is well protected through security measures. Some of these may be to require employees, investors and vendors to sign non-disclosure and non-compete agreements, to limit the number of employees with access to the trade secret, and to store the trade secret in a restricted and secure area. 

Trade secret protection will not prevent third parties from reverse engineering the trade secret and making that information public, which may destroy trade secret protection. 

12. What is a Nondisclosure (NDA) or Confidentiality Agreement?

An NDA is a contract between at least two parties.  When doing business, companies and individuals may exchange information that one or the other, or both, do not wish to share with third parties.  It is important for these parties doing business to specify the information that must remain confidential.  Therefore parties often outline in the terms of the NDA the intellectual property and other information they wish to protect from disclosure.  Both an NDA and confidentiality agreement may protect from the risk that confidential information will be obtained by third parties.

13. What is the Licensing of Intellectual Property

A license of intellectual property (IP) allows the owner of IP to give others the right to legally use their IP.  This license may be general or for a limited purpose and/or limited period of time.  The license is often in exchange for a fee that can be negotiated between the licensor and the licensee.  If the license is exclusive only the licensee can use the licensor’s IP. The license can be also be a non exclusive one which allows the licensor to license others the right to use to use the licensor’s IP .

14. What is an Assignment of Intellectual Property

An assignment of intellectual property (IP) is a transfer of IP rights which can be done by the owner of IP.  Unless the assignment is qualified, the assignment will give the recipient all of the  rights that the owner of the IP had prior to the transfer. An assignments of IP rights to a company is often a condition of employment with the company.  Also, founders of a company typically will assign all their IP rights to the company. ed. 

Employment

1. What is an independent contractor?

An independent contractor is a person (or other entity) who contracts with another to perform a service. The general rule is that an individual is an independent contractor if the person paying for the service has the right to control or direct the result of the work, but not what will be done and how it will be done. Accordingly, whether a person is classified as an employee or an independent contractor often turns on the amount of control the person paying for the services has over the details of the work. In addition to control, courts will consider eight other specific factors in determining how a worker should be classified: if the person being employed is engaged in a distinct occupation, whether the work being done is typically done by a specialist without supervision, the amount of skill required in the particular occupation, who supplies the instrumentalities, tools, and place of work, the length of time of the service, the method of payment for the service, whether the work being done is part of the employer’s regular business, and whether the parties believe they are creating an employee/employer relationship. If an employer pays taxes and provides benefits to the worker, it is extremely likely that the worker will be classified as an employee rather than an independent contractor.

2. What are the consequences of misclassifying an employee as an independent contractor?

A worker cannot be classified as an “independent contractor” if the nature of their work is really that of an employee. As mentioned above, courts will consider a multitude of factors in determining how a worker is classified, only one of which is what the parties have labeled the relationship. If an employee has been misclassified as an independent contractor, the employer may be subject to a number of costly penalties. Among these penalties are: wages the employee is entitled to that they were not paid, such as any overtime and minimum wage violations; back-taxes and penalties for federal and state income taxes, Social Security, Medicare, and unemployment; misclassified injured employees workers’ compensation benefits; and employee health insurance and retirement benefits.

3. What are the legal requirements for an “intern.”

Under federal law, employers are legally obligated to abide by the minimum wage and overtime laws, along with the obligation to provide other benefits for their employees.

However, the United States Supreme Court in Walling v. Portland Terminal Co. held that an exemption to these federal requirements exists for individuals working as interns (who work for their own advantage) as opposed to employees (who work for their employer’s advantage). The court considers six factors in determining if a particular work program should be classified as for an intern or as for an employee of the employer. The six factors are: 1) the internship, even though it includes actual operation of the facilities of the employer, is similar to training which would be given in an educational environment, 2) the internship experience is for the benefit of the intern, 3) the intern does not displace regular employees, but works under close supervision of existing staff, 4) the employer that provides the training derives no immediate advantage from the activities of the intern; and on occasion its operation may actually be impeded, 5) the intern is not necessarily entitled to a job at the conclusion of the internship, and 6) the employer and the intern understand that the intern is not entitled to wages for the time spent in the internship. Further, the Department of Labor has decided that in order for an individual to be regarded as an intern, all of these above six factors must be met. http://www.forbes.com/sites/theyec/2013/04/19/6-legal-requirements-for-unpaid-internship-programs/

4. What is employment discrimination?

Employment (workplace) discrimination is illegal if based on race, sex, religion, sexual orientation, marital status, national origin, age, or disability. Unfair treatment, harassment, denial of a reasonable change, improper questioning and retaliation are all forms of employment discrimination. Other types of employment discrimination include hiring, firing, promotions, training, wages and benefits.

5. What is Workers Compensation in California

Employers are required to pay for their employees’ work-related injuries or illnesses. In
California, all employers must purchase worker’s compensation insurance or be self insured. Generally, the system can offer both employees and employers benefits that each would not receive in a lawsuit for an injury suffered on the job. For the employee: workers’ compensation claims usually resolve quicker than other personal injury cases, so employees are able to receive their benefits sooner. Additionally, the workers’ compensation system is a no-fault system, meaning that, under this system, even if employees are negligent, they can still recover damages. For the employer: there are limits to liability, and employers pay only limited damages within each state’s statute. Damages employers pay include medical expenses, disability benefits, partial wage replacement (usually about 2/3 of regular income), and death benefits. Employees cannot seek punitive damages, pain and suffering, or injunctions through workers’ compensation.

Although workers’ compensation coverage is broad and covers most employees, there are some exclusions. These exclusions include smaller employers, part-time/temporary/seasonal workers, and certain industries. For covered employees there are four requirements to establish a workers’ compensation claim. First, there must be a personal injury as defined by each state. Second, the injury must be from an accident. Third, the injury must arise out of employment i.e. there is a causal connection of the risks that result in the claimant’s injury and the job including personal risks (e.g., a worker with a pre-existing condition), and neutral risks (e.g., a natural disaster such as an earthquake.) The final requirement for a workers' compensation claim is that the injury must occur within the course of employment. This requirement looks at the time, place, and circumstances surrounding the injury. If the injury occurs within the employment period, at a location an employee may reasonably be, and while the employee is engaged in work duties, a claimant satisfies

For more information regarding workers’ compensation in California, visit http://www.dir.ca.gov/DWC/.

6. What are the rules for Non-Compete Clauses in California

Generally, any clause restricting a person’s right to work is invalid. California Business and Professions Code 16600 states that “every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” This reflects California’s strong public policy in favor of ensuring a person’s right to pursue employment. One of the narrow exceptions to 16600 is when someone sells the “goodwill” of their business, and may be prohibited from continuing in a similar business in a specified geographic area. .

7. What are some legally required employer recordkeeping requirements?

Federal regulations require employers to keep employment and personnel records, but record keeping requirements vary for each regulation.

Documents relating to HIPAA privacy records and documents required by the retirement and welfare plan (Form 5500 under ERISA) must be kept for six years. The Age Discrimination in Employment Act (“ADEA”) requires employers to keep all payroll records for three years. (Payroll records contain information such as the worker’s name, address, occupation, rate of pay, hours worked, total wages earned deductions and net pay for a pay period.) Under the Fair labor Standards Act (“FLSA”) employers must keep all payroll records for at least three years. Employers must also keep any employee benefit plan, any written seniority or merit system, for the full period the plan is in effect, and for at least one year after termination of the plan. Employers must also keep for at least two years all records demonstrating the basis for paying different wages to opposite sex employees, including wage rates, job evaluations, seniority and merit systems, and collective bargaining agreements. For more information on FLSA recordkeeping requirements, visit http://www.dol.gov/whd/regs/compliance/whdfs21.htm.

The Family Medical Leave Act (“FMLA”) requires employers to comport with FLSA recordkeeping. For more information on FMLA requirements, visit http://www.dol.gov/compliance/guide/fmla.htm#records. The Equal Employment Opportunity Commission (“EEOC”) requires employers keep all personnel or employment records for one year, and if an employee is involuntarily terminated, the records must be kept for one year from the date of termination.

8. What is Employment at Will

The employment-at-will doctrine refers to the presumption that unless there is a law, an agreement or policy to the contrary (see below), employment is for an indefinite period of time. When employment is at will, an employer can terminate an employee at any time for any reason, (except an illegal one), or for no reason at all. Similarly, an employee is free to leave a job at any time for any or no reason without adverse legal consequences. At-will employment, also means that an employer can change the terms of the employment relationship (e.g., schedule change, demotion, reduce wages, etc.) with no notice without legal consequences. Employment relationships are presumed to be “at-will” in all states except Montana.

The at-will presumption is the default rule unless there is evidence of parties affirmatively entering a different form of relationship, such as through a written contract. There are also other circumstances that can overcome the at-will presumption such as: public policy, implied contract, and implied covenant of good faith. Almost every state has created exceptions to the at-will presumption for public policy. Examples of this are that an employee may not be fired: for refusing to perform an act that state law prohibits; for reporting a violation of law; for engaging in acts that are in the public interest; or, for exercising a statutory right.