Relaxing The Ban On General Solicitation

by Joe Wallin on January 23, 2012 in Angel Financing, Angel Investors, Capital, Investors, Rule 506, SEC, Seed, Venture Capital, Venture Funds with No comments

Raising capital is tough and using all of the free social media resources available to you is tempting. However, under current law, if you are a startup trying to raise capital, you have to be extremely careful how you go about it.

If you plan on using the most common securities law exemption for startups, Securities and Exchange Commission (SEC) Rule 506, you can’t post to the world at large on Twitter, LinkedIn, or Facebook, that your company is trying to raise funds.

SEC Rules

One of the conditions of Rule 506 is the ban on general solicitation. The ban on general solicitation is described in accompanying Rule 502 and provides:

Limitation on manner of offering. Except as provided in Rule 504(b)(1), neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not limited to, the following:

  1. Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and
  2. Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising;

Thus, if you post on Facebook, or LinkedIn, or Twitter that your company is raising funds, then your announcement to the world would violate the rules of your exemption, and you could get in plenty of trouble.

For example – Last year the SEC initiated proceedings against two individuals who launched a campaign to buy a company through solicitation of prospective investors on Facebook and Twitter without first registering the securities with the SEC and making the disclosures that accompany registration. You can read the story on the Securities Exchange Commission website.

Unbalanced General Solicitation Rules

This law banning general solicitation makes life more difficult for startups. Startups suffer an asymmetrical disadvantage compared to those with capital who are looking to make investments.

Think about it, if you have money to invest, you can tell the world about it, and companies will come to you seeking your investment. But if you are a company wishing to attract investment capital, the SEC limits you as to who, when, and how you tell the world about it.

The ban on general solicitation for startups slows down companies that are trying to raise capital and makes raising capital more difficult. This is unfortunate since according to studies done by the Kauffman Foundation, new companies create the bulk of the new jobs in this country.

Is Change On The Way?

Congress is attempting to address the issue. The House passed a bill repealing the ban on general solicitation. But the Senate has yet to act.

On January 6, 2012, the SEC’s Advisory Committee on Small and Emerging Companies chimed in. You can read their full recommendation (embedded) below. But the punchline was:

THEREFORE, the Advisory Committee recommends that the Commission take immediate action to relax or modify the restrictions on general solicitation and general advertising to permit general solicitation and general advertising in private offerings of securities under Rule 506 where securities are sold only to accredited investors.

The full recommendation of the committee is embedded below.

For More Info on Raising Capital:

Send Me A Gibber!

by Joe Wallin on January 5, 2012 in Gadgets, Mobile, Mobile Technology, New Technology, Technology with No comments

The great thing about technology is it keeps getting better at helping us communicate. Now, there is a new tool, which helps fill out another slice of the communication spectrum. Click on the step-by-step pictures for a larger view.

1) Find app

Gibberin allows you to send spoken messages to your contacts through an easy to use iPhone app. So, for example, if you want to send someone a quick note, but don’t want to type out a text message or an email, you can simply hit a button, record a voice-note (aka a “gibber”), and send that note to whomever you like.  There is no conversion to text.  They get the full benefit of the pace, inflection, emotion and emphasis in your recorded note. The recipient can easily reply via Gibberin, using the app in the same manner.

2) Create acct

This is easier than calling me, and having to wait for my voicemail (and risk actually having to talk to me!).

3) Find contacts

Install the Gibberin app on your iPhone and send me a Gibber. My handle is joe!

Here is how you use Gibberin:

First, download it from the app store. You can find it at the iTunes Store here. The app isfree.

4) Gibber

Next, on the contacts page, hit the + button, and under the user name, enter my user name “joe.”

Next, send me a gibber!

****

Disclaimer: Gibberin is a client of DWT.

SEC Issues Final Rules On The “Accredited Investor” Net Worth Standard

by Joe Wallin on December 31, 2011 in accredited investor, Dodd-Frank, SEC with No comments

The Securities Exchange Commission (SEC) has now issued the final amendments to the accredited investor standards that were prompted by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank required the SEC to revise its rules to exclude the value of a person’s “primary residence” for purposes of determining whether the person qualifies as an “accredited investor” on the basis of having a net worth in excess of $1M.

Because the Dodd-Frank Act required that the value of an investor’s primary residence be excluded from net worth, questions arose about how debt on a primary residence should be treated. For example, should debt on a primary residence be included in the net worth calculation, even if the total value of the residence was excluded?

The SEC’s proposed rules adopted a pragmatic, common sense approach. Net worth must exclude the value of a primary residence as an asset, can exclude debt on such residence up to the FMV of the primary residence, but must take into account the debt on the primary residence in excess of such FMV.

The final rules are substantially similar to the proposed rules, with one twist. The final rules say that debt secured by the primary residence, up to the estimated fair market value of the primary residence, doesn’t count against net worth–except for increases in primary residence debt incurred within 60 days of the sale of the securities. If you increase your debt secured by your primary residence within 60 days prior to purchasing securities, such increase must be counted as a liability.

In summary, in determining an investor’s net worth (assets over liabilities):

  1. Exclude an investor’s primary residence as an asset;
  2. Exclude debt secured by the primary residence, up to the estimated fair market value of the residence;
  3. Include the amount of any increase on the debt secured by the primary residence incurred within 60 days prior to the purchase of the securities (unless related to the acquisition of the primary residence); and
  4. Include debt in excess of the fair market value of the primary residence.

You see, wasn’t that easy?

The rules are effective February 27, 2012.

The final amendments are as follows:

(a) * * *

(5) Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000.

(i) Except as provided in paragraph (a)(5)(ii) of this section, for purposes of calculating net worth under this paragraph (a)(5):

(A) The person’s primary residence shall not be included as an asset;

(B) Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (except that if the amount of such indebtedness outstanding at the time of sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess shall be included as a liability); and

(C) Indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities shall be included as a liability;

(ii) Paragraph (a)(5)(i) of this section will not apply to any calculation of a person’s net worth made in connection with a purchase of securities in accordance with a right to purchase such securities, provided that

(A) Such right was held by the person on July 20, 2010;

(B) The person qualified as an accredited investor on the basis of net worth at the time the person acquired such right; and

(C) The person held securities of the same issuer, other than such right, on July 20, 2010.

For More Information About SEC Rules:

Qualified Small Business Stock (QSBS) Year-End Considerations

by StartUpAdmin on December 21, 2011 in AMT, QSB Stock, Stock Grant with No comments

By Dan Wright

Noncorporate investors who sold or plan to sell QSBS in 2011 and are expecting a large tax windfall under Section 1202 of the I.R.C. (“Section 1202”) will likely be disappointed. In general, the tax break under Section 1202 for gain realized by a noncorporate investor on the sale or exchange of QSBS in 2011, which is held by such investor as a capital asset and for a period of over 5 years, is about 1%. So why are people making such a big deal about Section 1202 as this year comes to a close?

Noncorporate investors who acquire QSBS after September 27, 2010, and before January 1, 2012, hold the stock for over 5 years, and then sell the stock at a gain will generally be able to exclude 100% of such gain (up to a minimum of $10 million) for both regular tax and AMT purposes. That’s right, potentially a 0% federal income tax! Of course, this assumes all of the other tests in the fine print of the rules are satisfied.

If you are looking for ways to take advantage of Section 1202 before year-end, here are some considerations:

  1. If you have a business that is held as a sole proprietorship, a single-member LLC or a partnership, then you should consider incorporating the business by the end of the year. For the 100% exclusion under Section 1202 to apply, the business has to be held as a domestic “C” corporation when the QSBS is issued to the investor or founder and during substantially all of their holding period of the QSBS. If the business has always had less than $50 million in gross assets, the owners who receive original issue stock upon incorporation of the business can generally qualify for the 100% exclusion under Section 1202 (assuming all other tests are met). However, incorporating a business can have unexpected immediate and long-term tax and legal consequences, so be sure to get good advice before making the change.
  2. If you are considering issuing stock options to key employees, board members, or service providers before the end of the year, think about using restricted stock instead. A stock option itself likely cannot qualify as QSBS, but stock received by exercising options likely can become QSBS on the date the option is exercised (i.e., when the stock is actually received), assuming the applicable requirements are met. On the other hand, restricted stock (with respect to which a valid Section 83(b) election is made at the time of issuance) likely can become QSBS when received, assuming the applicable requirements are met.
  3. Make sure that investors actually receive stock before the end of 2011. Having the investor cut a check to the company in 2011 which will be held by the company until the round closes and the stock is issued to investors (in 2012) will not likely qualify the stock for the 100% exclusion under Section 1202. In other words, the classic “rolling close” on an investment round could be a problem for investors, if the close doesn’t occur before January 1, 2012.
  4. If you are a CEO of a start-up, make sure that the company meets the detailed requirements under Section 1202 before you make any representations to potential investors. Because the 100% exclusion under Section 1202 is so beneficial to investors, this could become very contentious in 5 years when an investor is seeking the benefit in the midst of a delicate exit event. Few things are worse than having a disgruntled investor around when trying to close a deal. These requirements are much more complex than many executives (and even their advisors) often realize.
  5. If you do invest in QSBS in 2011, track your purchase date (and cost basis) carefully. You don’t want to find out after the fact that you sold your stock too early to enjoy the 100% exclusion under Section 1202.
  6. Want to make an investment through a pass-through entity? A partnership or “S” corporation can hold QSBS. As a partner/shareholder of such pass-through entity you can generally still enjoy the 100% exclusion under Section 1202 with respect to gain realized by the entity on the sale of QSBS allocated to you provided the applicable requirements are met. However, a requirement for the 100% exclusion under Section 1202 is that you must be a partner/shareholder on the date on which the pass-through entity acquired the QSBS and at all times thereafter until the entity sells the QSBS.
  7. Do you hold a convertible note issued by a qualified small business? You should consider converting the note before the end of 2011. Although a convertible note itself cannot qualify as QSBS, stock received by converting the note likely can become QSBS on the date the stock is issued, assuming the applicable requirements are met. Of course, to obtain the benefit of the 100% exclusion under Section 1202, the conversion would need to be completed (i.e., you receive your stock) before January 1, 2012. If you convert after the end of the year, the stock will be issued after the cut-off date, and it will not qualify for the 100% exclusion under Section 1202.

QSBS

Dan Wright is a CPA and a tax consultant with Clark Nuber P.S. in Bellevue where his practice focuses on serving emerging businesses. His areas of expertise include federal and state taxation of technology companies, executive compensation arrangements, choice of business entity issues, and business buy/sell/combination transactions. Dan holds a Master’s in Taxation degree from Brigham Young University. He enjoys hiking, biking and playing blues guitar.

*Please note that the views and opinions expressed in this guest blog post are not necessarily that of Davis Wright Tremaine and Joe Wallin.

For More Information:

Financial Boot Camp

by StartUpAdmin on December 16, 2011 in Finance, Gains, Tax with No comments

Financial Boot Camp is a three-class series designed to teach basic financial principles, demystify financial jargon, and provide a competitive advantage for non-financial professionals. Take one, two or all three seminars and gain financial knowledge you can use in the workplace.

Each seminar is taught by Diane Renihan, founder and principal of Ballantrae, LLC, an advisory firm providing interim, high-level CFO services to small- and medium-sized companies. Diane has more than 20 years of experience as a finance and accounting professional and has served as CFO of several dynamic, rapid growth companies – both public and private.

“Finance, like HR, is one of those critical areas where many founders/CEOs and executives lack expertise and interest. Diane’s “boot camp” approach makes learning the financial workings of any organization simple and fun. It’s timely and practical and I recommend it for anyone operating in today’s business environment!” – Shannon Swift, Swift HR Solutions

Financial Boot Camp provides much more than just financial theory. Real world examples bring financial basics to life and make it relevant to your everyday job responsibilities. And Diane knows how to explain complex financial concepts in readily understandable and practical ways!

Who should attend? Non-financial professionals looking to learn the “language” of finance. Looking to enhance your financial acumen and make yourself more relevant/invaluable in your current position? Financial Boot Camp can help level the playing field when partnering with financial executives and help you contribute to your organization’s profitability.

What will be covered? Financial Boot Camp covers key topics focused on:

Financial Fundamentals: Learn basic financial concepts and terminology. Seminar materials include a glossary of terms and acronyms to build a foundation in the “language” of finance. This is a prerequisite for the other two seminars.

  • Date: January 18, 2012
  • Location: Mercer Island Community Center (Parking is free!)
  • Time: Registration opens at 8:45a.m. Seminar from 9 a.m. to noon

The Story Behind the Numbers: Unlock the mystery of the three key financial statements—the balance sheet, income statement, and cash flow statement. Learn to make better financial decisions based on the true story the numbers tell.

  • Date: January 25, 2012
  • Location: Mercer Island Community Center (Parking is free!)
  • Time: Registration opens at 8:45a.m. Seminar from 9 a.m. to noon

Demystifying the Budgeting Process: Learn about developing a budget, who needs to be involved, and how it relates to the strategic plan. Explore the difference between top down, bottom up, and zero based budgeting.

  • Date: February 1, 2012
  • Location: Mercer Island Community Center (Parking is free!)
  • Time: Registration opens at 8:45a.m. Seminar from 9 a.m. to noon

Enrollment

Cost per seminar is $201. Or take the entire series for $501. To enroll, go to www.BallantraeLLC.com/bootcamp. Space is limited to 30 participants, so enroll early!

For additional information, call 206-669-8129 or email info@BallantraeLLC.com.

*Please note: This seminar is not sponsored by Davis Wright Tremaine or Joe Wallin. All information or views forwarded within the seminar are strictly that of it’s presenters and organizers.

State Legislature Faced with More Difficult Budget Choices – Time for a Tax Increase?

by StartUpAdmin on December 8, 2011 in B&O Tax, Tax with No comments

By Lewis McMurran 

Washington’s most recent revenue forecast for the current 2011-13 biennium was lowered once again.  The state legislature uses this quarterly forecast to craft their two year budget, which runs from July 1, 2011 until June 30, 2013.

While we are not technically in a recession as economic growth is in positive territory, the growth of tax revenue is much slower than previous recoveries.  This is occurring despite the hiring spree that the tech and aerospace industries have been on for the last couple years.  The ag/farming and trade sectors are also doing well.  Construction/real estate and auto sales are still slow, which generate high levels of sales tax that Washington relies on as its primary revenue source.  You can read the full text in the Washington State Economic and Revenue Forecast.

The state’s revenue projections are now $1.7 billion lower than the March 2011, on which the 2011-13 budget is based.  This is clearly a significant drop that makes providing government services and education more difficult.  The legislature needed a special session in May to do all the cuts necessary to be in balance.  States generally cannot incur budget deficits the way the federal government can.  The 2011-13 budget currently stands at $32.2 billion.  For comparison purposes, the 2007-09 budget was $32.5 Bil and 2009-11’s was $30.17 Bil.

We can debate the efficacy of state spending on K-12, higher education, health care, social services, correction and environment until we are blue in the face but it doesn’t change the fact the legislature has difficult choices to make.  They should not have ramped up health care and social services when times were good.  They should have put a brake on state employee pension and health care costs and COLAs for retirees years ago.  They should have implemented reforms to K-12 compensation schemes to reward performance over seniority, etc.

But many of these reforms have now been put in place (not yet in K-12) and now we need to move forward.  One of the biggest concerns for the technology industry and for business in general is the continued reduction in state support for higher education.  The colleges and universities have taken real cuts to the point where the state covers only 30% of the cost of attending college.  Tuition has gone up at every institution and it is students and parents who are bearing it.  Washington’s universities are still a good deal overall but for middle and lower income households the burden has increased significantly.

At the same time, young people have gotten the message that getting a 2 or 4 year degree helps them get employed and increases opportunity.  Displaced and laid off workers are seeking retraining at community colleges to update their skills.  This means there is greater demand for higher education than ever before.  But the reduction in state support limits access and will eventually erode quality.  Tuition increases mean that colleges and universities do not have to take as many out of state students to cover their costs.  UW will be experimenting with “differential tuition”.  This means charging more for higher cost degrees.  Engineering and bio-related majors are more expensive due to the cost of labs and equipment.

For businesses and citizens alike the question now is a tax increase of some type acceptable in the face of more budget cuts, especially in higher education.  Gov. Gregoire has proposed a half cent increase in the state portion of the sales tax (from 6.5% to 7.0%) for three years.  You can peruse the governor’s proposal in Revenue Alternatives for Building a Better Future.

A half cent increase in the sales tax “buys back” cuts to K-12 and higher education.  These two areas of the budget are critically important to the state’s future.  While education reform has been painfully slow, there are many signs of improvement in student achievement.  Math and science are getting more focus and attention.  Students have to pass a math test to graduate from high school, with the science requirement coming in 2015.

The advantages of a sales tax increase are that it is spread broadly over the taxpaying public—both businesses and consumers pay it.  It raises substantial money—over $400 million annually. It is also billed as temporary.

At this point, a temporary sales tax increase likely will not kill job creation or be a drag on the economy.  An extra half cent probably won’t stop anyone from buying a car or an appliance if they need it.

But let us also remember that the technology industry had its B&O tax rate increased 20% in 2010, from 1.5% to 1.8% of gross receipts.  This applies to all companies under the “services” category except biotech-related.  This is set to expire in 2013.  The tech industry has also had to absorb the sales tax on digital goods and products that has been difficult for smaller companies to handle.

There is some discussion of curtailing the B&O credit for R&D but no specific proposals have emerged yet.  The bottom line is that the state’s tech-based industries need engineers—aeronautical, electrical, mechanical and software—badly.  The state’s higher education system needs more state support to provide access and maintain quality.  The state’s technology industries are growing and need talent more than anything else.  If a temporary sales tax increase can help with supplying talent to the state’s most dynamic industries, then it may well be worth it.

Lewis McMurran ~ is currently Vice President of Government and External Affairs for Washington Technology Industry Association. He has been with the Washington Technology Industry Association since September of 2000. He is responsible for and directs the Washington Technology Industry Association’s lobbying and advocacy efforts at the local, state and federal level working with elected officials, educational institutions, business and civic associations. Mr. McMurran leads the WTIA’s policy development in conjunction with the WTIA Board of Directors and Government Affairs Group.

*The views expressed in this guest blog post express the views of the guest blogger and not those of Joe Wallin or Davis Wright Tremaine.

For More Information About Taxes:

New, Higher Tax Proposals Floating Around Olympia

by StartUpAdmin on December 6, 2011 in B&O Tax, Tax with 5 Comments

By Joe Wallin

In 2010, Washington voters resoundingly rejected adopting an income tax (I-1098) on individuals earning more than $200,000 per year, or couples earning more than $400,000. However, the issue is once again potentially alive.

Tucked deep in Governor Gregoire’s revenue proposals, titled Revenue Alternatives For Building A Better Future, is the idea of repealing the B&O tax (business and occupation tax) exemption on wages earned in excess of $250,000, and collecting tax at the “services and other” rate of 1.8%. You can find the text of the proposal here, but the graphic below shows the full text.

Also potentially on the table is a 5% excise tax on net capital gains on Washington residents. My partner Dick Giseburt says these taxes would arguably be unconstitutional income taxes under the Washington state constitution.

The Status Quo

If you are not familiar with Washington’s tax system, as it stands, the state doesn’t have an “income tax” as that term is traditionally understood. Instead, Washington State has a gross receipts tax, at several different flat rates depending on the business, with generally very limited exemptions, deductions or credits. This gross receipts tax applies to businesses and certain occupations.

For example ~ if you are in the business of providing independent contractor services outside the construction industry, you pay the B&O tax on your gross receipts from those services at the current “services and other” rate of 1.8%. Thus, it is not entirely true to say that Washington does not have an income tax. It has something very similar to an income tax that applies to persons in business. And it is easy to forget that this tax would apply to employee wages but for a carveout from wages specifically set forth in the statute in RCW 82.04.360.

That statute provides:

(1) This chapter [the B&O tax] does not apply to any person in respect to his or her employment in the capacity of an employee or servant as distinguished from that of an independent contractor. For the purposes of this section, the definition of employee includes those persons that are defined in section 3121(d)(3)(B) of the federal internal revenue code of 1986, as amended through January 1, 1991.

Theoretically, ignoring the potential constitutional defects, all the legislature would have to do is repeal RCW 82.04.360 to impose our “B&O” tax on all employees in this state.

For years, many directors serving on boards “forgot” that they owed the B&O tax on non-employee director fees. But the legislature reminded them in the 2010 legislative sessions about their obligations by passing specific amendments to RCW 82.04.360 that resolved any doubt about this issue.

Exercising the Excise

It will be interesting to see how the legislature responds to these two ideas, if at all, given the defeat Initiative 1098 took at the polls not too long ago. One of the arguments last year made against Initiative 1098 was that the tax would not have been deductible for federal income tax purposes because “excise” taxes are not deductible for federal income tax purposes. This argument would seemingly apply with even more force to the Governor’s new proposal–because her proposal is clearly an excise tax.

How would imposing the gross receipts tax on wages in excess of $250,000 affect startups? Arguably, very little, in the sense that most employees in most startups don’t receive wages greater than $250,000. But perhaps the income and the proposed capital gains tax would affect Washington startups by crimping the supply of capital available to invest in startups. Imposing an income tax might also cause companies that are considering relocating here not to. Of course, all of these arguments make great debate material, especially because it is so hard to find hard empirical data on the impact of taxes like these on things like startup formation and job creation.

The great thing about the Seattle community is that we have public debates about these matters. Last year, we hosted a forum about I-1098 where Bill Gates Sr., Nick Hanauer, Matt McIlwain and Lew McMurran vigorously debated the pros and cons of an income tax in Washington, from the effects on revenue to the effects on business and job creation.

Nick Hanauer is still concerned about this issue and just penned a great editorial in Bloomberg where he says:

“I can say with confidence that rich people don’t create jobs, nor do businesses, large or small. What does lead to more employment is the feedback loop between customers and businesses. And only consumers can set in motion a virtuous cycle that allows companies to survive and thrive and business owners to hire. An ordinary middle-class consumer is far more of a job creator than I ever have been or ever will be.”

Two Cents Worth of Sense

It will be interesting to see how these potential tax proposals play out in Olympia and throughout the state. I am sure if these proposals advance, we will have many great debates about them.

Read more on B&O and excise taxes:

Gamification: Applying Video Game Mechanics to Your Business

by StartUpAdmin on December 5, 2011 in Start Up Lawyer with No comments

Video game mechanics are more and more becoming a part of our everyday lives (otherwise known as gamification), even if you don’t realize it. Video games entrance us for all sorts of reasons, and that’s why so many people and companies are spending so much time and effort applying the methods and mechanics of the gaming experience to different aspects of our lives.

A Class For Everyone

New developments in gamification and the laws surrounding it will be the focus of an upcoming class at Davis Wright Tremaine titled, An Introduction to Video Games and Gamification. In it DWT faculty will be reviewing the use of game mechanics in:

  • Loyalty programs – Programs that increase customer brand loyalty through rewards programs, incentives, and brand involvement.
  • Customer and corporate behavior – Understanding how customers interact with the brand through game mechanics.
  • Customer and corporate perception – Applying game mechanics to form or change perception.

This class will introduce you to the unique issues associated with developing, using, and integrating video games and game mechanics into your organization. You will also learn what you need to know about ownership, regulatory issues, and risks.

Presented by Kraig Baker – a DWT partner who focuses on advising clients with respect to issues in media, entertainment, technology, advertising, privacy and Internet matters, with a particular emphasis on digital media and entertainment.

Where: Davis Wright Tremaine LLP


1201 Third Avenue, Suite 2200, Seattle, WA 98101

When: Wednesday, December 14, 2011

8:00 – 9:00 a.m.

There is no cost to attend this program, and you can get CLE credits for attending this class. Please email LaceyVinson@dwt.com if you are interested in attending or viewing the program via webcast.

“America Invents Act” Patent Law Overhaul: The Benefits and the Drawbacks

by StartUpAdmin on November 17, 2011 in About, Gadgets, New Technology with 1 Comment

By George Rondeau

“A good idea is never lost. Even though its originator or possessor may die without publicizing it, it will someday be reborn in the mind of another.” ~ Thomas Edison

As any inventor or innovator will tell you, an invention will never work without proper timing. This means that society has to be prepared to accept it, technology must be in place to be able to accommodate it, and the economic climate needs to be just right for it to move forward past the idea phase. However, securing a patent for that invention is all about timing, too, and inventors need to be aware of some recent drastic changes.

The Leahy-Smith America Invents Act (AIA) was signed into law by President Obama on September 16, 2011 and it constitutes the most significant overhaul of the U.S. patent system in decades. The provisions discussed go into effect on March 16, 2013; other provisions of the AIA start sooner.

With these changes, the U.S. has created two paths to winning the patent race:

One - Be the first to file a patent application (assuming nobody makes a public disclosure of the invention before you file the application).

Two - Be the first to publicly disclose the invention (assuming nobody files an application on the invention before your public disclosure). Of course, filing a patent application takes time and costs money, whereas making a public disclosure of the invention can be done quickly at no cost.

Conversion to “First-to-File System”

The AIA changes the U.S. from a “first-to-invent” system to a “first-to-file” system similar to the system used in most other countries but with a significant U.S. twist.  Under this provision of the AIA, which takes effect in 18 months (i.e., on March 16, 2013), an inventor may win the race to create an invention but lose the race to file a patent application on the invention, thereby being unable to patent his invention despite being the first to invent.

The US original “first-to-invent” system protected the first inventor. It allowed the applicant of a later-filed patent application to antedate or “swear behind” another inventor’s application by proving that the applicant conceived of his invention before the invention conception date of the other inventor.  In contrast, the “first-to-file” system used in most other countries simply awards the patent to the applicant with the earliest filing date.

Expectations from the changes:

  • Whoever files a patent application on an invention first will be entitled to a patent over another inventor who later files an application on the same invention, regardless of who was first to make the invention. This applies to the situation where multiple inventors independently invent the same invention.
  • The “first-to-file” system eliminates patent interferences, a type of proceeding before the Patent Office to determine who among multiple applicants claiming the same invention invented first.  The “first-to-invent” system often made it very difficult to know who had the valid patent rights between two pending applications on the same invention without engaging in an expensive interference proceeding conducted by the Patent Office.
  • Determining whether the inventor of a patent alleged to be infringed was the first inventor could also be decided by the court as an invalidity defense in an infringement action since prior invention by another was sufficient to invalidate a patent.  No longer will this defense be available.
  • Questions of conception, diligence, reduction to practice, abandonment, suppression, and concealment will no longer need to be answered, thus simplifying the determination of which of multiple inventors should hold valid patent rights and make the determination less expensive.
  • Eliminating the first-to-invent system also eliminates the ability of an inventor to swear his invention behind a prior art reference with an effective date no more than one year earlier.  The invention date simply has no significance under the AIA.

A Hybrid System

While the AIA has described the changes as an attempt to harmonize U.S. patent laws with those of most other countries, in actuality, the AIA created a new system unique to the United States. Some of the unique features are:

  • “Absolute novelty standard” versus grace period - Most countries have an “absolute novelty standard” (i.e., if the invention is rolled out to the public prior to the patent application date it is unpatentable), whereas the U.S. continues to provide inventors with a one-year grace period for public disclosures by the inventor.
  • Prior art exception - When an inventor makes the first public disclosure of an invention, for a one-year period afterward public disclosures and patent applications filed by others for the same invention are not considered to be prior art.
  • First impact of the first public disclosure – The first public disclosure prevents a subsequent disclosure of the invention by another true inventor from being prior art for one year against the subsequently filed application of the inventor who made the first public disclosure.
  • Second impact of the first public disclosure - Even if another true inventor files a patent application before the first-to-disclose inventor files his application, and thus is the first-to-file inventor, the first filed application is not prior art against the second filed application by the first-to-disclose inventor for one year.
  • Getting There First – Effectively, by making the first public disclosure of the invention, the first-to-disclose inventor gets a one year grace period in which to file his application without his own public disclosure being prior art against him, without another inventor being able to block him by filing the first application on the invention and without a subsequent public disclosure by another inventor being prior art.

Things to Watch Out For

One downside to using the “first-to-disclose” approach is the impact on foreign patent rights. As noted, in most countries a public disclosure before filing a patent application immediately results in loss of patent rights in that country, most times without regard to where the public disclosure occurred.  When foreign patent rights are not of concern, being first to publicly disclose an invention can be a winning strategy and is particularly attractive for a start-up or any company short on cash.  If the first-to-disclose approach is used, it is suggested that a provisional patent application also be filed at the same time, particularly if the public disclosure is a sale or disclosure of a product which may not include all invention details or alternative implementations which are desired to be protected.

Another potential downside is that the first-to-disclose inventor may find another person has derived/copied the invention and filed his own application before the first-to-disclose inventor files his application. This puts the first-to-disclose inventor under the burden of identifying such an application exists and proving the other person copied, or seeking to invalidate in a court the patent that results if it has already issued. This can be costly, and if a patent does issue to another inventor, it could create serious problems with potential investors and customers.

The window for such challenges is limited. If timely action is not taken, the opportunity to make the challenge will be lost and the first-to-disclose inventor may find his patent application blocked by the application or patent of the first-to-file inventor who derived/copied the invention from the public disclosure made by the first-to-disclose inventor.

George Rondeau – DWT Partner - practices intellectual property (IP) law, including domestic and international patent and trademark procurement, patentability and trademark registrability opinions, infringement and validity studies, infringement avoidance and due diligence reviews, portfolio analysis, and licensing of patents, trademarks and technology. He also counsels clients on IP strategic planning and dispute resolution and enforcement. In addition, George provides ongoing strategy and analysis support in patent litigation matters. His patent practice covers electrical, mechanical, and computer software/hardware inventions.

For other info about great ideas:

SEC Proposed “Bad Actor” Rules: Hard On Startups And Early Stage Companies

by StartUpAdmin on November 9, 2011 in bad actors, Regulation D, Rule 506, SEC, Start Ups with No comments

The Securities and Exchange Commission (SEC) has proposed new rules that will make it substantially more costly and difficult for startups and early stage companies to raise capital. These rules are designed to ensure that what they have labeled as “bad actors” are not involved in the securities offering business. No, these rules won’t spare you from any bad movies.

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