Featured in Alltop StartUpRoar

Thursday, March 31, 2011

Getting Rights to the Technology

If you have read my preceding articles, you now have an idea of the energy it takes to protect your products and create the startup.  The next segments will address a search and acquisition of the rights to the technology for your intended products.  Please keep in mind that most likely the technology you can afford will be very early in the development process and take a lot of effort to develop it to a point that will attract funding.  You are likely to have a few years before you obtain significant funding and that may only come after you have developed the product enough for partners or investors to assess the value of the technology and likelihood of success.  You will have even longer before you will have something to sell.  Most of the first few years you may even be working with little or no pay and have little or no money to advance the technology closer to a product stage.  You will have to piece together enough resources to develop a data package strong enough to attract investors or a partner and this will ultimately make your presentations and business plan look much stronger. 

You are now ready to search for technology for your company.  The company may have been formed or you plan to form the company once you acquire technology rights.  The first concern you will have will be to select a technology you are excited about.  That said, you must make sure the technology fits in the market place in a sector that has substantial sales potential.  You will also need to explore time to market, costs to get to market, patent coverage after product launch, and competition.  Most of these and other points will go into your business plan; a topic I will discuss later in this blog.  In short, WHERE IS THE MONEY AND WHEN DO I GET IT!  Remember this will be a business and that you will always have to present it that way.  Investors and potential partners do not care about lifestyle or other considerations, they are interested in the business prospects and you should be too.

In selecting the technology, you may already have IP or inventors identified but not have the rights yet.  Make sure you conduct your own diligence review before entering into a negotiation for the rights; business criteria and IP criteria need to be a fit.  Maybe you know a field, but have not identified a specific technology yet.  For example, you want to create a new type of solar panel or a treatment for diabetes.  A good place to search for IP is the technology transfer office associated with Universities and Government laboratories.  Many of these institutions have websites listing available technologies and they provide the correct person to contact to start your discussions.  If you have significant financial resources, you could contact large companies to see if they have technology or later stage products they wish to license out or sell.  The value of what the technology will cost you will depend on the area, competition for the IP, prospective future sales, and stage of development. 

Your search needs to be focused as does your product development plan.  Remember this is a business.  What is the end product, how long to get there, what is the market, and how much will it cost?   The product you want to sell must have a real market sufficient to attract partners or investors.  By that, I mean you need multi-million in sales and earnings.

In selecting IP, sometimes it is possible to find a patent that is an umbrella patent covering a field and allowing for multiple products.  This type of opportunity can be very attractive as it can lead to multiple products to sell.  On the other hand, a failure of one product can cause investors to be shy about other offerings in the portfolio even if they are likely to be great products.

You may have identified several products that fit together in a common theme.  This means several negotiations to the rights.  Singular products are a bit tougher to get funded, but it is possible if the market opportunity is right and the risk of development is low enough.

In approaching your negotiations for technology, I am recommending you read an article from Inc.  “10 Tips for Licensing Intellectual Property”: http://bit.ly/fj3qcQ .  Interestingly, these are tips for you in the future, but for now think of them as tips for the groups you intend to license a product from.  Your first lesson in this process is that you will be asking someone or some agency to allow you to have the rights to what could be a valuable asset. There are two types of diligence that take place in any of these transactions.  You review what you want to buy, and they review whether you are someone they believe can be trusted with their assets.  You can be almost certain they will put “claw back” provisions in the final license to allow them to recover the assets if you fail to move it along in a reasonable time frame; i.e. why tie up valuable assets with someone that cannot develop them.

Having no money is the most difficult place to start a discussion to obtain technology, but it is not a deal killer.  You can either try to obtain an option to license the technology or develop a license with a milestone that allows the owners to have the technology back if you are unable to raise capital or develop the product(s).  In this scenario, you offer payments for the right to market the technology and raise capital or find a partner.  The deal is made final at the closing of a financing or some other event.  Sometimes you can negotiate an ability to get option extensions without making extra payments, or you may be able to negotiate payment schedules low enough to afford.  Some institutions will allow an option extensions with no payments if they feel you are worthy of the risk or they may arrange to extract more after you get funding.

You can work with a knowledgeable person with finance experience to establish a value range for the technology.  One common way to do this is via an NPV (Net Present Value) calculation in a spreadsheet or a second is to determine value based on comparables in the market place. 

There are a number of terms that go to creating the financial input to a license agreement.  Some of the ones that are most commonly negotiated are:  1) option payment 2) upfront license payment, 3) milestone payments, 4) royalties, and 5) equity.  I usually like to negotiate the financial terms early in the discussion before I get legal counsel involved.  If the deal terms do not look like they are heading in a direction that will work for you, paying a lawyer to create a full license agreement makes no sense.  If your counsel or other colleagues have a relationship with the group you are negotiating with, they can be helpful in identifying what you are likely to get accepted and help get your first term sheet be a little closer to an acceptable one.  If you have a Board of Directors, ALWAYS keep them informed and show the term sheets before submitting them to the institution.  Remember, they are your Boss!

An example of one deal I encountered between a company and an institution had terms like:
·       Option payments of $50,000 for a 1 year option
·       Upfront payment $150,000 at signing of definitive agreement
·       Royalties of 5%. A reduction in royalties would possible if a second technology license was required and carried a second royalty on the product; this is an anti-stacking provision and the goal is to not have royalties so high that the product won’t sell or investors or partners can’t make money.
·       Milestones of $250K on completion of Phase 2 clinical trials,  $1MM on completion of Phase 3 clinical trials, $5MM on first sale of product in USA, $5MM on first sale of product in any other country.
·       20% equity with anti-dilution protection through first $5MM of financing.
Other terms were in the 2 page term sheet document, but I wanted to provide you with an idea of the types of terms that are discussed and may be included.  Keep in mind from the minute you walk in the office or first make contact by phone, you are negotiating.  Your attitude, experience, and personality all are being assessed.  They will want to evaluate you as much as you will evaluate them.

Considerations around terms are important and I will try to discuss this more later.  You will need to explore how the licensing terms will alter your cash flow and valuations as you progress. 
I have seen situations where multiple licenses would have been required and would have ended up with potential royalties being additive.  You must account for this as it is a possibility that you could have to pay more money out than you receive.  For example, suppose your aggregate royalties are 12% for multiple licenses and you receive an offer from a BigCo to pay you 10% in royalties on sales of the product.  This means you will be paying 2% more to the institutions that granted you a license than you will make for every item sold; that is not a business.  The financial terms you negotiate are extremely important to the success of your future business.  Don’t take them lightly!

 Taffy Williams is the author of:  Think Agile:  How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon

Wednesday, March 30, 2011

Inventions & Patents are Critical - The Technology Still Needs Development

Inventions and resulting patents lay the ground work for the products your company intends to market.  They protect the company by preventing competition for your products.  Most of all, they facilitate the potential to make money for your investors.  You will find that in any due diligence review potential partners or investor will spend an extensive amount of effort evaluating your NewCo’s patent estate.  You must make sure your patent portfolio is as complete as possible and well maintained.

When you create a new invention keeping it confidential prior to filing for a patent is a must.  Providing information to your patent counsel or technical transfer office (for universities) is the first step in the process.  It is essential that you not present data at conferences or to investors before appropriate filings are done.  You can usually present data after your legal counsel has filed at least a Provisional Patent, but sometimes foreign filings need to be made as well.   As a rule, tell your patent counsel you have meeting you need to present at and have them file what is needed.    It will take time, so do not give a short notice, you may not get the documents completed and filed in time.  Most public disclosures can prevent you from ever obtaining a patent.  Once you reveal the details publicly, the information becomes prior art in the field and will count against you in the patent process; even if you were the inventor.  Prior art is viewed by the patent examiner as public available info relating to your invention.  Patents are issued to cover inventions which are new, novel, and not something obvious to someone in the field.  Prior art will allow the examiner to take a position that the invention was obvious due to public data! 

There are occasions where you may not have the financial resources to file the Provisional Patent and/or foreign patents.  At a minimum, you must have confidentiality in place before you discuss the patent with your potential business partner or investor.  As a cost gauge, fees you might expect to see range $5-20K for initial filing in the USA. By the time you are in full prosecution of international rights aggregate costs may have be more than $50K.  By the time you get worldwide rights, your total fees could have amassed to more than $100K. In addition, expect regular maintenance fees for most countries every few years.  In one company where I managed the patent estate, the company was paying between $250-500K per year for filing and maintenance fees just for the IP which totaled around 50 patents and applications.

There is a high rate of failure to covert patents to profits via product sales!  About 1 in 5000 patents result in a product which is launched.  Roughly, 2 products are launched for every 3000 ideas.  Last time I looked up statistics, about 3,000 patents out of 1.5MM were commercially viable.  Why is this important?  Because you’re overall goal is to make money for your investors.  You will have to be extremely careful about the technology selection process and the IP that protects it. 

Many patents are considered very early stage technology and finding a partner or funding is difficult with only an issued patent.  NewCo is very likely to need to develop the product further or obtain more advanced data to get funding.  The costs vary on the type of product.  Along the way, new discoveries or patent extensions should be filed to enhance the protection.  This is a rather routine thought process in industry.  The overall goal is to extend your exclusivity as long as possible thereby increasing your chance for profits.

Finally, your protection mechanism is via the court system.  Many inventors have told me they will sue for infringement if someone sells a product their NewCo’s patents cover.  Yes, you can do this, but most legal professionals will not take the case on a contingent basis.  This means you may have to pay out of pocket.  In one company, our costs were at $5MM before we settled the case!  The legal process is very expensive and takes years to resolve.  So, take care in your efforts to have a clean IP position and freedom to operate for NewCo’s part.  For others that may infringe on your products, you will have to find your own way at that time.

All of this leaves you with a few ideas of what you need to think about in starting your NewCo. 

·       Do your own due diligence on the IP to the extent you can afford before you complete a licensing agreement for the technology.
·       Take great care in identifying what is covered in any invention you file. Give great thought as to what they cover as well as what they could cover in the future. 

·       Plan for IP costs and the protection of them.  The number of patents you have rights to will escalate your legal costs on an annual basis and increase your cash burn. 

·       Remember that having great patents is essential, having bad patents is costly.

·       Remember where you want to be with your product(s) at launch.  Make sure your intellectual property provides as much protection as possible. Make sure you do not infringe and plan for patent improvements to your estate.

Taffy Williams is the author of:  Think Agile:  How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon 

Tuesday, March 22, 2011

Intellectual Property: How Do I Get Rights to Patents?

There are a few ways to obtain the rights to IP for your NewCo.  Two of the most common are:  INVENT something or ACQUIRE the rights from someone else.  Ownership of patents will is something you will need to devote serious attention to before acquiring rights.  I have had more than one discussion with inventors that believed they owned the rights to the technology in their invention only to find that was not the case.  Inventors do not always have ownership and rights to license the intellectual property they create.  Just make sure you determine you are negotiating with the correct party for rights to inventions!

If you invent the product as sole inventor, you own 100% of the rights: UNLESS, you work for an institution which had you sign documents otherwise.  University faculty members unfamiliar with the dynamics at their institution often do not realize that their employment agreements give invention ownership to their university.  Inventors in industry tend to be more aware that the company owns their inventions and that those rights were provided for in their employment agreements.  This does not mean that the inventors do not get receive financial benefit from their institution or company: many institutions have a mechanism of sharing financial gain with the inventor.  But, for you or your NewCo to obtain licenses or acquisitions of rights to IP, make sure you are negotiating with the CORRECT owner of those technology rights.  

All inventors listed on patents own the intellectual property and equally have a 100% right to practice the invention: if owned by institutions those rights are held by the institutions.  If there are multiple institutions or multiple inventors, each having ownership, you will need to acquire the rights from all inventors or institutions to have EXCLUSIVE ownership of the rights to make a product.  Please don’t overlook this point.  Once when dealing with a licensing activity for a client, I found that there were two inventors each retaining their individual rights and ownership.  Inventor 1 had licensed rights to company 1 which was spending extensive funds to develop a product: i.e., millions of dollars.  Inventor 2 was in the unique position of being able to market and sell his/her rights to company 2.  This had the potential to create a scenario where a possible problem could occur.  If company 1 were to launch their product, company 2 could immediately follow by launching their product without infringing.  Company 1 would have spent large sums of money on development and advertising only to find Company 2 would have been able to sell the same product with minimal expenditures and advertising. This is not a good scenario and investors do not like such surprises.

Assuming you do not have a novel idea for a product to file your own patents, but do have a wish to start a company in a particular area, you will need to seek IP and obtain the rights to build NewCo.  You can also obtain rights to your own inventions if your institution owns those rights.  In seeking new technology or exploring the patent landscape of an invention, you can search patent data bases.  You likely already know that the USA patent website has a search feature.  You can search issued patents and some applications which have not issued via their website: http://USPTO.gov .  There are many search sites which cover US patents and some foreign filings and patents.  I sometimes will use the following links:  http://www.wipo.int/pctdb/en/  or http://www.patentstorm.us/ .  If you have never seen a patent before, you may want to do a search and take a look at some area of interest and get a feeling for what goes in them. 

If you are looking at a patent for the first time, please note there are several sections including:  Abstract, Drawings if applicable, References, Background of Invention, Summary of Invention, Detailed Description, Example(s), and Claims.  The last is a particularly important section as specific claims of the invention are spelled out and these are the key areas of focus when seeking what your rights are relative to the invention.  In preventing someone from selling products covered by you inventions, they must be in violation of one of the claims.  Your patent counsel may be able to infer more rights based on the body of the patent, but I usually look at claims first.

I will search for related patents and review claims when preparing to license or acquire rights to patents.  I will also explore whether I may need additional licenses or rights to commercialize a product.  This is not a legal or comprehensive search that will stand up I court, but I do get an overview that can help guide my business decisions at minimal or no cost.  You will use your patent counsel for all comprehensive work and for filing and possibly for creating license documents; do not leave them out of the process.  You will be standing in front of investor one day and get the question, “how do I know you own the rights and have freedom to operate.” That is when you say, call my patent counsel.

A second area to consider in your search for technology is identification of inventors and institutions working on technologies of interest.  The very start of a patent defines Inventors and Assignee, the possible owner.  Once when working for a company, I searched for a particular area of novel drug discovery from marine life forms.  I then reviewed the inventors and assignees to see which research organizations were was the prolific and then contacted them.  I went for meetings and discussed possible business relationships leading to the license any of their new discoveries.  This is a part of what your Business Development person may do and will be discussed later.  On other occasions, I searched for a specific University and/or Inventor to define what IP was available and then contacted the university.  Many University sites list available IP, but sometimes a search can give you ideas of areas and interests. I hope these examples provide a few ideas of how you can seek technology.

I can help provide guidance but you will want to discuss what you want to do and how to do it properly with your legal counsel.  Once you find technology, obtaining the rights would be the next step.  Your legal counsel can help with agreements but I usually like to negotiate the key business terms first.  As always, if you have questions, comments, or request for topics, contact me.

 Taffy Williams is the author of:  Think Agile:  How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon

Virtual Work Force: by Don Alexander

Introduction to Virtual Work Force the Blog’s First Guest Article
I was fortunate to have offers of educational guest articles for entrepreneurs. I am preparing the next section on IP for this blog which I hope to have completed in the near future. In the mean time, a friend offered to prepare a segment on the Virtual Work Force and I accepted before he changed his mind. This is an important topic for startups and will require further discussion. I am introducing the segment now in hopes that my readers will have a chance to think the topic and ask questions or suggest related topics they would like to have discussed. The contact information and website for the author is listed in case you would like to address any questions.

Virtual Work Force
By Don Alexander, Carlyle & Conlan, Morrisville, NC, 27560
In the world of professional and executive search, we are witnessing an increased interest in virtual workforces. On the workforce side, part of this trend is precipitated by the recent real estate market bubble and resulting inability for workers to relocate. Moreover, the proliferation of broadband technology allows many workers the ability to replicate most functions found in an office environment. In the future, other driving forces could include increasing gas prices and continued interest in companies that embrace quality of life aspects that can accompany virtual work.

Companies are increasingly leveraging a core group of highly skilled individuals within the life sciences industry. Most often, these core groups include a company CEO or President, CSO or Head of R&D and, depending on the assets of the company, a Chief Medical Officer, Business Development executive and other professionals. Today’s life sciences companies are only adding back office talent, such as CFO’s and HR, when a company hits an inflection point where outsourcing this type of work no longer makes economic sense. Company boards of directors and scientific advisory boards have been virtual for some time so it is not a leap that life science companies shed the bricks and mortar, except in cases where laboratory, manufacturing or other capital equipment intensive environments exist (*and even these environments can be outsourced). It is also not uncommon, in today’s workforce, to see a CEO located in Boston and a CMO located in San Diego and it will be less uncommon, in the future, that the CSO will be located in Shanghai.

While the upside for a company viewing the world as its potential workforce is compelling, the principal downside in moving to a more virtual workforce are the cultural aspects where workers embrace corporate vision and mission statements as employees and come together in a central location. In the future, however, it is likely that fewer highly skilled workers will be “employed” by any single employer. Instead, we may see more of a “mutual fund” model where workers consult for a number of companies on specific projects. This will provide the skilled worker with more “stability” than any single employer can provide as well as a broader base of skill sets and experiences to draw from. The company will benefit from variable, rather than fixed, costs.

Contact information for writer:
Don Alexander
Vice President, Life Sciences
Development & Commercialization
Carlyle & Conlan
430 Davis Drive, Ste 230
Morrisville, NC, 27560
T: +1(919) 474-0771 x105
F: +1(919) 474-0682

You can follow Taffy Williams on Twitter by @twilli2861 and you can email me with questions at twilli2861@aol.com and my company website is at http://www.ColonialTDC.com .

Monday, March 21, 2011

Intellectual Property (IP) and Know-how: Defined

This blog will eventually discuss several key issues relating to your technology, including:  selection, acquisition of rights, due diligence, commercial market, time to market, end users, size of market, and much more. The discussion of IP is sufficiently important to the NewCo that it will take more than one article to get the basics down. As such I want to discuss Intellectual Property (IP), Copyrights, Trademarks, and Know-how by first defining what it means to NewCo.  Most important will be the IP with a brief description of the others.  Wikipedia defines these terms as follows:

Intellectual property (IP) is a term referring to a number of distinct types of creations of the mind for which a set of exclusive rights are recognized—and the corresponding fields of law. Under intellectual property law, owners are granted certain exclusive rights to a variety of intangible assets, such as musical, literary, and artistic works; discoveries and inventions; and words, phrases, symbols, and designs. Common types of intellectual property include copyrights, trademarks, patents, industrial design rights and trade secrets in some jurisdictions.  Although many of the legal principles governing intellectual property have evolved over centuries, it was not until the 19th century that the term intellectual property began to be used, and not until the late 20th century that it became commonplace in the United States. The British Statute of Anne 1710 and the Statute of Monopolies 1623 are now seen as the origins of copyright and patent law respectively.

Know-how (or knowhow as it is sometimes written) is practical knowledge of how to get something done, as opposed to “know-what” (facts), “know-why” (science), or “know-who” (networking). Know-how is often tacit knowledge, which means that it is difficult to transfer to another person by means of writing it down or verbalizing it. The opposite of tacit knowledge is explicit knowledge.  In the context of industrial property (now generally viewed as intellectual property (IP)), know-how is a component in the transfer of technology in national and international environments, co-existing with or separate from other IP rights such as patents, trademarks and copyright and is an economic asset.

Copyright is a set of exclusive rights granted to the author or creator of an original work, including the right to copy, distribute and adapt the work. Copyright does not protect ideas, only their expression. In most jurisdictions copyright arises upon fixation and does not need to be registered. Copyright owners have the exclusive statutory right to exercise control over copying and other exploitation of the works for a specific period of time, after which the work is said to enter the public domain. Uses covered under limitations and exceptions to copyright, such as fair use, do not require permission from the copyright owner. All other uses require permission. Copyright owners can license or permanently transfer or assign their exclusive rights to others.  Initially copyright law only applied to the copying of books. Over time other uses such as translations and derivative works were made subject to copyright. Copyright now covers a wide range of works, including maps, sheet music, dramatic works, paintings, photographs, sound recordings, motion pictures and computer programs.

A Trademark or Trade Mark or Trade-Mark is a distinctive sign or indicator used by an individual, business organization, or other legal entity to identify that the products or services to consumers with which the trademark appears originate from a unique source, and to distinguish its products or services from those of other entities.  A trademark is typically a name, word, phrase, logo, symbol, design, image, or a combination of these elements. There is also a range of non-conventional trademarks comprising marks which do not fall into these standard categories, such as those based on color, smell, or sound.  The owner of a registered trademark may commence legal proceedings for trademark infringement to prevent unauthorized use of that trademark. However, registration is not required. The owner of a common law trademark may also file suit, but an unregistered mark may be protectable only within the geographical area within which it has been used or in geographical areas into which it may be reasonably expected to expand.  The term trademark is also used informally to refer to any distinguishing attribute by which an individual is readily identified, such as the well-known characteristics of celebrities. When a trademark is used in relation to services rather than products, it may sometimes be called a service mark, particularly in the United States.

A trademark may be designated by the following symbols:
 ™ (for an unregistered trade mark, that is, a mark used to promote or brand goods)
  (for an unregistered service mark, that is, a mark used to promote or brand services)
 ® (for a registered trademark)

Trademarks and Copyrights can be important forms of protection of products or symbols used to recognize a product.  There may be approaches to protecting aspects of computer programs.  But the real bread winners are the IP and Know-how.  IP and Know-how are essential to the success of the company as they are what make NewCo special and provide a moat around the business.  As far as Know-how, it will be a secret as long as you can keep the information secret.  Know-how is the special sauce that goes into your company.  It is something only NewCo knows and now public information is available that a competitor can use to reproduce your special sauce.  For example, try to find out how to make a Coke.  This info has been closely guarded for nearly 100 years. 

The rights associated with the patent portion of the IP help identify markets and potential value. The IP helps keep the competition away for some period of time and provides you a legal monopoly for as much as 20 years.  A patent will define claims which you can use to take an infringer to court and attempt to stop them from making a product you own the rights to.

What is a patent?  Think of a patent as a deed to property, like the deed to your home.  You actually have ownership and rights to keep others out of your home.  You can sell the home, rent it, or just allow the home to just set and do nothing.  It is your home to do with as you please; within the limits of the law.  Patents are similar.  Once the patent issues, it defines the technology or products you have invented and have rights of ownership.  You can develop the technology, license it, sell it, and you have the unique ability to prevent anyone from selling something that is covered by your patent. 

Sometimes when I discuss NewCos with entrepreneurs there is confusion about what a patent does and does not mean to the company.  As just stated, a patent DOES allow you to prevent someone from selling your product.  A patent DOES NOT automatically give the rights needed to sell a product.  When preparing a patent, it is a like blowing a bubble in a rose bush.  You want to blow the bubble as large as you can to fill the empty spaces, but if you blow it too large it will burst.  The first patent issued in completely new field will make every effort to cover as much of the field as possible.  As other inventors file for their new inventions in the field, they will attempt to cover uses, areas, and products not contemplated in the original patent or other issued patents in the field. 

Sometimes companies refer to the original patent as an UMBRELLA PATENT because of its very nature of trying to cover the whole field of a technology area and because it provides very broad coverage.  Assume, you invented and a patented table salt.  Your new patented invention now has a full term before expiration which is like the umbrella covering as much of the space as possible.  As the first patent in the field you attempted to cover the composition (make-up or chemical structure) of salt and therefore have a patent covering Composition of Matter; i.e. chemical makeup.  Uses of the chemical which are claimed in the patent cover making food taste better and preserving food.  Later, one of your competitors discovered the chemical can be used to make a great toothpaste additive and they file a patent for a particular use as toothpaste.  The original inventor never contemplated this use and it was not described in the first original patent.  Also, the use was not something that a person with knowledge of field would consider as obvious.  The patent examiner approved and allowed issuance of a Field of Use patent for salt as an additive to a toothpaste.  The owner of the composition of matter patent would not be able to practice the invention of use as toothpaste without first obtaining the rights from the inventor of the toothpaste, and the inventor of the toothpaste would not be able to sell the product without obtaining rights from the composition of matter patent.  This may sound a bit complicated and it can be very complicated when dealing with technology inventions in areas that have been around a while.  Essentially, these patents Block or Prevent the other inventor from particular uses or applications and each would need to obtain the rights of the other to commercialize the product.

The patent landscape around a product is of such a significant importance, that many BigCos and potential investors will ask the NewCos if they have obtained a Non-infringement Opinion Letter or a Freedom-to-Practice or Freedom-to-Operate Opinion from their legal counsel.  Most often the response to BigCo is No we do not have the financial resources to do that now.  While these are extremely important documents that help provide confidence that you can make and sell the products from your invention, these legal opinions are extremely expensive and most NewCos cannot afford them.  As an example, in a company where I was facing potential litigation with a competitor, it cost $100K to get a Non-infringement Opinion Letter and I received a quote of $500K for a Freedom to Operate Opinion.  We paid the $100K but could not afford the more comprehensive opinion letter.  When first starting out, most companies could not even pay the $100K and would rather spend the funds to advance the technology.  This does not mean the letters are not important, but if you cannot afford them you must try to gather as much information as possible to help address the questions from a potential investor.

To sum up, I want to make several important points:

·       Having a patent gives the right to prevent others from selling a product,
·       Having  a patent may NOT give all of the rights needed to sell a product
·       A patent review of all fields related to your product is needed to identify any blocking IP for your product
·       You will need to acquire rights to any blocking IP and those rights will cost something (a topic to discuss later)
·       You need to have a good patent counsel to help with ALL of your IP issues

As always, I hope you are following along in the series and will feel free to email me with your questions.  The topic of IP is essential to grasp before going further.  This topic will be broken down to small segments. I am not attempting to provide any legal advice nor am I the person to do so.  But, you do need to understand the basics to help direct your next steps in creating a company and talking with your legal counsel.  Once the section on IP is completed, we can discuss technology and obtaining IP right.

Taffy Williams is the author of:  Think Agile:  How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon 

Friday, March 18, 2011

“Show Me the Money”: Is This the Right Business Opportunity?

I have actually spoken to a number of out of work professionals that believed the quickest way to a salary after being let go by the previous employer was to start a company. They defined themselves as entrepreneurs when all they wanted was an income.   The fields being considered were medical, biotechnology, or technology types of business opportunities.   If you have been keeping up with my posts and you reviewed the article I referred to in the last posting, you should now realize you are NOT LIKELY to receive a salary in the near future when starting a new company (NewCo). 

This series of articles is NOT addressing the creation of businesses like landscaping, local mom & pop restaurant, cleaning service or many other opportunities that are intended to remain small.  These are great businesses for many entrepreneurial individuals.  These business opportunities could transition to national chains and that such an undertaking would be more applicable to this series of articles.  I am addressing a specific type of business that is likely to require significant capital and require you to issue equity or borrow large sums of money via some type of financing.  I am also discussing businesses that can grow to potential valuations well in excess of $100MM.

I referred you to an article written by Martin Zwilling in my last posting.   I want to summarize where what the basic points were in the article and add a few more considerations.

·        Most Startups get no professional investment in the early years

·        Self-funding is a great option IF you can afford  it; do not quit your day job

·        Friends & Family and maybe Angels and high-net-worth individuals are sources possibly of sovereign wealth funds and integrated high-net-worth networks

·        Small business, SBIR, Government, State Grants and/or loans are sources. The military, NIH, and NSF can also be considered.  There are also not-for-profits specific to certain diseases that fund programs as well.

·        Loans or lines-of-credit.  I am usually not in favor of borrowing against your house but people do it.  You can borrow from certain state agencies against your technology in the company; that is OK.

·        Startup Incubators.  Sometimes you can get services for equity in incubators.

·        Angel Investors and VC.  Angels often like to get in very early VCs usually come after the company is better established and better developed.  Be careful, you will start to lose control and could be extensively diluted in ownership.  The dilution can affect your potential financial gains whether you stay or are asked to leave the company.  These are topics that need a full article. 

·        Equity or future revenue streams could be traded for services.  You are trading paper today for promises in the future when you have money or value.  I always like this one!

·        Licensing or Partnering with a BigCo or Vendor.  You are forming a deal which will hopefully be a Win:Win arrangement.  These can come with upfront cash and future payments from the partner, or for services now and promise of future payments.  Again, this is a topic for a full article.

·        Commit to a major customer.  This may be more for technologies which are user oriented but may not fit with medical products for example.

Be creative and vary the approach finding something that works for you and your potential investor or partner.  You may find other ways to get the company off the ground with limited resources. 

In dealing with “Where’s the Money”, it is critical to relate this back to the technology and what the final marketed product will be.  Most professional investors in the medical area are looking for substantial returns because there is significant risk.  The risks are: 1) operational, the company fails to execute well, 2) regulatory, some agency like EPA, FDA, or USDA will not approve your product, 3) commercial, your product does not meet expectations on sales.  Other risks include; 4) IP, is there a “Freedom to Practice”, 5) flawed science, there are other risks associated with many technology related areas as well as with the management team.  The higher the Risk, the more the Reward expected by investors. 

Many VCs seek to gain 5-10 times their investment in as little as 3-5 years!  If you need $15MM, they want $75-$150MM in 3-5 years!  This means your product(s) have to generate potential sales that can make the company appreciate in price for them to capture their desired returns.  A recent example of a biotech company that has achieved success is Dendreon.  The company has appreciated to a value of more than $3BB.  At a conference, I sat by a friend that was also an investor in the company.  It was on the day of the FDA approval.  My friend’s fund had 5MM shares in Dendron.  You should have seen the smile on his face!  That is part of what you strive to do, make money and make your investors happy.  By the way, you own shares and are an investor too.

In the last few years, I reviewed programs seeking funding in the range of $1-5MM in investment.  Two come to mind as examples of what to NOT look for:

·        Company 1 had licensed a technology to create a device.  The device was quite useful in a laboratory and the company wanted to develop and sell the device.  When I asked how many potential USERS there were worldwide, the answer was between 100 & 1000 users.  The company planned to sell the product for around $500.  The product was not a consumable. The potential users would buy one and not need another.  The potential SALES of 1000 x $500 = $50,000 where all the company had as prospects.  Why would anyone ever consider investing a large sum of money for $50K total sales?  This is not a viable business, there is no real market, and the company could not identify alternate uses to make the market larger.

·        Company 2 had a similar problem.  They had a product that would sell for around $500 to a total market of 5,000 for projection of $250,000 at 100% capture.  They had the ability to expand the business to other USERS and had prospects of as much in $5MM per year in annual sales.  This product was a consumable which cost little to make.  Problem is that the development expenses required to create the final marketable product was estimated at $10MM.  Their annual peak year sales were estimated at $5MM for 100% of total market (you never get 100%).  A possible purchase price of the company at peak year sales would be 3-5 x earnings, or 3-5 x sales if they were really lucky; company value tops was $25MM.  The company potential appreciation of value would never reach a level to attract investment. 

You must consider the financial prospects of your product as well as the future value of the company and the time it will take to get to a reasonable level. Also, consider how you can achieve maximal growth with minimal or no funding in early years.  Potential investors are mostly interested in how will make money by investing in your company.  Nearly all investors will ask WHERE’S THE MONEY?  Ask yourself, will I get what I expect as my return?  Remember, you may have worked for extended time and worked hard work with only equity for your efforts.  Your high risk should be rewarded in the end with a large financial payout.  This can only be done if you build a company with high VALUATION potential in the future. You will always be able to look at new investors and say we have the same motivation; WHERE’S THE MONEY.

  Taffy Williams is the author of:  Think Agile:  How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon 

Thursday, March 17, 2011

Forming the Company & Structure - part of starting a company

This is the fourth article in the series. If you just started reading this article, you may want to read the others as well.  They are in the archives and can be retrieved. 

The topic for this discussion is generation of the business entity you are about to create.  Keep in mind, I have discussed that you must have resources to survive personally for a prolonged period.  Don’t start a company when you do not have any means of financial support.  DO NOT think you will draw a salary soon.  It is not likely to happen!

In starting the technology based business, which comes first, the Company or the Technology?  It is a bit like the chicken and egg story; it really doesn’t matter.  You can create the company and fill it with technology; even it is years later.  You can find technology and create the company overnight (or in a few days).  Either option can be made to work. 

The more important issue to resolve is the type of structure you want the business to have; a Corporation, a Limited Liability Company, or some other structure.   These structures are defined as below by www.investorwords.com :

Corporation:  “The most common form of business organization, and one which is chartered by a state and given many legal rights as an entity separate from its owners. This form of business is characterized by the limited liability of its owners, the issuance of shares of easily transferable stock, and existence as a going concern. The process of becoming a corporation, call incorporation, gives the company separate legal standing from its owners and protects those owners from being personally liable in the event that the company is sued (a condition known as limited liability). Incorporation also provides companies with a more flexible way to manage their ownership structure. In addition, there are different tax implications for corporations, although these can be both advantageous and disadvantageous. In these respects, corporations differ from sole proprietorships and limited partnerships.”

Limited Liability Company: Often abbreviated as an LLC. “A type of company, authorized only in certain states, whose owners and managers receive the limited liability and (usually) tax benefits of an S Corporation without having to conform to the S corporation restrictions.”  

There are many to several structural aspects which are available for the business and the best way to select the right one is with a good discussion with your attorney or accountant.  The choices between limited company or a corporation have a lot to do with taxes, payout of cash, and ownership.  There are pluses and minuses for each and you need to weigh the differences depending where your needs are in the future.  I have always been associated with companies which are C corporations.  As defined in Wikipedia:

A C corporation is a corporation in the United States that, for Federal income tax purposes, is taxed under 26 U.S.C. § 11 and Subchapter C (26 U.S.C. § 301 et seq.) of Chapter 1 of the Internal Revenue Code.  Most major companies (and many smaller companies) are treated as C corporations for Federal income tax purposes.

The income of a C corporation is double taxed, whereas the income of an S corporation (with a few exceptions) is not taxed at the entity. The income, or loss, is applied, Pro Rata, to each Shareholder and appears on their tax return as Schedule E income/(loss).

Unlike corporations treated as S corporations, a corporation may qualify as a C corporation without regard to any limit on the number of shareholders, foreign or domestic.

The C Corporation has been the structure desired by the funding sponsors affiliated with nearly all of the companies I have had an involvement.  A C Corporation is registered with a state (Delaware for example) by filing the appropriate documents.  There is a filing fee.  You can work with an attorney to file the forms and your counsel will generate all the paperwork associated with the company creation.  I have gone through the process without legal assistance, but would not recommend it to someone just starting out.  There will be associated costs of as little as a few hundred dollars to more than a thousand.  It depends on the complexity you want to add, what your counsel does, and the billing rate.  ASK the billing rate before you start and get an estimated total cost.  Why suffer sticker shock!

You will need to obtain a tax ID code from the IRS.  A corporation is like having a separate person to account for with respect to the state and federal government.  The corporation will have regular tax and reporting obligations even it has no source of revenues.  You will need to request an EIN number from the IRS; this is like a SSN for a company.  The EIN is to be your Tax ID for all future filings.  Your legal or finance advisor can help obtain the EIN and help with all of future filings.  I do not recommend that you try managing the filings yourself.  You are likely to get notes from the state or IRS telling you missed dates, the estimated tax or paid taxes are not correct, or other notes not so pleasant.

When you form a corporation or a LLC, you will have ownership that will be represented by issuances of shares.  These shares reflect your fractional ownership of the business.  For example, if you and your partner own half of the issued shares each, you each own half of the company.  The control of the company is 50:50 as well and the voting of the shares will carry equal weight; unless you have created a structure defining different classes of shares with different voting rights.  Keep in mind that when you have critical decisions they are often put to a vote by the shareholders.  A 50:50 ownership could result in ties unless you have other arrangements in advance to break such ties.  How you divide the shares and structure the control of the company will be an important consideration.  Again, your mentors, legal assistant, or financial person, can help if you take the time to discuss it and listen to their advice.  Most of the structural issues can be changed later by your legal representation, but it will cost you money!  Try to get it close initially and do not rush the decisions.  Discuss what you want to accomplish with your mentors and advisors be for you finalize your decisions.

I was involved in just such a company creation within the last few months.  A business decided to generate a spin-out of part of an existing company to a new company to be formed in Maryland.  It took a few weeks to complete the documentation and form the structure.  The CEO/Founder was not familiar with the process and he effectively used his mentors, as well as his finance and legal advisors.  This helped speed the process.

Following the formation of the company, a Board of Directors needs to be selected.  Yes you will need one of those!  If you thought you would not have a Boss that is not correct.  Most everyone has a Boss of some type.  The Board of Directors has the responsibility of oversight of the company and the responsibility of oversight and direction of the Senior Management.  This is often done by review of activities and setting milestones for management to achieve.  They review the finances and ensure accuracy in reporting and spending.  The Directors have a legal responsibility to ALL investors to ensure proper and ethical management of the company.  They will be your Boss. 

The members of the Board of Directors are elected by the shareholders, on the first day of formation of the company you may be the only shareholder and own 100% of all issued shares.  But as investments are made and shares issued to new investors, your percent ownership will be reduced.  Don’t be surprised if your 100% ownership eventually drops to 10% or less as you get funds from selling shares.  This means the Board will have a stronger representation from the investor pool and that your Boss has more stronger connections to new Shareholders than to you.  Please do not get hung up on DILUTION at this point.  I will try to discuss dilution in a later article.  Suffice it to say, it is better to have 10% of a lot of money than 100% of nothing.

I plan to discuss issues of early finances next in the mean time you may want to read an article written by Martin Zwilling:   http://blog.startupprofessionals.com/2011/03/most-startups-get-no-professional.html  
Martin published this blog recently and it covers most of what I will be discussing on the early financing options you may have.  After you are clear on early money, I will start some of the discussions around technology. 

I hope you will let me know if you have key issues you want discussed out of sequence.  I can either deal with them via email or by the blog.

Taffy Williams is the author of:  Think Agile:  How Smart Entrepreneurs Adapt in Order to Succeed to via Amazon