Reversing Public Polarity-Going Private after Going Public

In our last blog entry we discussed the burden that Sarbanes-Oxley has imposed on companies from everything to storage media to attracting talent through stock options. While most companies will simply accept this as a new cost of doing business, some are taking more drastic action. The time and expense of complying with the Sarbanes-Oxley regulations and other corporate governance reforms are causing an increasing number of public companies, particularly small and mid size firms, to consider going private (the “reverse IPO”). (READ FULL ARTICLE)

Simon Riveles

Sony Dual Shocked out of 90 Million

Sony Corp., manufacturers of the Playstation gaming console, have lost a 2002 patent infringment case filed by Immersion Corp. At issue was Sony's alleged infringing use of Immersion's patent which claims, among other things, the means by which to make an analog controller vibrate in timed synchronization to events occuring in a video game. Sony will of course appeal the case.

A Cold Winter with their SOX On—Tech Ventures are Tested by Sarbanes Oxley

Sarbanes Oxley (“SOX”) depending on who’s talking is either the Sheriff of the vaingloriously excessive pre-Enron corporate Wild West or an Orwellian, Big Brother-esque, bureaucratic yoke. The general thrust of the Act and its supporting regulations is a new reporting and transparency framework for all public companies. As with all things on paper, the idea is sound—force public companies to track their assets, retain probative materials and documents, and ultimately substantiate their valuations.

For larger companies, the compliance process has seen the likes of IBM and others quickly reallocating their resources and streamlining their data and reporting processes. "What people didn't realize is that they were doing business via e-mail . . . and what woke everyone up was Sarbanes-Oxley," chief strategist for IBM compliance and data retention solutions. Indeed, much of the Sarbanes legacy is and will be retaining and distilling data, as evidenced by a boom in higher end Sarbanes targeted storage drives. Moreover, spreadsheets, blogs, and other soft-data applications are being monitored, targeted, and processed by companies as potential Sarbanes hotbeds. Then again, the bigwigs can just outsource the nightmare to someone else. For the smaller than 75 million dollar ventures, SOX is being viewed with decidedly less enthusiasm.

Aside from the huge administrative burdens, the Act’s position on the venerable stock option is a blistering alarm to a variety of option dependent industries. Namely tech companies are fearful that that Act’s requirement that stock options be treated as expenses will chill their ability to attract and retain talent. Names like Google and Microsoft have been able to lure bright and dedicated programmers, C-levels, and a host of other essential labor with stock options. Stock options for talent in a cash burn start up environment is a critical weapon in the start up arsenal without hurting their valuation. And over the past ten years a new class of American millionaires has arisen.

Hence, with a new Republican congress, one can expect a new and fearsome lobbying effort to curtail SOX’s impact in this arena. It is no mystery that some Republicans are already eyeing options to reduce the number of teeth in SOX’s mouth. In fact, the House of Representatives passed a bill during the last Congress opposing the options-expensing requirement. However, it did not pass in the Senate. TechNet, a Silicon Valley-based network of CEOs, has made reviving the House initiative priority number one. Stock options are "a tool that startups and other technology firms use to draw talent to their firms," said TechNet spokesperson Jim Hock in Washington. "Unfortunately, it's fallen under the whole aura of Enron and CEO scandals."

Congress can and should assess their stance and look to bridge the gap with exceptions or risk significantly curtailing the second tech boom. There are a variety of other means to balance the public interest in properly valuing a young IPO. A bright line rule that calls an unexercised option an expense further complicates the valuation picture with a gross oversimplification, when an option is not an expense simply because it was issued.

Kaiser Wahab

Blackberry’s Get Increasingly Chatty

Everyone’s favorite portable i-lifeline, the Blackberry, just got more chatty. New Blackberry models will be bundled with both Yahoo Instant Messenger and AOL Instant Messenger. Similarly, older models will be able to download the IM software from Research in Motion’s web site, the Blackberry manufacturer. In response to the Blackberry's success, the cell phone manufacturers of the world are agressively marching out their handhelds to stave off the real market share threat of handhelds like the Blackberry that claim to integrate cell phone functionality seamlessly. Of note, is the fact that the deal is non-exclusive, leaving the door open for Microsoft to interject its popular MSN messaging software as well. This represents a major move in the already intense migration of traditionally PC oriented communication to handheld devices.

Kaiser Wahab

Limp Bizkit found on Hard Drive—Digital Home Porn Claim Under Copyright Law

You have to hand it to Fred Durst, lead singer of the mega hit hip hop hard core band Limp Bizkit. He really understands the value of a copyright. Fred is suing a group on Internet porn peddlers for allegedly distributing an unauthorized copy of a 3-minute video clip that depicts a sex act between Durst and his girlfriend. The lawsuit, which was filed in federal court last week, demands more than $70 million in damages in addition to actual profits generated by site operators airing the video. Adding to the bizarre intersection of e-commerce, copyright, and porn, the video which was on Durst's hard drive was, according to the complaint, actually hacked to recover a copy. So now there’s an identity theft dimension as well.

In addition to privacy invasion and misappropriation claims, the suit notably relies on copyright as well. Whether Durst actually registered the copyrights is unclear on the face of the partial complaint that I read, which makes reference to his declaration of complete ownership in the copyright. No doubt Fred claims he is the “author” for common law copyright purposes at the very least. But if he did register, I applaud him, as too often I am confronted with clients who have legitimate infringement claims but no registration, severely limiting their recourse. Could it be that Fred is well schooled in the advantages of federal registration and copyright litigation?

Without taking a position on the file sharing debate, I find it mildly ironic that Durst, an early champion of Napster, doesn’t believe in this instance that sharing is caring. I am mostly joking, as this is a severe invasion of personal privacy and is no doubt traumatic for Durst and his girlfriend. However, to rely on copyright as a fundamental basis for his claim does fly in the face of the RIAA’s arguments regarding Napster. At one point, Durst even planned a pro Napster free concert in 2000 dubbed "Limpdependence," during which Durst told the press regarding Napster's involvement, "We could care less about the older generation's need to do business as usual. We care more about what our fans want, and our fans want music on the Internet." Granted, Durst was more likely taking aim at the industry and was not necessarily attacking copyright protection.

Gossip blog Gawker.com, a site named in the suit, claims to have taken the video before Durst's lawyers contacted it: "We shared it with the world for about 2 hours. Then we wept, found God, took a hot bath, and removed the video from our site."

You can Read part of the complaint here.

Kaiser Wahab

Elect Wisely, Elect 83(b) For Venture Capital Financing Against a Founder’s Agreement

Before investing in a start-up, a venture capital company will conduct a thorough review with respect to all aspects of the company (often referred to as “due diligence”). The legal structure, intellectual property structure, as well as the agreements governing the founder’s rights are among the most scrutinized aspects of the emerging company.

Often referred to as a “shareholders’ agreement” or “stock agreement,” the agreement between the founders of the start-up typically addresses issues such as the assignment of intellectual property, the percentage interest of each founder in the venture, restrictions on the transferability of shares and rights of first or last refusal. The founder’s agreement governs the relationship between equity partners and enshrines their obligations to each other and the venture. Of particular importance, both to co-founders and venture capitalists, is the manner in which the document addresses the issue of stock ownership and the vesting of options.

All things being equal, a founder would like her interest in a company to vest immediately upon its creation. However, immediate vesting is generally frowned upon by co-founders and venture capitalists, who generally insist that each founder make a three or four year minimum commitment to the company. The founder is provided incentive to remain at the company by having the agreement provide that a small portion of the founder’s shares vest up front with the balance vesting on a monthly or quarterly basis. If a founder is insistent on having her interest vest immediately, most venture capitalists will require the agreement to establish a “claw back” of some or all of the founder’s shares in the event of her premature departure, termination or disability.

Tax Tips for Founder’s Agreements--83-(b) Election

Whenever there are restrictions on the shares issued, as in the case of “claw back” provisions, the founder should file an “83-(b) Election” with the Internal Revenue Service. This election allows the founder to disregard forfeiture provisions on the shares and take the value of the shares received into income when first received, rather than when the forfeiture restrictions are removed – usually a future date at which time such shares have gained significantly in value. A simple way to look at the absolute necessity of the election is as follows:

Assume Founder paid $1 a share for 20 out of a total 100 shares. Initially only 10 shares were vested. After four years, Founder’s remaining 10 common shares will vest. Meanwhile, the company undergoes an initial round of financing through which a VC buys the remaining 80 common shares and $1 million of preferred stock. Now, 4 years later, Founder finds that the 10 common shares to be vested are valued at $30,000 each.

Without a tax election, Founder will be hit with ordinary income tax on the ten shares for roughly $30,000 per share. Founder is now in a quandary and probably cannot sustain that kind of tax burden, putting pressure on the company to come to her monetary rescue. Of course, this is detrimental to a struggling startup with precious little cash to burn. While the company may be able to deduct the expense of covering Founder’s tax burden, a deduction is of little value when there is no income to offset.

If Founder had timely filed the 83(b) election, he would only pay tax on the 10 unvested shares to the extent that their fair market value, when the vesting agreement was executed, is greater than their cost. Since the shares had a fair market value of next to nothing as of the vesting agreement, when the shares vest at a far higher value, the attendant tax liability is blunted.

Such election must be made within 30 days of the shares issuance and a copy must be attached to the stockholder’s income tax return for the year of the election. The election by the founder enables the issuing company to take a compensation deduction in the year such amount is included in the founder’s income.

The election is not only good for the founder it’s VC friendly as well. In some instances, the VC will obligate a founder to make the 83(b) election. No VC would want a surprise tax bomb to bankrupt a founder in a target company.

Simon Riveles & Kaiser Wahab

Tattoos can Cost an Arm and a Leg if Copyright Ruling Favors the Artist in the Rasheed Wallace Case

A tattoo artist in Portland Oregon is suing Detroit Piston Rasheed Wallace to stop the basketball player from displaying the work in ads for Nike basketball shoes. According to the suit filed in U.S. District Court, the tattoo artist, Matthew Reed, claims he owns the copyright to “the Egyptian Family Pencil Drawing” now etched on Wallace’s arm. Reed maintains he researched the idea and came up with the design after being approached by Wallace in 1988 who requested an Egyptian-themed family design with a king and queen, three children, and a stylized sun in the background. Reed claims that last year he became aware of the Nike ad run, which was run on the air and Internet, featuring the tattoo and focusing on its creation. Although the merits of the suit have yet to be considered, copyright law does not necessarily entitle the purchaser of an image to employ it for a commercial purpose.

In fact, the copyright in a visual work may be owned by the creator while the actual work (e.g. a painting, sculpture, etc.) may be owned by a collector or other purchasers. This can lead to non-intuitive relationships, such as when a private collector owns the physical painting but cannot exploit it for commercial purposes. Here a variety of rights within the “bundle of rights” that comprise copyright are potentially infringed, including the right to or not to publicly display a work and the right to or not to reproduce the work.

If Reed wins, Wallace would obviously not face an order to amputate the offending limb. More likely, this will settle and Reed will get some cut of advertising action that is at least partly based on Wallace’s look. No doubt Reed feels he is partly to credit for that look, while Wallace will feel like this cost him an arm, if not a leg. And for tattoo artists, it will signal the use of “work for hire agreements” typically used in other fields such as photography.

You can see the complaint here.

Simon Riveles