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166 t Entrepreneurship -~-~· -·· ~"'""" --·--·----·-------

PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR

1 To identify and distinguish intellectual property assets of a new venture includ ing

software and Web sites.

2 To understand the nature of patents, the rights they provide, and the filing process.

3 To understand the purpose of a trademark and the procedure for filing.

4

To learn the purpose of a copyright and how to file for one.

5 To identify procedures that can protect a venture's trade secrets.

6 To understand the value of licensing to either expand a business or start a new venture.

7 To recognize the implications of new legislation that affects the board of directors and

internal auditing processes for public companies.

8 To illustrate important issues related to contracts, insurance, and product safety and liability.

167

OPENING PROFILE

STEVE LIPSCOMB

One of the hottest media concepts today is television poker. As this market continues

to gain popularity and spin dozens of new innovations for entrepreneurs, it repre-

sents one of the most difficult business models for which to provide any intellectual

property protection. Steve Lipscomb has emerged as one of the most aggressive and

innovative entrepreneurs among those trying to

compete in this media market. His World Poker

Tour, broadcast on the cable television Travel

Channel, became an instant hit show in 2003, as

evidenced by its audience size or television rating points. With this success, however,

new competitors evolved, making the strategy of protecting his investment even more

challenging.

Steve Lipscomb grew up in Nashville, Tennessee, and came from a long line of

Baptist ministers. His first entrepreneurial effort, after becoming an attorney, was to

launch an attorney referral venture. However, even after early entrepreneurial suc-

cess, his career made some dramatic changes, primarily because of discrimination

issues experienced by his mother after she had chosen to enter the Baptist Church

seminary. His anger over this experience led him to make a documentary film so that

the world would be made more aware of some of these discriminatory issues. He

then sold his attorney referral business, taught himself filmmaking, and proceeded

to make Battle of the Minds, which won acclaim and numerous awards after ap-

pearing on PBS television. This success resulted in a friendship with producer Norman

Lear and a film project to provide audiences with an inside look at the World Series

of Poker.

Although poker was not a foreign concept to Lipscomb, having once entered a

$100 satellite tournament, he felt that ESPN's televising of the World Series of Poker

was poorly presented. After his film project, Lipscomb had the strong vision that not

only could poker be made to be more interesting but that it would be possible to cre-

ate a major league of poker that would allow for entrepreneurial expansion into

merchandise, foreign licensing, Internet competition, and other business opportuni -

ties. With the help of two friends with television and licensing experience, Lipscomb

established a league of poker players who could enter tournaments as they pleased

159

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160 PART 2 FROM IDEA TO THE OPPORTUNITY

for prize money raised from sponsors. His business model was to establish a leag~­

of poker players similar to golf's PGA Tour. Thus, anyone with $10,000 could ente

one of the World Poker Tour events with a chance to win a large prize of $1 mi ll io-

or more.

Lipscomb's strategy was to produce a show before getting television to buy it. W rt'"

the support of Lakes Entertainment, a developer of casino gaming, and an investme .. .

of $3.5 million, the World Poker Tour and WPT Enterprises were born, including a list-

ing on the NASDAQ (WPTE). With this investment Lipscomb subsequently had to give

up 70 percent control of his business, but he was able to retain 16.5 percent for himself.

Armed with this infusion of venture capital Lipscomb hit the road to try to persuade t he

many popular casinos to support these poker tournaments. His format included two

unique concepts to make the televising of poker more interesting to the viewer. One

of these was a small camera under the table that allowed the viewers to see the two

cards that were dealt face down. Viewers could then play along with the tournament

players. In addition, he added unique graphics that presented on-screen icons of each

player's cards. Odds of winning were included at each stage of the betting process,

making this programming unique and more interesting to the television audience.

Lipscomb regarded these unique additions as intellectual property, but this has

created controversy with some of the competition. ESPN has duplicated Lipscomb's

camera and graphics in its presentation of another league, the World Series of Poker

Circuit. Lipscomb argues that the camera and graphics are proprietary with applica-

tions for patents pending. Without any resolution to the intellectual property issue,

Lipscomb has embarked on an aggressive strategy to build the image of WPTE. More

tournaments, more casinos, new products, higher stakes, international growth and

syndication, and the recent contract with Fox Sports Network (FSN) are all intended

to increase visibility and profitability to the company. Fox Sports Network is a much

better fit for WPT than the Travel Channel or Game Show Network. Audiences will be

higher, exposure will be greater, and FSN plans to include WPT in the Monday sports

block of programming. In addition to the new network, WPTE now owns and operates

WPT China, a multimedia company based in Beijing specializing in television produc-

tion of the WPT China National Traktor Poker Tour. Traktor Poker is a national card

game in China, and this 10-year exclusive deal is expected to add substantial income

not only from the tour but also from licensing and other partnerships with Chinese

firms.

~ow 'ff'l 'Its -s~vel'l'trl -sea-son, t'f'le tompany tont'rnues 'to s'trugg'1e fmanc·Ja'fly w'1th 'losses ot about $9.7 million in 2007 compared to positive profits of $7.8 million in 2006. Sales in

2007 compared to the previous year were also down from $29.3 million to $21.7 million.

Higher costs and less exposure with the existing network were major contributing

factors to this decline. Lipscomb is confident that the business outlook is favorable

now that the new network is in place and other international deals are complete. Even

though the intellectual property issues previously discussed may not be resolved very

soon, if at all, Lipscomb will continue to explore new opportunities through innovation

and creativity that will enhance sales and profitability. 1

ellectual property

Any patents, trademarks, yrights, or trade

s:crets held by the

= preneur

I Entrepreneurship, Eighth Edition I 169 --·------------ -~--- -------------+--- --

CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 161

WHAT IS INTELLECTUAL PROPERTY? Intellectual property-which includes patents, trademarks, copyrights, and trade secrets- represents important assets to the entrepreneur and should be understood even before engaging the services of an attorney. Too often entrepreneurs, because of their lack of understanding of intellectual property, ignore important steps that they should have taken to protect these assets. This chapter will describe all the important types of intellectual property, including software and Web sites, which have become unique problems to the Patent and Trademark Office. 2

NEED FOR A LAWYER Since all business is regulated by law, the entrepreneur needs to be aware of any regulations that may affect his or her new venture. At different stages of the start-up, the entrepreneur will need legal advice. It is also likely that the legal expertise required will vary based on such factors as whether the new venture is a franchise, an independent start-up, or a buy- out; whether it produces a consumer versus an industrial product; whether it is nonprofit; and whether it involves some aspect of computer software, exporting, or importing.

We begin with a discussion of how to select a lawyer. Since most lawyers have devel- oped special expertise, the entrepreneur should carefully evaluate his or her needs before hiring one. By being aware of when and what legal advice is required, the entrepreneur can save much time and money. Many of the areas in which the entrepreneur will need legal assistance are discussed in this chapter.

HOW TO SELECT A LAWYER Lawyers, like many other professionals, are specialists not just in the law but in specific areas of the law. The entrepreneur does not usually have the expertise or know-how to han- dle possible risks associated with the many difficult laws and regulations. A competent attorney is in a better position to understand all possible circumstances and outcomes related to any legal action.

In today's environment, lawyers are much more up-front about their fees. In fact, in some cases these fees, if for standard services, may even be advertised. In general, the lawyer may work on a retainer basis (stated amount per month or year) by which he or she provides office and consulting time. This does not include court time or other legal fees related to the action. This gives the entrepreneur the opportunity to call an attorney as the need arises without incurring high hourly visit fees.

In some instances the lawyer may be hired for a one-time fee. For example, a patent at- torney may be hired as a specialist to help the entrepreneur obtain a patent. Once the patent is obtained, this lawyer would not be needed, except perhaps if there was any litigation re- garding the patent. Other specialists for setting up the organization or for purchase of real estate may also be paid on a service-performed basis. Whatever the fee basis, the entrepre- neur should confront the cost issue initially so that no questions arise in the future.

Choosing a lawyer is like hiring an employee. The lawyer with whom you work should be someone you can relate to personally. In a large law firm, it is possible that an associate or junior partner would be assigned to the new venture. The entrepreneur should ask to meet with this person to ensure that there is compatibility.

A good working relationship with a lawyer will ease some of the risk in starting a new business and will give the entrepreneur necessary confidence. When resources are very lim- ited, the entrepreneur may consider offering the lawyer stock in exchange for his or her

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PROVIDE ADVICE TO AN ENTREPRENEUR ABO UT INTELLECTUAL PROPERTY PROTECTION

Locked doors and a security system protect your equipment, inventory, and payroll. But what protects your business's most valuable possessions? Intellec- tual property laws can protect your trade secrets, trademarks, and product design, provided you take the proper steps. Chicago attorney Kara E. F. Cenar of Welsh & Katz, an intellectual property firm, contends that businesses should start thinking about these is- sues earlier than most do. "Small businesses tend to delay securing intellectual property protection be- cause of the expense," Cenar says. "They tend not to see the value of intellectual property until a competi- tor infringes." But a business that hasn't applied for copyrights or patents and actively defended them will likely have trouble making its case in court.

One reason many business owners don't protect their intellectual property is that they don't recog- nize the value of the intangibles they own. Cenar ad- vises business owners to take their business plans to an experienced intellectual property attorney and discuss how to deal with these issues. Spending money up front for legal help can save a great deal later by giving you strong copyright or trademark rights, which can deter competitors from infringing and avoid litigation late r.

Once you've figured out what's worth protecting, you have to decide how to protect it. That isn't al- ways obvious. Traditionally, patents prohibit others from copying new devices and processes, while copy- rights do the same for creative endeavors such as books, music, and software. In many cases, though, the categories overlap. Likewise, trademark law now extends to such distinctive elements as a product's color and shape. Trade dress law concerns how the product is packaged and advertised. You might be able to choose what kind of protection to seek.

For instance, one of Welsh & Katz's clients is Ty Inc., maker of plush toys. Before launching the Beanie Baby line, Cenar explains, the owners brought in busi- ness and marketing plans to discuss intellectual prop- erty issues. The plan was for a limited number of toys in a variety of styles, and no advertising except word- of-mouth. Getting a patent on a plush toy might have been impossible and would have taken several years, too long for easily copied toys. Trademark and trade

162

dress protection wouldn't help much, because t he company planned a variety of styles. But copyrig hts are available for sculptural art, and they're inexpen- sive and easy to obtain. The company chose to reg is- ter copyr ights and defend them vigorously. Cena r's firm has fended off numerous knockoffs.

That's the next step: monitoring the marketplace for knockoffs and trademark infringement, and ta k- ing increasingly firm steps to enforce your rights. Efforts typically begin with a letter of warning an d could end with a court-ordered cease-and-desist order or even an award of damages. "If you don't take the time to enforce [your trademark], it becomes a ve ry weak mark," Cenar says. "But a strong mark deters in- fringement, wins lawsuits and gets people to settle early." Sleep on your rights, and you'll lose them. Be proactive, and you'll protect them-and save money in the long run.

ADVI CE TO AN ENTREPRENEUR An inventor with a newly invented technology comes to you for advice on the following matters:

1. In running this new venture, I need to invest all available resources in producing the products and attracting customers. How important is it for me to divert money from those efforts to protect my intellectual property?

2. I have sufficient resources to obtain intellectual property protection, but how effective is that protection without a large stock of resources to invest in going after those who infringe on my rights? If I do not have the resources to defend a patent, is it worth obtaining one in the first place?

3. Are there circumstances when it is better for me not to be an innovator but rather produce "knockoffs" of others' innovations? What do I need to watch out for when imitating the prod- ucts of others?

Source: Reprinted with permission of Entrepreneur Media, Inc. "You Have to Get Tough with Transgressors If You Want to Protect Your Intellectual Property," by Steven C. Bahls and Jane Easter Bahls, January 2003, Entrepreneur magazine : www.entrepreneur.com.

nt Grants holder

tion from others =:ring, using, or selling

sbrilar idea

Entrepreneurship, Eighth Edition

CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 163

services. The lawyer then will have a vested interest in the business and will likely provide more personalized services. However, in making such a major decision, the entrepreneur must consider any possible loss of control of the business.

LEGAL ISSUES IN SETTING UP THE ORGANIZATION The form of organization as well as franchise agreements are discussed in Chapters 9 and 14 and will not be addressed in detail here. Since there are many options that an entrepre- neur can choose in setting up an organization (see Chapter 9), it will be necessary to under- stand all the advantages and disadvantages of each regarding such issues as liability, taxes, continuity, transferability of interest, costs of setting up, and attractiveness for raising capital. Legal advice for these agreements is necessary to ensure that the most appropriate decisions have been made.

PATENTS A patent is a contract between the government and an inventor. In exchange for disclosure of the invention, the government grants the inventor exclusivity regarding the invention for a specified amount of time. At the end of this time, the government publishes the invention and it becomes part of the public domain. As part of the public domain, however, there is the assumption that the disclosure will stimulate ideas and perhaps even the development of an even better product that could replace the original.

Basically, the patent gives the owners a negative right because it prevents anyone else from making, using, or selling the defined invention. Moreover, even if an inventor has been granted a patent, in the process of producing or marketing the invention he or she may find that it infringes on the patent rights of others. The inventor should recognize the dis- tinction between utility and design patents and some of the differences in international patents that are discussed later in this chapter.

• Utility patents. When speaking about patents, most people are referring to utility patents. A utility patent has a term of 20 years, beginning on the date of filing with the Patent and Trademark Office (PTO). Any invention requiring FDA approval has also been amended to extend the term of the patent by the amount of time it takes the FDA to review the invention. Initial filing fees for a utility patent for a small entity can vary from $82 online to $165 by mail. Additional fees exist depending on the number of claims made in the patent application.

A utility patent basically grants the owner protection from anyone else making, using, and/or selling the identified invention and generally reflects protection of new, useful, and unobvious processes such as film developing, machines such as photocopiers, com- positions of matter such as chemical compounds or mixtures of ingredients, and articles of manufacture such as the toothpaste pump.

• Design patents. Covering new, original, ornamental, and unobvious designs for articles of manufacture, a design patent reflects the appearance of an object. These patents are granted for a 14-year term and, like the utility patent, provide the inventor with a negative right excluding others from making, using, or selling an article having the ornamental appearance given in the drawings included in the patent. The initial filing fee for each design application for a small entity is $110. There are also issuance fees, depending on the size of the item. These fees are much lower than for a utility patent.

Traditionally, design patents were thought to be useless because it was so easy to design around the patent. However, there is renewed interest in these patents. Examples

172 -l Entrepreneursh ip

164 PART 2 FROM IDEA TO THE OPPORTUNITY

provisional patent

application The initial

application to the U.S.

Patent and Trademark

Office providing evidence

of first to market

are shoe companies such as Reebok and Nike that have become more interested in obtaining design patents as a means of protecting their ornamental designs. These types of patents are also valuable for businesses that need to protect molded plastic parts, extrusions, and product and container configurations.

• Plant patents. These are issued under the same provisions as utility patents and are fo r new varieties of plants . These patents represent a limited area of interest, and thus very few of these types of patents are issued.

Patents are issued by the PTO . In addition to patents, this office administers other pro- grams and many online services for the entrepreneur, such as software for filing patents and forms for trademarks and copyrights, discussed later in this chapter. Although the Disclo- sure Document Program ended in 2007, it has been replaced by the Provisional Patent Application Program.

A patent reform bill was introduced to Congress in 2007, but with changes made inde- pendently by both the House and Senate there has not been any compromise. President Obama has indicated a desire to move on patent reform, and there will likely be changes in the near future . The most important part of the reform bill is the "first to file" system used in most other countries. What this means is that regardless of the date of the invention, it is the first one to file who will be granted the patent. 3

International Patents With the World Trade Organization (WTO) and its predecessor, the General Agreement on Tariffs and Trade (GATT), more global free trade has been encouraged. However, although international trade has increased at the rate of about 6 percent per year since GATT was created in 1948, until recently there still was a need for an international patent law to pro- tect firms from imitations and knockoffs. Another mechanism also was needed to provide firms some protection in global markets. 4

In response, the Patent Cooperation Treaty (PCT)-with over 100 participants-was established to facilitate patent filings in multiple countries in one office rather than filing in each separate country. Administered by the World Intellectual Property Organization (WIPO) in Geneva, Switzerland, it provides a preliminary search that assesses whether the filing fum will face any possible infringements in any country. 5 The company can then decide whether to proceed with the required filing of the patent in each country. It has a 30-month time frame to file for these in-country patents. Even though the PCT allows for simultaneous filing of a patent in all member countries, there may be significant differences in patent laws in each of these countries. For example, patent laws in the United States allow computer software to re- ceive both patent and copyright protection. On the other hand, in the European Union, patent protection is not always extended to software, although recent court judgments in the U.K. may change this as well. 6

The Provisional Application It is recommended that the entrepreneur first file a provisional patent application to es - tablish a date of conception of the invention. This provisional application replaces the disclosure document that was previously accepted by the PTO. The disclosure document was more loosely defined in its requirements and often led to issues when more than one person claimed the patent rights. In addition, the new provisional application is consis- tent with European procedures and can be critical when there is a foreign company

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CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 165

involved in the patent application. Basically, this application gives the entrepreneur who files the rights to the patent based on the simple concept of first to file. As stated previ- ously the requirements of the provisional application are somewhat more complete than the prior disclosure document since the entrepreneur must prepare a clear and concise de- scription of the invention. In addition to the written material, drawings may be included, if deemed necessary to understand the invention. Upon receipt of the information, the PTO will file the application on behalf of the inventor. The actual filing of the patent in its final form must occur no later than 12 months after the provisional disclosure docu- ment is filed.

Before actually applying for the patent it is advisable to retain a patent attorney to con- duct a patent search. After the attorney completes the search, a decision can be made as to the patentability of the invention.

The Patent Application The patent application must contain a complete history and description of the invention as well as claims for its usefulness. The actual form can be downloaded from the Patent and Trademark Office Web site. In general, the application will be divided into the following sections:

• Introduction. This section should contain the background and advantages of the invention and the nature of problems that it overcomes . It should clearly state how the invention differs from existing offerings.

• Description of invention. Next the application should contain a brief description of the drawings that accompany it. These drawings must comply with PTO requirements. Following this would be a detailed description of the invention, which may include engineering specifications, materials, components, and so on, that are vital to the actual making of the invention.

• Claims. This is probably the most difficult section of the application to prepare since claims are the criteria by which any infringements will be determined. They serve to specify what the entrepreneur is trying to patent. Essential parts of the invention should be described in broad terms so as to prevent others from getting around the patent. At the same time, the claims must not be so general that they hide the invention's uniqueness and advantages. This balance is difficult and should be discussed and debated with the patent attorney.

In addition to the preceding sections, the application should contain a declaration or oath that is signed by the inventor or inventors. Your attorney will supply this form. The completed application is then ready to be sent to the PTO, at which time the status of the invention becomes patent pending. This status is important to the entrepreneur because it now provides complete confidential protection until the application is approved. At that time, the patent is published and thus becomes accessible to the public for review.

A carefully written patent should provide protection and prevent competitors from working around it. However, once granted, it is also an invitation to sue or be sued if there is any infringement.

The fees for filing an application will vary, depending on the patent search and on claims made in the application. Attorney fees are also a factor in completing the patent application. Applicants may also file online using the EFS Web service provided by the PTO. This online service enables applicants to file their application without the need for special soft- ware, resulting in faster application processing.

17 4 Entrepreneurship -------- ----~ -- ----~------ -- ----------·-------------------- ~-- - -------- -- ------------ -----------

166 PART 2 FROM IDEA TO THE OPPORTUNITY

FIGURE 6.1 Options to Avoid Infringement

Assess whether No patent now exists

File for patent

Yes

Is patent recent New Do expired patents or is it nearly exist that accomplish expired? same purpose?

No I

l Ready to Yes expire Can product be Begin planning for

Develop product changed slightly introduction when without existing patent

using older designs

infringement? expires

No Yes

Seek license Develop modified version

Source: Adapted from H. D. Coleman and J.D. Vandenberg, "How to Follow the Leader," Inc. (July 1988), pp. 81-82.

Patent Infringement To this point, we have discussed the importance of and the procedures for filing a patent. It is also important for the entrepreneur to be sensitive about whether he or she is infringing

on someone else's patent. The fact that someone else already has a patent does not mean the end of any illusions of starting a business. Many businesses, inventions, or innovations are the result of improvements on, or modifications of, existing products. Copying and -~"\._~~'\, '\::><:;:,.. ~~"\._~~~ ... :<::& .. ~~~.;~_"<:;..~~ ~~ ~·-:~~~~"<:;..~~~~~~~~~"1£...~~ ~"'~

business strategy. If it is impossible to copy and improve the product to avoid patent infringement, the entrepreneur may try to license the product from the patent holder. Figure 6.1 illustrates the steps that an entrepreneur should follow as he or she considers m'lll'¥..~\\1\~ ~ })110~\\~\ ~~\ Th~') \W..~\\~~ 10\\ '0.\\ ~-i.\.~\.\.\\'S \)'0.\~~-\.\\..~ ~\\\1..~\l'-~\\~~'- '-'0."'- \\<;:)~

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process. If there is an existing patent that might involve infringement by the entrepreneur, licensing may be considered. If there is any doubt as to this issue, the entrepreneur should hire a patent attorney to ensure that there will not be any possibility of patent infringement. Table 6.1 provides a simple checklist that should be followed by an entrepreneur to mini- mize any patent risks.

BUSINESS METHOD PATENTS With the growth of Internet use and software development has emerged the use of business method patents. For example, Amazon.com owns a business method patent for the single- clicking feature used by a buyer on its Web site to order products. A few years ago eBay was

-----------------------------------------------------------------------------------------·' ~

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Entrepreneurship, Eighth Edition 17 5 - - - ---- ------- -- -- --- -- - --~ -------

CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 167

TABLE 6.1 Checklist for Minimizing Patent Risks

• Seek a patent attorney who has expertise in your product line.

• The entrepreneur should consider a design patent to protect the product design or product look.

• Before making an external disclosure of an invention at a conference or to the media, or before setting up a beta site, the entrepreneur should seek legal counsel since this external disclosure may negate a subsequent patent application.

• Evaluate competitor patents to gain insight into what they may be developing.

• If you think your product infringes on the patent of another firm, seek legal counsel.

• Verify that all employment contracts with individuals who may contribute new products have clauses assigning those inventions or new products to the venture.

• Be sure to properly mark all products granted a patent. Not having products marked could result in loss or damages in a patent suit.

• Consider licensing your patents. This can enhance the investment in a patent by creating new market opportunities and can increase long-term revenue.

sued by Tom Woolston and his company MercExchange claiming a violation of a patent he owned that covered many fundamental aspects of eBay's operations, such as the buying and selling of products through a reverse auction process. Priceline.com claims that it holds a patent related to its service where a buyer can submit a price bid for a particular service. Expedia was forced to pay royalties to Priceline.com after being sued for patent infringement by Priceline.com. Many firms that hold these types of patents have used them to assault com- petitors and subsequently provide a steady stream of income from royalties or licensing fees?

Given the increase in the assaults and because of the growth of digital technologies such as the Internet, computer software, and telecommunications, concerns have evolved regard- ing these business method patents. Examples of the focus of these concerns are tax strate- gies, the determination of insurance rates, or how commodities are purchased through a third party. These business practice patents are now being threatened by a recent court rul- ing that denied a patent for a process of hedging risks in commodity trading. The Federal Circuit Court denied the patent because it did not meet the machine or transformation test. This simply means that any business method or practice must be tied to a machine such as a computer. Thus, a mental process of calculations for hedging risks in commodity trading did not include a machine or computer and therefore was not granted a patent. 8

START -UP WITHOUT A PATENT Not all start-ups will have a product or concept that is patentable. In this case the entrepre- neur should understand the competitive environment (see Chapters 7 and 8) to ascertain any advantages that may exist or to identify a unique positioning strategy (see Chapter 8). With a unique marketing plan, the entrepreneur may find that striking early in the market pro- vides a significant advantage over any competitors. Maintaining this differential advantage will be a challenge but represents an important means of achieving long-term success.

TRADEMARKS A trademark may be a word, symbol, design, or some combination of such, or it could be a slogan or even a particular sound that identifies the source or sponsorship of certain goods or services. Unlike the patent, a trademark can last indefinitely, as long as the mark

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PROVIDE ADVICE TO AN ENTREPRENEUR INVENTOR ABOUT HOW TO MAKE PATENTS PAY

The niche patent-licensing business of Acacia Research (ACTG) is bearing fruit-and it has proved to be quite lucrative . Titans like Apple (AAPL}, Verizon (VZ}, Sie- mens (51}, and Dell Inc. (DELL) have opted to license certain patents held by Acacia. For Acacia, that makes the business all the more rewarding.

What's tiny Acacia's business strategy? It teams up with small, little-known tech companies and takes licenses on their patented technologies. Acacia then goes after companies it believes have infringed those patents. Fortunately for Acacia, it has settled quite a number of such patent violations out of court. And those companies that settle infringement claims usu- ally end up paying fees.

The latest company to come to terms with Acacia is giant computer maker Dell, which entered into a settlement that included a licensing agreement cov- ering a patent relating to network multifunction prin- ter technology.

In 2008, Apple signed two tech licenses with Acacia, and Verizon Wireless took a license on a process that synchronizes IP addresses between wireless network devices, says Acacia Chairman and CEO Paul Ryan. He figures that with the more than 100 patents Acacia now holds, many other companies are likely to end up signing licensing deals with Acacia.

So far, Acacia has been on a rapid growth path, according to both CEO Ryan and analysts. In 2008, says Ryan, Acacia was No. 42 on Deloitte Technol- ogy's list of the 500 fastest-growing tech outfits in the U.S . He says Acacia expects revenue growth to come from 45 patent licensing programs that have already begun generating revenues, including those signed in 2009.

Acacia's "growth prospects remain strong," says analyst Sean O'Neill of Singular Research, who rates

168

Acacia a buy. Revenues in the third quarter of 2008, he notes, increased 44.6% from a year earlier, exceed- ing analysts' expectations. On a sequential quarter- to-quarter basis, revenues jumped 93%, from the $7.1 million Acacia reported in the second quarter, notes O'Neill.

O'Neill expects Acacia to become profitable in 2009, with estimated earnings of 11 ~ a share on pro- jected revenues of $67.9 million. In 2008, Acacia is es- timated by analysts to have posted a loss of 46~ a share on sales of $44 million.

If, as CEO Ryan predicts, more prominent compa- nies sign agreements to settle patent infringements, Acacia's top and bottom lines would leap, along with its stock price.

Acacia CEO Ryan won't say which companies he expects will sign patent licensing agreements, but he is confident more big tech players will end up signing agreements this yea r. Expect some surprises.*

ADVICE TO AN ENTREPREN EUR A friend of yours has read the above article and wants to know if he could benefit from some of the patents he owns, just as Acacia was able to do. How would you advise him to proceed to learn if any of his patents are being used by other companies? He also wants to know if Acacia may be interested in any of his patents and what he could do to find out.

*Source: Reprinted from February 2, 2009 issue of Business Week by special pennission, copyright© 2009 by The McGraw-Hill Compa- nies, Inc., from "Acacia Research Finds Ways to Make Patents Pay," by Gene Marcial, www.businessweek.com.

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CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 169

continues to perform its indicated function. For all registrations filed after November 16, 1989, the trademark is given an initiallO-year registration with 10-year renewable terms. In the fifth to sixth year, the registrant is required to file an affidavit with the PTO indicat- ing that the mark is currently in commercial use . If no affidavit is filed, the registration is canceled. Between the ninth and tenth year after registration, and every 10 years thereafter, the owner must file an application for renewal of the trademark. Otherwise, the registration is canceled. (There is a six-month grace period.)

Trademark law allows the filing of a trademark solely on the intent to use the trademark in interstate or foreign commerce. The filing date then becomes the first date use of the mark. This does not imply that the entrepreneur cannot file after the mark has already been in use. If this is the case, the entrepreneur may file a sworn statement that the mark is in commercial use, listing the date of first use. A properly worded declaration is included in the PTO application form.

It is also possible to file for a trademark if you intend to use this mark in the future. You are allowed to file in good faith along with a sworn statement in the application that there is intent to use the trademark. Actual use of the trademark must occur before the PTO will register the mark. 9

The protection awarded is dependent on the character of the mark itself. There are four categories of trademarks: (1) coined marks denote no relationship between the mark and the goods or services (e.g ., Mercedes, Kodak) and afford the possibility of expansion to a wide range of products; (2) an arbitrary mark is one that has another meaning in our lan- guage (e.g., Apple) and is applied to a product or service; (3) a suggestive mark is used to suggest certain features, qualities , ingredients, or characteristics of a product or service (e.g., Halo shampoo). It differs from an arbitrary mark in that it tends to suggest some describable attribute of the product or service. Finally, (4) a descriptive mark must have become distinctive over a significant period of time and gained consumer recognition be- fore it can be registered. The mark then is considered to have secondary meaning; that is, it is descriptive of a particular product or service (e.g., Rubberoid as applied to roofing mate- rials that contain rubber. 10

Registering a trademark can offer significant advantages or benefits to the entrepreneur. Table 6.2 summarizes some of these benefits .

Registering the Trademark As indicated earlier, the PTO is responsible for the federal registration of trademarks. To file an application, the entrepreneur must complete a simple form that can be downloaded

TABLE 6.2 Benefits of a Registered Trademark

• It provides notice to everyone that you have exclusive rights to the use of the mark throughout the territorial limits of the United States.

• It entitles you to sue in federal court for trademark infringement, which can result in recovery of profits, damages, and costs.

• It establishes incontestable rights regarding the commercial use of the mark.

• It establishes the right to deposit registration with customs to prevent importation of goods with a similar mark.

• It entitles you to use the notice of registration (®).

• It provides a basis for filing trademark application in foreign countries.

178 I Entrepreneurship

170 PART 2 FROM IDEA TO THE OPPORTUNITY

copyright Right given

to prevent others from

printing, copying, or

publishing any original

works of authorship

and either submitted by mail or filed electronically using the Trademark Electronic Appli- cation System (TEAS) available on the PTO Web site.

Filing of the trademark registration must meet four requirements: (1) completion of the written form, (2) a drawing of the mark, (3) five specimens showing actual use of the mark, and (4) the fee. Each trademark must be applied for separately. Upon receipt of this information, the PTO assigns a serial number to the application and sends a filing receipt to the applicant.

The next step in the registering process is a determination by the examining attorney at the PTO as to whether the mark is suitable for registration. Within about three months, an initial determination is made as to its suitability. Any objections by the entrepreneur must be raised within six months, or the application is considered abandoned. If the trademark is refused, the entrepreneur still has the right to appeal to the PTO.

Once accepted, the trademark is published in the Trademark Official Gazette to allow any party 30 days to oppose or request an extension to oppose. If no opposition is filed, the regis- tration is issued. This entire procedure usually takes about 13 months from the initial filing.

COPYRIGHTS A copyright protects original works of authorship. The protection in a copyright does not protect the idea itself, and thus it allows someone else to use the idea or concept in a differ- entmanner.

The copyright law has become especially relevant because of the tremendous growth of the use of the Internet, especially to download music, literary work, pictures, and videos, to name a few. Although software was added to copyright law in 1980, the issues surrounding access to material on the Internet have led to major legal battles for the entertainment industry.

When Napster made its entrance in 1999, Internet users were able to exchange music files at will. The music industry scrambled and fought against this use since its sales of CDs were significantly impacted. After three years, the music industry was able to win its battle with Napster. In addition, the Supreme Court ruled that StreamCast and Grokster, which both have extensive peer-to-peer file sharing software, must implement content filters in their software to reduce any copyright-infringing capabilities.l 1

The Recording Industry Association of America (RIAA) has also aggressively pursued universities and individual students that have been found to be illegally downloading mu- sic. In addition to the 12 universities recently sent prelitigation letters, the RIAA is also pursuing individuals in what is referred to as "John Doe" lawsuits. One lawsuit involves a 20-year-old woman from Texas who admitted to downloading pirated music in her teens ; she is being asked to pay $7,400 to settle the suit. 12

Copyright protection related to the Internet will continue to be a concern and a gray area until precedents and regulations are made clear. Although these issues seem complicated, the registering procedure for copyright protection is fairly simple.

Copyrights are registered with the Library of Congress and will not usually require an attorney. To register a work, the applicant can send a completed application (available on- line at www.copyright.gov), two copies of the work, and the required filing fees (the initial filing fee is $35 if filed online or $45 if filed by mail, but other fees may apply based on the number of works included). As a general rule for works created after January 1, 1978, the term of the copyright is the life of the author plus 70 years.

Besides computer software, copyrights are desirable for such things as books, scripts, ar- ticles, poems, songs, sculptures, models, maps, blueprints, collages, printed material on board games, data, and music. In some instances, several forms of protection may be available. For example, the name of a board game may be protected by trademark, the game itself protected by a utility patent, the printed matter or the board protected by a copyright, and the playing pieces covered by a design patent.

e ETHICS

'""'P""""h;p, E;ghth Edrt;oo I 179 ···----- - -· ---- -- -·- --~-----

HOW MUCH RESPONSIBILITY SHOULD OUR YOUTH HAVE FOR ILLEGAL DOWNLOADING?

e lines have been drawn between the file-sharing co mpanies (P2P) that provide software for free down- oading of music and movies and the entertainment

dustry. The Supreme Court has ruled that these 2P companies do in fact facilitate the illegal down-

oading and sharing of entertainment . However, in s it e of the fact that there has been so much publicity

In addition to these college and university incidents, a recent Harris Interactive poll found that kids and teens, ranging in age from 8 to 18, continue to down- load and share files that are copyright protected- in spite of the fact that nearly 90 percent know it is illegal. What is alarming in this study is the fact that 80 percent of the participants understand the mean- ing of a copyright, yet they continue to perform ille- gal functions. This finding illustrates a challenging ethical dilemma that persists in our society. The par- ticipants were more concerned with downloading a virus or spyware than they were with getting in trouble with the law. It is apparent from this re- search that young people consider stealing software a victimless crime, which would seem to underline the need for more ethics education at home and at school.

rrounding the legality of such initiatives, the youth our nation continue to illegally download material

- at has been given copyright protection. This in- ~lud es college students as well, recently evidenced

th e fact that the Recording Industry Association L A merica (RIAA) filed copyright infringement law- it s against 405 students at 18 different colleges. is list of colleges included Columbia, Harvard, and

:: ·nceton . According to the lawsuit, these students , re allegedly using a new file-sharing application

"? led i2hub to download songs and movies at light- ~ · g speeds. The RIAA also has evidence that this - ·gh -speed network is also being used at another

Sources: Sebastian Rupley, "Infringing Copyrights at Mach 5," PC Magazine (June 7, 2005), p. 24, and "Majority of Youth Under- stand 'Copyright,' but Many Continue to Download lllegally,"

schools in 41 states. PR Newswire (May 18, 2004) pp. 1-3 .

ecret Protection

others revealing

ess

TRADE SECRETS In certain instances, the entrepreneur may prefer to maintain an idea or process as confiden- tial and to sell or license it as a trade secret. The trade secret will have a life as long as the idea or process remains a secret.

A trade secret is not covered by any federal law but is recognized under a governing body of common laws in each state. Employees involved in working with an idea or process may be asked to first sign a confidential information agreement that will protect against their giving out the trade secret either while an employee or after leaving the organization. A simple example of a trade secret nondisclosure agreement is illustrated in Table 6.3 . The entrepreneur should hire an attorney to help draw up any such agree- ment. The holder of the trade secret has the right to sue any signee who breaches such an agreement.

What or how much information to give to employees is difficult to judge and is often determined by the entrepreneur' s judgment. Historically, entrepreneurs tended to protect sensitive or confidential company information from anyone else by simply not making them privy to this information. Today, there is a tendency to take the opposite view, that the more information entrusted to employees , the more effective and creative employees can be. The argument is that employees cannot be creative unless they have a complete under- standing of what is going on in the business.

Most entrepreneurs have limited resources, so they choose not to find means to protect their ideas, products, or services. This could become a serious problem in the future, since gathering competitive information legally is so easy to accomplish, unless the entrepreneur takes the proper precautions . For example, it is often easy to learn competitive information

171

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172 PART 2 FROM IDEA TO THE OPPORTUNITY

TABLE 6.3 A Simple Trade Secret Nondisclosure Agreement

WHEREAS, New Venture Corporation (NVC), Anywhere Street, Anyplace, U.S.A., is the Owner of information relating to; and

WHEREAS, NVC is desirous of disclosing said information to the undersigned (hereinafter referred to as "Recipient") for the purposes of using, evaluating, or entering into further agreements using such trade secrets as an employee, consultant, or agent of NVC; and

WHEREAS, NVC wishes to maintain in confidence said information as trade secret; and

WHEREAS, the undersigned Recipient recognizes the necessity of maintaining the strictest confidence with respect to any trade secrets of NVC.

Recipient hereby agrees as follows:

1. Recipient shall observe the strictest secrecy with respect to all information presented by NVC and Recipient's evaluation thereof and shall disclose such information only to persons authorized to receive same by NVC. Recipient shall be responsible for any damage resulting from any breach of this Agreement by Recipient.

2. Recipient shall neither make use of nor disclose to any third party during the period of this Agreement and thereafter any such trade secrets or evaluation thereof unless prior consent in writing is given by NVC.

3. Restriction on disclosure does not apply to information previously known to Recipient or otherwise in the public domain. Any prior knowledge of trade secrets by the Recipient shall be disclosed in writing within (30) days.

4. At the completion of the services performed by the Recipient, Recipient shall wit~ in (30) days return all original materials provided by NVC and any copies, notes, or other documents that are in the Recipient's possession pertaining thereto.

5. Any trade secrets made public through publication or product announcements are excluded from this agreement.

6. This agreement is executed and delivered within the State of __ and it shall be construed, interpreted, and applied in accordance with the laws of that State.

7. This agreement. including the provision hereof, shall not be modified or changed in any manner except only in writing signed by all parties hereto.

Effective this day of 20

RECIPIENT:-------------

NEW VENTURE CORPORATION:

By:--------- Title: _______ _

Date:--------

through such means as trade shows, transient employees, media interviews or announce- ments, and even Web sites . In all instances, overzealous employees are the problem. To try to control this problem, entrepreneurs should consider some of the ideas listed below.

• Train employees to refer sensitive questions to one person.

• Provide escorts for all office visitors.

• Avoid discussing business in public places.

• Keep important travel plans secret.

• Control information that might be presented by employees at conferences or published in journals.

'"'~'~"'""h;p, E;ghth Edn;oo I 181 --------------------- -·-----··------~ ----~~------ ------------------------- ~~-------·· - ·--·-- --·--· -·+-· ----~----

ensing Contractual ~ment giving rights to

ers to use intellectual

~rty in return for a

• . alty or fee

CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 173

• Use simple security such as locked file cabinets, passwords on computers, and shredders where necessary.

• Have employees and consultants sign nondisclosure agreements.

• Debrief departing employees on any confidential information.

• Avoid faxing any sensitive information.

• Mark documents confidential when needed.

Unfortunately, protection against the leaking of trade secrets is difficult to enforce. More important, legal action can be taken only after the secret has been revealed. It is not neces- sary for the entrepreneur to worry extensively about every document or piece of informa- tion. As long as minimal precautions are taken, most problems can be avoided, primarily because leaks usually occur inadvertently.

LICENSING Licensing may be defined as an arrangement between two parties, where one party has proprietary rights over some information, process, or technology protected by a patent, trademark, or copyright. This arrangement, specified in a contract (discussed later in this chapter), requires the licensee to pay a royalty or some other specified sum to the holder of the proprietary rights (licensor) in return for permission to copy the patent, trademark, or copyright.

Thus, licensing has significant value as a marketing strategy to holders of patents, trade- marks, or copyrights to grow their business in new markets when they lack resources or ex- perience in those markets. It is also an important marketing strategy for entrepreneurs who wish to start a new venture but need permission to copy or incorporate the patent, trade- mark, or copyright with their ideas.

A patent license agreement specifies how the licensee would have access to the patent. For example, the licensor may still manufacture the product but give the licensee the rights to market it under their label in a noncompetitive market (i.e., foreign market). In other instances, the licensee may actually manufacture and market the patented product under its own label. This agreement must be carefully worded and should involve a lawyer, to ensure the protection of all parties.

Licensing a trademark generally involves a franchising agreement. The entrepreneur operates a business using the trademark and agrees to pay a fixed sum for use of the trademark, pay a royalty based on sales volume, buy supplies from the franchisor (exam- ples would be Shell, Dunkin' Donuts, Pepsi Cola or Coca Cola bottlers, or Midas muffler shops), or some combination of these. Franchising is discussed later in the text as an option for the entrepreneur as a way to start a new business or as a means of financing growth.

Copyrights are another popular licensed property. They involve rights to use or copy books, software, music, photographs, and plays, to name a few. In the late 1970s, computer games were designed using licenses from arcade games and movies. Television shows have also licensed their names for board games or computer games. Celebrities will often license the right to use their name, likeness, or image in a product (i.e., Tiger Woods golf clothing, Jessica Simpson perfume, Elvis Presley memorabilia, or Mickey Mouse lunch boxes). This is actually analogous to a trademark license.

Licensing has become a revenue boom for many Fortune 500 companies. These firms spend billions of dollars each year on the research and development of new technologies that they will never bring to market. As a result, they will often license patents, trademarks, and other intellectual property to small companies that can profit from them. Microsoft

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174 PART 2 FROM IDEA TO THE OPPORTUNITY

Corporation, with its IP Ventures Division, is a great example of a firm that has offeree technologies for biometric identity authentication, counterfeit-resistant labels, face detec- tion and tracking, and other intellectual property that it does not know how to market or has no intent to market.B These agreements have generated millions of dollars in revenue for Microsoft. IBM continues to generate more than $1 billion from its licensing agreements .1.!. ARC International, the world leader in computer processors, has increased its licensing of its technology to semiconductor companies in their chip design. At present there are abom 140 companies worldwide that rely on ARC's technology. 15

Although technology is one of the largest generators of licensing revenue, there are other significant players in this market. The entertainment industry, particularly motion picture studios such as Disney, Dream Works, Fox, Sony, and Warner Brothers, generates millions of dollars for its bottom line with licensing agreements for clothing, toys, games, and other related items. NBC Universal Inc., with its television, movie, music, and con- sumer products, amassed about $1 billion in revenues in 2008. Just recently, NBC Univer- sal released a full line of products from its successful television show "Heroes." 16 Although in 2006 Disney ended its 10-year licensing agreement with McDonald's, it has inked huge deals with retailers to market a variety of products based on the success of "High School Musical" and "Hannah Montana." These products are expected to result in $2.7 billion in global retail sales. In fact global retail sales of all Disney's licensed merchandise exceeded $30 billion in 2008_17 McDonald's, on the other hand, has moved on and signed licensing agreements with other motion picture studios such as Dream Works Animation SKG and Pixar Animation Studios. 18

Licensing is also popular around special sporting events, such as the Olympics, marathons, bowl games, and tournaments. Licenses to sell T-shirts, clothing, and other accessories require written permission in the form of a license agreement before sales are allowed.

Licensing represents opportunities for many firms to expand into new markets, expand product lines, or simply reach more customers within its existing target markets. Some examples include Microsoft's MSN Mobile group, which recently signed a licensing agree- ment with DeviceAtlas to incorporate their database so MSN can improve the content it presently delivers to its customers. This agreement has already resulted in significant in- creases in mobile registrations. 19 Retailers faced with economic pressures are looking for ways to increase sales of higher-margin items. For example, Safeway has been using Bugs Bunny and his Looney Tunes friends as part of their new Eating Right Kids food and bev- erage line. These items can command higher prices and provide what retailers feel is a value-added endorsement. 20

Before entering into a licensing agreement, the entrepreneur should ask the following questions:

• Will the customer recognize the licensed property?

• How well does the licensed property complement my products or services?

• How much experience do I have with the licensed property?

• What is the long-term outlook for the licensed property? (For example, the loss of popularity of a celebrity can also result in an end to a business involving that celebrity's name.)

• What kind of protection does the licensing agreement provide?

• What commitment do I have in terms of payment of royalties, sales quotas , and so on?

• Are renewal options possible and under what terms?

product safety and

Jability Responsibility

of a company to meet any

;egal specifications

;egarding a new product

;:overed by the Consumer

Product Safety Act

Eotrep'"'""hip, Eighth Editioo I 183 -- ------ --- --· --- -- -+- ----

CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 175

Licensing is an excellent option for the entrepreneur to increase revenue, without the risk and costly start-up investment. To be able to license requires the entrepreneur to have something to license, which is why it is so important to seek protection for any product, information, name, and so on, with a patent, trademark, or copyright. On the other hand, licensing can also be a way to start a new venture when the idea may infringe on someone else's patent, trademark, or copyright. In this instance, the entrepreneur has nothing to lose by trying to seek a license agreement from the holder of the property.

Licensing continues to be a powerful marketing tool. With the advice of a lawyer, entre- preneurs may find that licensing opportunities are a way to minimize risk, expand a business, or complement an existing product line.

PRODUCT SAFETY AND LIAS I LITY It is very important for the entrepreneur to assess whether any product that is to be mar- keted in the new venture is subject to any regulations under the Consumer Product Safety Act. The original act, which was passed in 1972 and then amended in 1990, created a five-member commission that has the power to prescribe safety standards for more than 15,000 types of consumer products. In August of 2008 there were significant changes that were made into law, now requiring stricter standards for potentially hazardous and unsafe products .

Large fines as well as recalls of any products that are deemed unsafe are the typical outcomes of any action enforced by the commission. For example, in 2007 U.S . compa- nies were forced to make more than 100 recalls involving about 9 million toys. Polly Pocket play sets and Batman action figures highlighted these recalls, given that these products were found to have high lead content or that they contained small accessories that could be potentially hazardous if swallowed by a child. The public outcry from these recalls was a major factor in getting Congress to act quickly on the new legisla- tion. In the past two decades, the Consumer Product Safety Commission had been oper- ating on tighter budgets and smaller staff and was not able to oversee the large number of new products being launched or imported each year. With a new budget, significantly larger staff, and support from the administration it is expected that the commission will now be able to take a more active role in making sure that firms meet the new legal re- quirements for product safety. Stricter enforcement as well as the threat of significant increases in fines for violations should improve the situation. As an example, the fines for violations in the past were $5,000 per violation. The new law allows for fines of $100,000 per violation with a cap of $15 million . The commission will also be able to take a more active role in demanding recalls where in the past it only could oversee any voluntary recalls. The development of stricter regulations regarding labeling and adver- tising is also part of the commission's responsibility under the new law. It is clear with just these mentioned changes that any entrepreneur involved in marketing potentially hazardous or unsafe products will need to make sure that products are tested by approved third-party testing facilities . 21

INSURANCE Some of the problems relating to product liability were discussed in the previous section. Besides being cautious, it is also in the best interests of the entrepreneur to purchase insur- ance in the event that problems do occur. Service-related businesses such as day-care cen- ters, amusement parks, and shopping centers have had significant increases in the number of lawsuits.

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176 PART 2 FROMIDEATOTHEOPPORTUNITY

TABLE 6.4 Types of Insurance and Possible Coverage

Types of Insurance

Property

Casualty

Coverage Possible

• Fire insurance to cover losses to goods and premises resulting from fire and lightning. Can extend coverage to include risks associated with explosion, riot, vehicle damage, windstorm hail, and smoke.

• Burglary and robbery to cover small losses for stolen property in cases of forced entry (burglary) or if force or threat of violence was involved (robbery).

• Business interruption will pay net profits and expenses when a business is shut down because of fire or other insured cause.

• General liability covers the costs of defense and judgments obtained against the company resulting from bodily injury or property damage. This coverage can also be extended to cover product liability.

• Automobile liability is needed when employees use their own cars for company business.

Life • Life insurance protects the continuity of the business (especially a partnership). It can also provide financial protection for survivors of a sole proprietorship or for loss of a key corporate executive.

Workers' compensation • May be mandatory in some states. Provides benefits to employees in case of work-related injury.

Bonding • This shifts responsibility to the employee for performance of a job. It protects company in case of employee theft of funds or protects contractor if subcontractor fails to complete a job within an agreed-upon time frame.

In general, most firms should consider coverage for those situations as described in Table 6.4. Each of these types of insurance provides a means of managing risk in the new business. The main problem is that the entrepreneur usually has limited resources in the be- ginning. Thus, it is important to first determine whether any of these types of insurance are needed. Note that some insurance, such as disability and vehicle coverage, is required by law and cannot be avoided. Other insurance, such as life insurance of key employees, is not required but may be necessary to protect the financial net worth of the venture. Once the entrepreneur determines what types of insurance are needed, then a decision can be made as to how much insurance and from what company. It is wise to get quotes from more than one insurance firm since rates and options can also vary. The total insurance cost represents an important financial planning factor, and the entrepreneur needs to consider increasing premiums in cost projections.

Skyrocketing medical costs have probably had the most significant impact on insurance premiums . This is especially true for workers' compensation premiums, which for some entrepreneurs have doubled or tripled in the last few years. Insurance companies calcu- late the premium for workers' compensation as a percentage of payroll, the type of busi- ness, and the number of prior claims. Given the problems with fraudulent or suspicious claims, some states are beginning to undertake reforms in the coverage. Even before re- forms are enacted, the entrepreneur can take some action to control the premiums by pay- ing attention to details, such as promoting safety through comprehensive guidelines that

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CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 177

are communicated to every staff member. Being personally involved with safety can, in · the long run, significantly control workers' compensation premiums.

Entrepreneurs also have to consider health care coverage. This is an important ben- efit to employees and will require the venture to cover a significant portion of this expense for the employee. Rates to the company will vary significantly depending on the plan and its various options. Health insurance premiums are less expensive if there is a large group of insured participants. This is, of course, difficult for a start-up venture but can be resolved by joining a group such as a professional association that offers such coverage.

However, if you are a self-employed entrepreneur, the options are limited. If you are leaving a corporate position, consider extending your health care benefits with COBRA. This usually allows you to continue on the same health care policy you were on for about three years . However, you now will have to pay the entire premium on the policy. If your COBRA has expired or one is not available, you can consider contacting your state insurance department, which can supply a list of insurance companies that provide individual health care insurance. Policies that have higher deductibles can also be con- sidered because of their lower premiums . For additional assistance in these matters it is recommended that the entrepreneur contact the Association of Health Insurance Agents, the Health Insurance Association of America, or the U.S. Labor Department, all located in Washington, D.C.

Most recently there has been some controversy regarding safety for employees in home- based businesses. The government's response has been that the company is responsible for safety or health violations in home-based offices. The best protection for entrepreneurs operating home-based businesses is to write handbooks with stated policies on home office safety.

Seeking advice from an insurance agent is often difficult because the agent is trying to sell insurance. However, there are specialists at universities or the Small Business Admin- istration who can provide this advice at little or no cost.

SARBANES-OXLEY ACT After a lengthy period of reported corporate misconduct involving companies such as Enron and Arthur Andersen, Congress passed the Sarbanes-Oxley Act in 2002. Although this act has provided a mechanism for greater control over the financial activities of public companies, it also has created some difficulties for start-ups and smaller companies. Argu- ments are now being put forth that the law was passed too quickly as a result of all the cor- porate scandals and that the provisions are too vague and their implementation by CPAs too rigid. In fact it is argued that the cost of compliance is not only prohibitive but that it has led to a decline in the number of start-ups going public. 22

The act contains a number of provisions, and no attempt will be made here to cover them all. Instead an overview of the law's requirements will be discussed. The complete law or relevant sections can be downloaded from the Internet.

The Sarbanes-Oxley Act covers a wide range of corporate governance activities. Under this law, CEOs are required to vouch for financial statements through a series of internal control mechanisms and reports. Directors must meet background, length of service, and responsibilities requirements regarding internal auditing and control. Any attempt to influence the auditor or impede the internal auditing process is considered a criminal act. In addition, the law covers bank fraud; securities fraud; and fraud by wire, radio, or TV. 23

186 Entrepreneurship ---· .... ..:.._....._;..,_.._ .,

178 PART 2 FROM IDEA TO THE OPPORTUNITY

contract A legally

binding agreement

between two parties

With the passage of this law there has been some concern as to the interpretation of this law and subsequent directors' liability. For example, will this law discourage qualified in- dividuals from being members of important boards because of their concern for negative publicity that could be initiated by a disgruntled employee or stockholder?

Foreign companies that trade on U .S. stock exchanges are often delisted since there are major conflicts with the provisions of the new law and the laws of that foreign country. For example, independent audit committees, required by the new law, conflict with some foreign countries' rules and customs. This is only one example of the many conflicts tha· presently exist with foreign laws and customs. 24

At present, private companies are not included in this act. However, there could be some future controls established to prevent any of these governance issues in private companies. Private companies are also subject to control if they consult with a public company and in any way influence that public company in any wrongdoing established by the Sarbanes- Oxley Act.

The other option, of course, is for the entrepreneur to set up a board of advisors instead of an extended board of directors. Advisors would not be subject to liability since they do not formulate fmal policy for the venture but only provide recommendations to the actual board of directors , which in this case could consist of the management of the start-up ven- ture. If a venture capitalist or even an angel investor were involved, they would require a board seat, in which case the use of a board of advisors would not likely be acceptable and liability protection would be necessary.

CONTRACTS The entrepreneur, in starting a new venture, will be involved in a number of negotiations and contracts with vendors, landlords, and clients. A contract is a legally enforceable agree- ment between two or more parties as long as certain conditions are met. Table 6.5 identi- fies these conditions and the outcomes (breaches of contract) should one party not live up to the terms of the contract. It is very important for the entrepreneur to understand the

TABLE 6.5 Contract Conditions and Results of a Breach of Contract

Contract Conditions

• An offer is made. It can be oral or written but is not binding until voluntary acceptance of offer is given.

• Voluntary acceptance of offer.

• Consideration (something of value) is given by both parties.

• Both parties are competent and/or have the right to negotiate for their firms.

• Contract must be legal. Any illegal activities under a contract are not binding. An example might be gambling.

• Any sales of $500 or more must be in writing.

Results of a Contract Breach

• The party in violation of a contract may be required to live up to the agreement or pay damages.

• If one party fails to live up to its end of a contract. the second party may also agree to drop the matter and thus not live up to the agreement as well. This is referred to as contract restitution.

_ ____ ______ ___ ____ ______ ____ __ _ ___ __ ___ _____ _____ __ __ _ _ __ _ _ _ Eo_'~_P"'""~h;P:_E;gh<h_Ed;~~"---~-1_81 ___ _

EVIEW

MARY

CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 179

fundamental issues related to contracts while also recognizing the need for a lawyer in many of these negotiations.

Often business deals are concluded with a handshake. Ordering supplies, lining up financing, reaching an agreement with a partner, and so on, are common situations in which a handshake consummates the deal. Usually, when things are operating smoothly, this pro- cedure is sufficient. However, if there are disagreements, the entrepreneur may find that there is no deal and that he or she may be liable for something never intended. The courts generally provide some guidelines based on precedence of cases. One rule is to never rely on a handshake if the deal cannot be completed within one year. For example, a company that trains salespeople asked another firm to produce videotapes used in the training. The training firm was asked to promise to use the tapes only for its own sales force and not to sell the tapes to others. Some time after the tapes were produced, this firm began to produce and sell the tapes under a newly formed company. The original developer of the tapes brought suit, and the courts ruled that an oral agreement for more than one year is not en- forceable. The only way that this could have been prevented was if the copying firm had signed a contract.

In addition to the one-year rule of thumb, the courts insist that a written contract ex- ist for all transactions over $500 . Even a quote on a specified number of parts from a manufacturer may not be considered a legal contract. For example, if an entrepreneur asked for and received a quote for 10 items and then ordered only 1 item, the seller would not have to sell that item at the original quoted price unless a written contract ex- isted. If the items totaled over $500, even the quoted price could be changed without a written contract.

Most sellers would not want to try to avoid their obligations in the preceding example. However, unusual circumstances may arise that force the seller to change his or her mind. Thus, the safest way to conduct business deals is with a written contract, especially if the amount of the deal is over $500 and is likely to extend beyond one year.

Any deal involving real estate must be in writing to be valid. Leases, rentals, and pur- chases all necessitate some type of written agreement.

Although a lawyer might be necessary in very complicated or large transactions, the en- trepreneur cannot always afford one. Therefore, it is helpful for the entrepreneur to under- stand that before signing a contract he or she should do the following:

1. Understand the terms and conditions in the contract.

2. Cross out anything that you do not agree to .

3. Do not sign if there are blank spaces (these can be crossed out) .

4. Make a copy for your files after signing.

This chapter explores some of the major concerns regarding intellectual property of the entrepreneur, as well as other important legal issues such as product safety, insur- ance, contracts, and the Sarbanes-Oxley Act. The problems with intellectual property have become more complicated with the growth of the Internet. It is important for the entrepreneur to seek legal advice in making any intellectual property legal decisions

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180 PART 2 FROM IDEA TO THE OPPORTUNITY

such as patents, trademarks, copyrights, and trade secrets. Lawyers have specialties that can provide the entrepreneur with the most appropriate advice under the circum- stances. There are also resources identified in the chapter that should be considered before hiring an attorney. Some of this information can save time and money for the entrepreneur.

A patent requires a patent attorney, who assists the entrepreneur in completing an application to the Patent and Trademark Office with the history and description of the invention, as well as claims for its usefulness. An assessment of the existing patent(s) will he lp to ascertain whether infringement is likely and to evaluate the possibilities of modifying the patented product or licensing the rights from the holder of the patent. A provisional patent can be filed that will give the entrepreneur 12 months to finalize the patent. Being the first to file with a provisional patent can be very useful to pro- vide immediate notification of ownership of the patent rights as well as provide time to develop business strategies.

A trademark may be a word, symbol, design, or some combination, or a slogan or sound that identifies the source of certain goods or services. Trademarks give the en- trepreneur certain benefits as long as the following four requirements are met: (1) com- pletion of the written application form, (2} submission of a drawing of the mark, (3} submission of five specimens showing actual use of the mark, and (4) payment of the required fees.

Copyrights protect original works of authorship. Copyrights are registered with the Library of Congress and do not usually require an attorney. Copyrights have become relevant to the use of the Internet, especially to download music, literary works, pic- tures, or videos. Copyright protection related to the Internet will continue to be a gray area until regulations are made clearer. Both trademark and copyright applications can be filed electronica lly.

Licensing is a viable means of starting a business using someone else's product, name, information, and so on. It is also an important strategy that the entrepreneur can use to expand the business without extensive risk or large investments.

The entrepreneur should also be sensitive to possible product safety and liability requirements. Careful scrutiny of possible product problems, as well as insurance, can reduce the risk. Other risks relating to property insurance, life insurance, health insur- ance, workers' compensation, and bonding should be evaluated to ascertain the most cost-effective program for the entrepreneur.

Contracts are an important part of the transactions that the entrepreneur will make. As a rule of thumb, oral agreements are invalid for deals over one year and over $500. In addition, all real estate transactions must be in writing to be valid. It is impor- tant in a written agreement to identify all the parties and their respective roles, to describe the transaction in detail, to specify the value of the deal, and to obtain the signatures of the persons with whom you are doing business.

The Sarbanes-Oxley Act was passed in 2002 and places a great burden on pub lic companies to streamline their financial reporting, modify the role and responsibility of boards of directors, and basically provide more checks and balances to avoid repeating the scandals of WorldCom, Enron, and others. There are a number of pro- visions of the law, and entrepreneurs should be aware of any relevant requirements, particularly if there is intent to take the company public. At this point the law applies only to public companies, but there are possible interactions with private firms as well as likely changes to these laws that will require continued scrutiny by entrepreneurs.

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CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 181

RESEARCH TASKS

1. Using the Internet, obtain copies of three patents that are at least three years old. What are the elements that are common across these patents? What are the differences? Which do you believe will be the greatest success? Can you find any evidence of products that are now on the market that incorporate any of these patented technologies?

2. Search press reports for patent infringement cases. Describe the process and the outcome. Of particular value are examples that list the legal costs of defending patent infringements and the amount awarded for a successful defense.

3. What are some of the world's most famous trademarks? Use data to back up your answer.

4. Provide a real-life example for each of the following different types of product liability: (a) negligence, (b) warranty, (c) strict liability, and (d) misrepresentation. When possible, report both the details and the payouts.

5. How much does it cost to apply for and obtain a patent?

CLASS DISCUSSION

1. Provide three examples of companies that use trade secrets to keep competitors from imitat ing their products. What activities do they undertake to maintain this secrecy? How effective do you think they are?

2. Should copyrighted music be available on the Internet free of charge, even if it is against the wishes of the artist and the recording company? Consider both sides of the argument to make a more convincing argument.

3. To what extent should the government be involved in creating and enforcing safety laws and to what extent should companies (and industries) be responsible for creating their own standards and self-policing those standards?

SELECTED READINGS

Baroncelli, Eugenia; Carsten Fink; and Beata Javorcik. (2005). The Global Distribution of Trademarks: Some Stylised Facts. World Economy, vol. 28, no. 6, pp. 765-82.

This paper provides the first empirical analysis of the global distribution of trade- marks. The analysis is based on data compiled and published by the World Intellec- tual Property Organization. It includes an analysis of trademark registrations across countries of different income groups and different sectors of the economy. The re- sults provide implications for changes in intellectual property protection in interna- tional trade.

Caballero-Sanz, F.; R. Moner-Colonques; and J. Sempere-Monerris. (2005). Licensing Policies for a New Product. Economics of Innovation & New Technology, vol. 14, no. 8, pp. 697-713.

This paper assesses the licensing policies for the developer of a new product. The study argues that the best licensing policy is fixed-fee licensing with an exclusive ter- ritory clause. Consumers are felt to be better off with the fixed-fee arrangement but do not prefer the exclusive territory provision.

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182 PART 2 FROM IDEA TO THE OPPORTUNITY

Chaudhry, Rahul; and Kajigailiu G. Kamei. (July 2008). Can Your Firm Keep Its Secrets? Managing Intellectual Property, Issue 181, pp. 109-12.

Trade secrets have become an important strategy of choice to protect confidentia l information. The information age has enhanced the amount and importance of nonpatentable information. This article focuses on a definition of a trade secret and describes ways to protect this information.

Cromley, Timothy. (2004). Twenty Steps for Pricing a Patent. Journal of Accountancy, vol. 198, no. 5, pp. 31-34.

There are a number of steps that can be followed to assist the accountant in deter- mining an evaluation of a patent. In addition to a discussion of these procedures, this paper also discusses the makeup of a valuation team.

Depoorter, Ben; Francisco Parisi; and Sven Vanneste. (2005). Problems with the Enforcement of Copyright Law: Is There a Social Norm Backlash? International Journal of the Economics of Business, vol. 12, no . 3, pp. 361-69.

Copyright norms have developed in opposition to existing copyright laws. This arti- cle argues that copyright enforcement efforts may actually induce further copyright disobedience by reinforcing the moral and social beliefs against conventional copy- right law.

Dodwell, William J. (2008). Six Years of the Sarbanes-Oxley Act. CPA Journal, vol. 78, no. 8, pp. 38-43.

An assessment of corporate financial reporting is provided in this review of the effectiveness of the Sarbanes-Oxley Act. The backlash of negative factors that was created from the new law is presented as well as a subsequent cost-benefit analysis of the relative significance of each of these factors.

France, M.; and S. Siwolop. (1996). How to Skin a Copycat. BusinessWeek (October 21, 1996), pp. 4-7.

Small businesses are particularly vulnerable to knockoffs because of their limited resources. A number of examples, with effective strategies that can be used to fight knockoffs, are presented.

Johnson, E. Scott. (February 2003). Using and Protecting Trademarks. CPA Journal, pp. 39-41.

This article argues that because a trademark is an appreciating asset with a poten- tially perpetual life, it is important to choose trademarks carefully and protect them through federal registration and controlled licensing. It discusses issues of trade- mark clearance, the establishment of trademark rights, the federal trademark reg- istration and application process, and domain names.

Marshall, Jeffrey; and Ellen M. Hetfes. (July/August 2008). Smaller Firms Get Hit Harder Overseas, Survey Finds. Financial Executive, pp. 9-10.

The expansion of many small entities into foreign markets raises some significant legal issues. Differences in laws, languages, currencies, and styles of conducting business enhance the need for hiring a lawyer. The survey reported here indicates a shift in relevant factors in doing business overseas from terrorism and political insta- bility to currency risk and supply chain failure.

Ryan, Kenneth E. (February 2003). Product Liability Risk Control. Professional Safety, pp. 20-25.

In the current legal climate, parties injured by the defective product can easily sue not only the manufacturer of the product, but also any commercial supplier in the distribution channel, including the wholesaler and the retailer. The article discusses some of the risks and liabilities that these parties face and some of the product quality guidelines that they can follow to limit their liability.

D NOTES

Entrepreneurship, Eighth Edition

CHAPTER 6 PROTECTING THE IDEA AND OTHER LEGAL ISSUES FOR THE ENTREPRENEUR 183

Weiss, Carter. (2006). Innovative Designs Make Us Successful, but Defending Our Intellectual Property Keeps Us in Business. Fortune Small Business, vol. 16, no. 9, pp. 81-82.

This article relates the experience of an entrepreneur trying to protect one of his company's signature products, a neoprene wine tote, from copycats. It further dis- cusses how the company managed to maintain its legal rights to this product by spending a certain amount of its budget each year policing copycats and how the threat of a lawsuit usually Jed to negotiation and resolution of the issue.

1. See L. Olmstead, "How Steve Lipscomb Reinvented Poker and Built the Hottest Business in America," Inc. (May 2005), pp. 80-92; "World Poker Tour® Season VII Premiers January 4 on Fox Sports Network; Series Joins FSN's Sunday Night Sports Block," Business Wire (December 22, 2008), pp. 1-2; www.WorldPokerTour.com, 2007 Annual Report, pp. 1-34.

2. Patent and Trademark Office, U.S. Department of Commerce Web site (www.uspto.gov).

3. J. Rutherford, "Patent Licensing," Licensing Journal (February 2008), pp. 28-29.

4. "Weighing Up the WTO," Economist (November 23, 2002), p. 72. 5. W. B. State, "Filing Strategies under the Patent Cooperation Treaty," Intellec-

tual Property and Technology Law Journal (October 2002), pp. 1-6. 6. J. P. Kamath, "Judge Backs UK Patents for Software," Computer Weekly

(March 25, 2008), p. 6. 7. R. C. Scheinfeld and J.D. Sullivan, "Internet-Related Patents: Are They Paying

Off?" New York Law Journal (December 10, 2002), p. 5. 8. See G. Pike, "Business Method Patents in Jeopardy," Information Today

(January 2009), pp. 15, 17; and J. Rapoza, "Hope for Innovation," £Week (November 10, 2008), p. 52.

9. See www.uspto.gov/main/trademarks.htm. 10. S. W. Halpern, C. A. Nard, and K. L. Port, Fundamentals of United States Intellec-

tual Property Law (Boston: Kluwer Law International, 1999), pp. 30-34. 11. "Face the Music," Economist (April 2, 2005), pp. 57-58. 12. K. Fritz, "Playing a Different Tune," Information Today (December 2008), p. 15;

D. 0. Blood and Kee-Min Ngiam, "A Focus on Filters: Latest Developments in MGM v. Grokster," Intellectual Property & Technology Law Journal (February 2008), pp. 7-8.

13. "Patents: Cuffing Innovation," Electronics Design (April 28, 2005), pp. 49-55. 14. K. Chow, "Patent Play: Making Money from Intellectual Property," Ottawa

Business Journal (September 29, 2008), p. 12. 15. "ARC Announces New Licensing Agreements with Leading European

Semiconductor Companies and Design Teams," Business Wire (March 6, 2007), p. 1.

16. C. Purcell, "Finding Revenue beyond the Screen," Television Week(April21, 2008), pp. 6-7.

17. "Retailing Today," News in Brief(June 23, 2008), p. 4. 18. M. Marr and S. Grey, "McDonald's Woos New Partners as Disney Pact

Nears End," The Wall Street Journal, Eastern Edition (June 6, 2005) pp. B1-B2.

19. "MSN Mobile and Morodo Join Number of Companies Adopting DeviceAtlas Database for Delivering Device-Aware Content," PR Newswire (August 5, 2008), pp. 1-2.

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20. "Licensed to Sell: Direct-to-Licensing Agreements Appear to be a Natural Evolution for Retailers' Private Label Lines, Which Keep Trending Upward to Gourmet, Organic, and Other High-Quality Alternatives," Private Label Buyer (November 1, 2008), pp. 85-87.

21. A. Nicholas, "Dangerous Goods," Inside Counsel (November 2008), pp. 16-18. 22. I. Mount, "Death of the IPO Dream," Fortune Small Business (April 2005},

pp. 16-18. 23. G. Weiss, "Tighter Nooses for White Collars," BusinessWeek(April 7, 2003),

p. 10. 24. P. S. Foote and J. Chen, "Accounting Standards, Disclosure Requirements,

and Foreign Company Listings on Stock Exchanges," Chinese Business Review (September 2008), p. 35.