The High-touch Legal Services® Blog • For Startup/Early-stage Companies

In a November 30 article (“Trust Me”), the Wall Street Journal offers tips to entrepreneurs who want to gain credibility in the eyes of potential funding sources.

Based on a study of key individuals at 28 entrepreneurial ventures, the article asserts that “the most successful founders were masters at making symbolic gestures that signaled stability and credibility” in four vital areas:

1. Personal Credibility – Example: Revealing personal details that strike a chord with listeners
2. The Company’s Professionalism – Example: Thoughtfully prepared web page and business cards
3. The Track Record – Example: Showing a prototype or a controlled product demonstration
4. Emphasizing and Building Ties - Example: Being associated with prestigious stakeholders

Takeaway: In a tough, competitive economic environment – especially if you are an entrepreneur without a track record – sending a message of credibility is just as important as having a great  product, a large market, and the right management team.

Disclaimer: This post does not constitute legal advice and does not establish an attorney-client relationship.

When a foreign company wants to start up in the U.S., it usually creates a separate corporation here so U.S. obligations and liabilities will not flow back to the overseas parent.

The U.S. corporation needs a federal Employer Identification Number (EIN) – at the very least, to open a bank account, even if the corporation will have no employees in the U.S. In a recent post on its website (Use of Nominees in the EIN Application Process), the Internal Revenue Service recently made it more difficult for foreign companies to obtain an EIN.

To obtain an EIN, the corporation typically provides the social security number (SSN) of a “principal officer”.  In the past, the IRS was rather vague as to what this term meant, stating that it referred to a “president, vice president, or other principal officer”. So, for example, if the corporation’s overseas president did not have an SSN because s/he never worked in the U.S., the corporation could temporarily appoint as vice president an individual who has an SSN, which the corporation then would use to apply for an EIN.

The IRS now states that it “does not authorize” this approach because it facilitates tax non-compliance. Instead, the principal officer must be someone who “controls, manages, or directs the applicant entity and the disposition of its funds and assets”.

The bottom line: A foreign company looking to start up in the U.S. will need to include, among its officers, at least one who (a) controls, manages, or directs the corporation and the disposition of its funds and assets and (b) has an SSN.

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Update as of December 7, 2009

A tax practitioner in Florida provided the following information:

I work in the tax advisory service line and focus on mostly international tax services.  This of course includes helping foreign entities establish US operations, which I see is one of your specialties.  I took a minute to browse your blog and saw that you’ve run into the principal officer SSN problem on the EIN application.  From my experience, the IRS does not reject the application if an SSN is not included.  We simply enter “FOREIGNUS” on line 7b of the SS-4.  The only issue is that the EIN cannot be applied for online because the system rejects anything that is not in a ###-##-#### format.

Another couple of tips for the SS-4 for foreign applicants:

• Enter a US c/o person on line 3
• Use a US address for mailing address and the foreign address for street address
• Call (215)-516-6999 to obtain the EIN directly from an agent and they will  give you a fax number so you can fax them the SS-4

The bottom line: Foreign companies whose officers do not have Social Security Numbers should use the telephone, rather than the IRS website, to obtain an EIN. But be prepared for a long wait – when I called to confirm the procedure, I hung up after being on hold for about ten minutes.

Disclaimer: This post does not constitute legal advice and does not establish an attorney-client relationship.

From time to time, a client corporation wants to enter into a business transaction with one of its directors. An astute CEO, recognizing the potential for a conflict of interest, will ask whether and how such a transaction can take place without violating any laws or any fiduciary obligations to the corporation.

California Corporations Code Section 310 provides that, generally, a transaction between a corporation and one of its directors is permitted if, following disclosure of all material facts and the director’s interest in the transaction, it is approved either by a disinterested majority of the board of directors (usually the easier approach) or by the shareholders.

Absent such approval, the transaction will not be void or voidable if the interested director can prove that the transaction was fair and reasonable to the corporation when it was entered into.

Observation: Obtaining board or shareholder approval in advance usually is quicker, safer and less expensive than trying to prove that a transaction was fair and reasonable after the fact.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

This question was asked a few days ago (in different form) on LinkedIn. The following, slightly edited, is the response that I provided:

As is always the case with alleged copyright infringement, the outcome of the case will depend on the facts.

AFLAC v. Assurant, et al. illustrates where the line between what is protected and what is not protected can be drawn. Here is a brief summary:

• AFLAC created, with substantial expenditure of personnel time, certain new insurance policies that, it felt, would provide a competitive advantage because of the narrative style used in the policies.
• Defendant insurance companies copied substantial portions of AFLAC’s policies for their own use.
• AFLAC sued, alleging copyright infringement.
• The Federal District Court found infringement of the non-boilerplate portions of the policies and enjoined the defendants from selling their infringing policies for the pendency of the suit.

The moral: There is not likely to be a problem if you copy routine legal or business terms, but if you copy unique provisions that are important to another company’s business, you might find yourself on the short end of a copyright infringement lawsuit.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.

I recently met a software developer who wants to start a business. He immediately started talking to me about obtaining a patent. Condensed a bit, our conversation went roughly as follows:

• Dana: Without giving away information that would jeopardize your ability to obtain a patent, what would the software do?
• Developer: It is enterprise customer relationship management (CRM) software.
• Dana: What is novel and non-obvious about it?
• Developer: It will be based on a unique algorithm.
• Dana: You cannot patent an algorithm.
• Developer: I can get a patent on software that implements an algorithm.
• Dana: Perhaps. But there are other means, such as trade secrets, that might adequately protect the software [cut off in mid-sentence]….
• Developer: VCs want to invest in companies that have patents.

Leaving aside the singular focus on VC funding – something that few entrepreneurs obtain (see Realistic Financing Options for Startup Companies) – the would-be entrepreneur was similarly myopic in focusing on a patent as the only type of intellectual property that matters.

A patent grants its owner the right to exclude others from making, using, offering for sale, or selling the invention, or importing the invention into the United States. Note that this is not the right to do things  – it is the right to preclude others from doing things.

In an industry where development costs are exceedingly high, such as development of drugs or medical devices, patents can be crucial to prevent competitors from quickly selling inexpensive knock-off products.

Patents do have their disadvantages, however:

• Patents can be expensive to prosecute and maintain, especially if they are sought in multiple countries.
• It can take several years for a patent to issue, during which time a fast-moving marketplace can undergo significant changes, perhaps undermining the value of the patent.
• Litigation to enforce a patent can cost hundreds of thousands of dollars.

As a result, software developers often find it easier and more cost-effective to rely on trade secret protection for their products, even if they suspect patent protection may be available.

Trade secret protection is inexpensive and easy to obtain. California Civil Code Section 3426.1(d) says that a trade secret is “information…that [d]erives independent economic value…from not being generally known to the public…and…is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

This means, in effect, that by using confidentiality provisions in agreements and by providing only object code to customers, developers can gain immediate protection for their software while getting to market as quickly as possible – which is a sensible recipe for building a successful business without a patent.

This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.