VSW2016 begins today!

The theme for Vancouver Startup Week 2016 is “Connecting Vancouver to the World” and we couldn’t be more thrilled to show off what Vancouver’s thriving scene of startups has to offer.  It’s going to be an action packed week and we look forward to attending many exciting events.

Come by our offices on Wednesday, September 28th from 1-4 p.m. for our featured event with Manning Elliott LLP: “Start Like a Pro – How Good Startups Build Success”. We’re lucky to have seasoned entreprenuers including Michael Gokturk, CEO and Founder of Payfirma, and Ashiq Ahamed, CEO and Co-Founder of brewhound , joining us to share their lessons so you can learn the easy way.  After the panel discussion, join one of our roundtable breakout sessions to learn about specific topics with  one of our experienced lawyers and Manning Elliott LLP’s accountants.

Intellectual Property and its Value to Your Company

Often a start-up company’s most valuable asset is its intellectual property (“IP”) portfolio.  The forms of IP that make up its portfolio will depend on the space a company inhabits, the stage of its growth and its ideas, processes and products. To preserve and grow a company’s value, it is crucial for founders to understand the forms of IP their companies have created, and will continue to generate, and to ensure these forms of IP are protected.

What Types of IP Might Form Your IP Portfolio?

To begin, it may be a useful exercise to conduct an IP audit on your own company to determine the forms of IP that now, and may in the future, make up your company’s IP portfolio.  Since each category of IP covers a slightly different asset, and comes with its own set of rights and protections, it is important to differentiate between the multiple categories of IP.  Consider each of the categories below and whether your company may hold or generate these forms of IP.

Copyright

If your company has created an original and creative ‘work’, it may be protected under Canadian law.  Works may include literary, artistic, dramatic, visual, and musical productions, performances, sound recordings, and some forms of telecommunication and computer programming. Copyright is the exclusive right to produce, reproduce, perform or deliver these ‘works’, or a substantial part of them, in any form.  For example, your company may hold a right to its logo as an artistic creation, and with it, the exclusive right to produce and copy it. Anyone else attempting to create and distribute a copy of your company’s logo would be infringing it’s copyright.

Original works are automatically protected by copyright law on creation, but it is often a good idea to register the copyright and obtain a certificate from the Canadian Intellectual Property Office. A certificate may then be used as evidence of ownership if the matter ever undergoes litigation. As a general rule, copyright protection in Canada exists for the creator’s lifetime plus fifty years after the death of the creator, at which point the work becomes available to the public.

Trademarks

The law of trademarks governs the use of ‘marks’, including the sounds, designs, logos, slogans and brand names associated with a company’s specific goods or services. Marks are used to distinguish the goods and services of one company from those of competitors, and will ultimately form the basis of a company’s reputation and good will. Some forms of copyright may also be registered as a trademark (a logo, for example). Registering a trademark in Canada allows the registrant to protect the trademark under law with exclusive rights to use of the mark in Canada for 15 years, with the possibility of renewal. Companies must guard against others infringing their trademark (e.g., by using a confusingly similar logo or the same slogan for a product) and also ensure it is not infringing others’ work.

Industrial Designs

Industrial designs are a product’s visual features or appearance, including their shape, pattern, ornamentation, and configuration, or a combination of these factors.  The shape of Apple’s iPhone, a chair by Charles Eames, or the particular silhouette of a Mercedes-Benz are each examples of an industrial design.  Much like trademarks, industrial design registration grants the registrant exclusive rights to the design for up to 10 years in Canada.  The design must be original for the application to be eligible for registration (i.e., it cannot closely resemble another design). Application for registration must occur within one year of the design being initially published, so it is recommended that applicants register as soon as possible. Registration only protects the appearance of the industrial design, and does not protect its function or process of construction.

Patents

Patents protect new, non-obvious, and useful inventions, such as processes or methods (e.g., investment strategies or a process for mobile commerce), machines (e.g., a 3D printer), products, compositions of matter (e.g., pharmaceutical drugs), or novel and useful improvements to an existing invention. With a patent, the inventor and patent holder is granted the right to a monopoly in the market for a designated period of time in exchange for sharing the invention.  To gain patent rights, the inventor must apply to the Canadian Intellectual Property Office.  Patent applications are involved and time-consuming relative to other forms of IP protection; however, once obtained, patent holders may use their patents to gain a profit by licensing it or selling it as an asset.

If you think your company has created a new and useful invention capable of being patented, it is important to file an application in a timely manner and to keep these inventions completely secret, because public disclosure may prevent a successful patent filing.  In Canada and the United States, an exception to this rule exists if the public disclosure was made by the inventor (or someone who learned of the invention directly from the inventor) less than one year before filing the application.

Trade Secrets

A trade secret involves confidential business information, the knowledge of which is inherently valuable. Unlike a patent, if this secret information is released, there is no protection because once the information becomes revealed, it will never become a secret again. For this reason, some companies prefer not to share their confidential information by filing a patent, instead opting to keep the information a secret.  The most famous example of a trade secret is the formula for Coca-Cola soda. This formula has value in and of itself, and if it were released then that would have negative implications for Coca-Cola’s business. Since there is no registration process, if your company holds trade secrets that it wishes to maintain, it must be sure to protect this information with non-disclosure agreements, confidentiality agreements and clauses, and security methods such as data encryption to protect the trade secret.

Do You Own Your IP?

It is a harsh realization to learn that your company does not own all of its IP – for example, if your company engages a contractor to provide services that involve building out your idea, unless the contract specifies otherwise, that contractor may have some ownership claim over the output of the work they performed. It is a best practice to set out ownership at the outset, by providing for IP assignment in a contractor agreement, for example, or a more comprehensive Protection of Corporate Interests document that may also include confidentiality or non compete provisions. Using these sorts of agreements will help your company avoid others claiming rights to a its IP down the road.

Why IP is Crucial for Startups

For emerging companies seeking outside financing, the strength of the company’s IP portfolio is an important factor in attracting investors. One of the first questions a venture capitalist or other investor will ask is whether or not the startup actually owns the intellectual property that is foundational to the business.  If a company is unable to prove it owns all of the rights to its IP, potential investors could quickly turn away to find another startup to invest in – namely, one that has held onto its IP.  In addition to ensuring a company owns and has protected its IP, it is also important to avoid a situation where a company has infringed another’s IP, subjecting it to potential costly and time consuming infringement claims.

Roadmap to IP Protection

To best get a handle on your startup’s intellectual property portfolio, we suggest conducting an IP audit (either informally on your own or by hiring an advisor) to see what your company’s current circumstances are.  Next, determine whether your company owns all of this IP and, if not, how it may be assigned. Finally, consider the extent to which the company’s IP is protected by registrations, employment agreements, or NDAs for example, and set in place a company procedure to ensure adequate protection moving forward.

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With a broad variety of intellectual property rights available to companies and individuals in Canada, we advise that you speak with your legal counsel, or a trademark or patent agent, before taking action with regard to protecting your intellectual property.

by Morgan McDonald and Brandon Deans, Temporary Articled Student

The Scope and Limitations of Non-Disclosure Agreements

In an economic climate where information is often a business’s primary asset, it is important that companies be able to control the disclosure of key information such as intellectual property, strategic plans, data, research and development, and financial forecasts.  The surest way to prevent unwanted disclosure is simply to not share information that you wish to keep confidential, but often times this is not practical and risks stifling business growth.  If and when your company decides to share this type of information with an outside third party, entering into a non-disclosure agreement (an “NDA”, or sometimes referred to as a confidentiality agreement) prior to sharing the information may help prevent the receiving party from disclosing the information provided.  Although an NDA has its place in commercial practice, it does not come without its limitations.  For this reason, we suggest relying on an NDA as only one part of your company’s practice for keeping key information confidential.

What is an NDA?

An NDA is a contract between two or more parties, with at least one disclosing party and at least one receiving party. The disclosing party is the entity sharing confidential information that they wish to remain undisclosed beyond this arrangement, while the receiving party is the entity receiving the confidential information.

The NDA must define the information that you expect to remain confidential (the disclosing party will prefer a broader definition to protect more information) and the purposes for which it may be used (this should be defined carefully to ensure that the receiving party is not able to use the information for any purpose outside what the disclosing party intends to share it for).  The agreement may also set out the particular individuals who are responsible for receiving and controlling the individuals or the “further recipients” with whom they may share the information with.  The receiving party and these further recipients may be held responsible for disclosing or using the information outside the terms of the NDA. Depending on the form of information, the parties may also require the receiving party to return the confidential information, or when that is not possible, to destroy it in a commercially reasonable manner.

The agreement will also set out the disclosing party’s remedies in case of a breach.  These may include monetary damages, injunctive relief, and indemnification for harms caused by the breach.  Depending on the information in question, breach of an NDA may cause irreparable damage to the disclosing party. For example, if the disclosed information lands in the hands of a competitor, or otherwise proves unfavorable to the disclosing party once publicly known.  Unfortunately, as is the case with contractual breaches, a harmed party would have to go to court to have the breach enforced, which can be costly, time-consuming, and ultimately won’t reverse the unwanted disclosure.  Much in the same way that IP law can’t protect trade secrets, the release of the information itself is what is harmful and it is difficult to undo this damage.

Are NDAs All the Same?

While it may be tempting to use a template NDA or other confidentiality agreement found on the Internet, there are many provisions in confidentiality agreements that should be tailored to the specific business relationship at hand.  Using a confidentiality agreement that is suitable for your company’s goals and circumstances is imperative to ensuring your key information is not disclosed.  The form of an NDA may vary and will depend on the particular situation at hand, for example, will only one party be disclosing information, or both? A one-way NDA is appropriate when only one party (the disclosing party) is sharing confidential information. Mutual NDAs, on the other hand, are useful when all parties to the agreement are sharing confidential information and act as both receiving and disclosing entities, for example, when deciding whether to enter into a joint venture, a partnership, or merge into one entity.  The NDA will allow both parties to learn more about each other such that they can determine whether to make the significant decision of merging or entering into a partnership.  Both parties will be granted protection under a two-way NDA, and will often be subject to equal restrictions.

Will the information be shared over a period of time or is this a one-time disclosure? The term of disclosure may be important to clarify whether information being shared falls under the protection of the NDA. Additionally, the disclosure term and the period the information is subject to these restrictions are quite distinct timelines.  Although the disclosing party may want the information to be held confidential indefinitely, there are some jurisdictions where a court will not enforce this, leaving your company unprotected where you may expect the information to be kept confidential forever.

Is the information being shared for a particular purpose and should you limit the ways in which the receiving party may use the information it receives?  It is important to consider your goals for sharing the information and define the boundaries of use accordingly.  The purpose of use should be flexible enough to enable the receiving party to use the information as the disclosing party intends, say to evaluate a potential partnership or investment. But is should not be defined so broadly as to allow the receiving party to use the information for any purpose, negating any protection the disclosing party may expect.

Additionally, an NDA may spell out whether and when the information may be disclosed further to a recipient that is not party to the contract.  A more flexible limit on “further disclosure” would allow a recipient to share the disclosed information only with those persons within the receiving party’s organization, as is necessary to carry out the purpose of the NDA on a strictly “need to know” basis. Alternatively, an agreement may restrict the recipient to sharing the confidential information only with particular persons who are expressly authorized in writing to receive the information.  This would suit shorter-term projects with a limited scope.

In certain circumstances, it may be appropriate to include a non-solicit, non-hire, or non-compete provision in the NDA, to restrict the recipient from being able to use your company’s information to solicit your company’s customers, employees, or compete with your business.  If this is not necessary, however, it is not advisable to retain and rely on a provision that a court may find unenforceable

Other Ways to Protect Your Confidential Information

Once confidential information is publicly disclosed, it becomes quite difficult to successfully engage in damage control and prevent the disclosed information from being spread further. This is particularly true where information can be permanently stored and instantly spread over the Internet.  While NDAs can be useful in certain situations, we suggest that your company consider these agreements as only one part of its practice to protect key information.

Consider whether and to what extent you are comfortable sharing certain confidential information. There may be circumstances where you do not need to share your “secret sauce” in order to engage in a working relationship, so consider limiting this disclosure to what is truly needed.  Many of the clauses that you may include in an NDA may also be set out in other agreements that your company enters into, including employment and independent contractor agreements, licensing and supply agreements, and financing arrangements.

Companies may take precautions internally as well. From instituting shredding policies and requiring certain documents to be stored in locked cabinets to controlling network login in and out of the office.  Your company may wish to limit certain information to only those employees who have a need to know the information to perform their job.  In certain situations, it may also a good idea to gently remind parties, such as employees or independent contractors, of their confidential obligations to your company from time to time or when the relationship is over.  Depending on the form of your company’s confidential information, it may be reasonable to perform internal audits of your protective policies and measures and work from these results to increase protection.  Finally, certain information may be so important to your company to warrant implementing security policies and precautions or register the company’s intellectual property under trademark or patent registration.

Implementing and following security practices that work for your company, in addition to using an NDA when appropriate, will continue to serve your company as it grows and will help to avoid costly litigation and prevent unwanted disclosure of your company’s most important information.

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If your company is considering disclosure of confidential information to another entity, do not hesitate to take action and get an NDA before parting with any important knowledge. Because of the nuances involved in drafting NDAs, such as utilizing appropriate scope when defining terms, it is important to seek legal advice from your counsel so that your agreement is properly drafted.

by Morgan McDonald and Brandon Deans, Temporary Articled Student

So You Want to Crowdfund?

In 2012 we published an article on the future of crowdfunding and whether it could help finance innovation by providing Canadian businesses with a new source for capital. Fast forward to 2016 and interest in crowdfunding has grown immensely within the startup community. Crowdfunding can be a useful tool for startups; however it is not without its disadvantages. Given its potential value, every startup should understand both what crowdfunding is and when to use it.

What is Crowdfunding

Crowdfunding involves raising capital by soliciting relatively small amounts of money from a large number of individuals. In exchange for money funders generally receive value in return, which can be in the form of a reward, a presale, interest payments, or equity in the startup.

There are a number of benefits to crowdfunding. Often, startups pose too great of a risk to attract institutional investors, venture capitalists, and other typical financing sources. Crowdfunding can be a means to raise the necessary capital to get started, and can also complement other means of raising capital, particularly in early stages of financing such as seed rounds. Crowdfunding can also provide your business with quick cash. For example, if you need bridge money to get you through a particularly lean period between financing rounds, crowdfunding can be used to obtain those funds. You can also reach a wider range of potential investors, and the investment level required per individual is lower.

A startup may want to use crowdfunding to demonstrate business or product viability. This is particularly true if you are offering presales – if a product or service sells exceptionally well during this stage, it can indicate that there is a market for the product or service offering.

Although crowdfunding may have many benefits, it may not be the right choice for your startup. Managing a crowdfunding campaign also takes time and money, and it can be difficult to predict success. Each type of crowdfunding comes with its own specific benefits and disadvantages, and these are discussed in turn below.

Types of Crowdfunding

Crowdfunding can be categorized into different types depending on the form it takes and what the funder receives (if anything) in exchange for their money. These include: donation, rewards-based, presale, debt, and equity crowdfunding.

Donation, Reward-Based, and Presale Crowdfunding

Donation crowdfunding involves individuals, charities, or other entities soliciting donations online. In these circumstances, funders have no expectation of receiving anything in return.

Rewards-based crowdfunding involves the use of rewards to encourage people to contribute funds. For example, a startup that needs funds to create a product may offer branded merchandise in exchange for contributions. Note that many platforms will return raised money back to funders if the company does not reach its fundraising target within the specified time.

Presale crowdfunding is fairly straightforward; a startup solicits funding by selling a product or service before it has actually been produced. This allows customers to be first in line for a new product. Presales are useful when you are unsure of the demand for your product or service and do not want to spend money upfront in creating something that does not sell.

Debt  Crowdfunding

Debt crowdfunding, also called “crowd lending”, is similar to the concept of micro lending – a large number of people put in a relatively small amount of money with the expectation of receiving the principal plus interest back in return. There are variations to this, such as forgivable loans, whereby the money is only repaid if the business starts generating revenue. Each company determines its own specific lending terms.

Debt crowdfunding is particularly useful if a startup needs funding but wants to maintain control and equity ownership of its business. Debt crowdfunding is less risky for investors than equity crowdfunding, since they are promised a return on their money, which is steadier than with equity crowdfunding. However, given the lower risk and steady return, the payout for investors can be smaller than with equity crowdfunding.

Debt crowdfunding can also take the form of convertible debt, either to common or non-convertible preference shares, which are considered equity and discussed further below.

Equity Crowdfunding

In equity crowdfunding, funders receive securities in exchange for their investment. Securities can be shares (common or preferred), debentures, partnership units, and other forms of non-derivative securities. This type of crowdfunding is relatively new to the Canadian market.

Businesses selling crowdfunded securities are regulated by the jurisdiction in which they are situated – if you use equity crowdfunding in British Columbia, you must comply with British Columbia’s Securities Act. Since the introduction of crowdfunding in Canada, several securities exemptions have been introduced for equity crowdfunding that eliminate the need to prepare an expensive and lengthy prospectus. Canada does not have one national crowdfunding exemption, and you can rely on more than one if multiple are applicable.

In British Columbia, the Startup Crowdfunding Exemption has been available via BC Instrument 45-535 – Start-up Crowdfunding Registration and Prospectus Exemptions since May 14, 2015 (this exemption is also available in Saskatchewan, Manitoba, Quebec, New Brunswick, and Nova Scotia); however, it cannot be relied on if the company is a reporting issuer or an investment fund. Additionally, the company’s head office must be located in the jurisdiction. A startup may offer a maximum of two crowdfunded distributions per year, and may raise up to a maximum of $250,000 in each distribution. Investors are limited to investing up to $1,500 per distribution. Startups are not required to prepare a prospectus under this exemption; however, they must still prepare an offering document using 45-535 Form 1 Startup Crowdfunding – Offering Document and the investors must understand and acknowledge the risk warnings presented therein.  The offering document must also provide basic information about the company and explain how the company will use the money raised and the minimum amount required to achieve these goals.

Startups in Manitoba, Ontario, Quebec, New Brunswick or Nova Scotia may also rely on Multilateral Instrument 45-108 – Crowdfunding, also known as the “Crowdfunding Exemption”, which came into force on January 25, 2016. As we previously discussed, the Crowdfunding Exemption expressly includes non-convertible debt securities linked to a fixed or floating interest rate and securities convertible into a common share or a non-convertible preference.

Equity crowdfunding can be challenging for a number of reasons. To begin, a startup cannot control who purchases the shares, and may acquire a large number of shareholders. For example under BC’s Startup Crowdfunding Exemption, you may raise up to $250,000.00 per offering but investors are limited to providing $1,500.00 – this amounts to potentially 166 new shareholders per offering if you raise the maximum amount. Depending on the type of shares issued, these new shareholders may receive voting rights, require annual meetings, and share in future profits. Equity crowdfunding also requires funders who are invested for the long term, since the shares may remain illiquid for some time until the startup has become more developed. Moreover, management will need to remain accountable to these newly acquired shareholders, who may be less likely to offer the same valuable advice, mentorship, management expertise, or network to the startup that angel investors or venture capitalists may provide in return.

Applicable securities exemptions restrict the amount of money that you can raise per distribution, and how often you can undertake a distribution, which can be very limiting for startups. As mentioned above, under the Startup Crowdfunding Exemption, you are limited to $250,000 per offering, two offerings per year, and a maximum of $500,000 every 12 months. Under the Crowdfunding Exemption, you may raise a maximum of $1,500,000 per year.

If, in completing an equity crowdfunding campaign, the startup has over 50 unique shareholders (excluding current and former employees) it will be required to meet ongoing compliance requirements and filings in each jurisdiction in which the company has sold securities and that of its head office. While the filings are not altogether onerous and may, for the most part, be filed electronically, certain filings (such as the report of exempt distribution) must be filed within a certain timeline after completing the financing, and these documents (including the offering document) will be available publically online. The company must also send a confirmation notice to each participating investor within 30 days of closing the distribution.

Is Crowdfunding Right for Your Company?

While crowdfunding may seem like a quick way to easy money, certain types of crowdfunding may also have significant downsides. Before launching a crowdfunding campaign, each company should consider which type of crowdfunding will help it achieve its goals. Specifically, before launching an equity crowdfunding campaign, we suggest that you consider: whether other sources of funding may be more appropriate; whether you and any other management will be able to spare the time and energy needed to run a crowdfunding campaign and also whether you have the capacity to handle the needs of shareholders and securities regulators going forward; and the amount of money and number of shares you want to raise and issue and the type and characteristics of those shares.  To decide whether crowdfunding is right for your company, and  to determine which form of crowdfunding to pursue, we recommend that you consult a lawyer specializing in corporate and securities law before taking any action.

by Morgan McDonald, Lindsay Dykstra, Articled Student and Brandon Deans, Temporary Articled Student

 

A cautionary note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2016