Putting a valuation on an early-stage company can be difficult, particularly when the company is pre-revenue and still developing its product or technology.  Nevertheless, because most early-stage investment (known as “seed” funding) is in the form of equity, the issue has to be addressed.  The company’s founders and the potential investors then go through an awkward dance where management says the company is worth X and the seed-investors say the company is worth Y (a number you can be sure is much less than X).  The parties will either come to an agreement or they won’t.  The worst situation is where an agreement is reached but one side (almost always the founders) feels that they’ve been taken advantage of.  This can lead to an acrimonious relationship between management and investors and hamstring the company in soliciting future investments.

In some cases, the founders and seed-investors choose to avoid the difficult issue of valuation altogether by agreeing to a convertible debt structure in which the valuation is determined at a future date; such as the first round of financing when valuation is less difficult to fairly determine.  Under this approach (and there are others), the investors receive a convertible promissory note in return for their investment.  The principal and interest on the note then convert to stock based upon the valuation established for the company on the Series A round of financing.  Because the seed investors undertook more risk than the Series A investors, the convertible debt is usually supplemented with so-called “warrant coverage”.  (A “warrant” is a stock option for investors.)  The warrant is usually exercisable for a number of shares of the Series A preferred stock (the number of shares being tied to a percentage of the face amount of the convertible note), on the same terms as the Series A investors, and at a favorable strike price.

–Matt

Stanford professor and copyright icon Larry Lessig appeared on Charlie Rose recently.  The interview can be viewed here.  In my law school days, I was lucky enough to be involved in a lecture Lessig gave to the student body in which he emphasized the need for balance in copyright law policy.  A copy of that lecture can be found here.  He’s still delivering the same message.  In the Rose interview, Lessig speaks out against the abolitionist movement growing against copyright.

Money quote:

My real fear is that the last ten years have unleashed a kind of revolutionary attitude among the generation that will take over in ten years.  And it will be hard for them to distinguish between sensible copyright legislation and the kind that we’ve got right now.  So my real fear is we’re going to lose control of this animal… I just want to reform [copyright law] to make it make sense.

To learn more about Lessig and his work, visit his website.

–Matt

A corporate client used a corporate redemption to acquire 83% of the stock of its founder, who was no longer qualified to own a Disadvantaged Business Enterprise (“DBE”) under the U.S. Department of Transportation regulations because he had a net worth of over $750,000.  51% of the remaining 17% of the stock was sold to one of the client’s employee, who qualified as a minority owner and also satisfied the net worth requirement.  MDOT refused to acknowledge the redemption and sale, saying that it was a sham transaction, and denied our client’s application for re-certification as a DBE.  We appealed.

The MDOT regulations neither endorse nor forbid use of a corporate redemption to transfer control of an MBE.  There are no published agency or court decisions on the issue.  Relying on expert testimony from a certified professional accountant, we argued that this form of transfer was legitimate, and should be recognized by MDOT.  The Court accepted our analysis of the impact of the redemption on the value of the company at the time of transfer of control, and ordered MDOT to certify the company as a DBE.

We were dealing with a complicated series of corporate transactions which MDOT contended were not genuine.  The challenge was to explain the transactions in a straightforward, simple manner, not easily done when the other side is saying it is a sham.  Trust your judgment, and press ahead with what you believe is logical and defensible.  Administrative appeals are not impossible to win.  We were prepared and used compelling exhibits and testimony.  By focusing on the validity of the corporate redemption, both during the hearing and in written closing argument, we succeeded in persuading the administrative law judge that MDOT had erred.

–Randy

A client recently sent me this article about the family of the late Rev. Martin Luther King Jr. (MLK) “demanding a share of the proceeds from the sudden wave of T-shirts, posters and other merchandise depicting the civil rights leader alongside Barack Obama.”  The family is asserting MLK’s right of publicity (i.e., the right to control and commercially exploit his name and image for profit), which passed to his heirs after his death.  While it is not at all unusual for the heirs of a deceased celebrity to police unauthorized commercial exploitation of the celebrity’s name and image, this paragraph from the article struck me as slightly off the mark:

“King’s writings, likeness and voice are considered intellectual property, and almost any use – from graduate thesis papers to TV documentaries – are subject to approval by his estate, now administered by his surviving children, Martin Luther King III, Dexter King and the Rev. Bernice King.  (Because Obama is an elected official, his words and image are in the public domain and can be used without permission.)”

While right of publicity cases and outcomes can vary greatly depending on the particular facts and state law at issue (right of publicity law is slightly different state by state), it is not generally true that use of a celebrity’s name and image in a thesis paper or documentary requires the prior consent of the celebrity or the celebrity’s heirs.  Thesis papers (scholarship) and documentaries (news reporting) are at the core of First Amendment and fair use protection.  As such, they are generally considered a public benefit and, therefore, protected; even though doing so may deny a celebrity or the celebrity’s heirs the right to control or exploit use of the celebrity’s name and image appearing in such works.

Also, President-Elect Obama’s image is not in the “public domain” any more than MLK’s image is, or any other celebrity for that matter.  Politicians don’t waive their right of publicity when they get elected to office (their right of privacy is a different matter).  Most, however, don’t enforce their publicity rights because of the negative publicity it may invoke.  (Governor Schwarzenegger is an exception and has aggressively policed unauthorized commercial use of his name and image even while holding public office.)  The only difference between your standard Hollywood celebrity and a political figure is that use of the political figure’s name and image may invoke special considerations of First Amendment and fair use protection.

–Matt

The so-called “notice-and-takedown” procedure in the Digital Millennium Copyright Act of 1998 (the “DMCA”) – previously referenced here – provides copyright holders with the means to remove allegedly infringing material from websites.  The copyright holder provides the notice, and the website operator does the taking down.  The notice, to be effective, must contain, among other things, a statement from the copyright holder that it has a “good faith belief” that infringement of its work is actually taking place.  17 U.S.C. § 512(c)(3)(A).  In a recent California case, Lenz v. Universal Music Corporation, a federal court held that in order to validly claim such a “good faith belief” the copyright holder must consider whether the use of the material constitutes “fair use”.  (Fair use is the doctrine in United States copyright law that allows limited use of copyrighted material without requiring permission from the copyright holder, such as use for scholarship, review, news reporting, and certain non-commercial, transformative uses).

The Lenz case involved a video posted on YouTube of a baby dancing to Prince’s song “Let’s Go Crazy”.  The video was posted by the baby’s mother.  Universal, owner of the Prince song, sent a DMCA takedown notice to YouTube.  YouTube complied.  Momma Lentz sent a counter-notice, claiming that the video was “fair use” and sued Universal claiming the company failed to consider fair use before sending its notice, as it was required to do.  The court agreed.

Under Lenz, copyright holders must now consider fair use before sending a DMCA takedown notice.  However, the court in Lenz noted that, while fair use must be considered, the copyright holder need not reach the right conclusion.  The court further noted that the consideration given to the fair use question need not be extensive.  It is enough then that the copyright holder demonstrate only that fair use was considered in order to avoid liability under Lenz.

–Matt