Optima Law Group Blog

(Employee) Stock Option Plan

THINGS TO THINK ABOUT WHEN MAKING DECISIONS ON A STOCK OPTION PLAN FOR YOUR COMPANY

 

A stock option is a benefit awarded by a company in the form of an option to another party, typically an employee or consultant, to buy stock in the company at a stated fixed price within the predetermined terms and schedule of the plan or upon meeting certain corporate goals.

Simplified example: An employee is given 100 options to purchase 100 shares at $10 per share for a period of one year starting in three years. If after three years the stock price has risen, say to $15, the employee can exercise the options and purchase the shares at the exercise price and realize a gain of $500 upon sale of stock, or can choose to hold the stock for larger potential future gains.

 

Basic terminology to know:

  • Exercise: is the payment of the Exercise price of an option and the subsequent issue of the share(s) subject to the option
  • Exercise price (strike price): the specified contract price at which the holder can buy the share(s)
  • Spread: difference between exercise price and market value at the time of exercise
  • Option term: the period or duration of time the employee can hold the option before its expiration or exercise of the option
  • Vesting period: the required time that a holder must wait before a holder can exercise an option

 

  • Attracts talented employees for the long term: Stock options can be gifted or granted with employment packages to attract talented individuals and incentivize them to perform well while also ensuring that they share a common interest with shareholders in boosting the company’s stock value and staying with the company at least until such time that they are able to exercise the option. Offering stock options can be especially appealing to startups who do not have the financial means to offer large salaries at the beginning of employment as it allows them to be competitive with established companies. Stock options are not just for employees – they can be used to compensate service providers, contractors and attract talented board members.

 

  • Choosing shares and options: There is some flexibility when it comes to deciding how many shares and options you want to offer employees. Typically, 5% to 20 % of outstanding shares are set aside for employee stock options, but it is ultimately up to the company’s board and / or equity holders to determine the percentage. There are two kinds of stock options: incentive stock options (ISOs – reserved for employees) and nonqualified stock options (NSOs – used for all others).  The difference between the two is the tax benefit of ISOs in which taxation can be deferred and may potentially qualify for capital gains rates rather than normal income tax rates. A stock option plan can contain other tools as well that the board may use instead of stock options, such as Stock Appreciation Rights and Restricted Stock and outright stock grants. A good stock option plan will provide the board with tools to fit any situation.

 

  • Determine particulars: A party or parties should be assigned the responsibility of overseeing the deployment of the stock option plan, and the vesting schedule should also be determined as well as the amount of the exercise price and transferability specifics, typically by the Board.

 

  • Dilution: The main disadvantage of offering stock option plans to employees is the possibility of dilution of existing shareholders. This can happen when employees exercise their options causing the number of existing shares to increase which thus, decreases the percentage ownership provided by each share.

 

  • Address end of employment: A good stock option plan will clearly address what happens to the options in the event the employee is terminated, voluntarily leaves, passes away, and like situations. You don’t want options continuing to vest after an employee leaves or is terminated.

 

  • Compliance: The issuance of options and underlying shares requires compliance with federal and state corporate and securities laws; therefore experienced corporate legal counsel should be consulted throughout the entire process.

 

  • Transferability: Most stock option plans do not allow for the transfer of options during the life of the employee. The transferability of the stock resulting from the exercise of the stock option will depend upon factors including whether the company is public or private. Experienced legal counsel will be helpful with these issues. 

 

For more detailed information on the taxation of stock options click on this link: http://www.sdbizadv.com/blog/taxation-of-employee-stock-options/41795

 

If you have any questions about stock option plans, please do not hesitate to reach to us. We would love to hear from you at 858-964-4697 or info@optimalawgroup.com.

California to Allow Finders

A finder is an individual or small entity, controlled by both state and federal regulations, who acts as an intermediary to promote the sale of securities; in other words, they help you find money. However, these individuals or small entities are required to be licensed broker-dealers, registered by the federal government and often states. It is acknowledged that many individuals and small businesses act as finders in California even without being licensed and registered with the state. This poses liability for all involved and violators can be subject to administrative, civil and criminal penalties. Additionally, use of a finder can negatively impact current and future fundraising efforts in other ways. 

The current landscape can back companies, who need capital and who have had no luck raising capital on their own, into a corner: “Do I break the law and risk its consequences by working with a finder or do I do nothing and try and get by without additional capital?”

The Corporations Committee (State Bar of CA Business Law Section) whose purpose is to examine and then advocate needed changes to the California Corporations Code to promote efficiency, has found that the services finders provide are extremely beneficial in providing assistance to small to mid-sized businesses, which would otherwise be unable to obtain sufficient capital to operate. Unfortunately, it can also be costly for both parties – the finder to become a licensed broker-dealer, and for the individual or business to hire a licensed broker-dealer. This can contribute to one of the many reasons finders do not comply with state regulations. California and federal law agree that a finder’s activity may be lawful or unlawful depending on the degree of involvement or compensation received, yet there is no clear distinction as to what degree constitutes illegal activity, which leaves much to interpretation in the Code for finders or persons acting outside the narrow scope of the definition of a “broker-dealer”. For these reasons, the Committee would like to amend portions of the Corporate Securities Law of 1968 Section 25004(a), which defines a broker-dealer, to:

(1) Provide transparency among issuers, finders and investors which would help to mitigate liability and;

(2) Recognize the benefits finders provide.

This is a very interesting development that could change the fundraising landscape. If enacted, the amendment would help to improve efficiency and effectiveness in practice by establishing requirements based upon the current legal framework for persons acting as finders in connection with securities transactions who fall outside of the definition of a broker-dealer. The Proposal would create a safe harbor, which would exempt from the definition of a broker-dealer persons acting in compliance with the Proposal’s requirements, thereby exempting such persons from the certification and other requirements of Code section 25210 which states it is unlawful for a broker-dealer to conduct business in California without a certificate from the California Department of Corporations. Finally, it would provide a mechanism to furnish individuals and small business entities with capital, offer investor protection, and contribute to a financially stable ecosystem.

Until this proposed amendment is enacted, it remains illegal to work with finders in California. If you are considering using a finder or have any questions about this nuanced subject, please give us a call at 858-964-4697 or shoot us an email at info@optimalawgroup.com. We would love to hear from you. There will be more developments in the future and we will keep you updated.

The proposed text of the amendment can be found here: 

http://www.calbar.ca.gov/portals/0/documents/legislation/proposals/BLS-2013-03-finders-ADA.pdf

Business Owner’s Guide to the Defend Trade Secrets Act of 2016

On May 11, 2016, President Obama signed into law the Defend Trade Secrets Act (“DTSA”), an amendment to the Federal Economic Espionage Act of 1996, which created a federal civil cause of action for trade secret misappropriation. Federal jurisdiction carries with it many benefits, not least of which is establishing a nationally applicable body of law regarding trade secrets. Individual states have long enforced their versions of the Uniform Trade Secrets Act (“UTSA”), but significant variations exist among the jurisdictions. DTSA has been touted as a way to introduce more predictability into trade secret law. It is still too soon to know whether this hope will be born out. Importantly, DTSA does not preempt existing state-based trade secret law. To the extent that differences between the state and federal law persist, protections afforded by the laws will also differ. As such, it is likely that state trade secret law and DTSA will evolve as parallel laws. So, what do you need to know as a business owner to protect your trade secrets in light of this new law? Read on.

 

The Basics

For a more thorough look at what a trade secret is, check out our blog from October 2016: http://www.optimalawgroup.com/blog/trade-secrets. What follows is a quick, high-level look at trade secrets. Trade secrets are legally protectable information and can include a formula, pattern, compilation, program, device, method, technique, or process. The common definition of a trade secret has three parts: (1) information; (2) reasonable measures taken to protect the information; and (3) which derives independent economic value from not being generally known. Misappropriation of a trade secret commonly occurs in one of two ways: (1) an individual personally acquires a trade secret by improper means; or (2) an individual publishes a trade secret and he knows that the person who gave him the information acquired it through improper means or under circumstances giving rise to a duty to maintain its secrecy or limit its use. "Improper means" include theft, fraud, bribery, industrial espionage, breaching a contractual duty to keep something confidential, or inducing others to breach that duty.

 

Protection

Much of DTSA protections are on track with UTSA. For example, DTSA provides for injunctive relief for actual or threatened misappropriation, monetary damages for actual losses and unjust enrichment, and exemplary damages for willful and malicious misappropriation – similar to UTSA. One marked departure, however, is the creation of an ex parte seizure provision allowing courts to seize property “necessary to prevent the propagation or dissemination of the trade secret that is the subject of the action.” This relief is only available in extraordinary situations and is guarded by steep penalties for any plaintiff willing to abuse it. But, it provides a mechanism to prevent the destruction or concealment of trade secrets due to advanced notice to the defendant.

 

Obligation

As a business owner, you need to know that DTSA has placed an affirmative obligation on companies like yours. Namely, you will need to include an advisement to employees about whistleblower protections afforded by DTSA in documents governing the use of trade secrets or other confidential information. Failure to provide this required disclosure limits the plaintiff’s ability to recover exemplary damages and attorney’s fees in instances of wrongful disclosure. We recommend that you review all your contracts, but pay special attention to employment agreements, consulting agreements, non-disclosure agreements, and proprietary rights agreements. These are the most likely places you will need to include the disclosures discussed above and will likely require modifications. We have already drafted the language required to comply with the law and we would love to work with you to bring your agreements into compliance. 

 

Questions?

Trade secret law is only becoming more complex with the newly enacted law. Questions about whether your business is required to incorporate the new disclosures and how to do so? If you have any questions or concerns about whether you should be protecting potential trade secrets, or any other intellectual property, give us a call at 858-964-4697 or shoot us an email at info@optimalawgroup.com. We would love to hear from you.

 

Trade Secrets

We will be doing an informative blog post in November on the new Defend Trade Secrets Act of 2016 and how it impacts our clients. To prepare for that topic, this post is a general primer on the basics of understanding trade secrets. Enjoy!

 

What is a Trade Secret?

Broadly speaking, any confidential business information which provides an enterprise a competitive edge may be considered a trade secret. Trade secrets encompass all manner of confidential business information, including development, manufacturing, industrial and other commercial secrets. A simple, classic example would be a confidential customer or vendor list. The unauthorized use of such information by persons other than the holder is regarded as an unfair practice and a violation of the trade secret. Depending on the legal system, the protection of trade secrets forms part of the general concept of protection against unfair competition or is based on specific provisions or case law on the protection of confidential information.

The subject matter of trade secrets is usually defined in broad terms and includes sales methods, distribution methods, consumer profiles, advertising strategies, lists of suppliers and clients, and manufacturing processes. While a final determination of what information constitutes a trade secret will depend on the circumstances of each individual case, clearly unfair practices in respect of secret information include industrial or commercial espionage, breach of contract and breach of confidence.

 

How are Trade Secrets Protected?

Contrary to patents, trade secrets are protected without registration, that is, trade secrets are protected without any state run procedural formalities. Consequently, a trade secret can be protected for an unlimited period of time. For these reasons, the protection of trade secrets may appear to be particularly attractive for businesses. There are, however, conditions for the information to be considered a trade secret. Compliance with such conditions may turn out to be more difficult and costly than it would appear at first glance. While these conditions vary from country to country, some general standards exist which are referred to in Art. 39 of the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS Agreement):

·         The information must be secret (i.e. it is not generally known among, or readily accessible to, circles that normally deal with the kind of information in question).

·         It must have commercial value because it is a secret.

·         It must have been subject to reasonable steps by the rightful holder of the information to keep it secret (e.g., through confidentiality agreements, limited access rights, encrypted data etc.).

 

Patents or Trade Secrets?

Trade secrets are essentially of two kinds. On the one hand, trade secrets may concern information, data, methods, etc. that do not meet the patentability criteria and therefore can only be protected as trade secrets. This would be the case of customers’ lists or manufacturing processes that are not sufficiently inventive to be granted a patent (though they may qualify for protection as a utility model in certain countries). On the other hand, trade secrets may concern inventions that would meet the patentability criteria and could therefore be protected by patents. In the latter case, the business will face a choice: to patent the invention or to keep it as a trade secret.

Some advantages of trade secrets include:

·         Trade secret protection has the advantage of not being limited in time (patents last in general for up to 20 years from the filing of an application, and a typical patent term is 15-17 years). The protection therefore continues indefinitely as long as the secret is maintained as confidential and not revealed to the public.

·         Trade secrets involve no drafting, filing and registration costs.  Patents are expensive and have ongoing maintenance costs.  It is not uncommon for a single patent obtained in major countries (e.g. the US, Europe, Japan, Canada, Australia, China and South Korea) to costs in excess of $500,000 over the life of the patent.  Even a patent obtained only in the United States can easily cost $50,000-$100,000 over the life of the patent. 

·         Trade secrets have immediate effect.

·         Trade secret protection does not require compliance with formalities such as disclosure of the information to a Government authorities or publication of the details of the invention as required for a patent.

There are, however, some concrete disadvantages of protecting confidential business information as a trade secret, especially when the information meets the criteria for patentability:

·         If the secret is embodied in an innovative product, others may be able to inspect it, dissect it and analyze it (i.e. "reverse engineer" it) and discover the secret and be thereafter entitled to use it.  Trade secret protection of an invention in fact does not provide the exclusive right to exclude third parties from making commercial use of it. Only patents and utility models can provide this type of protection.

·         Once the secret is made public, anyone may have access to it and use it at will.

·         A trade secret is more difficult to enforce than a patent. The level of protection granted to trade secrets varies significantly from country to country, but is generally considered weak, particularly when compared with the protection granted by a patent.  Often, an improper disclosure is done by lower level of employees (who should not have had access to the trade secret in the first place) who, even if sued in a court of law, has no funds to compensate the trade secret holder for its loss.

·         A trade secret may be patented by someone else who developed the relevant information by legitimate means.  This in turn could limit or exclude the original trade secret holder’s right to use the trade secret they created.

 

Thank you to the World Intellectual Property Organization for information used in this post.

 

If you have any questions about protecting your trade secrets or seeking patent protection, please do not hesitate to reach to us. We would love to hear from you at 858-964-4697 or info@optimalawgroup.com.

Equity Crowdfunding

What do you need to know about the SEC’s recently enacted Equity Crowdfunding rules?

 

Crowdfunding is an exciting innovation of our internet age. By using the internet as a medium to reach the masses, a company can launch an idea and ask many people to contribute money to fund their idea. The theory is that many hands make light work. Websites like Kickstarter.com and Indiegogo.com are excellent examples of the fundraising type of crowdfunding where the purchaser is essentially giving money to the company. This blog, however, is focused solely on what is termed “Equity Crowdfunding.” Equity Crowdfunding is when a company (“issuer”) asks many people (“purchasers” or “investors”) to contribute an amount of money toward their goal, and in return, the purchasers receive equity in the company. Under direction of the JOBS Act, Title III, the SEC has recently finalized a regulatory structure for this type of funding effective May 16, 2016. The final rules are over 600 pages, however, we have listed some of the highlights below. Note that this is only a small portion of the rules and we recommend contacting an attorney to safely navigate the SEC’s Equity Crowdfunding rules.

 

Who is eligible to Equity Crowdfund?

 

In issuing its final rules, the SEC outlined who is NOT eligible to use the Equity Crowdfunding rules:

·         Companies organized outside the U.S.;

·         Companies required to report to the SEC;

·         Investment companies;

·         Disqualified companies;

·         Companies that have failed to comply with the annual reporting requirement during the two years preceding the filing of a Equity Crowdfunding offering; and

·         Companies with no specific business plan or whose business plan is to engage in a merger or acquisition with an unidentified company.

 

How much can a company raise?

 

The SEC stated that an eligible company can raise up to $1 million of securities through Equity Crowdfunding. When a company is also issuing securities using other registration exemptions, the company must comply with the separate requirements of the exemption and the separate limits will apply. Companies will need to be especially careful during simultaneous offerings under Equity Crowdfunding rules and another Securities Act registration requirement. For example, issuing securities under a “quiet” Rule 506(c) offering prohibits solicitations and a company taking advantage of 506(c) and Equity Crowdfunding would have to ensure 506(c) purchasers were not solicited by the Equity Crowdfunding offer.

 

How much can an investor give?

 

An individual investor can only purchase, from ALL Equity Crowdfunding issuers, during a 12-month period:

·         The greater of $2,000 or 5 percent of the lesser of the investor’s annual income or net worth if       either annual income or net worth is less than $100,000; or

·         10 percent of the lesser of the investor’s annual income or net worth, not to exceed $100,000, if both annual income and net worth are equal to or exceed $100,000.

 

Are there any required disclosures?

 

The SEC requires that prior to launching an Equity Crowdfunding offering, the company must file with the SEC and provide to investor (and the intermediary) an offering statement. The offering statement has a whole host of required information with varying requirements based on the target offering amount.

 

What are the mechanics of Equity Crowdfunding?

 

Equity Crowdfunding must be conducted:

·         though a single intermediary that is an SEC-registered broker-dealer or an SEC-registered funding portal that is also a FINRA member; and

·         exclusively through the intermediary’s platform.

Investors are entitled to cancel their investment commitments at any time and for any reason until 48 hours prior to the offering deadline. Any material change in offering terms will require a reaffirmation of the investor’s commitment.

 

While Equity Crowdfunding has its advantages, it also has drawbacks and is not a fit for every company. As always, don’t hesitate to reach out to us if you have any questions about Equity Crowdfunding, other options for capital raising, or anything else relating to the success of your business. We would love to hear from you at 858-964-4697 or info@optimalawgroup.com.

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