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JOE HADZIMA: OK.

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The second part of
tonight is going

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to deal with legal issues.

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And the first thing I
have to caution you on

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is-- whoops, what happened.

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I take that back.

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I didn't start at the beginning.

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This is background for education
only and it's not legal advice.

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Have to say that.

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00:00:54,440 --> 00:00:58,150
One of the things is that law
stuff is very fact specific.

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So anything that I
tell you here now

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could change based on the facts.

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And the law could change too.

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What I'm going to do is
go through an awful lot

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of slides covering a whole
bunch of areas of law

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related to startups.

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And I put on a
website-- the Deck.

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You can get that
now if you want.

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What I'd like you to
do is I'm going to try

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to point out the big issues.

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And at the end of the day,
it's more like an issue

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spotting thing.

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Will you recognize things
as you encounter them

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so that you have a
framework to have

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a discussion with
your legal adviser,

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with your team, et cetera.

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So we're going to go
to a pretty good clip.

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I'll try to take questions
but I reserve the right

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to sort of push through.

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So it's about legal issues.

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I'll see if I get
this thing working.

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00:01:49,731 --> 00:01:50,230
Sorry.

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00:01:55,500 --> 00:01:58,380
First of all, do we have
any lawyers in the audience?

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Uh-oh.

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00:01:59,810 --> 00:02:00,320
One lawyer.

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OK.

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All right.

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00:02:05,044 --> 00:02:06,710
[INAUDIBLE] came up
with this great idea

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that I did last year--
is to take the life

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cycle of the business and to
look at it through various sets

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of layers here.

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Starting with intellectual
property, legal entity, people,

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and financing.

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And across from pre- idea stage
all the way through financing.

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So we're going to
walk through that.

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And the first stage is going
to be the intellectual property

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stage.

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And it's the idea part.

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And the question is who
owns the IP for the venture.

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And then the pre-
outside financing

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is, how do you protect that.

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So that's the theme
for this part.

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Now how do we relate
to a business plan.

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And this is Fiona
Murray's Four Key Ideas

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for Startups The first is
controlling the knowledge

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underlying an invention.

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If that's important to
your business success,

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that's one of the
keys to startup.

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The second is secrecy.

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Maybe nobody else knows
exactly how you do what you do.

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The third is speed.

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Even with that other stuff
you need to move quickly.

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And that could be a real
key advantage-- an idea.

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And the fourth
thing-- in thinking

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about intellectual
property-- is there a way

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you could lock in customers.

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The way you go
about dealing with

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your intellectual property.

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And then how can that help
you in your business plan.

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Well first of all, IP
is a valuable asset

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and you can use it
to raise capital.

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One of the issues
with a lot of IP

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is the investors don't
really understand what it is.

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But they think it's important.

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And so if you don't
have some, they're

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going to be questioning,
why aren't you

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doing something there.

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So it's really a combination
of, is this important to you

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and have you thought about it.

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Now there is correlation
between IP and success.

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I did a study-- it was published
in the Intellectual Asset

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Management publication-- in
which we run these analyzes

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on venture backed companies.

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We run about 9,000 companies
through the set of metrics.

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And we took five top funds.

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Kleiner Perkins, New
Enterprise, Domain-- and we

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looked at patents
and we said, if we

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were to try to figure out
which companies had IP

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and how good was their IP and
what was there success rates.

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We look at the
portfolios and said,

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well we know some companies
have been acquired

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or they've gone public.

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Those are winners.

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And some companies
are out of business.

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They failed.

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And then a bunch of
the other companies--

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we don't know where
they are from a thing.

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And what we did is we
looked at our rankings

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based on analyzing IP.

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And it turned out to 86%
of the winners scored high

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in their patent strategy.

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Which is sort of
interesting when you think.

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The Kleiner Perkins success
rate is one out of three.

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That is one out of
every three investments

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that they make turns
out to be a success.

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And they've got the best
track record out there.

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So IP can really
correlate with success.

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The other thing
people look at is

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you can establish that
you are a good manager

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of your technology.

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And that can help you in
on your business plan.

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Now I'm going to run two
different types of IP

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protection, starting with none.

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And then trademark, copyright,
trade secret, patent,

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and combination.

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Now trademark and
copyright-- I'll

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get into more detail--
but basically these

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are things that can
enhance your value.

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But they don't
necessarily block others

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from doing what you're doing.

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Whereas trade secret
can prevent others.

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If they don't know how you
do it, they can't do it.

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00:06:04,480 --> 00:06:07,900
And then patent is sort
of a combination of both.

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Because in order to get
a patent, as you'll see,

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you have to actually
disclose what you're doing.

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So you're telling
people the secret sauce

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but you get some
rights in return.

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And then in some cases you get
combinations of protections.

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Like software can be protected
by copyright and by patent.

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So trademarks, what
are these things.

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Well basically a
trademark is-- it can

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be a name, a symbol, a sound.

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Harley Davidson
actually trademarked

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the sound of the vroom vroom.

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Color pink for insulation
is Owens Corning.

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And what it is--
it's something that

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tells a consumer that you're the
source of that good or service.

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So if I say Mercedes-Benz, you
have an image of what it is.

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So it connects the customer
with a particular source.

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And it can be all
sorts of things.

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It can be a house
mark, which would

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be IBM or Virtual Inc, which
is sort of the company names.

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It can be a product mark.

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Like ThinkPad used to be IBM.

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Now a Lenovo product.

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And Mimio was the
virtual ink one.

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The rights you get from
trademark arise through use.

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And if you register it you
get a whole bunch of benefits.

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And it's not very
expensive process to do it.

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You should use a fanciful name.

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So who would have thought
Apple for a computer.

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That's a strong mark.

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Don't pick something
that's merely descriptive,

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like storage technology or
analog devices as a mark.

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And for the business plan, if
you're putting it together,

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you can actually check on
the availability of a mark

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by going to the USPTO and you
can search for a mark name.

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Any questions on that so far?

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00:08:02,530 --> 00:08:05,480
OK, so the next
one is copyright.

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So copyright is
basically the right

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to prevent others from
making copies of what you do.

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And it rises just
from creating a work.

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So if I write a
letter to my mother,

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I have a copyright in that.

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Federal registration
is a plus in terms

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of the ability to enforce that.

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It protects the expression,
not the function.

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So I can actually copyright
my exact code in software.

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But I can't, through copyright,
prevent somebody else

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from looking at the
code and writing

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equivalent kind of things, as
long as they are not exactly

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copying it.

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Now for a business
plan, the key thing

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with copyright that people
trip over is who owns it.

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The owner of a copyright
is the author of the work,

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be it software, a
document, or whatever.

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It's the author.

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Now unless that
author is an employee

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00:09:07,700 --> 00:09:11,750
and is generating that in
the course of employment.

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00:09:11,750 --> 00:09:14,570
So if you go and hire an
independent contractor

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00:09:14,570 --> 00:09:17,800
to write code for
you, don't own it,

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00:09:17,800 --> 00:09:19,924
even though you paid for it.

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And so you've got
to make sure you

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have an assignment of
ownership of that work to you.

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Or when the investors
come in and they

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do their due diligence,
they're going to say,

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00:09:30,920 --> 00:09:32,860
you don't actually own it.

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I had a case back
in my law days where

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someone paid over a half
million dollars for code

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and couldn't actually
get ownership of it

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00:09:40,450 --> 00:09:42,880
because he hadn't protected it.

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And I also mentioned here, look
at open source as an issue.

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Where you're using
open source, make

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00:09:48,170 --> 00:09:52,050
sure you're complying with
the license for open source.

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Because investors, when they
come in-- you do all this work,

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you do your pitch.

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They send in the troops
to look you over then

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they find these landmines
you've planted there

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that you could have avoided.

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00:10:03,320 --> 00:10:06,830
So keep that in mind.

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00:10:06,830 --> 00:10:09,390
Now trade secret
is what it says.

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00:10:09,390 --> 00:10:12,721
It's a secret it's something
that gives you, hopefully,

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00:10:12,721 --> 00:10:14,970
an unfair competitive advantage
that nobody else knows

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how to do.

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00:10:15,540 --> 00:10:19,480
And the most famous one is
the formula for Coca Cola.

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00:10:19,480 --> 00:10:22,260
Which, I don't know whether
chemically you could figure it

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00:10:22,260 --> 00:10:24,240
out-- apparently nobody has.

215
00:10:24,240 --> 00:10:25,630
But that's an example.

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00:10:25,630 --> 00:10:29,300
It's been a secret
for a long time.

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00:10:29,300 --> 00:10:30,020
I should back up.

218
00:10:30,020 --> 00:10:32,480
A copyright is
effectively a long time.

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00:10:32,480 --> 00:10:35,170
It's like 75 years.

220
00:10:35,170 --> 00:10:38,220
Trademark is indefinite as
long as you keep renewing it.

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00:10:38,220 --> 00:10:40,900
Trade secret is indefinite
until it's finally

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00:10:40,900 --> 00:10:42,540
out there in the world.

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So you protect trade
secrets through

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00:10:46,250 --> 00:10:47,867
non-disclosure
agreements, if you're

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00:10:47,867 --> 00:10:49,450
going to actually
have to describe it,

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00:10:49,450 --> 00:10:51,760
or you just don't
tell people about it.

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00:10:54,900 --> 00:10:58,330
I think I'll just
leave it at that point

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The sort of big gorilla in
the IP spaces is patents.

229
00:11:02,020 --> 00:11:05,090
Because they have much
stronger rights that you get.

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00:11:05,090 --> 00:11:07,750
They're more expensive to get,
but they're stronger rights.

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00:11:07,750 --> 00:11:11,720
So a patent is really a
limited time monopoly.

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00:11:11,720 --> 00:11:14,100
And we don't really like
monopolies in the US.

233
00:11:14,100 --> 00:11:16,130
We have antitrust laws.

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00:11:16,130 --> 00:11:17,790
But in this case--
societal benefit,

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00:11:17,790 --> 00:11:19,414
it goes right back
to the Constitution.

236
00:11:19,414 --> 00:11:22,450
It says, look, we're going
to get ahead as a society

237
00:11:22,450 --> 00:11:25,680
if an inventor will
tell us how he did it.

238
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And in exchange, we'll give
the inventor a limited time

239
00:11:29,150 --> 00:11:33,490
monopoly to prevent others
from doing something.

240
00:11:33,490 --> 00:11:35,660
It has to be applied for.

241
00:11:35,660 --> 00:11:37,820
In the US, that's with
the patent office.

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00:11:37,820 --> 00:11:40,270
These patents are
country by country.

243
00:11:40,270 --> 00:11:44,420
In fact, most of these IP
rights are country by country.

244
00:11:44,420 --> 00:11:45,540
Now, what do you get.

245
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Well, it's very much
like real estate.

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00:11:49,140 --> 00:11:50,630
The fundamental
right-- and we'll

247
00:11:50,630 --> 00:11:52,730
go into a little more
detail in a moment--

248
00:11:52,730 --> 00:11:55,650
is the right to prevent
people from trespassing

249
00:11:55,650 --> 00:11:57,740
on your invention.

250
00:11:57,740 --> 00:11:59,790
So if you own a
piece of real estate,

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00:11:59,790 --> 00:12:02,270
your fundamental
right is, if I own

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00:12:02,270 --> 00:12:05,650
it and you walk on my
property, I can kick you off.

253
00:12:05,650 --> 00:12:08,000
Call the police,
get off my property.

254
00:12:08,000 --> 00:12:10,810
And that's essentially
what a patent does.

255
00:12:10,810 --> 00:12:12,810
The way it does that is
you could prevent others

256
00:12:12,810 --> 00:12:16,910
from making, using, selling,
importing, and distributing

257
00:12:16,910 --> 00:12:18,160
your invention.

258
00:12:18,160 --> 00:12:21,170
So you can't take something
that's patented in the US,

259
00:12:21,170 --> 00:12:24,040
take it to a third, a
second, another country,

260
00:12:24,040 --> 00:12:26,590
make it and bring
it back into the US.

261
00:12:26,590 --> 00:12:28,960
That would be an infringement.

262
00:12:28,960 --> 00:12:32,990
Now the ownership of a patent
is not necessarily the right

263
00:12:32,990 --> 00:12:34,310
to use it.

264
00:12:34,310 --> 00:12:36,627
That's a hard one
to think about.

265
00:12:36,627 --> 00:12:37,460
What does that mean.

266
00:12:37,460 --> 00:12:39,040
Well, think about real estate.

267
00:12:39,040 --> 00:12:41,390
If my fundamental right
is, I can keep you

268
00:12:41,390 --> 00:12:43,240
from walking on my
land, does that mean

269
00:12:43,240 --> 00:12:46,360
I can actually use my land.

270
00:12:46,360 --> 00:12:47,280
Well, maybe not.

271
00:12:47,280 --> 00:12:52,570
Suppose I have to walk across
your land to get to my land.

272
00:12:52,570 --> 00:12:55,010
I might not actually
be able to use my land

273
00:12:55,010 --> 00:12:56,950
but I can certainly
keep you off of it.

274
00:12:56,950 --> 00:12:58,160
And so that's the analogy.

275
00:12:58,160 --> 00:13:00,790
Some people think that
it's a right to use.

276
00:13:00,790 --> 00:13:03,830
It's really a right to exclude.

277
00:13:03,830 --> 00:13:06,320
And the claims in the
patent are like the fence

278
00:13:06,320 --> 00:13:07,930
around the property.

279
00:13:07,930 --> 00:13:10,660
So those to find what
the legal property

280
00:13:10,660 --> 00:13:13,600
is that you can
keep people out of.

281
00:13:13,600 --> 00:13:15,680
And the duration is
20 years from the date

282
00:13:15,680 --> 00:13:18,150
of filing under the new rules.

283
00:13:21,640 --> 00:13:27,260
Now what do you have
to do to get a patent.

284
00:13:27,260 --> 00:13:30,170
It has to be
something new, novel.

285
00:13:30,170 --> 00:13:33,610
And to get it, you have
to show the examiner.

286
00:13:33,610 --> 00:13:36,130
You make a filing
with the patent office

287
00:13:36,130 --> 00:13:38,420
and you have to
tell the examiner

288
00:13:38,420 --> 00:13:40,630
how yours is different from
what else is out there.

289
00:13:40,630 --> 00:13:42,060
Let's call prior art.

290
00:13:42,060 --> 00:13:44,360
So you have to cite prior art.

291
00:13:44,360 --> 00:13:46,370
So it has to be useful, also.

292
00:13:46,370 --> 00:13:49,680
That's not really an
issue for most patents.

293
00:13:49,680 --> 00:13:51,390
There's some pretty
un-useful things that

294
00:13:51,390 --> 00:13:54,250
have been patented out there.

295
00:13:54,250 --> 00:13:56,170
It has to be patentable
subject matter, which

296
00:13:56,170 --> 00:13:59,150
is this whole thing we're
seeing now with business method

297
00:13:59,150 --> 00:14:03,270
patents that I won't
go into any detail on.

298
00:14:03,270 --> 00:14:05,820
And it can't
previously have been

299
00:14:05,820 --> 00:14:09,020
sold or publicly described.

300
00:14:09,020 --> 00:14:12,160
In the US you have
a one year window

301
00:14:12,160 --> 00:14:15,710
from the time you publicly
describe your invention

302
00:14:15,710 --> 00:14:21,070
or you put on the
market for sale.

303
00:14:21,070 --> 00:14:24,390
You have one year in which you
get an application on file.

304
00:14:24,390 --> 00:14:28,640
And if you don't, you won't be
able to get a patent at all.

305
00:14:28,640 --> 00:14:32,900
Now the public description has
to be an enabling description.

306
00:14:32,900 --> 00:14:35,100
So it has to be something
that actually explains it.

307
00:14:35,100 --> 00:14:36,670
So if I stood here
and said, I've

308
00:14:36,670 --> 00:14:39,770
got this invention for
anti-gravity boots,

309
00:14:39,770 --> 00:14:42,730
I haven't told you anything
about how it's done.

310
00:14:42,730 --> 00:14:44,290
So it has to be enabling.

311
00:14:44,290 --> 00:14:47,750
Now the other
requirement is that what

312
00:14:47,750 --> 00:14:50,500
you're trying to patent has
to be not obvious to one

313
00:14:50,500 --> 00:14:53,720
of ordinary skill in the art.

314
00:14:53,720 --> 00:14:57,720
Now the word is ordinary
skill in the art.

315
00:14:57,720 --> 00:15:00,360
I had a MIT professor
who decided, well,

316
00:15:00,360 --> 00:15:03,860
this was sort of-- anybody
could have figured this out.

317
00:15:03,860 --> 00:15:06,940
Because he was used to dealing
at MIT professor level.

318
00:15:06,940 --> 00:15:08,190
And so I said, I'm not sure.

319
00:15:08,190 --> 00:15:09,898
You better go check
with a patent lawyer.

320
00:15:09,898 --> 00:15:11,890
And sure enough, it was
not something anyone

321
00:15:11,890 --> 00:15:14,550
with an ordinary skill would
have been able to figure out.

322
00:15:14,550 --> 00:15:20,000
Examples of overcoming that
part is that the prior art

323
00:15:20,000 --> 00:15:21,640
teaches against it.

324
00:15:21,640 --> 00:15:23,880
Other people say
it can't be done.

325
00:15:23,880 --> 00:15:26,150
And you've shown it or
its commercial success.

326
00:15:26,150 --> 00:15:27,850
Bob Langer does a
great story about some

327
00:15:27,850 --> 00:15:31,000
of his early patents,
where he came in and showed

328
00:15:31,000 --> 00:15:31,740
the examiner.

329
00:15:31,740 --> 00:15:36,020
Look, if it was so obvious,
how come nobody else did it.

330
00:15:36,020 --> 00:15:36,640
Nobody else.

331
00:15:36,640 --> 00:15:38,820
And here are some papers
that said it can't be done.

332
00:15:38,820 --> 00:15:41,750
And that's how he overcame
his original set of issues.

333
00:15:45,002 --> 00:15:46,710
I hear a question?

334
00:15:46,710 --> 00:15:49,530
OK.

335
00:15:49,530 --> 00:15:51,044
In the back, yes.

336
00:15:51,044 --> 00:15:52,294
AUDIENCE: Not previously sold.

337
00:15:52,294 --> 00:15:54,377
Does that mean not previously
sold by anyone else?

338
00:15:54,377 --> 00:15:57,134
Or can you not sell it
until you have the patent?

339
00:15:57,134 --> 00:15:58,300
JOE HADZIMA: Let me go back.

340
00:15:58,300 --> 00:16:00,230
I said it was one
year in the US.

341
00:16:00,230 --> 00:16:02,760
I should also mention in
the rest of the world,

342
00:16:02,760 --> 00:16:06,720
if you disclose or offer
for sale before you file,

343
00:16:06,720 --> 00:16:09,760
you won't be able to get a
patent in any other country.

344
00:16:09,760 --> 00:16:12,260
AUDIENCE: One year is
from the first time you--

345
00:16:12,260 --> 00:16:16,400
JOE HADZIMA: Either publicly
disclose or hold out for sale.

346
00:16:16,400 --> 00:16:16,900
Yeah.

347
00:16:16,900 --> 00:16:20,560
And there are a lot of nuances
on the hold out for sale.

348
00:16:20,560 --> 00:16:22,000
The purpose of
going through this

349
00:16:22,000 --> 00:16:24,291
is I want you know sort of
what the general issues are.

350
00:16:24,291 --> 00:16:25,780
And so you'll think about it.

351
00:16:25,780 --> 00:16:27,919
Oh, maybe we ought
to get that-- if we

352
00:16:27,919 --> 00:16:29,460
want to have a
patent, maybe we ought

353
00:16:29,460 --> 00:16:33,830
to go talk to someone before
we take it to a demo day

354
00:16:33,830 --> 00:16:36,680
and blow our chances.

355
00:16:36,680 --> 00:16:42,125
AUDIENCE: So does public
disclosure include things

356
00:16:42,125 --> 00:16:46,580
like telling your peers in a lab
or telling students in a class?

357
00:16:46,580 --> 00:16:53,510
And also, if you
[INAUDIBLE] use an object

358
00:16:53,510 --> 00:16:56,975
in [INAUDIBLE]
without revealing how

359
00:16:56,975 --> 00:17:01,322
one goes from input to
output-- is that a disclosure?

360
00:17:01,322 --> 00:17:02,280
JOE HADZIMA: All right.

361
00:17:02,280 --> 00:17:05,260
So the question is,
is a public disclosure

362
00:17:05,260 --> 00:17:07,339
if you talk to your
lab mates or you do it

363
00:17:07,339 --> 00:17:09,690
in the confines of
an academic setting.

364
00:17:09,690 --> 00:17:11,650
Sort of a closed
kind of setting.

365
00:17:11,650 --> 00:17:14,300
And in general,
yes, but you want

366
00:17:14,300 --> 00:17:15,900
to be very careful about that.

367
00:17:15,900 --> 00:17:23,760
It's one of those facts and
circumstances type things.

368
00:17:23,760 --> 00:17:25,550
There is an exception
to the holding

369
00:17:25,550 --> 00:17:30,070
out for sale for experimental
use of something.

370
00:17:30,070 --> 00:17:32,700
But again, the point
here is you don't

371
00:17:32,700 --> 00:17:34,410
want to rely on
these after the fact.

372
00:17:34,410 --> 00:17:37,190
You want to, if you're planning
some activities where you think

373
00:17:37,190 --> 00:17:39,340
it's really important
about a patent,

374
00:17:39,340 --> 00:17:41,790
make sure you know what the
exact rule is at that time.

375
00:17:41,790 --> 00:17:44,950
Because it could change
next week with a court case.

376
00:17:44,950 --> 00:17:47,019
These are just red
flag type things.

377
00:17:47,019 --> 00:17:48,560
AUDIENCE: What about
the second half?

378
00:17:48,560 --> 00:17:49,935
Where if you're
demoing something

379
00:17:49,935 --> 00:17:53,151
but you give no indication of
what it's worth [INAUDIBLE].

380
00:17:53,151 --> 00:17:55,650
JOE HADZIMA: So the question
is, if you're demoing something

381
00:17:55,650 --> 00:17:58,024
and you don't explain how it
works, is that a disclosure.

382
00:17:58,024 --> 00:18:00,680
It's actually been held
that way in some cases.

383
00:18:00,680 --> 00:18:04,050
Where you actually couldn't
see the actual device.

384
00:18:04,050 --> 00:18:07,970
So again, my point
is, think about ahead

385
00:18:07,970 --> 00:18:11,300
of time and with
the given facts,

386
00:18:11,300 --> 00:18:13,580
make sure you get some good
advice before you go off

387
00:18:13,580 --> 00:18:17,910
and do it and then wish you had
thought about it ahead of time.

388
00:18:17,910 --> 00:18:18,410
OK.

389
00:18:18,410 --> 00:18:21,510
So let me keep moving.

390
00:18:21,510 --> 00:18:22,535
Oops, let's see.

391
00:18:26,850 --> 00:18:28,990
Same issue from a
business plan viewpoint.

392
00:18:28,990 --> 00:18:30,570
Do you actually
own the technology.

393
00:18:30,570 --> 00:18:35,660
So a patent issues in
the name of an inventor.

394
00:18:35,660 --> 00:18:39,012
And a company only gets it
if the inventor assigns it.

395
00:18:39,012 --> 00:18:41,470
So if you're a technical person,
you go work for a company,

396
00:18:41,470 --> 00:18:43,660
you probably end up signing
an invention disclosure

397
00:18:43,660 --> 00:18:45,890
agreement and an assignment.

398
00:18:45,890 --> 00:18:48,980
So if you invent something
in the course of your work,

399
00:18:48,980 --> 00:18:50,657
you agree the employer owns it.

400
00:18:50,657 --> 00:18:52,490
And if you're a startup
and you hire people,

401
00:18:52,490 --> 00:18:55,632
you want to have something
along those lines also.

402
00:18:55,632 --> 00:18:57,340
You could in-license
from the university.

403
00:18:57,340 --> 00:19:01,130
I'll tell you a little bit about
MIT and how it works there.

404
00:19:01,130 --> 00:19:04,460
And did you let it go
into the public domain.

405
00:19:04,460 --> 00:19:06,905
In other words, did you screw
up these one year rules.

406
00:19:09,620 --> 00:19:10,170
OK.

407
00:19:10,170 --> 00:19:12,980
Now obtaining a patent
involves sort of four steps.

408
00:19:12,980 --> 00:19:15,460
In Determining what to patent.

409
00:19:15,460 --> 00:19:16,970
Determining when to file.

410
00:19:16,970 --> 00:19:18,490
You got to prepare
the applications.

411
00:19:18,490 --> 00:19:20,670
And then you've got
to prosecute it,

412
00:19:20,670 --> 00:19:24,120
which means you negotiate
with the Patent Office

413
00:19:24,120 --> 00:19:25,462
about getting a patent.

414
00:19:25,462 --> 00:19:26,795
And that can take several years.

415
00:19:29,360 --> 00:19:32,650
Determining what the patent
really is more about not

416
00:19:32,650 --> 00:19:34,540
what can I get a patent on.

417
00:19:34,540 --> 00:19:35,600
Its what's useful.

418
00:19:35,600 --> 00:19:38,660
Because patents are
pretty expensive.

419
00:19:38,660 --> 00:19:41,270
And you probably don't
have enough money

420
00:19:41,270 --> 00:19:44,614
to patent everything
you actually invent.

421
00:19:44,614 --> 00:19:46,780
And when you say, what do
I want to get a patent on,

422
00:19:46,780 --> 00:19:48,250
you say, well, what
value does it add.

423
00:19:48,250 --> 00:19:50,624
Remember we talked about we
want to create value-- that's

424
00:19:50,624 --> 00:19:53,000
part of the mission here.

425
00:19:53,000 --> 00:19:54,410
If I patent this,
is it valuable.

426
00:19:54,410 --> 00:19:55,910
Does it create commercial value.

427
00:19:55,910 --> 00:20:00,410
Does it prevent
competitors from using it.

428
00:20:00,410 --> 00:20:03,082
And in determining whether
it has commercial value

429
00:20:03,082 --> 00:20:05,290
or not, or whether you can
easily get a patent on it,

430
00:20:05,290 --> 00:20:08,602
you want to compare
against the prior art.

431
00:20:08,602 --> 00:20:11,060
So this is where I get to do
a little pitch for the company

432
00:20:11,060 --> 00:20:13,660
that I founded called IP Vision.

433
00:20:13,660 --> 00:20:16,630
We were doing early stage
technology commercialization

434
00:20:16,630 --> 00:20:17,810
out of MIT.

435
00:20:17,810 --> 00:20:20,850
And the problem we had doing
the same kind of things

436
00:20:20,850 --> 00:20:24,340
we're talking about
in class-- market,

437
00:20:24,340 --> 00:20:26,525
time to market, what's the
strategy-- is we always

438
00:20:26,525 --> 00:20:27,900
had a problem
figuring out what's

439
00:20:27,900 --> 00:20:29,602
the intellectual property.

440
00:20:29,602 --> 00:20:31,185
And the only way we
could really do it

441
00:20:31,185 --> 00:20:34,720
was try to read a ton of patents
or send it out to a law firm.

442
00:20:34,720 --> 00:20:36,580
And we get back a
real thick report.

443
00:20:36,580 --> 00:20:40,340
It was perfectly accurate,
but not very helpful.

444
00:20:40,340 --> 00:20:44,270
So we invented our own way
to map out the IP space.

445
00:20:44,270 --> 00:20:46,770
And this is an example
of our landing page.

446
00:20:46,770 --> 00:20:49,630
The free version is
at see-the-forest.com,

447
00:20:49,630 --> 00:20:52,362
with hyphens in-between there.

448
00:20:52,362 --> 00:20:53,320
There's a free version.

449
00:20:53,320 --> 00:20:55,100
And for people in
the MIT community,

450
00:20:55,100 --> 00:20:58,500
we give free upgrades to
premium while you're working

451
00:20:58,500 --> 00:20:59,550
on your plans and stuff.

452
00:20:59,550 --> 00:21:01,310
So check it out
and I'll show you

453
00:21:01,310 --> 00:21:04,100
an example of what
it looks like.

454
00:21:04,100 --> 00:21:09,340
This is Virtual Inks, one
of its key first patents.

455
00:21:09,340 --> 00:21:10,560
And this is a patent map.

456
00:21:10,560 --> 00:21:14,170
The horizontal axis is time.

457
00:21:14,170 --> 00:21:16,740
The patent is here.

458
00:21:16,740 --> 00:21:19,550
Each of these boxes
is aligned in time,

459
00:21:19,550 --> 00:21:23,600
with the left edge being
the issue date and the tail

460
00:21:23,600 --> 00:21:25,490
being the filing date.

461
00:21:25,490 --> 00:21:27,650
And this is a single
patent landscape

462
00:21:27,650 --> 00:21:29,580
map when they started off.

463
00:21:29,580 --> 00:21:30,900
And these are the citations.

464
00:21:30,900 --> 00:21:34,450
So this patent cited all these
other patents as prior art

465
00:21:34,450 --> 00:21:38,250
in the course of
the examination.

466
00:21:38,250 --> 00:21:43,060
So by looking at these maps
you can see who's in the space

467
00:21:43,060 --> 00:21:44,960
and see what's going on.

468
00:21:44,960 --> 00:21:49,210
You can right click on the
system on any of the boxes

469
00:21:49,210 --> 00:21:51,700
and get the underlying
information.

470
00:21:51,700 --> 00:21:56,700
The statistics boxes on the
map shows you who's on the map

471
00:21:56,700 --> 00:21:59,390
so you can see quickly
who's in the space.

472
00:21:59,390 --> 00:22:03,081
And this is what this patent
looked like several years

473
00:22:03,081 --> 00:22:03,580
later.

474
00:22:03,580 --> 00:22:05,100
So when it issued,
of course nobody

475
00:22:05,100 --> 00:22:08,100
else was citing it because
these are not publicly

476
00:22:08,100 --> 00:22:11,760
disclosed back in this
day-- until it was issued.

477
00:22:11,760 --> 00:22:18,660
Over time, other things started
to cite Yonald's patent.

478
00:22:18,660 --> 00:22:21,630
So it's an example of
something where you can quickly

479
00:22:21,630 --> 00:22:23,315
look at it and check it out.

480
00:22:23,315 --> 00:22:25,680
And if you have any questions,
let me know on that.

481
00:22:25,680 --> 00:22:31,130
This is what the Virtual Ink
US portfolio looked like it

482
00:22:31,130 --> 00:22:32,950
when it had 12 patents.

483
00:22:32,950 --> 00:22:37,530
And you can see these
are some of patents.

484
00:22:37,530 --> 00:22:39,650
And you can start to see
other companies citing.

485
00:22:39,650 --> 00:22:43,180
So these are potential
partners, customers.

486
00:22:43,180 --> 00:22:45,210
It can also help you,
as you try to figure out

487
00:22:45,210 --> 00:22:46,860
as you look at a
space, where do you

488
00:22:46,860 --> 00:22:50,040
want to take the
commercialization plan.

489
00:22:50,040 --> 00:22:55,450
So check it out let me know
if you have any questions.

490
00:22:55,450 --> 00:23:00,000
OK, so the question
is when to file.

491
00:23:00,000 --> 00:23:01,150
Before you lose rights.

492
00:23:01,150 --> 00:23:06,630
So that's the whole thing about
if you do a public disclosure

493
00:23:06,630 --> 00:23:09,670
and you want to get a patent in
France or Germany or something,

494
00:23:09,670 --> 00:23:12,080
and you haven't filed
already somewhere,

495
00:23:12,080 --> 00:23:14,520
you're going to lose that.

496
00:23:14,520 --> 00:23:17,450
And then you want
to take into account

497
00:23:17,450 --> 00:23:21,840
we have new domain now called
the America Invents Act.

498
00:23:21,840 --> 00:23:26,350
Before, it used to be in the
US, that the first to invent won

499
00:23:26,350 --> 00:23:29,290
in a dispute between inventors.

500
00:23:29,290 --> 00:23:31,830
Under the new rules that
came into effect this year,

501
00:23:31,830 --> 00:23:33,490
it's the first to file.

502
00:23:33,490 --> 00:23:36,110
Which is actually a
tougher one for startups

503
00:23:36,110 --> 00:23:39,730
because you'd like to not
encounter all of that cost

504
00:23:39,730 --> 00:23:41,260
for filing until
you actually get

505
00:23:41,260 --> 00:23:43,600
an idea that it's a good idea.

506
00:23:43,600 --> 00:23:46,820
But you could lose the
race to the Patent Office.

507
00:23:46,820 --> 00:23:53,000
So it makes a little harder
on startups these days.

508
00:23:53,000 --> 00:23:56,080
A way to deal with the
high cost of filings

509
00:23:56,080 --> 00:24:00,710
are things called
Provisional Applications.

510
00:24:00,710 --> 00:24:03,160
Provisionals are
very simple things.

511
00:24:03,160 --> 00:24:04,660
They don't even
have to have claims.

512
00:24:04,660 --> 00:24:07,510
They just describe
what the invention is.

513
00:24:07,510 --> 00:24:13,100
And I've even seen people going
to give a paper at a talk slap

514
00:24:13,100 --> 00:24:14,940
a cover page on it and file it.

515
00:24:14,940 --> 00:24:16,650
And what it does
is it establishes

516
00:24:16,650 --> 00:24:19,730
a filing date, which means
for the rest of the world,

517
00:24:19,730 --> 00:24:21,060
you filed.

518
00:24:21,060 --> 00:24:22,900
And you now have one
year from the date

519
00:24:22,900 --> 00:24:24,280
you made the
provisional in order

520
00:24:24,280 --> 00:24:28,170
to decide whether you really
want a patent on the thing

521
00:24:28,170 --> 00:24:29,690
as you've tested out the market.

522
00:24:29,690 --> 00:24:32,040
These are pretty inexpensive.

523
00:24:32,040 --> 00:24:35,430
It's $130-- I checked the
other day-- for small entities.

524
00:24:35,430 --> 00:24:38,010
And for micro entities,
which all of you would be,

525
00:24:38,010 --> 00:24:40,230
it's $65 dollars.

526
00:24:40,230 --> 00:24:44,050
Nothing happens at the
PTO once it's filed.

527
00:24:44,050 --> 00:24:45,760
It's just a placeholder.

528
00:24:45,760 --> 00:24:50,530
And the only risk is that
if you disclose something

529
00:24:50,530 --> 00:24:56,100
in the provisional and when
you go to file the utility

530
00:24:56,100 --> 00:24:59,260
patent a year later,
you include things

531
00:24:59,260 --> 00:25:01,880
that weren't in the provisional,
you may have lost that.

532
00:25:01,880 --> 00:25:04,610
So you have to sort
of think that through.

533
00:25:04,610 --> 00:25:11,170
When we were developing the IP
Vision site as a SAS platform,

534
00:25:11,170 --> 00:25:14,170
we were doing revs
every four to six weeks.

535
00:25:14,170 --> 00:25:18,610
And for every release we'd
sit down and say, what is it

536
00:25:18,610 --> 00:25:22,920
we did that might be of interest
that we might want to patent.

537
00:25:22,920 --> 00:25:25,090
What did we think about
doing but we didn't actually

538
00:25:25,090 --> 00:25:28,720
do because it wasn't in
the development plan.

539
00:25:28,720 --> 00:25:32,740
We'd systematically do that and
we'd file provisional patents.

540
00:25:32,740 --> 00:25:34,070
$100 a pop.

541
00:25:34,070 --> 00:25:36,390
And it kept holding
our place until we

542
00:25:36,390 --> 00:25:39,440
were ready to figure out what
we really wanted to patent

543
00:25:39,440 --> 00:25:41,400
and spend the extra money on.

544
00:25:41,400 --> 00:25:42,274
Was there a question?

545
00:25:42,274 --> 00:25:43,222
AUDIENCE: Yeah, quick question.

546
00:25:43,222 --> 00:25:45,222
You said that they slapped
a coverage fee on it.

547
00:25:45,222 --> 00:25:47,962
[INAUDIBLE] That's then
publicly in the books.

548
00:25:47,962 --> 00:25:49,860
So does that mean--

549
00:25:49,860 --> 00:25:52,135
JOE HADZIMA: Oh sorry,
provisionals are not published.

550
00:25:52,135 --> 00:25:54,760
AUDIENCE: But weren't they going
to present it at a conference,

551
00:25:54,760 --> 00:25:55,740
you said?

552
00:25:55,740 --> 00:25:57,815
JOE HADZIMA: They
may go disclose it.

553
00:25:57,815 --> 00:26:00,106
AUDIENCE: Does that [INAUDIBLE]
an international patent

554
00:26:00,106 --> 00:26:00,606
platform?

555
00:26:00,606 --> 00:26:03,534
JOE HADZIMA: No, a provisional
counts as a filing.

556
00:26:03,534 --> 00:26:04,700
AUDIENCE: For international?

557
00:26:04,700 --> 00:26:07,450
JOE HADZIMA: For
international, yeah.

558
00:26:07,450 --> 00:26:09,230
That's the good part
of the invention.

559
00:26:09,230 --> 00:26:12,340
Now a patent lawyer will
say you're better off doing

560
00:26:12,340 --> 00:26:15,250
a whole application and get the
claims and think it through.

561
00:26:15,250 --> 00:26:18,090
Well, there's a lot of things
that would be good to do.

562
00:26:18,090 --> 00:26:20,060
It's just time and resources.

563
00:26:20,060 --> 00:26:26,640
So this is a reasonable
approach to think about.

564
00:26:26,640 --> 00:26:28,085
As I say, it's all
fact dependent.

565
00:26:28,085 --> 00:26:29,710
If you have something
that's really key

566
00:26:29,710 --> 00:26:32,420
and you really understand
exactly what the invention is,

567
00:26:32,420 --> 00:26:35,030
it might be worth going
directly to a full filing.

568
00:26:35,030 --> 00:26:37,682
But it's just a strategy.

569
00:26:37,682 --> 00:26:38,181
OK?

570
00:26:40,887 --> 00:26:41,840
So what's in a patent.

571
00:26:41,840 --> 00:26:43,350
How many people that
actually looked at a patent?

572
00:26:43,350 --> 00:26:44,310
Read one?

573
00:26:44,310 --> 00:26:47,030
Anyone have a patent?

574
00:26:47,030 --> 00:26:48,050
Couple.

575
00:26:48,050 --> 00:26:48,840
Good.

576
00:26:48,840 --> 00:26:53,470
So it's sort of like a
term paper in a sense.

577
00:26:53,470 --> 00:26:56,635
There's a part of it
that says, describe

578
00:26:56,635 --> 00:26:57,920
to me what the invention is.

579
00:26:57,920 --> 00:27:00,130
And again, it's a
societal trade off.

580
00:27:00,130 --> 00:27:02,700
You tell me your invention,
I'll give you this limited time

581
00:27:02,700 --> 00:27:03,660
monopoly.

582
00:27:03,660 --> 00:27:07,260
So part of the usual set up is
there's a field of invention,

583
00:27:07,260 --> 00:27:08,930
there's a background.

584
00:27:08,930 --> 00:27:12,850
You usually describe what's
broken that you fixed.

585
00:27:12,850 --> 00:27:15,780
To show why yours is novel
and nobody else has done it.

586
00:27:15,780 --> 00:27:17,090
Non-obvious.

587
00:27:17,090 --> 00:27:18,610
Then you summarize
the invention.

588
00:27:18,610 --> 00:27:21,380
Then you go into a
detailed description.

589
00:27:21,380 --> 00:27:23,040
And there's this
technical thing saying

590
00:27:23,040 --> 00:27:26,170
you have to really explain what
the best mode of practicing

591
00:27:26,170 --> 00:27:27,380
your invention is.

592
00:27:27,380 --> 00:27:30,800
Because again, the idea
is if that knowledge gets

593
00:27:30,800 --> 00:27:33,200
in a society, everybody
can build off of it

594
00:27:33,200 --> 00:27:35,360
and we all get better.

595
00:27:35,360 --> 00:27:38,890
And we give you the rights to
exclude for the 20 year period.

596
00:27:38,890 --> 00:27:41,960
So you've got to really
actually describe how it works.

597
00:27:41,960 --> 00:27:44,740
And then the claims
are the key part.

598
00:27:44,740 --> 00:27:48,450
Now from a cost viewpoint,
I think everyone in the room

599
00:27:48,450 --> 00:27:53,210
is capable of writing
everything about the patent

600
00:27:53,210 --> 00:27:55,930
and save a bunch of money,
at least as a first draft.

601
00:27:55,930 --> 00:27:57,400
You want the patent lawyers.

602
00:27:57,400 --> 00:28:00,450
So the people that know
how to craft the claims.

603
00:28:00,450 --> 00:28:02,250
The claims are the tricky part.

604
00:28:02,250 --> 00:28:04,330
If you ever have to
enforce this stuff,

605
00:28:04,330 --> 00:28:06,660
it's the claims
that really matter.

606
00:28:06,660 --> 00:28:09,030
So that's where you want to
spend the legal money-- is

607
00:28:09,030 --> 00:28:10,430
on the claims.

608
00:28:10,430 --> 00:28:12,560
And if you just go in and
drop your lab notebook

609
00:28:12,560 --> 00:28:14,850
on the patent
lawyer's desk, you're

610
00:28:14,850 --> 00:28:17,270
paying by the hour for
stuff that you probably

611
00:28:17,270 --> 00:28:18,907
are better off doing
yourself and doing

612
00:28:18,907 --> 00:28:20,990
the first draft of what
it is you're trying to do.

613
00:28:23,010 --> 00:28:27,660
Cost of-- US, an application
is about anywhere from $5,000

614
00:28:27,660 --> 00:28:30,300
to $15,000 on average.

615
00:28:30,300 --> 00:28:33,330
I've actually ended up
spending $30,000 because I

616
00:28:33,330 --> 00:28:35,470
didn't control the process.

617
00:28:35,470 --> 00:28:38,690
One of my co-founders kept
calling the patent lawyer

618
00:28:38,690 --> 00:28:41,260
and throwing new things
in without telling me.

619
00:28:41,260 --> 00:28:43,000
And then I get the bill.

620
00:28:43,000 --> 00:28:46,240
I thought I had
the control on it.

621
00:28:46,240 --> 00:28:49,780
The filing fee is not that much.

622
00:28:49,780 --> 00:28:52,910
I should mention that
applications in the US

623
00:28:52,910 --> 00:28:56,970
are now published 18
months after they're filed.

624
00:28:56,970 --> 00:28:59,590
That is the official
utility application, not

625
00:28:59,590 --> 00:29:00,850
the provisional.

626
00:29:00,850 --> 00:29:04,550
So when you actually file your
full application, 18 months,

627
00:29:04,550 --> 00:29:05,320
they're published.

628
00:29:05,320 --> 00:29:08,040
And the only exception
is if you say,

629
00:29:08,040 --> 00:29:11,680
I don't want to get a patent
any place else in the world,

630
00:29:11,680 --> 00:29:15,630
then they will publish it in
the US until it actually issues,

631
00:29:15,630 --> 00:29:17,520
if and when it issues.

632
00:29:17,520 --> 00:29:21,000
Foreign applications
are really expensive.

633
00:29:21,000 --> 00:29:23,910
There was a government
accounting office study

634
00:29:23,910 --> 00:29:26,830
in the early 2000
era that looked

635
00:29:26,830 --> 00:29:32,060
at 10 countries and an invention
by a relatively small entity.

636
00:29:32,060 --> 00:29:34,565
And they estimated it would
cost somewhere between $300,000

637
00:29:34,565 --> 00:29:38,650
and $500,000 to file
and maintain a patent

638
00:29:38,650 --> 00:29:41,030
and in the 10 major countries.

639
00:29:41,030 --> 00:29:45,890
So you want to be a little bit
thoughtful about this stuff.

640
00:29:45,890 --> 00:29:50,320
Now I'm going to switch over
to university licensing.

641
00:29:50,320 --> 00:29:53,090
And a little bit of history.

642
00:29:53,090 --> 00:29:55,960
The federal government
sponsors a lot of research

643
00:29:55,960 --> 00:29:57,800
all over the country.

644
00:29:57,800 --> 00:30:00,530
And it used to be
the ownership of that

645
00:30:00,530 --> 00:30:03,210
was the federal government and
somebody in Washington trying

646
00:30:03,210 --> 00:30:05,280
to figure out what
was happening.

647
00:30:05,280 --> 00:30:09,550
The Bayh-Dole Act came around
in 1980 and it said, look,

648
00:30:09,550 --> 00:30:11,930
we're going to put licensing
down at the university level

649
00:30:11,930 --> 00:30:14,270
where the research is done
because they'll have a better

650
00:30:14,270 --> 00:30:16,170
idea of what's going on.

651
00:30:16,170 --> 00:30:17,880
And we're going to
give them some rights

652
00:30:17,880 --> 00:30:18,755
and some obligations.

653
00:30:21,730 --> 00:30:25,030
So the key point here-- you can
look at it on the slide later--

654
00:30:25,030 --> 00:30:28,700
is really putting it at
the university level.

655
00:30:28,700 --> 00:30:33,480
There is some emphasis in
the rules about licensing

656
00:30:33,480 --> 00:30:35,485
to small companies.

657
00:30:35,485 --> 00:30:38,500
It used to be the big companies,
now the small companies.

658
00:30:38,500 --> 00:30:42,750
And there's a provision for
royalties to inventors out

659
00:30:42,750 --> 00:30:44,550
of the process.

660
00:30:44,550 --> 00:30:47,310
Now at MIT it's the
Technology Licensing Office,

661
00:30:47,310 --> 00:30:48,900
known as the TLO.

662
00:30:48,900 --> 00:30:52,200
That is the place
that administers this.

663
00:30:52,200 --> 00:30:56,570
Now the primary goal stated
by the TLO is tech transfer.

664
00:30:56,570 --> 00:30:59,690
They want to get inventions
out into the marketplace.

665
00:30:59,690 --> 00:31:04,500
And the secondary goal
is to generate revenue.

666
00:31:04,500 --> 00:31:07,590
And there's the website
for checking it out.

667
00:31:07,590 --> 00:31:09,940
Now, the secondary goal--
a lot of universities

668
00:31:09,940 --> 00:31:12,630
seem to put the emphasis more
on the revenue side and less

669
00:31:12,630 --> 00:31:14,130
on the tech transfer.

670
00:31:14,130 --> 00:31:15,565
So MIT is a little
unique in this.

671
00:31:18,030 --> 00:31:19,950
There's a question
of who owns stuff.

672
00:31:19,950 --> 00:31:22,660
There's MIT IP Ownership Policy.

673
00:31:22,660 --> 00:31:24,920
You can check us out at the TLO.

674
00:31:24,920 --> 00:31:27,240
And essentially,
it says, look, MIT

675
00:31:27,240 --> 00:31:30,450
is going to own the
work that's done here

676
00:31:30,450 --> 00:31:37,550
by staff and researchers if
it's under funded research.

677
00:31:37,550 --> 00:31:41,090
It will also own it if there's
a significant use of MIT

678
00:31:41,090 --> 00:31:42,630
resources-- facilities.

679
00:31:42,630 --> 00:31:45,850
So if you're using
the nuclear reactor.

680
00:31:45,850 --> 00:31:47,390
It doesn't mean
that you're using

681
00:31:47,390 --> 00:31:50,060
Athena or stuff like that.

682
00:31:50,060 --> 00:31:51,600
But if you're using
significant use,

683
00:31:51,600 --> 00:31:53,565
then MIT may claim ownership.

684
00:31:56,100 --> 00:31:58,420
If you have questions
about ownership,

685
00:31:58,420 --> 00:32:01,200
the TLO is pretty approachable.

686
00:32:01,200 --> 00:32:04,010
So you can go over and
chat with them about it.

687
00:32:04,010 --> 00:32:07,960
And they often will
waive or clarify rights

688
00:32:07,960 --> 00:32:12,380
to enable you to
start your company.

689
00:32:12,380 --> 00:32:16,205
What you don't want to
do is go down the path,

690
00:32:16,205 --> 00:32:18,080
get investors interested,
and then have them,

691
00:32:18,080 --> 00:32:21,180
again, find out that
maybe you don't actually

692
00:32:21,180 --> 00:32:22,310
have rights to the stuff.

693
00:32:22,310 --> 00:32:24,650
That's not a good place to be.

694
00:32:27,860 --> 00:32:32,300
Now this place has got a
lot of smart people doing

695
00:32:32,300 --> 00:32:34,080
a lot of interesting things.

696
00:32:34,080 --> 00:32:37,430
And not all of it falls
under the sponsored research

697
00:32:37,430 --> 00:32:40,820
or significant
use of facilities.

698
00:32:40,820 --> 00:32:42,830
So MIT actually
has a policy that

699
00:32:42,830 --> 00:32:45,770
says we will voluntarily
look at and maybe

700
00:32:45,770 --> 00:32:48,440
take on board inventions
the people have.

701
00:32:51,000 --> 00:32:52,740
Even if it wasn't
under funded research.

702
00:32:52,740 --> 00:32:56,890
And what they'll do is so
prosecute the patent around

703
00:32:56,890 --> 00:32:58,990
and engage in licensing.

704
00:32:58,990 --> 00:33:04,530
So that's opened up the number
of things that the TLO does.

705
00:33:04,530 --> 00:33:06,420
And they're pretty
open about it.

706
00:33:06,420 --> 00:33:09,150
Now as a startup,
what can you do.

707
00:33:09,150 --> 00:33:11,990
Licensing can be expensive.

708
00:33:11,990 --> 00:33:13,870
You're trying to
put a plan together,

709
00:33:13,870 --> 00:33:15,780
you're trying to
figure out your market,

710
00:33:15,780 --> 00:33:19,230
you want to secure the
rights, and you need funding.

711
00:33:19,230 --> 00:33:21,430
So typically what
happens is you'll get

712
00:33:21,430 --> 00:33:26,130
an option on the technology.

713
00:33:26,130 --> 00:33:28,260
We'll call it just
technology broadly.

714
00:33:28,260 --> 00:33:30,050
It's usually six
months to a year.

715
00:33:30,050 --> 00:33:33,450
It's not that expensive.

716
00:33:33,450 --> 00:33:37,590
You'll have to assume some of
the patent prosecution costs.

717
00:33:37,590 --> 00:33:39,580
And what it allows
you to do-- that is,

718
00:33:39,580 --> 00:33:41,830
to know-- that when
you take the idea out

719
00:33:41,830 --> 00:33:45,559
to the investor community,
you actually can fulfill.

720
00:33:45,559 --> 00:33:46,850
You've got everything lined up.

721
00:33:46,850 --> 00:33:48,740
I've got rights to the patents.

722
00:33:48,740 --> 00:33:52,170
I've got my idea, I've got my
team, I just need your money.

723
00:33:52,170 --> 00:33:55,220
And away you go.

724
00:33:55,220 --> 00:33:57,580
Typical license terms.

725
00:33:57,580 --> 00:34:02,280
This is a couple years
old, care of Steve Brown,

726
00:34:02,280 --> 00:34:05,170
who used to be at the TLO.

727
00:34:05,170 --> 00:34:08,489
The components of the license
you'll find include issue fees.

728
00:34:08,489 --> 00:34:10,530
In other words, what does
it cost to actually get

729
00:34:10,530 --> 00:34:12,400
the license directly.

730
00:34:12,400 --> 00:34:14,520
There's maintenance
fees to continue

731
00:34:14,520 --> 00:34:17,290
to maintain the license.

732
00:34:17,290 --> 00:34:18,230
There's diligence.

733
00:34:18,230 --> 00:34:22,540
They don't want you
to just sit on it.

734
00:34:22,540 --> 00:34:24,870
And what I've done
in the columns here

735
00:34:24,870 --> 00:34:27,880
is if you don't want
to give up equity,

736
00:34:27,880 --> 00:34:32,380
what the typical terms are, and
what the terms are with equity.

737
00:34:32,380 --> 00:34:34,620
Royalty as a percentage of sale.

738
00:34:34,620 --> 00:34:37,590
You see 3% to 5% with no equity.

739
00:34:37,590 --> 00:34:40,360
2% to 4%, maybe with.

740
00:34:40,360 --> 00:34:43,739
Patent costs are
the same, et cetera.

741
00:34:43,739 --> 00:34:48,679
Now from equity side, one
of the big innovations

742
00:34:48,679 --> 00:34:51,469
that MIT did is-- it used
to be only big companies

743
00:34:51,469 --> 00:34:53,949
would come in and license.

744
00:34:53,949 --> 00:34:57,359
But we look here and all the
entrepreneurial stuff going on.

745
00:34:57,359 --> 00:34:59,150
They said, well we want
to figure out a way

746
00:34:59,150 --> 00:35:00,950
to encourage small companies.

747
00:35:00,950 --> 00:35:02,140
And so how do we do that.

748
00:35:02,140 --> 00:35:05,080
Well the equity was
one way to do it.

749
00:35:05,080 --> 00:35:08,760
And we'll take equity in
lieu of the cash fees.

750
00:35:08,760 --> 00:35:11,770
Typically it's single
digit percentage of equity

751
00:35:11,770 --> 00:35:14,340
that you give up.

752
00:35:14,340 --> 00:35:17,600
And that percentage is
maintained undiluted, usually

753
00:35:17,600 --> 00:35:21,084
through the first major
round of financing.

754
00:35:21,084 --> 00:35:22,500
And we'll talk
about what dilution

755
00:35:22,500 --> 00:35:25,500
means when we get into
terms here in a little bit.

756
00:35:25,500 --> 00:35:27,600
These were typical
royalties a few years ago

757
00:35:27,600 --> 00:35:28,780
for university patents.

758
00:35:28,780 --> 00:35:31,232
You'll see they're
all over the place.

759
00:35:31,232 --> 00:35:32,440
Again, it's in the materials.

760
00:35:32,440 --> 00:35:36,460
You can check those out.

761
00:35:36,460 --> 00:35:38,670
Now how do they have
split things up.

762
00:35:38,670 --> 00:35:41,600
Just so you have
an appreciation.

763
00:35:41,600 --> 00:35:43,710
If there is any
return from a license,

764
00:35:43,710 --> 00:35:46,420
be it royalties or a
company goes public

765
00:35:46,420 --> 00:35:49,740
and MIT sells the
stock, 15% percent

766
00:35:49,740 --> 00:35:53,580
comes off the top to pay
for TLO operating expenses.

767
00:35:53,580 --> 00:35:56,330
Than they deduct
the patent costs.

768
00:35:56,330 --> 00:36:00,380
And then after that, a third
of it goes to the inventors.

769
00:36:00,380 --> 00:36:02,450
And then basically, with
some other adjustments,

770
00:36:02,450 --> 00:36:08,870
the other two thirds are split
between the department and MIT

771
00:36:08,870 --> 00:36:11,530
in general.

772
00:36:11,530 --> 00:36:14,370
So that's a
university licensing.

773
00:36:14,370 --> 00:36:20,110
Any questions on that?

774
00:36:20,110 --> 00:36:21,960
OK, really do approach the TLO.

775
00:36:21,960 --> 00:36:23,710
They're pretty responsive.

776
00:36:23,710 --> 00:36:25,366
Or they can be.

777
00:36:25,366 --> 00:36:26,992
AUDIENCE: Can you
kind of name some

778
00:36:26,992 --> 00:36:29,758
of the pitfalls of some
[INAUDIBLE] something

779
00:36:29,758 --> 00:36:33,174
out of the lab, and
not necessarily-- like

780
00:36:33,174 --> 00:36:38,542
when to sever ties
with the research lab

781
00:36:38,542 --> 00:36:41,144
and make sure you have
a really strong wall

782
00:36:41,144 --> 00:36:42,977
between the two and [INAUDIBLE]

783
00:36:42,977 --> 00:36:45,060
JOE HADZIMA: Yeah there's
a whole bunch of things.

784
00:36:45,060 --> 00:36:52,370
So the basic strategy is
that if you're funded,

785
00:36:52,370 --> 00:36:55,610
you get your license, and
you set up shop outside,

786
00:36:55,610 --> 00:36:59,970
and the people that are at
MIT go across the street

787
00:36:59,970 --> 00:37:01,980
and do their work in
the lab or whatever.

788
00:37:01,980 --> 00:37:06,740
Across the street,
not on MIT campus.

789
00:37:06,740 --> 00:37:08,510
And that sort of
works the same way

790
00:37:08,510 --> 00:37:10,210
if you're starting a company.

791
00:37:10,210 --> 00:37:11,810
That you try to
separate the two.

792
00:37:11,810 --> 00:37:14,740
Now it gets a little complex if
you're under sponsored research

793
00:37:14,740 --> 00:37:16,130
and you're being
funded in a lab.

794
00:37:16,130 --> 00:37:18,050
It can get a little complex.

795
00:37:18,050 --> 00:37:21,230
We had a situation a few years
ago back when I was practicing.

796
00:37:21,230 --> 00:37:23,260
Where my client was a
professor in the AI,

797
00:37:23,260 --> 00:37:28,420
artificial intelligence group,
and one of his PhD students

798
00:37:28,420 --> 00:37:32,560
was split between the
Media Lab and the AI group.

799
00:37:32,560 --> 00:37:35,400
And because of the way the
Media Lab stuff worked,

800
00:37:35,400 --> 00:37:38,520
the professors
inventions were somehow

801
00:37:38,520 --> 00:37:40,390
being claimed by the Media Lab.

802
00:37:40,390 --> 00:37:42,230
So there's some real
technical stuff there.

803
00:37:42,230 --> 00:37:45,130
But there are plenty of people
who can help you out on that.

804
00:37:45,130 --> 00:37:47,010
And I just want to
put a red flag up.

805
00:37:47,010 --> 00:37:48,250
Again, to think about it.

806
00:37:48,250 --> 00:37:50,570
In terms of whether you
can actually own it,

807
00:37:50,570 --> 00:37:54,610
the TLO can be
approachable on that.

808
00:37:54,610 --> 00:37:57,840
OK, now I want to switch
to the next topic, which is

809
00:37:57,840 --> 00:38:00,949
legal forms of doing business.

810
00:38:00,949 --> 00:38:01,990
How do you get organized.

811
00:38:01,990 --> 00:38:04,559
And again, these are sort of
the red flag kind of things.

812
00:38:04,559 --> 00:38:05,600
I'm going to cut through.

813
00:38:05,600 --> 00:38:08,650
I do a whole couple of sessions
at Sloan on this stuff.

814
00:38:08,650 --> 00:38:11,290
But here I'm going to try
to give you the high level

815
00:38:11,290 --> 00:38:13,580
conclusions.

816
00:38:13,580 --> 00:38:16,700
So in most cases
for companies that

817
00:38:16,700 --> 00:38:18,670
are technology
based companies that

818
00:38:18,670 --> 00:38:22,120
are going to need any
kind of financing,

819
00:38:22,120 --> 00:38:26,340
the choice is a
Delaware corporation.

820
00:38:26,340 --> 00:38:29,060
Delaware has a
corporate law that's

821
00:38:29,060 --> 00:38:35,740
very flexible,
predictable, and it

822
00:38:35,740 --> 00:38:40,150
has its separate court that
hears specific cases surround

823
00:38:40,150 --> 00:38:42,310
stockholder rights.

824
00:38:42,310 --> 00:38:46,380
And so the default tends
to be towards Delaware.

825
00:38:46,380 --> 00:38:51,190
And the question is, when
should you incorporate.

826
00:38:51,190 --> 00:38:52,550
Or should you incorporate.

827
00:38:52,550 --> 00:38:55,520
Basically, the corporation
gives you limited liability

828
00:38:55,520 --> 00:38:59,510
as owners of the business.

829
00:39:02,250 --> 00:39:05,542
You can't say, look,
I've got this idea.

830
00:39:05,542 --> 00:39:07,000
I'm going to set
up a company, I'll

831
00:39:07,000 --> 00:39:08,950
transfer my invention
to the company,

832
00:39:08,950 --> 00:39:11,460
and I won't have any
personal liability.

833
00:39:11,460 --> 00:39:14,610
You're always liable
for your own acts.

834
00:39:14,610 --> 00:39:18,410
The question here, from
launching a company viewpoint,

835
00:39:18,410 --> 00:39:21,530
is are your investors going
to be liable for your acts.

836
00:39:21,530 --> 00:39:26,270
So that's where corporate form
protects the shareholders.

837
00:39:26,270 --> 00:39:30,120
Now the question is
when to incorporate.

838
00:39:30,120 --> 00:39:32,560
You should do it
sooner than later

839
00:39:32,560 --> 00:39:38,890
to avoid personal liability
based on your ownership

840
00:39:38,890 --> 00:39:41,430
and toward
partnership liability.

841
00:39:41,430 --> 00:39:45,480
And there's a thing I'm going to
go into called the Section 83.

842
00:39:45,480 --> 00:39:50,040
And that's a real catch for
you if you don't work on it

843
00:39:50,040 --> 00:39:53,330
and incorporate early.

844
00:39:53,330 --> 00:39:55,540
Now the next question
is, all right,

845
00:39:55,540 --> 00:39:58,270
I got a corporate
form, how is it taxed.

846
00:39:58,270 --> 00:40:01,030
And again, the default
that I always recommend

847
00:40:01,030 --> 00:40:05,540
is to file what's called
an S corporation election.

848
00:40:05,540 --> 00:40:09,830
So a regular corporation
is taxed on its profit.

849
00:40:09,830 --> 00:40:12,300
And when that profit is handed
out to the shareholders,

850
00:40:12,300 --> 00:40:13,100
it's taxed again.

851
00:40:13,100 --> 00:40:14,920
So there's two layers of tax.

852
00:40:14,920 --> 00:40:18,810
A Subchapter S, if you qualify--
there's only one layer of tax.

853
00:40:18,810 --> 00:40:20,260
The corporation doesn't pay tax.

854
00:40:23,230 --> 00:40:26,980
But the attributes get passed
through to the shareholders.

855
00:40:26,980 --> 00:40:28,880
You have to have fewer
than 100 shareholders.

856
00:40:28,880 --> 00:40:31,970
One class of stock.

857
00:40:31,970 --> 00:40:34,857
And you can't have
nonresident aliens

858
00:40:34,857 --> 00:40:36,690
as shareholders, which
is an issue if you're

859
00:40:36,690 --> 00:40:40,430
a foreign student.

860
00:40:40,430 --> 00:40:44,640
And it has to be
primarily human beings,

861
00:40:44,640 --> 00:40:46,570
except for certain
types of trusts.

862
00:40:46,570 --> 00:40:48,620
So as soon as a
venture capital firm--

863
00:40:48,620 --> 00:40:53,370
if you take the money-- invests,
it'll destroy the Subchapter S

864
00:40:53,370 --> 00:40:55,560
status and it'll
be taxed as a C.

865
00:40:55,560 --> 00:40:58,350
But it can really
make a difference.

866
00:40:58,350 --> 00:41:01,500
The first company that was
taken out of the Media Lab

867
00:41:01,500 --> 00:41:05,940
was a company called DIVA,
Digital Video Applications.

868
00:41:05,940 --> 00:41:08,580
And the founder said, if we
don't ever get venture money,

869
00:41:08,580 --> 00:41:10,200
we'll never succeed.

870
00:41:10,200 --> 00:41:13,380
And I said, well let's do
it with the S corporation.

871
00:41:13,380 --> 00:41:15,460
Well they never did
raise venture money.

872
00:41:15,460 --> 00:41:17,491
They sold the company
two years later

873
00:41:17,491 --> 00:41:19,490
for I think it was somewhere
around $10 million.

874
00:41:19,490 --> 00:41:25,796
And they saved a million and a
half or more having done that.

875
00:41:25,796 --> 00:41:28,750
Let me move through here.

876
00:41:28,750 --> 00:41:31,260
Here's an example of the
S corporation taxation.

877
00:41:31,260 --> 00:41:33,010
I'll just leave it in there.

878
00:41:33,010 --> 00:41:34,680
You can see the
two layers of tax.

879
00:41:34,680 --> 00:41:37,690
And the net effect is,
well why would you do this

880
00:41:37,690 --> 00:41:39,280
if most startups lose money.

881
00:41:39,280 --> 00:41:40,590
They're not going to be taxed.

882
00:41:40,590 --> 00:41:42,340
And the issue is
it's when it gets

883
00:41:42,340 --> 00:41:45,220
acquired that you can succeed.

884
00:41:45,220 --> 00:41:49,390
And you can save 20 plus
percent under current rates.

885
00:41:49,390 --> 00:41:53,440
You can work the math from
the slides that are online.

886
00:41:53,440 --> 00:41:57,070
Now I want to switch to
something that is actually

887
00:41:57,070 --> 00:41:59,520
an issue for you personally.

888
00:41:59,520 --> 00:42:00,800
And it can be a big thing.

889
00:42:00,800 --> 00:42:03,560
It's a very odd part
of the Internal Revenue

890
00:42:03,560 --> 00:42:05,970
code called Section 83.

891
00:42:05,970 --> 00:42:09,380
And it says, if you receive
property in connection

892
00:42:09,380 --> 00:42:12,995
with providing
services- and here stock

893
00:42:12,995 --> 00:42:17,620
is property for this purpose--
then you have ordinary income.

894
00:42:17,620 --> 00:42:21,260
That's like you get when
you get a paycheck, which

895
00:42:21,260 --> 00:42:26,090
can be taxed up to 35 plus
percent under current rates.

896
00:42:26,090 --> 00:42:28,530
And the amount is the fair
market value of the property

897
00:42:28,530 --> 00:42:32,660
that you get, minus
what you paid.

898
00:42:32,660 --> 00:42:35,860
And that's what the income
is that you pay tax on.

899
00:42:35,860 --> 00:42:37,410
So here's an example.

900
00:42:37,410 --> 00:42:38,247
I like your idea.

901
00:42:38,247 --> 00:42:40,080
And I say, I'll tell
you what, I'll give you

902
00:42:40,080 --> 00:42:45,440
a million dollars, we'll start
a company, and how about 50-50.

903
00:42:45,440 --> 00:42:47,050
And you say, OK.

904
00:42:47,050 --> 00:42:49,910
For this purpose, you say 50-50.

905
00:42:49,910 --> 00:42:53,350
What happens is, let
me ask you how much

906
00:42:53,350 --> 00:42:54,970
is your 50% of the company.

907
00:42:54,970 --> 00:42:57,740
I provide the capital,
a million dollars,

908
00:42:57,740 --> 00:43:02,100
we each have 50% of the company,
and you get the other 50%,

909
00:43:02,100 --> 00:43:05,810
how much is your side worth.

910
00:43:05,810 --> 00:43:06,630
Anybody?

911
00:43:06,630 --> 00:43:09,047
AUDIENCE: What's the [INAUDIBLE]

912
00:43:09,047 --> 00:43:10,880
JOE HADZIMA: I put the
first million dollars

913
00:43:10,880 --> 00:43:12,481
in for half the company.

914
00:43:12,481 --> 00:43:14,390
AUDIENCE: [INAUDIBLE]

915
00:43:14,390 --> 00:43:16,304
JOE HADZIMA: Yeah, it
could be a million or--

916
00:43:16,304 --> 00:43:18,280
AUDIENCE: $750,000.

917
00:43:18,280 --> 00:43:20,114
JOE HADZIMA: $750,000.

918
00:43:20,114 --> 00:43:21,530
Well you could say
it's a million,

919
00:43:21,530 --> 00:43:24,100
because why would I pay
a million for one half

920
00:43:24,100 --> 00:43:25,970
if the other half
wasn't worth a million.

921
00:43:25,970 --> 00:43:28,650
On the other hand, once the
million dollars goes in,

922
00:43:28,650 --> 00:43:32,310
and there's no real asset in
there other than the million

923
00:43:32,310 --> 00:43:34,800
dollars, you sort of own
half the million dollars.

924
00:43:34,800 --> 00:43:36,320
So let's just do the math.

925
00:43:36,320 --> 00:43:41,180
So the fair market value, if it
was at $500,000, you pay zero,

926
00:43:41,180 --> 00:43:44,900
your ordinary income
is $500,000 taxed

927
00:43:44,900 --> 00:43:49,390
at 35% percent or something.

928
00:43:49,390 --> 00:43:49,970
Not good.

929
00:43:49,970 --> 00:43:54,150
And if it's a million, 40%
would be $200,000 you owe.

930
00:43:54,150 --> 00:43:57,820
And if it's a million,
you owe $400,000.

931
00:43:57,820 --> 00:43:59,400
Congratulations.

932
00:43:59,400 --> 00:44:00,840
Tax bill.

933
00:44:00,840 --> 00:44:03,610
So that's not a
good result, right?

934
00:44:03,610 --> 00:44:05,820
So the question is,
how do you avoid that.

935
00:44:05,820 --> 00:44:09,030
Well the trick is
to separate the time

936
00:44:09,030 --> 00:44:13,180
when you get your stock from the
time the investment comes in.

937
00:44:13,180 --> 00:44:16,190
So if you come in to a
lawyer's office on Friday

938
00:44:16,190 --> 00:44:19,460
with a term sheet and
say, let's incorporate,

939
00:44:19,460 --> 00:44:21,500
we're going to close
next week, the question

940
00:44:21,500 --> 00:44:25,110
is, what happened between
Friday and when you closed.

941
00:44:25,110 --> 00:44:26,672
Well maybe a patent
issued or you

942
00:44:26,672 --> 00:44:28,570
got FDA approval or something.

943
00:44:28,570 --> 00:44:34,400
So you stretch those
further in time

944
00:44:34,400 --> 00:44:36,060
and you get your
stock early then

945
00:44:36,060 --> 00:44:37,905
you don't fall into this trap.

946
00:44:37,905 --> 00:44:39,780
It's when you get your
stock at the same time

947
00:44:39,780 --> 00:44:41,400
the investment comes in.

948
00:44:41,400 --> 00:44:46,370
So the mission here is to
incorporate earlier and issue

949
00:44:46,370 --> 00:44:50,410
stock as soon as you
can and make what's

950
00:44:50,410 --> 00:44:55,500
called an 83(b) election, which
we won't go into fully here,

951
00:44:55,500 --> 00:44:58,080
but you have to do
that within 30 days.

952
00:44:58,080 --> 00:45:02,650
So the question is, why doesn't
stock get issued in time.

953
00:45:02,650 --> 00:45:03,710
Even with startups.

954
00:45:03,710 --> 00:45:08,120
I see so many situations
where the team is working,

955
00:45:08,120 --> 00:45:10,650
they're doing all the things
that guys up here talked about.

956
00:45:10,650 --> 00:45:13,255
And the investment comes
in and they may even

957
00:45:13,255 --> 00:45:16,330
have incorporated, but
they haven't actually

958
00:45:16,330 --> 00:45:18,450
given the stock out.

959
00:45:18,450 --> 00:45:24,859
And I think it could be anything
from too busy to nobody's quite

960
00:45:24,859 --> 00:45:25,900
sure who should get what.

961
00:45:25,900 --> 00:45:27,630
You heard John
talk about everyone

962
00:45:27,630 --> 00:45:29,255
pulling their weight
except one person.

963
00:45:32,400 --> 00:45:34,750
What I do see in the case
of technical startups

964
00:45:34,750 --> 00:45:38,590
is the issue between
the technologists

965
00:45:38,590 --> 00:45:42,180
who maybe has the idea--
so think of the dynamics.

966
00:45:42,180 --> 00:45:44,060
We're starting a company.

967
00:45:44,060 --> 00:45:46,780
We've got to sort of prove out
the technology with a prototype

968
00:45:46,780 --> 00:45:47,930
or something.

969
00:45:47,930 --> 00:45:50,500
And the technologist
is working in the lab.

970
00:45:50,500 --> 00:45:53,270
Working really hard
on it, long hours.

971
00:45:53,270 --> 00:45:55,860
And the business side people
are waiting, maybe even

972
00:45:55,860 --> 00:45:59,222
keep their day job
doing the planning.

973
00:45:59,222 --> 00:46:00,680
And there's sort
of this dichotomy.

974
00:46:00,680 --> 00:46:03,280
So if you think
about it this way.

975
00:46:03,280 --> 00:46:07,900
If you say I have time
across a horizontal axis

976
00:46:07,900 --> 00:46:10,710
and relative importance.

977
00:46:10,710 --> 00:46:15,130
And I said, where would you
put the technology person

978
00:46:15,130 --> 00:46:20,110
on this chart at the beginning.

979
00:46:20,110 --> 00:46:22,170
How relatively important
is the technology

980
00:46:22,170 --> 00:46:24,660
in a start up at the beginning.

981
00:46:24,660 --> 00:46:26,910
Well it's going to be high,
because if it doesn't work

982
00:46:26,910 --> 00:46:28,300
you don't have anything.

983
00:46:28,300 --> 00:46:31,094
And where would you
put the business guy.

984
00:46:31,094 --> 00:46:32,845
AUDIENCE: [INAUDIBLE]

985
00:46:32,845 --> 00:46:34,470
JOE HADZIMA: Well
over time, technology

986
00:46:34,470 --> 00:46:35,900
is less important, right?

987
00:46:35,900 --> 00:46:37,540
Relatively speaking.

988
00:46:37,540 --> 00:46:41,210
And the business starts at the
bottom, relatively speaking,

989
00:46:41,210 --> 00:46:42,390
and improves over time.

990
00:46:42,390 --> 00:46:44,430
And at some point,
they're balanced off.

991
00:46:44,430 --> 00:46:47,000
Whether they cross or not
isn't really important.

992
00:46:47,000 --> 00:46:48,830
The important
thing is to realize

993
00:46:48,830 --> 00:46:52,062
you can have team dynamics
where the technology people, who

994
00:46:52,062 --> 00:46:53,520
think it's their
invention, they're

995
00:46:53,520 --> 00:46:56,020
doing all the
work-- and then how

996
00:46:56,020 --> 00:47:00,000
do you end up splitting stock
in a situation like that.

997
00:47:00,000 --> 00:47:02,660
Well it's my technology,
I don't want to give it.

998
00:47:02,660 --> 00:47:04,390
You guys aren't really doing it.

999
00:47:04,390 --> 00:47:07,070
And you get a lot of
tension around that.

1000
00:47:07,070 --> 00:47:09,040
But just simply
realizing the dynamics

1001
00:47:09,040 --> 00:47:11,134
of relative importance.

1002
00:47:11,134 --> 00:47:12,550
And you heard from
the people here

1003
00:47:12,550 --> 00:47:14,190
about needing a
whole team to pull

1004
00:47:14,190 --> 00:47:18,580
it off can at least put people
in the same way of thinking

1005
00:47:18,580 --> 00:47:19,620
about it.

1006
00:47:19,620 --> 00:47:21,620
Does that make sense?

1007
00:47:21,620 --> 00:47:24,350
OK.

1008
00:47:24,350 --> 00:47:27,050
Now what you heard from
the have the team here

1009
00:47:27,050 --> 00:47:28,880
tonight that people
was the most important.

1010
00:47:28,880 --> 00:47:31,040
And most companies fail
because of people issues.

1011
00:47:31,040 --> 00:47:35,770
So you got to sort out
those relationships upfront.

1012
00:47:35,770 --> 00:47:41,120
Now in a small company,
the stockholders

1013
00:47:41,120 --> 00:47:42,730
owe each other a fiduciary duty.

1014
00:47:42,730 --> 00:47:44,910
Meaning you got a
sort of treat everyone

1015
00:47:44,910 --> 00:47:46,836
with a degree of fairness.

1016
00:47:46,836 --> 00:47:48,210
So you'll have a
set of questions

1017
00:47:48,210 --> 00:47:49,520
about who sits on the board.

1018
00:47:49,520 --> 00:47:54,640
If you populate a board other
than for legal, who owes what

1019
00:47:54,640 --> 00:47:58,020
titles, what functional things.

1020
00:47:58,020 --> 00:47:59,720
You want to talk
about restrictions

1021
00:47:59,720 --> 00:48:02,180
on stock transfers.

1022
00:48:02,180 --> 00:48:04,380
Rights of first refusal,
tag along rights,

1023
00:48:04,380 --> 00:48:07,190
all of these terms
here you can read

1024
00:48:07,190 --> 00:48:10,310
about in the founders memo,
which is in the resources

1025
00:48:10,310 --> 00:48:13,400
part of the website.

1026
00:48:13,400 --> 00:48:16,980
This is a memo that years
ago-- I had one week,

1027
00:48:16,980 --> 00:48:23,230
as a relatively young lawyer,
and I had three teams come in.

1028
00:48:23,230 --> 00:48:25,460
Great startup teams from MIT.

1029
00:48:25,460 --> 00:48:27,797
And with each team I
spent four to five hours

1030
00:48:27,797 --> 00:48:30,130
with them trying to walk them
through the kind of things

1031
00:48:30,130 --> 00:48:31,392
that you need to think about.

1032
00:48:31,392 --> 00:48:33,850
So at the end of the week I'm
thinking, this is ridiculous.

1033
00:48:33,850 --> 00:48:37,200
I went through the same set of
exercises with these people.

1034
00:48:37,200 --> 00:48:39,447
They don't want to
pay me to do this.

1035
00:48:39,447 --> 00:48:41,530
I don't want to spend all
the time educating them.

1036
00:48:41,530 --> 00:48:44,161
So I went home and I wrote
the beginning or the Founder's

1037
00:48:44,161 --> 00:48:46,410
Memo, which sort of sets out
all of the kind of things

1038
00:48:46,410 --> 00:48:47,272
to think about.

1039
00:48:47,272 --> 00:48:49,230
And what I would do after
that is, I would say,

1040
00:48:49,230 --> 00:48:52,144
if you're going to come
in and meet with me,

1041
00:48:52,144 --> 00:48:53,810
I want you all to
read the founders memo

1042
00:48:53,810 --> 00:48:58,540
and start talking about
what philosophy you have

1043
00:48:58,540 --> 00:49:00,440
and understand
some of the issues.

1044
00:49:00,440 --> 00:49:03,640
So we don't spend a lot
of time educating you

1045
00:49:03,640 --> 00:49:05,210
while the meter's running.

1046
00:49:05,210 --> 00:49:06,620
And that worked
very effectively.

1047
00:49:06,620 --> 00:49:09,130
So the Founder's Memo--
it's not a fancy memo

1048
00:49:09,130 --> 00:49:11,299
but it's been very helpful
to people over the years

1049
00:49:11,299 --> 00:49:11,840
they tell me.

1050
00:49:15,200 --> 00:49:18,060
So the question is how to
founder's equity split.

1051
00:49:18,060 --> 00:49:24,040
The Wasserman book is a good one
to look out on different ways

1052
00:49:24,040 --> 00:49:26,720
founders think about splitting.

1053
00:49:26,720 --> 00:49:28,540
There's no one formula.

1054
00:49:28,540 --> 00:49:29,910
There's a culture.

1055
00:49:29,910 --> 00:49:32,640
I negotiated Kenan Systems.

1056
00:49:32,640 --> 00:49:37,780
It was a very successful company
sold for a billion dollars.

1057
00:49:37,780 --> 00:49:41,250
It was owned by one
person, Kenan Sahin.

1058
00:49:41,250 --> 00:49:45,100
He paid all of his
people good salaries.

1059
00:49:45,100 --> 00:49:46,580
And that culture worked.

1060
00:49:46,580 --> 00:49:48,780
It was a very
successful company.

1061
00:49:48,780 --> 00:49:53,180
He ended up giving $100
million to MIT, which was nice.

1062
00:49:53,180 --> 00:49:54,880
But it doesn't mean
that you always

1063
00:49:54,880 --> 00:49:56,120
have to spread equity around.

1064
00:49:59,600 --> 00:50:01,590
And part of this is
from Charlie's slides.

1065
00:50:01,590 --> 00:50:04,130
You're going to look at the
value of past contributions

1066
00:50:04,130 --> 00:50:06,580
and future contributions.

1067
00:50:06,580 --> 00:50:08,050
Sacrifice commitment.

1068
00:50:08,050 --> 00:50:11,360
Ownership of IP.

1069
00:50:11,360 --> 00:50:15,490
People's internal or
external market value.

1070
00:50:15,490 --> 00:50:16,980
And internal equity.

1071
00:50:16,980 --> 00:50:20,820
There was a good
team that was set up

1072
00:50:20,820 --> 00:50:23,680
that went through a really
disciplined exercise

1073
00:50:23,680 --> 00:50:27,430
where there was at MIT
professor and a post-doc.

1074
00:50:27,430 --> 00:50:29,760
And they were trying to
figure out how to split it up.

1075
00:50:29,760 --> 00:50:31,740
So I said to each
of them, well you

1076
00:50:31,740 --> 00:50:37,220
write down what you think you're
giving up to join the company.

1077
00:50:37,220 --> 00:50:38,950
And we just have a
discussion about it.

1078
00:50:38,950 --> 00:50:40,420
So the professor
said, well, I've

1079
00:50:40,420 --> 00:50:42,430
got a worldwide reputation.

1080
00:50:42,430 --> 00:50:44,270
I'm allowed to consult
one day a week.

1081
00:50:44,270 --> 00:50:47,000
If I joined the company, I'm
not going to be doing that.

1082
00:50:47,000 --> 00:50:49,430
My consulting rate is x.

1083
00:50:49,430 --> 00:50:51,750
And he had a bunch of things.

1084
00:50:51,750 --> 00:50:55,300
The post-doc said, well, I'll
be giving up my academic career.

1085
00:50:55,300 --> 00:50:57,870
It would be very hard
for me to go back.

1086
00:50:57,870 --> 00:51:00,900
If I got a job in industry,
I'd be making this much.

1087
00:51:00,900 --> 00:51:04,669
I'm going to be spending
full time on this.

1088
00:51:04,669 --> 00:51:06,210
And it created a
framework where they

1089
00:51:06,210 --> 00:51:10,240
could have a discussion around
how they were approaching it.

1090
00:51:10,240 --> 00:51:12,110
It was fairly successful.

1091
00:51:12,110 --> 00:51:13,710
And that works often with MIT.

1092
00:51:13,710 --> 00:51:17,660
People were sort of data driven.

1093
00:51:17,660 --> 00:51:23,388
The other thing about
equity-- when you get beyond--

1094
00:51:24,414 --> 00:51:25,580
I'll mention it in a moment.

1095
00:51:25,580 --> 00:51:29,570
We're going to switch
over now to employees

1096
00:51:29,570 --> 00:51:30,600
and outside contractors.

1097
00:51:33,630 --> 00:51:36,206
This is the slide from
Charlie the other night.

1098
00:51:36,206 --> 00:51:37,960
He included in here
about how to think

1099
00:51:37,960 --> 00:51:41,140
about equity with employees.

1100
00:51:41,140 --> 00:51:49,751
One of the issues with employees
is does stock motivate.

1101
00:51:49,751 --> 00:51:50,750
Does it really motivate.

1102
00:51:50,750 --> 00:51:54,490
If you've never actually
been in a company

1103
00:51:54,490 --> 00:51:59,010
and had an event occur
where that piece of paper

1104
00:51:59,010 --> 00:52:01,550
was enough money to buy a
nice car or a down payment

1105
00:52:01,550 --> 00:52:04,930
on a house or something--
it's just a piece of paper.

1106
00:52:04,930 --> 00:52:09,200
The first job I had out of MIT
was with a spin-off company

1107
00:52:09,200 --> 00:52:10,640
from Pugh-Roberts.

1108
00:52:10,640 --> 00:52:12,860
Ed Roberts at Sloan School.

1109
00:52:12,860 --> 00:52:17,640
We were in a triple decker
house up on [? Leigh ?] Street.

1110
00:52:17,640 --> 00:52:18,920
I was the third employee.

1111
00:52:18,920 --> 00:52:22,490
We had the third floor
because his other company

1112
00:52:22,490 --> 00:52:25,310
was on the nice floors.

1113
00:52:25,310 --> 00:52:26,870
And so the first
day I get there,

1114
00:52:26,870 --> 00:52:29,050
I come sort of mid
morning, it's time.

1115
00:52:29,050 --> 00:52:32,500
I've got to go down, use the
bathroom after all a coffee.

1116
00:52:32,500 --> 00:52:34,660
So the bathroom was
one of those half baths

1117
00:52:34,660 --> 00:52:38,960
under the stairway under
these triple decker houses.

1118
00:52:38,960 --> 00:52:42,200
So I go down there, I open
the door, and I look in.

1119
00:52:42,200 --> 00:52:45,970
And the entire wall
this little half bath

1120
00:52:45,970 --> 00:52:49,335
is papered with what looks
like real stock certificates.

1121
00:52:49,335 --> 00:52:51,335
I mean first of all, I
thought it was wallpaper.

1122
00:52:51,335 --> 00:52:52,770
That's sort of a
weird wallpaper.

1123
00:52:52,770 --> 00:52:53,353
Then I looked.

1124
00:52:53,353 --> 00:52:55,850
They're real stock certificates.

1125
00:52:55,850 --> 00:52:58,230
So clearly they weren't
worth a whole lot if they

1126
00:52:58,230 --> 00:53:00,160
were wallpapering a bathroom.

1127
00:53:00,160 --> 00:53:01,630
So to me it said two things.

1128
00:53:01,630 --> 00:53:07,160
One is if you don't want
to work for wallpaper,

1129
00:53:07,160 --> 00:53:08,550
get back to work.

1130
00:53:08,550 --> 00:53:12,030
And secondly, what is
this stuff called stock.

1131
00:53:12,030 --> 00:53:17,000
So a lot of employees-- you
shouldn't assume right away

1132
00:53:17,000 --> 00:53:20,770
that equity motivates people.

1133
00:53:20,770 --> 00:53:22,670
People don't understand
it many cases.

1134
00:53:22,670 --> 00:53:26,540
There was a story about
Prime Computer and Bose,

1135
00:53:26,540 --> 00:53:28,600
where they were
recruiting an engineer.

1136
00:53:28,600 --> 00:53:31,920
And they basically had
the same cash salary.

1137
00:53:31,920 --> 00:53:35,100
But one company was
offering twice as much stock

1138
00:53:35,100 --> 00:53:37,210
as the other-- number of shares.

1139
00:53:37,210 --> 00:53:41,540
And what was not clear was that
they had the same market value.

1140
00:53:41,540 --> 00:53:45,271
One stock was worth twice as
much per share as the other.

1141
00:53:45,271 --> 00:53:47,770
So the perception, if you're
not used to dealing with stock,

1142
00:53:47,770 --> 00:53:50,040
that people automatically
understand how it works.

1143
00:53:50,040 --> 00:53:52,220
You shouldn't assume.

1144
00:53:52,220 --> 00:53:56,890
There is a market for labor if
you're in certain industries--

1145
00:53:56,890 --> 00:53:58,400
you're going to
need to give equity

1146
00:53:58,400 --> 00:54:00,190
to bring in the good people.

1147
00:54:00,190 --> 00:54:01,940
But you really have
to think about that.

1148
00:54:01,940 --> 00:54:04,050
Don't just go pattern
thinking about.

1149
00:54:04,050 --> 00:54:06,200
Oh everyone gets
stock because that's

1150
00:54:06,200 --> 00:54:07,800
the way everyone does things.

1151
00:54:07,800 --> 00:54:09,150
You have to think about that.

1152
00:54:12,690 --> 00:54:17,920
So the question is if
you're starting a company

1153
00:54:17,920 --> 00:54:19,810
and you're going
out and let's say

1154
00:54:19,810 --> 00:54:22,440
you're successful in raising
some outside money, what

1155
00:54:22,440 --> 00:54:27,310
fraction of the equity goes into
the equity compensation pool.

1156
00:54:27,310 --> 00:54:30,270
Well Charlie had
that nice template

1157
00:54:30,270 --> 00:54:31,630
for financial projections.

1158
00:54:31,630 --> 00:54:33,260
And he had a head count.

1159
00:54:33,260 --> 00:54:37,690
And as you recall, he matched
the head count to equity

1160
00:54:37,690 --> 00:54:39,790
based on the type of position.

1161
00:54:39,790 --> 00:54:43,270
And the initial stock
pool for companies

1162
00:54:43,270 --> 00:54:48,740
is usually two to three years
worth of the head count plan.

1163
00:54:48,740 --> 00:54:51,680
Now what does that translate
if your venture-backed.

1164
00:54:51,680 --> 00:54:54,860
In my experience, at first
round venture financing,

1165
00:54:54,860 --> 00:54:58,500
you're probably going to have
somewhere between 12% and 18%

1166
00:54:58,500 --> 00:55:03,260
of the total equity
reserved for employees.

1167
00:55:03,260 --> 00:55:04,910
It'll be at the
lower end of that

1168
00:55:04,910 --> 00:55:07,570
if you've got more of
your team fleshed out.

1169
00:55:07,570 --> 00:55:10,010
It'll be at the higher end or
even higher if it's just you

1170
00:55:10,010 --> 00:55:11,860
and you've got to
hire in some people.

1171
00:55:11,860 --> 00:55:14,470
But that's a reasonable
rule of thumb.

1172
00:55:14,470 --> 00:55:16,610
And for most equity
plans, you're

1173
00:55:16,610 --> 00:55:20,550
going to think about
employees, directors, and maybe

1174
00:55:20,550 --> 00:55:21,050
consultants.

1175
00:55:24,140 --> 00:55:26,350
And if you try to
calibrate this,

1176
00:55:26,350 --> 00:55:28,160
there are surveys
and places you can

1177
00:55:28,160 --> 00:55:31,680
go to see what the market is
for different types of equity

1178
00:55:31,680 --> 00:55:33,219
grants.

1179
00:55:33,219 --> 00:55:34,760
Again, from Charlie's
slides, just as

1180
00:55:34,760 --> 00:55:35,860
a reminder in one place.

1181
00:55:35,860 --> 00:55:37,580
These were some
ownership percentages

1182
00:55:37,580 --> 00:55:41,730
he talked about after
two rounds of financing.

1183
00:55:41,730 --> 00:55:44,080
And you will always end
up granting more later

1184
00:55:44,080 --> 00:55:45,430
to keep people incented.

1185
00:55:48,310 --> 00:55:51,950
This was his spreadsheet
with dilution showing.

1186
00:55:51,950 --> 00:55:53,550
I just put it here
for reference.

1187
00:55:53,550 --> 00:55:55,260
[? Yonald ?] is going
to do a great job

1188
00:55:55,260 --> 00:55:57,312
on the last night
of the class where

1189
00:55:57,312 --> 00:55:59,520
he's going to walk you
through what actually happened

1190
00:55:59,520 --> 00:56:02,250
to employees and
founders and investors.

1191
00:56:02,250 --> 00:56:07,970
So I think we'll let him get
into that in more detail.

1192
00:56:07,970 --> 00:56:12,680
Now we'll run through common
forms of equity compensation.

1193
00:56:12,680 --> 00:56:14,972
There's restricted stock.

1194
00:56:14,972 --> 00:56:16,430
And there are two
types of options.

1195
00:56:16,430 --> 00:56:18,550
One is an incentive
stock option,

1196
00:56:18,550 --> 00:56:22,300
which has certain tax benefits
and their non-qualified.

1197
00:56:22,300 --> 00:56:28,030
Again, restricted stock is
stock that's granted to somebody

1198
00:56:28,030 --> 00:56:33,100
or sold to somebody and it
starts a capital gains holding

1199
00:56:33,100 --> 00:56:36,580
period for tax and SCC.

1200
00:56:36,580 --> 00:56:39,110
It's usually subject to vesting.

1201
00:56:39,110 --> 00:56:42,150
Charlie talked about vesting.

1202
00:56:42,150 --> 00:56:45,680
And you may want to file
an 83(b) election because

1203
00:56:45,680 --> 00:56:47,540
of the vesting.

1204
00:56:47,540 --> 00:56:50,850
You can read more about
that in the Founder's Memo.

1205
00:56:50,850 --> 00:56:53,290
Incentive stock
options are options

1206
00:56:53,290 --> 00:56:55,860
to comply with tax requirements.

1207
00:56:55,860 --> 00:56:58,970
They're granted
only to employees.

1208
00:56:58,970 --> 00:57:01,450
And they have to be
granted at an exercise

1209
00:57:01,450 --> 00:57:02,787
price that's fair market value.

1210
00:57:02,787 --> 00:57:03,620
What does that mean.

1211
00:57:03,620 --> 00:57:06,290
That means you can buy
100 shares of stock

1212
00:57:06,290 --> 00:57:07,900
at today's price.

1213
00:57:07,900 --> 00:57:10,370
And the theory is that
hopefully, over time the stock

1214
00:57:10,370 --> 00:57:11,500
goes up.

1215
00:57:11,500 --> 00:57:14,810
Maybe it's $10 exercised and
when a person exercises it,

1216
00:57:14,810 --> 00:57:15,830
it's $100.

1217
00:57:15,830 --> 00:57:20,570
So they pay $10 and they
get stock worth $100.

1218
00:57:20,570 --> 00:57:25,400
And those exercise vesting
occur over time, typically.

1219
00:57:25,400 --> 00:57:26,470
And there's no tax on it.

1220
00:57:26,470 --> 00:57:28,960
You're not taxed when
you get the stock.

1221
00:57:28,960 --> 00:57:32,530
There may be an alternative
minimum tax issue.

1222
00:57:32,530 --> 00:57:35,000
Again, a placeholder
for you to think about.

1223
00:57:35,000 --> 00:57:37,910
And there will be taxation
on the sale of the stock.

1224
00:57:37,910 --> 00:57:40,910
And if you end up following
the holding period,

1225
00:57:40,910 --> 00:57:43,610
you'll have capital gains,
which is a good thing.

1226
00:57:43,610 --> 00:57:45,470
And that's one year
from the exercise

1227
00:57:45,470 --> 00:57:49,220
and two years from
the date of grant.

1228
00:57:49,220 --> 00:57:53,040
And non-qualified
are basically options

1229
00:57:53,040 --> 00:57:58,480
that have no tax on
vesting or grant,

1230
00:57:58,480 --> 00:58:02,620
but ordinary income on exercise.

1231
00:58:02,620 --> 00:58:06,007
So that means when you
exercise the difference

1232
00:58:06,007 --> 00:58:08,215
between the exercise price
and the fair market value,

1233
00:58:08,215 --> 00:58:10,420
you have to pay-- it's
like somebody gave you

1234
00:58:10,420 --> 00:58:12,080
that much cash.

1235
00:58:12,080 --> 00:58:15,370
Now these instruments of
founder stock, restricted stock

1236
00:58:15,370 --> 00:58:19,750
options, and non-qualifieds all
work together in sort of a way.

1237
00:58:19,750 --> 00:58:22,860
What you really would like to
do if you're a founder or early

1238
00:58:22,860 --> 00:58:28,120
on, you actually want to get
your stock early and then ride

1239
00:58:28,120 --> 00:58:30,950
the appreciation.

1240
00:58:30,950 --> 00:58:34,090
Just like you'd buy any
stock in the market.

1241
00:58:34,090 --> 00:58:36,740
What happens though if
you're given stock--

1242
00:58:36,740 --> 00:58:39,870
you have income when
you get the stock

1243
00:58:39,870 --> 00:58:41,120
based on the market value.

1244
00:58:41,120 --> 00:58:45,300
So over time, as the company
raises more rounds of funding,

1245
00:58:45,300 --> 00:58:46,930
it becomes more
expensive for someone

1246
00:58:46,930 --> 00:58:50,020
to actually acquire
the stock directly.

1247
00:58:50,020 --> 00:58:52,604
And since there's no
market for the stock,

1248
00:58:52,604 --> 00:58:54,020
you're in a situation
where you're

1249
00:58:54,020 --> 00:58:55,780
taxed on the stock but no exit.

1250
00:58:55,780 --> 00:58:57,560
You have no way to pay it.

1251
00:58:57,560 --> 00:59:00,070
So that's when people
switch over and use options.

1252
00:59:00,070 --> 00:59:03,630
Because options-- you're not
taxed when you get an option.

1253
00:59:03,630 --> 00:59:06,290
You sort of control
when the tax occurs.

1254
00:59:06,290 --> 00:59:10,290
So that's just a general
theme to think about.

1255
00:59:10,290 --> 00:59:12,402
Vesting.

1256
00:59:12,402 --> 00:59:14,110
There are basically
two types of vesting.

1257
00:59:14,110 --> 00:59:18,150
Time-based vesting and
performance vesting.

1258
00:59:18,150 --> 00:59:21,600
What you're really trying to
do is you go into it thinking,

1259
00:59:21,600 --> 00:59:23,720
well, we have a set of
things we need to get done.

1260
00:59:23,720 --> 00:59:26,370
And you want to provide
incentives for people to do it.

1261
00:59:26,370 --> 00:59:28,099
And so in an ideal
world you'd know

1262
00:59:28,099 --> 00:59:29,390
exactly what needed to be done.

1263
00:59:29,390 --> 00:59:32,300
And you'd say, when you
deliver the first prototype,

1264
00:59:32,300 --> 00:59:34,630
you vest on and
50% of your option.

1265
00:59:34,630 --> 00:59:37,495
And when we do our first
customer ship, another 25%.

1266
00:59:38,680 --> 00:59:41,090
The problem is it's
never that clean.

1267
00:59:41,090 --> 00:59:44,120
You're never quite sure.

1268
00:59:44,120 --> 00:59:48,060
And so the default
tends to be time.

1269
00:59:48,060 --> 00:59:50,300
We're going to be in this
for a period of time.

1270
00:59:50,300 --> 00:59:53,210
If you're here pulling
on the oar with a team,

1271
00:59:53,210 --> 00:59:54,830
then you'll vest.

1272
00:59:54,830 --> 00:59:58,960
Typical vesting is
a one year cliff.

1273
00:59:58,960 --> 01:00:01,770
That means if you're
here less than a year you

1274
01:00:01,770 --> 01:00:04,100
don't get anything.

1275
01:00:04,100 --> 01:00:07,219
After one year it's usually 25%.

1276
01:00:07,219 --> 01:00:09,760
And then it's either monthly or
quarterly over the next three

1277
01:00:09,760 --> 01:00:10,259
years.

1278
01:00:10,259 --> 01:00:12,730
So at the end of four
years, you're fully vested

1279
01:00:12,730 --> 01:00:16,170
and have rights in the stock.

1280
01:00:16,170 --> 01:00:18,310
I put something in here
about accelerated vesting

1281
01:00:18,310 --> 01:00:20,432
on changing control.

1282
01:00:20,432 --> 01:00:21,390
You'll hear about that.

1283
01:00:21,390 --> 01:00:23,010
And there are a whole bunch
of issues about whether that

1284
01:00:23,010 --> 01:00:23,870
makes any sense.

1285
01:00:23,870 --> 01:00:27,020
So keep that in mind.

1286
01:00:27,020 --> 01:00:30,290
You have to think about what
happens if someone leaves.

1287
01:00:30,290 --> 01:00:34,190
You gave them this equity and
do you get to buy it back.

1288
01:00:34,190 --> 01:00:35,560
Do they forfeit it.

1289
01:00:35,560 --> 01:00:37,500
What if they leave
under bad circumstances

1290
01:00:37,500 --> 01:00:39,690
where they gave
away trade secrets.

1291
01:00:39,690 --> 01:00:43,102
And what if they violate
non-competition agreements.

1292
01:00:43,102 --> 01:00:44,810
So you probably want
to think about those

1293
01:00:44,810 --> 01:00:46,450
in the design of your plan.

1294
01:00:46,450 --> 01:00:48,100
And again, think of
this as a checklist

1295
01:00:48,100 --> 01:00:51,380
when you're dealing with
your lawyer on this.

1296
01:00:51,380 --> 01:00:54,980
Have they talked
about these things.

1297
01:00:54,980 --> 01:01:00,340
Now suppose you actually
have the stock and you leave.

1298
01:01:00,340 --> 01:01:01,050
What's the deal.

1299
01:01:01,050 --> 01:01:04,956
Do you get to keep
it when you leave.

1300
01:01:04,956 --> 01:01:09,360
Do you have to sell it
back at then fair value.

1301
01:01:09,360 --> 01:01:09,890
Never.

1302
01:01:09,890 --> 01:01:13,380
I mean, these are
philosophical issues

1303
01:01:13,380 --> 01:01:15,002
that the Founder's
Memo talks about.

1304
01:01:15,002 --> 01:01:16,460
And at the beginning
is a good time

1305
01:01:16,460 --> 01:01:17,510
to talk about it
because you don't

1306
01:01:17,510 --> 01:01:18,801
know who's going to be leaving.

1307
01:01:18,801 --> 01:01:21,110
So it's sort of a
neutral thing about what

1308
01:01:21,110 --> 01:01:22,450
your philosophy is going to be.

1309
01:01:26,370 --> 01:01:30,430
Over time, on a people
issue, at the beginning

1310
01:01:30,430 --> 01:01:33,570
the whole issue of boards-- I
put independent directors here.

1311
01:01:33,570 --> 01:01:37,520
Somewhere around the
time of first funding.

1312
01:01:37,520 --> 01:01:40,050
Funding people are
going to want to come in

1313
01:01:40,050 --> 01:01:41,550
and the venture
capitalists actually

1314
01:01:41,550 --> 01:01:43,508
do have to get some board
seats under the rules

1315
01:01:43,508 --> 01:01:45,620
that they operate under.

1316
01:01:45,620 --> 01:01:47,290
There's often an
independent director

1317
01:01:47,290 --> 01:01:48,620
that they'll negotiate.

1318
01:01:48,620 --> 01:01:50,670
So you want to be
thinking ahead.

1319
01:01:50,670 --> 01:01:54,870
Who's an independent director
that could be on my board

1320
01:01:54,870 --> 01:01:56,900
and acceptable to venture.

1321
01:01:56,900 --> 01:01:59,680
Because if you don't
have a candidate in mind

1322
01:01:59,680 --> 01:02:01,870
they certainly
will talk about it.

1323
01:02:04,490 --> 01:02:06,982
OK, financing.

1324
01:02:06,982 --> 01:02:09,190
I'm going to run you quickly
through securities laws.

1325
01:02:13,357 --> 01:02:14,940
Essentially, this
is an area you don't

1326
01:02:14,940 --> 01:02:18,470
want to try to do brain
surgery yourself with.

1327
01:02:18,470 --> 01:02:21,460
You can get into
really big troubles.

1328
01:02:21,460 --> 01:02:26,370
Any offer or even an
offer of securities

1329
01:02:26,370 --> 01:02:28,910
has to be registered with
the Securities and Exchange

1330
01:02:28,910 --> 01:02:30,200
Commission.

1331
01:02:30,200 --> 01:02:35,400
And that could be a big
expensive proposition.

1332
01:02:35,400 --> 01:02:37,410
So you want to think
about exemptions.

1333
01:02:37,410 --> 01:02:39,994
There are exemptions there
for private placements.

1334
01:02:39,994 --> 01:02:41,410
And there's certain
rules you have

1335
01:02:41,410 --> 01:02:44,780
to do in following it through.

1336
01:02:44,780 --> 01:02:51,390
What you don't want
to do is-- question

1337
01:02:51,390 --> 01:02:53,704
is, if you don't comply,
what is the big deal.

1338
01:02:53,704 --> 01:02:55,870
Well, first of all, it's
criminal-- can be criminal.

1339
01:02:55,870 --> 01:02:59,140
And it could be personal
liability on the founder.

1340
01:02:59,140 --> 01:03:02,400
In other words, they can get
their money back from you.

1341
01:03:02,400 --> 01:03:03,480
And it could be a mess.

1342
01:03:03,480 --> 01:03:06,360
And in the materials,
under Resources, there's

1343
01:03:06,360 --> 01:03:09,540
a column I did for Boston
Business Journal that

1344
01:03:09,540 --> 01:03:12,490
talked about a company that
really got into bad trouble

1345
01:03:12,490 --> 01:03:14,470
because they screwed up on this.

1346
01:03:14,470 --> 01:03:16,890
So my red letter
thing here is, don't,

1347
01:03:16,890 --> 01:03:21,110
in a business plan, put
language in that offers to sell.

1348
01:03:21,110 --> 01:03:25,440
We're offering 10% of the
company for $2 million.

1349
01:03:25,440 --> 01:03:27,940
How do you say
that's not an offer.

1350
01:03:27,940 --> 01:03:30,480
So the business plan or
any of the documents,

1351
01:03:30,480 --> 01:03:32,510
really, is this
is an opportunity.

1352
01:03:32,510 --> 01:03:33,820
We're addressing this market.

1353
01:03:33,820 --> 01:03:35,840
The market's this big.

1354
01:03:35,840 --> 01:03:38,420
And you might say, and
the resources we need

1355
01:03:38,420 --> 01:03:39,860
is this amount.

1356
01:03:39,860 --> 01:03:41,484
If people are
interested in that,

1357
01:03:41,484 --> 01:03:43,400
they're going to have a
conversation with you.

1358
01:03:43,400 --> 01:03:47,470
And you can handle
it in a careful way.

1359
01:03:47,470 --> 01:03:50,350
But I see over and over again,
people putting in plans.

1360
01:03:50,350 --> 01:03:51,995
First of all, it's
presumptuous, right?

1361
01:03:55,680 --> 01:03:58,605
Have a discussion
with the investor

1362
01:03:58,605 --> 01:03:59,980
and you can get
down the numbers.

1363
01:03:59,980 --> 01:04:01,604
But certainly don't
put it in the plan.

1364
01:04:04,030 --> 01:04:06,090
We do have now
crowdfunding coming along.

1365
01:04:06,090 --> 01:04:09,170
We're waiting for some SEC
rules to get a little bit more

1366
01:04:09,170 --> 01:04:09,700
refined.

1367
01:04:09,700 --> 01:04:11,866
That's going to open up a
whole other set of issues.

1368
01:04:11,866 --> 01:04:15,580
But it may be a good way-- just
like crowdfunding for products

1369
01:04:15,580 --> 01:04:20,110
has been around-- this is
crowdfunding for selling stock

1370
01:04:20,110 --> 01:04:22,170
or interest in the company.

1371
01:04:22,170 --> 01:04:23,862
I don't know enough
yet to explain how

1372
01:04:23,862 --> 01:04:25,070
that's going to work for you.

1373
01:04:25,070 --> 01:04:27,815
But keep an eye on
that separately.

1374
01:04:31,150 --> 01:04:35,130
I put in a section in the deck
looking at capital structure

1375
01:04:35,130 --> 01:04:36,065
instruments.

1376
01:04:36,065 --> 01:04:37,910
For some people,
this is old hat.

1377
01:04:37,910 --> 01:04:40,162
For the people that
aren't, this is

1378
01:04:40,162 --> 01:04:41,370
something you should look at.

1379
01:04:41,370 --> 01:04:43,495
It just talks about different
kinds of instruments.

1380
01:04:43,495 --> 01:04:45,680
At the bottom is common stock.

1381
01:04:45,680 --> 01:04:50,010
Common stock is what's the
value after everyone else has

1382
01:04:50,010 --> 01:04:50,790
gotten paid.

1383
01:04:50,790 --> 01:04:56,070
So if you're Bill Gates and you
own common stock in Microsoft,

1384
01:04:56,070 --> 01:04:58,990
you're like the richest
guy in the world.

1385
01:04:58,990 --> 01:05:03,470
If you're a startup, this
might be worth nothing.

1386
01:05:03,470 --> 01:05:04,920
Above it are
different instruments

1387
01:05:04,920 --> 01:05:06,920
that you can play with.

1388
01:05:06,920 --> 01:05:09,600
And for the non-Sloan
people, take a look

1389
01:05:09,600 --> 01:05:11,460
at the next few slides
that describe this.

1390
01:05:11,460 --> 01:05:15,770
I'm just going to zip
through them, given the time.

1391
01:05:15,770 --> 01:05:18,450
This visual just shows
what a capital structure

1392
01:05:18,450 --> 01:05:19,550
will look like over time.

1393
01:05:19,550 --> 01:05:22,610
At a startup, it's
primarily all common.

1394
01:05:22,610 --> 01:05:24,560
And by the time you're
Microsoft or an LBO,

1395
01:05:24,560 --> 01:05:28,500
you see more complex
capital structures.

1396
01:05:28,500 --> 01:05:31,160
That's your instant
MBA course for people

1397
01:05:31,160 --> 01:05:34,520
not in the MBA program.

1398
01:05:34,520 --> 01:05:38,470
We talked about convertible
note financing the other night.

1399
01:05:38,470 --> 01:05:41,380
Traditionally this bridged
from one round to another

1400
01:05:41,380 --> 01:05:44,440
as you were trying to
keep the company going.

1401
01:05:44,440 --> 01:05:49,550
It has the benefit of being
quick, relatively inexpensive,

1402
01:05:49,550 --> 01:05:52,530
and it can avoid
valuation issues.

1403
01:05:52,530 --> 01:05:55,240
So a classic problem
is the first run

1404
01:05:55,240 --> 01:05:58,340
investors value the
company too high.

1405
01:05:58,340 --> 01:05:59,789
The next round
comes in and says,

1406
01:05:59,789 --> 01:06:01,830
we're never going to pay
that much because things

1407
01:06:01,830 --> 01:06:03,620
have happened or whatever.

1408
01:06:03,620 --> 01:06:06,390
And the first round has to
have this discussion-- how

1409
01:06:06,390 --> 01:06:09,490
they get crammed down in their
percentage of the company.

1410
01:06:09,490 --> 01:06:11,830
Convertible note allows
you to sort of not

1411
01:06:11,830 --> 01:06:14,705
set that actual
valuation until later.

1412
01:06:14,705 --> 01:06:16,080
There's a good
discussion of this

1413
01:06:16,080 --> 01:06:19,780
at startupcompanylawyer.com,
which

1414
01:06:19,780 --> 01:06:21,430
talks about the pros and cons.

1415
01:06:21,430 --> 01:06:24,880
So again, another
resource to look at.

1416
01:06:24,880 --> 01:06:27,530
This is an example
of a term sheet.

1417
01:06:27,530 --> 01:06:30,820
If you go to firms--
like Cooly LLP

1418
01:06:30,820 --> 01:06:34,170
has a nice, open
source models of what

1419
01:06:34,170 --> 01:06:35,440
the documents look like.

1420
01:06:35,440 --> 01:06:38,480
There's also some good
resources at Wilson Sonsini

1421
01:06:38,480 --> 01:06:40,210
and at Goodwin Procter.

1422
01:06:40,210 --> 01:06:42,950
Much more accessible these
days than they were back

1423
01:06:42,950 --> 01:06:45,860
when I was starting out.

1424
01:06:45,860 --> 01:06:49,340
Now we're going to run quickly
through angel and venture

1425
01:06:49,340 --> 01:06:49,840
funding.

1426
01:06:53,900 --> 01:06:56,150
A typical way to do this
is you take a term sheet

1427
01:06:56,150 --> 01:06:57,610
and you take it
apart and you talk

1428
01:06:57,610 --> 01:07:01,180
about each of the little
components of the term sheet.

1429
01:07:01,180 --> 01:07:03,610
And that's a useful
way to do it.

1430
01:07:03,610 --> 01:07:05,460
I think the way
for an entrepreneur

1431
01:07:05,460 --> 01:07:09,130
to think about why all these
terms is to understand what

1432
01:07:09,130 --> 01:07:11,990
the major deal elements are.

1433
01:07:11,990 --> 01:07:15,160
And from an investor viewpoint,
it's these four elements.

1434
01:07:15,160 --> 01:07:19,050
One is a preferred return,
for reasons we'll talk about.

1435
01:07:19,050 --> 01:07:22,920
Protection of valuation and
position versus future money

1436
01:07:22,920 --> 01:07:24,590
that comes in.

1437
01:07:24,590 --> 01:07:27,050
The requirement to manage
the investment and the exit

1438
01:07:27,050 --> 01:07:29,540
strategy.

1439
01:07:29,540 --> 01:07:32,990
So for example, if you
think a preferred return,

1440
01:07:32,990 --> 01:07:38,770
an investor looks at you and
he sees a plan or a promise.

1441
01:07:38,770 --> 01:07:40,120
The investor writes a check.

1442
01:07:40,120 --> 01:07:42,690
The investor has
basically done everything

1443
01:07:42,690 --> 01:07:44,820
that he said he would do.

1444
01:07:44,820 --> 01:07:46,660
He'll be there to
advise and all that.

1445
01:07:46,660 --> 01:07:48,250
But basically he'll
want his money.

1446
01:07:48,250 --> 01:07:51,860
The entrepreneur
hasn't done anything

1447
01:07:51,860 --> 01:07:53,110
from the investor perspective.

1448
01:07:53,110 --> 01:07:56,900
They put together a plan
that's yet to be executed on.

1449
01:07:56,900 --> 01:07:59,750
And so the result is
the investor typically

1450
01:07:59,750 --> 01:08:04,010
wants to get paid before
the entrepreneur gets paid.

1451
01:08:04,010 --> 01:08:05,750
He gets his money back first.

1452
01:08:05,750 --> 01:08:08,150
And the instrument is usually
the convertible preferred

1453
01:08:08,150 --> 01:08:10,260
stock.

1454
01:08:10,260 --> 01:08:13,730
It usually has dividends.

1455
01:08:13,730 --> 01:08:17,479
And an important part is
the liquidation preference.

1456
01:08:17,479 --> 01:08:19,029
So the liquidation
preference says,

1457
01:08:19,029 --> 01:08:21,020
look, there are two types.

1458
01:08:21,020 --> 01:08:23,750
One is a straight preference.

1459
01:08:23,750 --> 01:08:26,850
It says, if the company-- we
have a liquidation-- which I'll

1460
01:08:26,850 --> 01:08:30,060
talk about what that means
in a moment-- the investor

1461
01:08:30,060 --> 01:08:33,560
can either choose
to get the money he

1462
01:08:33,560 --> 01:08:36,000
put in back pluses dividends.

1463
01:08:36,000 --> 01:08:38,920
Or you can convert, because
it's usually convertible,

1464
01:08:38,920 --> 01:08:41,830
into whatever the convertible
amount of the company would be.

1465
01:08:41,830 --> 01:08:45,010
So it's simply a math exercise.

1466
01:08:45,010 --> 01:08:46,830
That's a straight
liquidation preference.

1467
01:08:46,830 --> 01:08:49,520
A participating or
double dip is one

1468
01:08:49,520 --> 01:08:53,340
that's not particularly good in
many cases for an entrepreneur.

1469
01:08:53,340 --> 01:08:56,260
It says the investor
gets his money back first

1470
01:08:56,260 --> 01:08:59,810
and then he converts and
pretends he was like you

1471
01:08:59,810 --> 01:09:03,240
and gets a percentage
of the company.

1472
01:09:03,240 --> 01:09:06,970
I put a chart in comparing
how that math works.

1473
01:09:06,970 --> 01:09:08,930
I think it's pretty
self explanatory if you

1474
01:09:08,930 --> 01:09:11,819
look at it in the materials.

1475
01:09:11,819 --> 01:09:15,569
And I put a case in
here which says--

1476
01:09:15,569 --> 01:09:16,870
there are two cases presented.

1477
01:09:16,870 --> 01:09:20,060
One is, a founder sells 40%
of the company for $5 million

1478
01:09:20,060 --> 01:09:23,760
of convertible preferred,
with a $5 million

1479
01:09:23,760 --> 01:09:27,319
liquidation preference.

1480
01:09:27,319 --> 01:09:28,899
But no participating rights.

1481
01:09:28,899 --> 01:09:33,510
In Case B, they sell
33% of the company

1482
01:09:33,510 --> 01:09:36,689
with participating preferred.

1483
01:09:36,689 --> 01:09:40,130
And this example shows
you the trade off.

1484
01:09:40,130 --> 01:09:43,050
Essentially, in this
case, if the exit

1485
01:09:43,050 --> 01:09:46,330
is $35 million or less,
than the first case

1486
01:09:46,330 --> 01:09:48,880
is better for the founders,
which means actually

1487
01:09:48,880 --> 01:09:51,250
giving up a bigger
percentage of the company

1488
01:09:51,250 --> 01:09:53,337
and having a straight preferred.

1489
01:09:53,337 --> 01:09:54,795
So take a look at
that after class.

1490
01:09:58,360 --> 01:10:01,155
The liquidation events
could be really liquidation,

1491
01:10:01,155 --> 01:10:03,300
meaning the company's shut down.

1492
01:10:03,300 --> 01:10:06,810
But it's often defined
to be a merger.

1493
01:10:06,810 --> 01:10:12,370
So if the company is acquired,
the liquidation kicks in.

1494
01:10:12,370 --> 01:10:14,200
That's the preferred
return part as you

1495
01:10:14,200 --> 01:10:17,480
look through the term sheet.

1496
01:10:17,480 --> 01:10:19,420
The second major
element is protection

1497
01:10:19,420 --> 01:10:22,470
of value and position
versus future money

1498
01:10:22,470 --> 01:10:27,090
and that's where anti-dilution
protection comes in.

1499
01:10:27,090 --> 01:10:30,690
And I give you an example
of a term sheet with that.

1500
01:10:33,450 --> 01:10:37,430
Anti-dilution and
conversion go hand in hand.

1501
01:10:37,430 --> 01:10:40,670
So typically, a
convertible-preferred

1502
01:10:40,670 --> 01:10:41,920
trades one for one.

1503
01:10:41,920 --> 01:10:44,800
One share of preferred
converts to one share

1504
01:10:44,800 --> 01:10:46,860
of common at the beginning.

1505
01:10:46,860 --> 01:10:48,930
And anti-dilution
says, if an event

1506
01:10:48,930 --> 01:10:55,740
occurs in which you issue
stock for less money

1507
01:10:55,740 --> 01:10:58,540
or priced less
than price I paid,

1508
01:10:58,540 --> 01:11:01,790
then when I convert I
want to get more shares.

1509
01:11:01,790 --> 01:11:05,300
Because your value of
the company's gone down.

1510
01:11:05,300 --> 01:11:08,470
I came in at this level
and you did something.

1511
01:11:08,470 --> 01:11:11,550
You didn't grow the company,
you made the value go down,

1512
01:11:11,550 --> 01:11:13,500
and therefore I need
to get compensated.

1513
01:11:16,310 --> 01:11:19,410
And the two main types of
these is the full ratchet,

1514
01:11:19,410 --> 01:11:21,580
which is really bad
for an entrepreneur.

1515
01:11:21,580 --> 01:11:24,550
That says if I issue
even one share of stock

1516
01:11:24,550 --> 01:11:27,680
for less money than what
you, the investor, put in,

1517
01:11:27,680 --> 01:11:29,820
then the price of that
one share of stock

1518
01:11:29,820 --> 01:11:32,160
becomes a conversion price.

1519
01:11:32,160 --> 01:11:37,640
So if I converted at $10 a share
and you issued one share at $1,

1520
01:11:37,640 --> 01:11:40,880
now all my money
converts at $1 a share.

1521
01:11:40,880 --> 01:11:43,046
So I get 10 times more.

1522
01:11:43,046 --> 01:11:44,920
The more typical one is
the weighted average.

1523
01:11:44,920 --> 01:11:46,420
And there's a formula
for that that.

1524
01:11:46,420 --> 01:11:50,350
It looks at the
price and the amount.

1525
01:11:50,350 --> 01:11:52,790
On the resources page there
are a bunch of venture capital

1526
01:11:52,790 --> 01:11:55,020
terms that will help
explain a lot of what

1527
01:11:55,020 --> 01:11:57,980
we went through here.

1528
01:11:57,980 --> 01:12:01,150
And that brings us
to borrow, which

1529
01:12:01,150 --> 01:12:04,900
is we're going to go into
negotiation skills, in Yost

1530
01:12:04,900 --> 01:12:07,350
you're doing organization
and people issues.

1531
01:12:07,350 --> 01:12:08,065
Tomorrow?

1532
01:12:08,065 --> 01:12:10,390
AUDIENCE: [INAUDIBLE]

1533
01:12:12,639 --> 01:12:14,680
JOE HADZIMA: So I raced
you through a whole bunch

1534
01:12:14,680 --> 01:12:17,420
of legal stuff that we
could have spend hours

1535
01:12:17,420 --> 01:12:18,980
on each portion of it.

1536
01:12:18,980 --> 01:12:23,270
Again, I want to step back,
say, take the deck that's there,

1537
01:12:23,270 --> 01:12:26,440
read through it, and use
it as sort of a guidepost

1538
01:12:26,440 --> 01:12:28,320
as you go forward on
some of the stuff.

1539
01:12:28,320 --> 01:12:31,400
There are plenty of resources
that I've mentioned that you

1540
01:12:31,400 --> 01:12:32,850
can sort of self educate.

1541
01:12:32,850 --> 01:12:36,077
I'm happy to chat with you
offline about those things.

1542
01:12:36,077 --> 01:12:38,160
I know no other way to get
it out in front of you,

1543
01:12:38,160 --> 01:12:40,900
short of having you take
a whole legal course.

1544
01:12:40,900 --> 01:12:43,350
So hopefully you'll find that.