William Carleton, Counselor @ Law

Light reading

Last night I participated in a "legal best practices" panel at the new WIN Reactor space (near the Seattle Art Museum Sculpture Park).

I'm just getting to know about the Reactor program. Its head, Chip Hallett, described it as a "launch incubator" for startups in the game industry.

The panel was a mix of lawyers and game company founders/CEOs. As anyone would expect going in, the founders/CEOs were more interesting to hear. (That said, Seattle attorney Scott Warner did an uncommonly good job of moderating the discussion; he'd be a good moderator even when the topic isn't legal).

I think the whole show (long – 2 1/2 hours?) is preserved for posterity on video - I can actually see it being a good resource for first time game startup entrepreneurs, because Scott was so careful to cover all the basic topics - so I sure as heck won't attempt anything like a recap here.

What I do want to remark on briefly: the answers the CEOs/founders gave to one of Scott's questions, to the effect of, do you read all the legal contracts that affect your business?

Bob Berry of Uber Entertainment, Matt Wilson of Detonator Games, and Randy Chung of Zhurosoft, each said, yes, of course, every line, you have to.

I knew this is the answer Bob would give, as I and my firm represent Uber and know his style. But I was impressed to hear Matt and Randy equally adamant.

Sensing that he had hit an especially rich vein in the silver mine, Scott pressed everyone for examples of where contracts go wrong, issues presented or sections and legal contracts to be especially wary of. Everyone had great examples. We got into not just legal drafting "gotchas" but also the nitty-gritty of payment terms and how important it is to spell out unspoken assumptions.

If I come across a link to the video archive, I'll try to remember to post it here.

I'll leave you with a link to a video calling card that Bob kindly created for me in the span of about 90 seconds, using a fun app created by a startup which is part of the current WIN/Reactor class, Freak'n Genius. It had me in stitches.

Photo courtesy of Julian Allen, REACTOR community manager.

The 1202 Planning Opportunity

Since Joe Wallin first broke the news nationally (best I can tell) that the fiscal cliff bill included revival of a previously expired 100% exclusion from capital gains tax for certain holdings in QSB stock, people have been wondering on Twitter why no branded financial or tech media outlet has picked up the story.

It's a fair question, particularly when you consider that big media properties have been reporting on other "tax extenders" in the fiscal cliff bill. 

A partial answer may be that there is nothing outrageous or scandalous about the QSB exclusion. Whereas the tax breaks in the fiscal cliff legislation for Hollywood movie production, for electric scooter manufacturing, for NASCAR race tracks, and the like, are laughable, or tragic, or both, and so more fun to talk about. (See for example this entertaining piece by Brad Plumer in the Washington Post, From NASCAR to rum, the 10 weirdest parts of the ‘fiscal cliff’ bill.)

A better answer may be that the exclusion for QSB stock is so difficult to explain.

Here's a paragraph from a post Joe wrote in the summer of 2010, summarizing what QSB stock is:

In general, 'qualified small business stock' is stock in a C corporation acquired by a taxpayer at its original issue if as of the date of issuance such corporation was a 'qualified small business,' and during substantially all of the taxpayer’s holding period for such stock, the corporation met certain active business requirements and was a C corporation. A 'qualified small business' in general means a business with less than $50 million in gross assets. The active business requirements require that at least 80 percent (by value) of the assets of the corporation be used by the corporation in the active conduct of 1 or more 'qualified trades or businesses.'

Much to chew on there, and you must also slog through the analysis of whether or not you are dealing with one of the "qualified trades or businesses."

Get those fundamentals settled, and you're still not done: you have to hold the stock for 5 years. And the exclusion from capital gains tax applies *only* to your initial $10 million in gain.

Among the planning opportunities this fiscal cliff tax benefit affords:

• A chance to weigh whether a C corp makes more sense for the structure of your new business than an LLC or other alternatives;
• Whether you should convert your LLC into a C corp before the benefit expires at the end of 2013;
• From the investor perspective, whether you can negotiate reps and covenants in your investment documents to give you and others in the deal a fair shot at meeting the requirements of the exclusion; and
• From the perspective of an employee, whether you should exercise a stock option in a timely way.

This is complicated stuff. Even if you master the rules in the abstract, you are likely to yet need advice from a good accountant and/or a tax lawyer. But it may be worth the effort.

Here are some references to help us all get (re)started (caution, all of these were prepared in the context of the exclusion in prior incarnations):

• QUALIFIED SMALL BUSINESS STOCK - TAX ALERT, by Asher Bearman, from The Venture Alley in October 2010.
• SECTION 1202 QUALIFIED SMALL BUSINESS STOCK (pdf), by David B. Strong, a Morrison Foerster white paper from August 2011 hanging out on the open web.
• IF YOU ARE AN LLC, CONSIDER BECOMING A C CORPORATION BEFORE YEAR END, by Joe Wallin, from his Startup Law Blog in October 2010.
• A comment from lawyer George Grellas on Hacker News from 2010, with an overview of the subject, including the provocative point that founder shares can potentially qualify.

Photo: Tom Magliery / Flickr.

Startup Law Event Tonight in Seattle

I'm one of several attorneys and accountants speaking tonight at an event, "Legal Advice For Entrepreneurs & Their Companies," organized by Peter Fosso and hosted by Joe Wallin at the Davis Wright law firm's offices in Seattle at 1201 Third Avenue. There is a $15 fee to attend.

1201 Third Avenue is a building Paul Goldberger, writing in 1988, called "one of those rare instances in which a downtown office tower big enough to transform a city's skyline is actually a good piece of architecture."

Pictured: 1201 Third Avenue is just right of center in the frame. This view from a conference room window at my firm's offices at 600 University Street, three blocks east.

New Startuper Resources: A Lawyer's List

From time to time, new startupers ask me where they might do some background reading on basic legal choices before them as they form their own companies.

I always think reading up is a good idea. Particularly if the entrepreneurs and I choose to work together, I appreciate the efforts they make to "do homework" and come to our meetings ready to take the discussion past the introductory level. Saves time and money, too!

The last time I got the question, I took 10 minutes and put together the list below. It is somewhat Washington-centric, but not overly so.

Here are some good blog posts on the "choice of entity" issue:

• http://www.startupcompanylawyer.com/2009/03/12/what-type-of-entity-should-i-form/
• http://www.startuplawblog.com/choice-of-entity/

Here are some good blog posts on the "state of incorporation" issue:

• http://www.wac6.com/wac6/2011/01/test-1-2-3.html
• http://www.theventurealley.com/startups/delaware-versus-washington-where-should-i-incorporate-my-startup/

Here are some good blog posts on the "founder vesting" issue:

• http://cdixon.org/2009/04/21/founder-vesting/ (non-laywer post)
• http://www.startuplawblog.com/tag/reverse-vesting/

Here are some good blogs to follow, non-legal and legal, about startup industry standards and trends:

• http://www.avc.com/ (Fred Wilson's blog; the de facto industry standard for web entrepreneurs; read it every day)
• http://cdixon.org/ (Chris Dixon's blog; not as accessible as Fred's blog, but offers analysis from an entrepreneur's perspective) 
• http://www.startupcompanylawyer.com/ (Yokum Taku's blog; doesn't blog much currently, but archives the almost definitive FAQ on venture-style startup legal issues)
• http://www.startuplawblog.com/ (Joe Wallin's startup law blog, covers standard issues and stays up on current developments)

Here is a key provision of Washington law regarding assignments of invention:

• http://apps.leg.wa.gov/rcw/default.aspx?cite=49.44.140

Flickr photo by Steve Rotman.

Paid Time Off & the Startup Runway

Along with 47 other attorneys licensed to practice in the State of Washington, I've written about our local "willful withholding of wages" statute, and how it can be a trap for founders and board directors of startup companies.

"Statute" means a law passed by the legislature and signed by the governor, then codified in black and white in the "Revised Code of Washington." Statutes can be contrasted with "common law," which is a phrase to describe legal doctrines iterated over decades, sometimes centuries, through scores of judicial decisions and the setting of precedents.

That's a digression there.

But in a way it isn't. Because the fact that there is chapter and verse statutory law around employee wages makes certain leverage points, vis a vis paying employees, pretty darn sharp.

We all know that part of the reason you set up a corporation or LLC for conducting a business is to insulate yourself from the liabilities associated with that business, over and above how you fund that business. Right?

Wages in Washington are an exception to that rule.

The willfully withheld wages statue in Washington tells companies this: fail to pay your employees what you owe them, and those employees will have the ability to look beyond the corporate or company form. They will be able to sue your officers and directors personally. And they can sue for twice the amount of the wages withheld. Plus attorneys fees. What's more, they will be able to serve the spouses of those officers and directors at their homes on the weekend.

And they will win. (Translation: you will have to pay them.)

All this build up by way of saying the Gerry Langeler of OVP has a great post up about the potential trap of PTO, or "paid time off."

He's connecting the dots between what seems like a benign, employee friendly policy, and the hammer of Washington statutory law, which (quite appropriately) reflects the sovereign's public policy to protect workers.

If PTO accrues, then it is going to have to be paid. Come hell, high water, earthquake, fire, or the brick wall of no next payroll and no new financing in sight, that PTO is still going to be paid.

Gerry's quick to the point that this reality can cut acreage out of a startup's remaining runway when an extra month or two of operations might make a difference.

"Right now, we have a firm with over $250K in the bank, but we may have to shut it down or fire-sale it because there is about $250K of PTO 'overhang' hanging like the Sword of Damocles over the firm. On the other hand, if we could run the company off that cash for a month or two more, perhaps something good could happen on either the customer or M&A front."

Gerry writes as someone who knows the problem well, can see it coming and will plan accordingly. But not all startups have someone with his experience on the board. It can be a real surprise for some entrepeneurs to learn that they have far less (personal exposure-less) runway than they thought they did. Sometimes months less!

Picture from Ivan Smith's website, "Nova Scotia's Electric Scrapbook."

Voidable Messes

I finished Tim Wu's The Master Switch Thursday night, and there's a sentence near the end of the book that has been bugging me since:

"Certainly at the time [Google began operations in 1996], the legality of what was done wasn't entirely clear; and truth to tell, if a copyright lawyer had been among Google's founders, it's doubtful the thing would have gotten off the ground."

Adding injury to insult, I found myself yesterday passing on the opportunity to represent a promising startup that has been operating without formality for a couple of years. There was too much hair, too many issues it would take too much time and too much money to fix.

Messes get cleaned up, to be sure! Who hasn't seen the movie, The Social Network? That cluster-fuck of a founding, organizationally speaking, was cleaned up after enough people with money thought it important enough to do so. Investor interest in Facebook was strong enough even to survive the kind of litigation that would have sunk most startups.

There are similar stories, maybe slightly smaller scale, set here in Seattle, some from the dot com era.

But many entrepreneurs want to spend next to nothing on legal fees. Paradoxically, spending nothing up front almost always means spending much more later to fix things, if they can be fixed. To really save money entails not putting everything off during the entire pre-investment stage of development, means doing the basic things at the outset. 

So I ask myself, is that what I'm here for, to pummel the radicals and disruptors I admire back into conventional legal boxes?

The answer to that question has to be "no," but I need to keep asking it while angling for harmony with the edge that makes the most difference.

On First Looking Into Grellas's Website

After "On First Looking Into Chapman's Homer" by John Keats.

MUCH have I surf’ed ineff'ble threads of fiber,
 And many goodly sites and list serves read;
 Through many RSS feeds have I sped,
Aggregated in obedience to Dave Winer.
Of legal sites for startups, I thought none finer​
 Than that which retro-bespectacled Yokum ruled as his demesne;
 Nor did I imagine an alternative startup law 101 FAQ scene ​
Till I heard Grellas speak out deeper and wider:​
Then felt I like some watcher of the skies​
 When the ISS streaks across her ken;
Or like a tricked-out smart phone, with which GPS pries
 And geolocates your movements, the data then
Mashed with other data deep inside
 Server farms in places such as Burien.