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A practical guide to patent filings

Bryan wrote:

We are modifying existing technology to solve a common, ongoing problem with a novel and compelling solution.  I feel the system is patentable (business method and/or software) as it meets all published legal criteria for such, and my business partner, an IP attorney, agrees. His firm is doing the work and deferring fees until if/when issued.  I read your answer to a similar question, but ours does appear to have some (potentially) patentable IP, which, unfortunately, could be replicated.  Our patent application will be filed soon, but do you have any advice on bringing this product to market?
It’s important that you have your patent applications properly filed before you disclose the product to the market.  I’m sure your business partner is on top of this aspect, and it's great that you are getting sound legal advice here.  The rules do change often, and so having some guidance is key.  Getting fees deferred is a good thing and very applicable for a startup.  

(Note: for those of you in a similar situation, you should directly ask your attorneys to defer fees, up to a reasonable limit, pending patent approval or revenue in the business)
Once you have made the filing, it is likely that you should be clear to bring the product to market.  Again, get a clear answer to this question.  If the patent is granted it will be granted as of the filing date, and anyone who copies your IP in the mean time will be in violation of the patent.  It would be compeltely impractical, for most businesses, to wait for a patent grant (5-7 years later) to actual start the actual business. 
Keep in mind it will take years to get the patent through the process.  Obviously you will want to be engaged in the business much sooner than this.  However, you want to be careful so as not to disclose your patentable technology to the market before the appropriate protections are in place, so as not to invalidate your own patent filing.  
So, get the right advice from your partner and attorney, make the appropriate filings, and then get cracking on the actual operating side of the business.  




How to buy shares in your own company?

Alex asks if he needs to purchase shares in his own company when he starts it.  We've got the answer in this video. 


Authorized vs. Outstanding Shares - Calculating shares for a new business partner.

Audio/Video post answering the question of how to calcultate shares for a new business partner.  Looks into Authorized vs. Outsanding shares.



Paying a consultant to raise money for your startup

Besim wrote:

A consultant has offered to find an investment of $1 million for my startup. As a reward he is asking for an option expiring in five years to subscribe at par value for ordinary shares representing 5% of the capital of the company.  
What does this mean?  Should this option be exercised, how much will I receive for 5% of the company considering that post money valuation would be $4 million.  However, current issued shere capital is 100 shares at $1 each.
The "Par Value" of a share of stock has nothing to do with the actual market value of the stock.  Par value refers to a price per share that is setup in the corporate charter, and it is usually near zero, often less than $0.01/share.  What he is asking for, I suspect, is an option to acquire the stock for, effectively, zero dollars.

It's unclear to me whether he is asking for 5% of the company, or if he is asking for 5% of the shares that are received from the $1 million investment.  I hope, and suspect, it's the latter.  It would be a typical arrangement for someone acting in this capactity to receive a commission on the money they helped to secure, and 5% is a pretty typical ask for the size of the investment you are looking for.

Sometimes they want to be paid in cash from the proceedes of the financing, meaning that if you raise $1 million, you would pay the finder 5%, or $50,000 when the financing is complete.  In your case, and in the case of many startups, that $50,000 is a lot of money that you were hoping to have put into the business, and so rather than pay $50,000 cash, I would rather you conver that to additional equity.  I believe this is what he is suggesting.

However, there may be no reason to structure this an an option.  More on that below.  I suggest you structure as follows:

The new investor(s) will purchase $1M worth of your stock at a price you mutually agree to.  It sounds like you are looking for $4M post-money which means they will be buying stock at price equal to $3M divided by the number of shares you currently have.  This gives you a price per share, indicating that your company is worth $3M today, then they will add $1M in cash, thus you will be worth $4M "post money" or after the investment.  I will point out that the $3M pre-money valuation is up for negotiation, but lets assume for now that this is the price.  

Also lets assume that you have 1 million shares of stock today.  This means your current price-per-share is ($3M pre-money valuation) / (1 million shares) = $3 per share.

The new investors will invest $1M, and they will be issued newly created shares.  Thus, their $1M dollars buys them 333,333 shares at a price of $3 per share.  Once issued, your company will now have 1,333,333 shares issued and outstanding, at a price of $3 per share, giving you a post money valuation of $4M.

What I suggest is that the agent who finds you the money be issued shares at this time, equal to 5% of the amount of money they helped to raise.   Issuing an exipring stock option seems compeletely unnecessary to me.  Thus, the agent should receive (5% * $1M) = $50,000 worth of shares at $3 per share = 16,667 shares.  
This then would give your company a total of 1,350,000 shares of stock, valued at $3 each, for a total post money of $4.05M.  You will receive $1M in capital to grow your business, the new investors bought 24.7% of the company, the agent would receive $50,000 worth of stock as valued at the price set by the investors.

I suspect that the reason the agent is looking for an option has to do with taxes.  The detail here depends on the tax structure wherever you live, and they don't want to pay taxes on the $50,000.  There are a number of options likely available to you, and you should have your attorneys draw up the right arrangement.  It could be that you pay some of that $50,000 in cash, such that they can pay the tax bill, or it could be that his shares are valued as common stock like yours (and thus have a market value far less than the preferred stock purchased by the investors), or it could be that the stock option is the best way to go.   

Again, the suggestion of the option is likely around taxes and there could be different paths available to deal with that.  In the end I would prefer that there be no lingering option because the cleaner you can keep your capitalization table, the better.  Work with your attorneys to find the best answer here, or at least reach an agreement with your agent that as a part of the closing of the financing, your attorneys will draw up language that makes everyone happy.


Can I sell stock before I've started making money?

Marco wrote:

I have a newly started honey farm that has very good prospects... It will take 3-6 months to realize our first profits because honey is seasonal, but we have lines of outlets agreed to buy our unique jamaican honey. Can I issue some shares now and collect a pool of funds from their sale, even though I have yet to make a sale? How freely can I use the funds?


Hi Marco.  Absolutely you can.  There have been thousands of companies which raised money and never got their products to market at all.  Obviously that's not your goal, but investing is risky and early stage investing is particularly risky.  Any investor putting money into your company should be well aware of this and it's expected.

As far as how you can use the funds, this will be determined by the investment agreement between you and your investors.  Generally these agreements will be very open and you can use the funds for any business purpose, but again, it's all in the specifics of that agreement.  You will want to consult with a lawyer on drawing up these agreements and complying with any securities laws in your area.

For your pariticular business, it may be possible to get a line of credit from a bank based on committed sales.  If you have customers committed to buying, then those commitments can sometimes be leveraged into bank financing especially with seasonal businesses.  If you do talk to a bank, be sure you have spent the time to put together a solid business plan, pitch, and financial projections.  Looking professional and prepared will go a long way.