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What trademark and other legal issues are involved in selecting a company name?

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[The following post is courtesy of John Slafsky and Aaron Hendelman in WSGR’s Trademarks and Advertising Practices Group.]

Among the most important tasks in the founding of a new company are the development and clearance of a company name.  There are two very different sets of legal issues, and a host of business issues, involved in the process.

Legal Issues

One set of legal issues concerns availability of the name under state law relating to entity names.  In the case of corporations or limited partnerships, this involves checking with the Secretary of State of the states where they are formed and where they must “qualify” to do business (usually where they have offices or resident employees or a sales force).

The Secretary of State checks the state records to ensure that there is no other corporation or limited partnership with an identical or closely similar name; if one is found, the new name is generally not permitted.  This happens even if the two companies are in vastly different lines of commerce; the sheer similarity of the name bars the second name.  (On some occasions, consent of the earlier company or a relatively minor alteration of the name, such as “ULTIGRA, INC.” to “ULTIGRA SOFTWARE, INC.,” may increase the chances that the state will allow the new name.)

The second set of legal issues concerns trademark law.  The Secretary of State’s approval of a business name does not grant trademark rights or authorize a company to use a particular business name in commercial activities.  (Nor does registration of a corresponding domain name result in any significant legal rights.)  A company may have incorporated under a name but find itself liable for trademark infringement or dilution — with potential risks of an injunction, disgorgement of profits, payment of damages, and more — for use of the name.

Trademark infringement occurs when a person or company uses a name or mark in a way that causes a likelihood of confusion with another person or company with respect to source, sponsorship, or affiliation of products, services, or commercial activities.  Thus, “McCoffee” may infringe upon the marks of McDonald’s Corporation by leading the public to believe that “McCoffee” is a product or an affiliated company of McDonald’s.  A company also may be liable for trademark dilution by using the famous mark of another company even if there is no competitive overlap or likelihood of confusion. For example, the name “Pentium Petroleum Corporation” may well dilute the PENTIUM trademark of Intel Corporation.  It therefore is important to assess the potential trademark law risks of a name before adopting it as a company name.

The fact that a company still has a low public profile, or does not yet have products on the market and does not yet have a website, does not immunize it from challenges.  Some companies have been sued for allegedly causing confusion through their financing activities or for use of a pre-release code name for a new product.

Some companies, in a rush to form a company, devise names in a hurry and do not clear them for trademark purposes.  Often, they consider the name a “place holder” until a later time when they can invest the money and effort to attend to a new name.  This creates a number of risks.  First, there is the risk of liability.  Second, management may “fall in love” with the placeholder name and become unwilling to give it up later.  Third, the company may develop goodwill under the placeholder name that will be lost upon a name change.  Fourth, the company may incur significant legal and administrative costs when it later undergoes a name change.

Our Assessment

Legal assessment of a business name involves several steps.

We check the availability of the name with the Secretary of State for the relevant states; if the name is available with the Secretary of State, we reserve it pending an in-depth search.  The Secretary of State availability check and reservation require only nominal fees.

We also perform searches of trademark databases in-house using on-line services or other research materials.  The purpose of the searches is to determine whether a name is so likely to be unavailable that a more comprehensive search would be wasteful.  A preliminary screening search is not sufficient diligence to assess the real issues in adoption of the name.

After the screening search, we obtain an in-depth trademark search from an outside search company.  It examines federal and state trademark registers and a large number of sources of unofficial information about company and product names in relevant fields.  We obtain an extra copy of the search report for our client and expect it to review the report carefully for potential conflicts; we then discuss our assessment with the client. 

Once a company is comfortable with the level of risk of its chosen name, it is important to find ways to protect the name.  If the name will be used on products, or in connection with the advertising or promotion of services, it often is a good idea to file an application for federal registration of the name based on the company’s intent to use the mark.  This will help establish rights to the name; more importantly, it gives early notice to others who might otherwise overlook the company’s name when they do searches to develop their own names.

For further information, please contact John Slafsky or Aaron Hendelman in WSGR’s Trademarks and Advertising Practices Group. 

What’s the difference between an ISO and an NSO?

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[The following is not intended to be comprehensive answer. Please consult your own tax advisors and don’t expect me to answer specific questions in the comments.]

Incentive stock options (“ISOs”) can only be granted to employees.  Non-qualified stock options (“NSOs”) can be granted to anyone, including employees, consultants and directors. 

No regular federal income tax is recognized upon exercise of an ISO, while ordinary income is recognized upon exercise of an NSO based on the excess, if any, of the fair market value of the shares on the date of exercise over the exercise price. NSO exercises by employees are subject to tax withholding. However, alternative minimum tax may apply to the exercise of an ISO.

If shares acquired upon exercise of an ISO are held for more than one year after the date of exercise of the ISO and more than two years after the date of grant of the ISO, any gain or loss on sale or other disposition will be long-term capital gain or loss. An earlier sale or other disposition (a “disqualifying disposition”) will disqualify the ISO and cause it to be treated as an NSO, which will result in ordinary income tax on the excess, if any, of the lesser of (1) the fair market value of the shares on the date of exercise, or (2) the proceeds from the sale or other disposition, over the purchase price.

A company may generally take a deduction for the compensation deemed paid upon exercise of an NSO.  Similarly, to the extent that the employee realizes ordinary income in connection with a disqualifying disposition of shares received upon exercise of an ISO, the company may take a corresponding deduction for compensation deemed paid. If an optionee holds an ISO for the full statutory holding period, the company will not then be entitled to any tax deduction.

Below is a table summarizing the principal differences between an ISO and an NSO.

  ISO NSO
 Tax Qualification Requirements: * The option price must at least equal the fair market value of the stock at the time of grant.

* The option cannot be transferable, except at death.

* There is a $100,000 limit on the aggregate fair market value (determined at the time the option is granted) of stock which may be acquired by any employee during any calendar year (any amount exceeding the limit is treated as a NSO).

* All options must be granted within 10 years of plan adoption or approval of the plan, whichever is earlier.

* The options must be exercised within 10 years of grant.

* The options must be exercised within three months of termination of employment (extended to one year for disability, with no time limit in the case of death).

 None, but an NSO granted with an option price less than the fair market value of the stock at the time of grant will be subject to taxation on vesting and penalty taxes under Section 409A.
Who Can Receive: Employees only Anyone
How Taxed for Employee: * There is no taxable income to the employee at the time of grant or timely exercise.

* However, the difference between the value of the stock at exercise and the exercise price is an item of adjustment for purposes of the alternative minimum tax.

* Gain or loss when the stock is later sold is long-term capital gain or loss. Gain or loss is the difference between the amount realized from the sale and the tax basis (i.e., the amount paid on exercise).

* Disqualifying disposition destroys favorable tax treatment.

 * The difference between the value of the stock at exercise and the exercise price is ordinary income.

* The income recognized on exercise is subject to income tax withholding and to employment taxes.

* When the stock is later sold, the gain or loss is capital gain or loss (calculated as the difference between the sales price and tax basis, which is the sum of the exercise price and the income recognized at exercise).