What trademark and other legal issues are involved in selecting a company name?
March 7, 2008
[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 inspection and information rights does a stockholder have?
February 9, 2008
Most states allow stockholders to demand access to a corporation’s books and records, and a stockholder list, as long as the stockholder has a proper purpose and meets certain procedural requirements.
Delaware General Corporation Law Section 220(b) provides that “Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from … [t]he corporation’s stock ledger, a list of its stockholders, and its other books and records …”
A stockholder that wants to exercise inspection rights should probably engage an experienced attorney because a corporation can reject the request for failure to comply with procedural requirements.
If the corporation refuses to permit an inspection or does not reply to the demand within 5 business days, the stockholder may apply to the Delaware Court of Chancery for an order to compel such inspection.
One requirement for exercising inspection rights is a proper purpose for the demand. Section 220(b) provides that “[a] proper purpose shall mean a purpose reasonably related to such person’s interest as a stockholder.”
Delaware courts have held that the following purposes, among others, are proper: gather information prior to filing a stockholder derivative suit, communication with other stockholders regarding a solicitation of proxies, communication with other stockholders regarding a stockholder class action against the corporation, communication with other stockholders for the purpose of influencing management to change its policies, communication with other stockholders to encourage them to dissent from merger and seek appraisal, valuation of one’s stockholdings, and investigation of suspected mismanagement where some credible basis for the stockholder’s suspicions is shown to exist.
Courts have rejected inspections for purposes such as: gaining information to facilitate a tender offer when the stockholder has already been enjoined from pursuing a tender offer, valuing the company as a whole in order to determine whether to increase one’s bid in a tender offer, gathering information for use in a stockholder’s individual employment-related claims against the corporation, obtaining information to use to exert economic pressure upon a third party in connection with a labor union’s strike, or satisfying idle curiosity.
If a stockholder seeks to inspect only the corporation’s stock ledger or list of stockholders, the burden of proof is on the corporation to establish that the inspection if for an improper purpose. If the stockholder seeks to inspect the corporation’s books and records, other than its stock ledger or list of stockholders, then the burden of proof is on the stockholder to show a proper purpose.
A stockholder will be entitled to inspect documents that are essential and sufficient to the accomplishment of the proper purpose. The Court of Chancery may “prescribe any limitations or conditions with reference to the inspection, or award such other or further relief as the Court may deem just and proper.” A stockholder may be required to execute a confidentiality agreement in order to exercise inspection rights.
Given that disgruntled stockholders can create problems by exercising inspection rights, companies should be careful about their stockholder base.
How do you calculate Delaware franchise taxes?
February 1, 2008
A corporation’s Delaware Annual Franchise Tax Report is prepared by Delaware calculating the corporation’s annual tax obligation using the “authorized shares” method, reflecting a very large annual franchise tax obligation for most corporations. However, use of the optional “assumed par value capital” method of tax calculation will typically result in a lower tax obligation than the amount shown in the “amount due” box online for the tax bill. A corporation has the option of using whichever method of tax calculation results in the lower tax. Explanation of the Delaware tax calculation methods are posted on the Delaware Division of Corporations’ web site as set forth below.
HOW TO CALCULATE FRANCHISE TAXES
All corporations formed in the State of Delaware are required to file an Annual Report and to pay a franchise tax. The Annual Report filing fee for all domestic corporations is $25.00. Taxes and Annual Reports are to be received no later than March 1st of each year. The minimum tax is $35.00 with a maximum tax of $165,000.00. Taxpayers owing $5,000.00 or more make estimated payments with 40% due June 1st, 20% due by September 1st, 20% due by December 1st, and the remainder due March 1st.
The Annual Franchise Tax is calculated based on the authorized shares method. Use the method that results in the lesser tax. The total tax will never be less than $35.00 or more than $165,000.00.
Authorized Shares Method
For corporations having no par value stock the authorized shares method will always result in the lesser tax.
- 3,000 shares or less (minimum tax) $35.00
- 3,001 - 5,000 shares - $62.50
- 5,001 - 10,000 shares - $112.50
- each additional 10,000 shares or portion thereof add $62.50
- maximum yearly tax is $165,000.00
For Example
A corporation with 10,005 shares authorized pays $175.00 ($112.50 plus $62.50)
A corporation with 100,000 shares authorized pays $675.00 ($112.50 plus $562.50[$62.50 x 9])
Assumed Par Value Capital Method
To use this method, you must give figures for all issued shares (including treasury shares) and total gross assets in the spaces provided in your Annual Franchise Tax Report. Total Gross Assets shall be those “total assets” reported on the U.S. Form 1120, Schedule L (Federal Return) relative to the company’s fiscal year ending the calendar year of the report. The tax rate under this method is $250.00 per million or portion of a million. If the assumed par value capital is less than $1,000,000, the tax is calculated by dividing the assumed par value capital by $1,000,000 then multiplying that result by $250.00.
The example cited below is for a corporation having 1,000,000 shares of stock with a par value of $1.00 and 250,000 shares of stock with a par value of $5.00 , gross assets of $1,000,000.00 and issued shares totaling 485,000.
- Divide your total gross assets by your total issued shares carrying to 6 decimal places. The result is your “assumed par”.Example: $1,000,000 assets, 485,000 issued shares = $2.061856 assumed par.
- Multiply the assumed par by the number of authorized shares having a par value of less than the assumed par.Example: $2.061856 assumed par s 1,000,000 shares = $2,061,856.
- Multiply the number of authorized shares with a par value greater than the assumed par by their respective par value.Example: 250,000 shares s $5.00 par value = $1,250,000
- Add the results of #2 and #3 above. The result is your assumed par value capital.Example: $2,061,856 plus 1,250,000 = $3,311 956 assumed par value capital.
- Figure your tax by dividing the assumed par value capital, rounded up to the next million if it is over $1,000,000, by 1,000,000 and then multiply by $250.00.Example: 4 x $250.00 = $1,000.00
NOTE: If an amendment changing your stock or par value was filed with the Division of Corporations during the year, issued shares and total gross assets within 30 days of the amendment must be given for each portion of the year during which each distinct authorized amount of capital stock or par value was in effect. The tax is then prorated for each portion of the year dividing the number of days the stock/par value was in effect by 365 days (366 leap year), then multiplying this result by the tax calculated for that portion of the year. The total tax for the year is the sum of all the prorated taxes for each portion of the year.
You may also use our Franchise Tax Calculator for estimating your taxes.
How many shares should be authorized in the certificate of incorporation?
January 25, 2008
I usually advise companies to authorize around 10 to 15 million shares of common stock. Around 8 or 9 million shares are issued to founders with a 1 million to 2 million share option pool, for a fully-diluted base of around 10 million shares. The remaining authorized but unissued shares are a reserve in the event more shares need to be issued.
From a purely mathematical perspective, it doesn’t matter whether there are 1 million or 10 million fully-diluted shares. However, when companies are granting options to new employees, even the smartest engineers feel better receiving options to purchase 100,000 shares as opposed to 10,000 shares, even if it represents the same percentage ownership of the company.
Assuming a $15/share IPO price and dilution due to financings, 20 million shares outstanding will result in a $300M market cap, which is about the minimum size necessary to complete a successful IPO. This avoids having to do a reverse or forward stock split at the time of an IPO.
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