written by David Postolski, Partner at Gearhart Law
Crowdfunding is the use of small amounts of capital from a large number of individuals to back or finance a new business venture. Crowdfunding makes use of the easy accessibility of vast networks of people through social media and crowdfunding websites to bring backers or investors and entrepreneurs together.
Knowing the terminology of crowdfunding is the first step. When we discuss reward-based crowdfunding, such as Kickstarter or Indiegogo, we refer to backers who receive a reward after making a donation to an entrepreneur’s campaign on a portal site during a limited period of time. When we discuss crowdfinancing or equity crowdfunding, such as Rock the Post or Seedrs, we refer to investors, making a monetary investment, in exchange for an equity stake in an issuer’s company through an a intermediary site.
This distinction is crucial as in the US, equity crowdfunding or crowdfinancing is restricted by regulations on who is allowed to fund a new business and how much they are allowed to contribute or invest. Investments made through a crowdfinancing intermediary site are regulated by the Securities and Exchange Commission (SEC). Reward-based or donation-based crowdfunding is not regulated in the US.
Traditionally, in the US, an individual entity that is deemed and confirmed as an accredited investor may invest in an entity in exchange for an equity stake in that entity. An accredited investor must have a net worth of at least $1m, not including the value of the investor’s primary residence, or have income of at least $200,000 each year for the last two years (or $300,000 together with the investor’s spouse if married).
In the past, companies seeking investment were not able to solicit or advertise to accredited investors, especially on the internet. Traditionally, the offering and receiving of equity in exchange for monetary investment was a ‘gated community’, one restricted to high net worth individuals, where access was only granted to companies or issuers seeking investment if they knew someone. However, with the passing of the JOBS Act, the ban on solicitation and advertising to accredited investors was lifted.
As of September 2013, the general solicitation of accredited investors through crowdfunding intermediaries on the internet, under title II of the JOBS Act, was instituted. Issuers of equity can now do a limited kind of advertising to investors, essentially a very short notice in print or electronic media that directs potential investors to the intermediary platform that is hosting the offering opportunity. Soon after, in June 2015, title IV of the JOBS Act (also known as Regulation A+) went live. This allowed for the general solicitation of non-accredited investors of up to $50m per business.
However, the most dramatic and sweeping change in crowdfinancing came into effect more recently. Title III of the JOBS Act now allows for the general solicitation of the non-accredited investor up to $1m per business per year. Thus, as of 16 May 2016, all individuals, regardless of their net worth, are able to invest, through an equity crowdfunding intermediary on the internet. An individual or investor can now invest sums ranging from $2000 to $100,000 in exchange for equity in a new business. The investment must be made through a registered broker dealer or a crowdfunding portal acting as an intermediary.
Regardless of the type of crowdfunding practiced, crowdfunding or crowdfinancing provides a forum to anyone with a great idea to pitch it to backers and investors. Backers can select from thousands of projects posted on portals or on intermediary sites and back a project for as little as $1 to receive a pre-sale of a product, the chance to take part in a social cause or have equity in a company launching a new product.
From an intellectual property (IP) perspective, using the influence and financing of a crowd can provide an inexpensive resource and mechanism for confirming and validating new ideas. Starting a new campaign or making an offering on an intermediary site means you will be faced with a number of business, legal and ethical decisions, all of which must be resolved before you get your new campaign or offering off the ground. To understand the unique business and IP issues now facing more people than ever, one must also understand the terminology associated with IP. The three types of IP are patent, trademark and copyright. Each has unique consequences for the players in a crowdfunding or crowdfinancing opportunity.
IP is the power of exclusion rights awarded to entities, for a limited time, in exchange for that entity disclosing what their idea is. In the US, IP rights are federal rights that are registered with federal agencies, such as the Department of Commerce’s United States Patent and Trademark Office (PTO) or the Copyright Office. Patent and trademark rights are applied for and granted after an examination process by the respective federal agency. Once granted, IP rights last 20 years for a patent, 10 years for a trademark (which is renewable for additional 10 year periods if use of the trademark continues), and the life of the creator plus 70 years for a copyright.
Patent. A patent is the exclusive right granted by the government to an inventor, conferring to him or her the sole right to exclude others from making, using or selling an invention. A patent is granted to an inventor who can prove their invention is novel and non-obvious. The patent must be a sufficiently described writing that solves a problem and that contains the best way to practice the invention. Under the America Invents Acts (AIA), US patent laws have undergone a dramatic change not seen in the US since 1952. The Act switches the US’ patent system from a first to invent system to a first inventor to file system. Thus, as of 16 March 2013, when the AIA came into effect, inventors must race to the patent office to file their patent applications. Inventors must file their applications with the patent office in order to obtain the superior right of who is the first inventor of a patentable idea. It no longer matters when one invented, but rather when an inventor files his or her patent application.
Also, under the new law, the inventor who needed to race to the patent office had two important protections in place to ensure the inventor would be able to do so. First, the AIA allows for a 75 percent reduction in official fees for an inventor who is deemed to be a micro entity, that is, an inventor with less than four patents to his or her name and who makes less than three times the national average salary (approximately $55,000, thus an inventor who makes less than $165,000). The second and most important feature of the AIA was the promulgation of a one year grace period. This affords an inventor the ability to make a public disclosure or to publish their invention or idea publicly and it also allows that inventor to follow that public disclosure or publication with a patent application as long as the patent application is filed within one year of that disclosure or publication. This publication conditioned one year grace period seemingly allows inventors to use crowdfunding as a mechanism, but it comes with risks.
In a world where crowdfunding and crowdfinancing is the preferred way to garner investment or backing for an idea or invention, inventors now have the ability to publicly disclose their ideas in an attempt to validate and financially support their inventions. The date of this or any public disclosure is one that must be tracked closely, for if the patent application is not filed within one year then the right to claim invention of the idea is lost to the inventor forever. What neither the AIA nor the SEC accounted for was the widespread use and popularity of such crowdfunding portals and intermediaries.
The public disclosure on crowdfunding is so great and the idea or invention is seen by so many, that it would be close to impossible to track down whether another individual learned of your idea and beat the true inventor to the PTO and filed their patent application before the public discloser did. Though the law protects the first inventor to file their patent application and not the first person who misappropriates an idea and files their patent application, proving such facts would be difficult. Thus, it is of paramount importance that an inventor, entrepreneur or an offeror of equity has a patent application on file before a major public disclosure on a portal or intermediary site is made. Since it is essential that details are shared with investors and backers in order for them to buy in to an idea, it follows that potentially patentable and novel ideas will be shared. Having a patent application on file is an essential and necessary step to starting the crowdfunding or crowdfinancing project.
In the world of patents, entities have a choice to make in pursuing patents. The choice being to disclose their potentially patentable idea to the PTO, in exchange for receiving the limited 20 year patented monopoly, or not disclosing and keeping their idea as a trade secret. A trade secret is not a registrable right filed with a federal agency, nor is it applied for and examined like a patent or trademark. A trade secret is a form of IP that can potentially last forever, provided that the secret is kept and not misappropriated or reverse engineered. Though one can choose the trade secret route for these reasons and others, the world of crowdfunding may not be the appropriate venue for garnering investment for a trade secret.
The world of crowdfunding is based on strangers who want to back you or investors who want to invest in your idea, invention or product they understand or that is sufficiently explained to them. The more a backer or investor knows, the more it is likely the backer will support your project or idea. The desire to keep your competitive advantage a trade secret may not garner the required degree of backing. Keeping something a secret is likely not the most practical outcome in the world of crowdfunding. That being said, it is clear that as more of one’s trade secret is exposed and disclosed on a crowdfunding site, the need to file a patent application increases.
Trademark. A trademark is a word, phrase, symbol or design that identifies and distinguishes the source of goods from others. A service mark is a word, phrase, symbol or design that identifies and distinguishes the source of a service rather than a good. The federal right of trademark grants a user the right to exclude others from using any mark that might be confusingly similar to theirs. Deciding on the brand or trademark of a product is extremely important, especially when patents are not pursued or chosen.
The name you choose for your product, service or company will build brand recognition from the moment your crowdfunding campaign is launched. Thus, having a brand or logo chosen before you launch your campaign is an important decision. Choosing a name that is not cleared for use may mean that you might be infringing someone else’s already filed or registered trademark. In addition, since the US is a common law country, companies that use trademarks that have yet to be filed with the PTO may still have certain rights that predate your use of your proposed trademark. Accusations of infringement could play out in the very public arena of crowdfunding and can only have a negative and potentially disastrous effect on your campaign or offering.
In today’s digital world, with its new methods of advertising, such as social media, a unique and distinct trademark can make all the difference. Obtaining a US federal trademark requires interstate commerce and a distinct word, logo or phrase. Distinction can be acquired by using words that are non-generic and non-descriptive. Words or logos that create a suggestion of what a company sells or provides is evidence of distinction. Words that have an arbitrary meaning or words that are fanciful or made up also assume distinctive qualities and what brand owners strive for in naming their company, product or service.
Similar to patents, trademark law is borne of the US constitution, specifically the Commerce Clause. The PTO contains millions of patent and trademark records which are available for searching. In a process often referred to as clearance, a trademark applicant, with the assistance of an attorney, should search the name and logo they desire in order to gain clearance on moving forward. Understanding potentially conflicting or similar marks allows for a trademark owner to appreciate and understand the risks and rewards of going forward with their proposed brand strategy. The onus of trademark clearance, as well as resolving disputes, is on the trademark owner and not the crowdfunding intermediary or portal, as evidenced by their terms and conditions.
Copyright. Crowdfunding campaigns or offerings often require the use of a video or other multimedia creation to lure backers and investors to their opportunity among the sea of others. Standing out is essential, from a patent and trademark perspective, and even more so from a copyright perspective. The creative works, such as videos and photos, are often the first visuals backers or investors see when visiting a crowdfunding site or intermediary. A copyright is a legal right that grants the creator of an original work the exclusive right to stop others from using, distributing, publicly performing, displaying and making derivative works of their original work.
A copyright is automatic in the creator and does not have to be applied for. Instead, a copyright must be registered as yours or registered as a work you commissioned another to create for you with the Copyright Office. Utilising a proper work made for hire agreement that clearly transfers the copyright from the automatic owner creator to you as the entity hiring that creator, is essential for an entity to be deemed the true owner of the creative work should a dispute arise. Without a proper transfer of title, a US court may deem that any proceeds received via a crowdfunding campaign or offering was attributed to the artistic work and thus the property of the original creator.
Avoiding such a pitfall is an easy fix. Whether you are the creator or if you are hiring another to create an artistic work, it is important that when utilising a crowdfunding portal or intermediary site that ownership of all works are ascertained and proper. Having legal title to creative and artistic works that you hire others to create for you is a must when faced with a copyright infringement allegation. Similarly, the use of images in your offering or campaign must be authorised and attributed. This includes the names, likeness and personal identifiable information of others.
Planning for your campaign or offering – before and after you launch
Before launching a campaign, it is important that an entity follows these very important steps, which will ensure that their crowdfunding experience is positive, uninterrupted and allows their backers or investors to participate in a commercially successful product or launch. When one has an idea suitable for crowdfunding, performing a novelty patent search with a patent attorney is a recommended prerequisite. Of course, the individual can perform their own commercial search on the internet but one must remember that it is the inventor who filed their patent application first that will obtain the superior right. Thus a search of prior patents and patent applications will be a necessary first step to determine if the idea is truly novel.
Once the search clears, and a novel path forward exists, a patent application must be filed prior to the very public disclosure that occurs with crowdfunding. In addition, an inventor can seek to file a provisional patent application, which would afford the inventor their place in line for examination by the PTO, once they convert their provisional filing to a non-provisional within one year. Often, this year is used to garner additional support or investment or even additional research time, while maintaining the very important patent application filing date.
Similarly, the trademark process should also be commenced with a clearance search and resulting trademark application. The US trademark system allows for an entity to file their trademark application even though they are not yet using their mark in interstate commerce. Such a trademark application is filed as an intent to use application and is a great mechanism for crowd funders to utilise while they garner market validation and support from the crowd of potential backers and investors.
Lastly, registering your copyright in, or obtaining the authorisation to use or to display, images, audio visuals and artwork of others, to be used in the campaign or offering, is crucial before you launch. Obtaining legal copyright title to the videos you create to entice backers and investors is critical before you launch.
All of the aforementioned IP strategies are the entity posting the campaign or the issuer’s responsibility. The crowdfunding portals or crowdfinancing intermediaries do not hold any of these responsibilities. In fact, their terms and conditions specifically put the responsibility on the entity posting the campaign or on the issuer. They are a ‘go between’ and in the world of crowdfinancing, an intermediary with very little care or concern for IP and how it is protected and monetised.
After your campaign or offering launches, the obligations of IP do not end. The patent and trademark applications that were filed pre-launch will be examined and eventually registered after your campaign ends. Since the reach of crowdfunding is global, one must decide whether to file their patent and trademark applications in another country, a decision that must be made within six months from filing for the trademark and within one year from filing for the patent application. In addition, the very public and global arena of crowdfunding means that one must be diligent in watching for, identifying and eliminating potential infringers of your product, service or brand. Though many intermediaries do not mention the phrase ‘intellectual property’, a company’s IP is its value proposition or what establishes its value and worth. Thus a company should seek to have its core technology, product, service or brand protected in some way.
In addition, a professionally accredited investor, for example a venture capitalist, would do a large amount of due diligence surrounding the company and individual they are investing in, including looking at the company’s IP portfolio. The non-accredited investor should do the same. Given the public nature of regulation crowdfunding, the non-accredited investor will have the opportunity and means to communicate with the entrepreneur or issuer and should be asking about the IP and competitive landscape.
The future looks bright for the interplay between crowdfunding or crowdfinancing and IP laws. With increased awareness and education, the inadvertent loss of patent rights can be avoided. In addition, with enough due diligence and planning, an entity’s trademark and copyrighted works may also be protected. Likewise, with thoughtful business planning, the odds of a successful campaign or offering are increased. More importantly, appreciating the IP and business issues will allow for a successful venture way after the campaign or offering ends.
David Postolski is a partner at Gearhart Law LLC. He can be contacted on +1 (908) 608 8119 or by email: email@example.com.
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