Friday, January 30, 2015

Monster Learns Beastly Lesson

Last summer, the Beastie Boys won a $1.7 million judgment against Monster Energy Drink for the unauthorized use of their music in a promotional video. The judgment included statutory damages and penalties, and I thought was a pretty good recovery for the group, but the Beastie Boys now want another $2.4 million to cover the costs of the suit.  

The lawsuit involved a promotional video that Monster created using a mix of five Beastie Boys’ songs. I may be a little fuzzy on the facts, but the BB mix had been created by a disc jockey, Z-Trip (Zach Sciacca), who had earlier been authorized by the Beastie Boys to create the mix in connection with the promotion of a BB album. Z-Trip was apparently authorized to use the mix himself as a promotional item, but was not authorized to sell or license it.

Z-Trip used the mix at a party during the Monster-sponsored snowboarding event “Ruckus in the Rockies”.  A Monster employee charged with making a highlight video of the RITR event included footage of the live Z-Trip program and used some 23 minutes of the BB mix as background music. The video was posted on the Monster website, YouTube, and Facebook.

From the beginning, Monster essentially admitted wrongdoing and offered $125,000 to settle the matter, eventually raising the offer to $250,000 just before trial. The Beastie Boys initially wanted $2 million and wouldn’t come down to the Monster offer. (By the time Monster made the offer of $250,000, the BB probably had incurred more than that in trial preparation costs.)

Having failed to reach a settlement, Monster proceeded to defend its actions at trial on grounds that it had been authorized by Z-Trip to use the mix, and that Z-Trip was therefore liable for the infringement.  (Z-Trip was also sued by Monster, but the case against him was dismissed on summary judgment.) The Monster employee responsible for the video had sent a preliminary cut of the video to Z-Trip with the message “Please have a look at the video from this past weekend and let me know if you approve,” to which Z-Trip replied “Dope!” And that was apparently good enough for Monster to believe they had authorization to use the Beastie Boys’ music in its promotional video, although it’s not clear that they even asked about authorization until after the BBs claimed infringement.  

Had Monster undertaken even a basic clearance check before co-opting the Beastie Boys’ music, it would have learned that the music was not to be licensed at any price. Only shortly before the snowboarding event and creation of the Monster video,  Beastie Boys’ member Adam “MCA” Yauch died and had stated in his will that he did not want the band’s music to be used for advertising. I don’t know if that is legally enforceable against the band and/or the other members (a question for the GPM Estate Planning Practice Group), but the timing was such that the remaining members of the group were committed to respecting his wishes.

Considering this personal issue and that a significant aspect of the trial was whether “Dope” created a legally binding contract between the disc jockey and Monster for use of the Beastie Boys’ music, you can begin to understand why the BBs would want to recover their legal costs. I can’t blame them, but it doesn’t work that way. Sadly, enforcing one’s rights frequently costs more than any damages that can be recovered, particularly in intellectual property matters where the primary goal is usually to stop the infringement. Damages are usually hard to prove and penalties are often not available for technical reasons. Most suits settle for exactly these reasons.

In this case, the Beastie Boys actually did quite well considering that they probably experienced little actual damage from the use of their music in the Monster video. Monster, on the other hand, sadly miscalculated the cost of their irresponsible behavior. I wonder what they spent on legal fees. 

Tuesday, January 27, 2015

Non-qualified Stock Options or Restricted Stock Awards?

Recently, an early-stage, high-growth client (a Delaware S corp.) called to ask whether, and when, to begin awarding stock options, in this case the non-qualified variety (NSOs), instead of using restricted stock grants to key contributors. Many growing companies struggle with this same issue, and the recipient and company may have differing views. Although there are five common types of individual equity compensation awards (stock options, restricted stock, stock appreciation rights, phantom stock, and employee stock purchase plans), this post focuses on NSOs and restricted stock.

A NSO grants someone the right to purchase a predetermined number of shares at a predetermined exercise price (for tax reasons, at least the fair market value on the date of grant). Typically, a NSO vests over time, after achievement of performance milestones, or a combination of the two. When exercised, the individual recognizes ordinary income equal to the excess of (i) the fair market value of the stock received over (ii) the exercise price.

For example, assume a NSO to purchase up to 100 shares at an exercise price of $10 per share. The NSO vests at the rate of 25% per year for four years and has a 10-year term. At the conclusion of the four-year vesting period, the recipient exercises 50 options. If the fair market value of a share was $20 at such time, the optionee has ordinary income equal to the difference between the $20 fair market value and the $10 exercise price, or $10 per share ($500 total). Therefore, a NSO operates as a tax-deferral mechanism by delaying the recognition of income until the option is exercised. The company receives an equivalent deduction. Of course, NSOs are highly dependent on a company’s performance because if the fair market value of the stock falls below the exercise price, the option is essentially worthless.    

A restricted stock award is a grant of shares which are subject to as risk of forfeiture until certain restrictions, like the passage of time or achievement of performance milestones, are met. For example, an employee may be granted 360 shares of restricted stock that “vest” over a period of 36 months at the rate of 10 shares per month, provided the employee continues to be employed. If the employee ceases to be employed, the restricted stock agreement often will give the company the right to repurchase any “vested” shares, with the right to any “unvested” shares automatically terminating.

The tax consequences to someone receiving restricted stock depend upon whether a Section 83(b) election was filed with the IRS. When a 83(b) election is timely filed (it must be filed within 30 days of the issuance) the recipient reports as ordinary income, the excess of (i) the stock’s fair market value at the time of the award over (ii) the amount, if any, paid for the stock. The recipient then has no tax consequences as the risk of forfeiture lapses. Alternatively, if no 83(b) election is filed, the recipient is taxed as the risk of forfeiture lapses, in an amount equal to the excess of (i) the value of the stock at the time of vesting over (ii) the amount paid for the stock, if any. This is also taxed as ordinary income and the company receives a compensation-related deduction at the same time and in the same amount. 

The type of equity compensation award granted is likely to be based on the goals and objectives of both the company and the recipient.  For example, when a company’s stock has very little value, the recipient is likely to prefer restricted stock; however, as the value of the stock rises, the recipient may prefer NSOs because of the potential immediate tax (with an 83(b) election) on grant. On the other hand, if the company performs poorly, the stock’s value may fall below the NSO’s exercise price, rendering the NSO worthless. Restricted stock awards may be more complicated for the company because the recipient becomes a shareholder on the award date, even though some of the shares remain subject to forfeiture.  Therefore, unless clearly defined in the agreement granting the restricted stock, issues may arise as to the voting, dividend, and other shareholder rights the recipient has with respect to the unvested shares.

This is a high-level summary of two types of equity compensation awards that might be useful to entrepreneurs. Of course, it is important to discuss equity compensation with your legal counsel and other tax advisors in order to develop and implement a plan that achieves the desired objectives.

Tuesday, January 13, 2015

To Work with Family, or to Not Work with Family?

Working with family members can be a double-edged sword. It may seem easier to start a business with family members because you already know and trust them, but if things go awry, the disputes can be even more personal and intense. Think about it–if things go bad, instead of losing a business partner, you may ruin a relationship with your sibling, cousin, or in-laws. I’ve even seen situations where siblings sue each other and children sue their parents when the business isn’t as successful as planned. Family members shouldn’t have to turn to litigation to resolve their business disputes. So, what can you do to prevent the worst from happening?

Below are a few suggestions from Andreas Scott (a financial advisor at Total Wealth Advisors, LLC) and me regarding common issues faced by family businesses. Andreas has extensive experience in advising family businesses and his goal is to help his clients create and control their total wealth picture.  

Ownership vs. Management

Ownership and management are two different functions that are often lumped together. When including family members in your business, consider if they would be more effective as an employee, a member of management, a board member, and/or an owner of the company. Each of these roles provides the family member with different responsibilities and rights to the business. For instance, if you give the family member an equity interest in the company, consider if it should be a non-voting equity interest. This would give the family member the benefit of having economic rights, but prevent the individual from having governance rights. Also, if a management transition is necessary, we recommend having open conversations with family members to discuss your future involvement in the company and how that would impact their economic and governance rights and roles within the company.

Going External

A significant decision that many successful family businesses will face is whether to bring in external management. When a family business reaches the second, third, or fourth generation, there will be differing views on whether it is appropriate to bring in professional external management or to continue to keep all management within the family. It may be beneficial to have an independent party weigh in on important decisions, but it’s important to understand the implications of bringing in external management from an estate, wealth, and ownership standpoint.

Differences in Generational Views

It may seem obvious, but the first generation and the third generation will have different views of the family business. If left unaddressed, opposing views can cause significant tension within the family. If Grandpa doesn’t believe his grandson has the same respect for the business that he does, it could cause challenges not only at the dinner table, but also when it comes time to run the business and do the estate planning. To resolve these issues, it’s important to work with professionals (e.g., an attorney, accountant, wealth manager, etc.) who are both subject-matter specialists and who understand the underlying family dynamics.

Although it may seem easier to work with family members, remember to tread carefully because conflicts in the work place will inevitably follow you home.

Monday, January 5, 2015

How to Answer the Top Five Legal Questions You Will Get from Family Members at Holiday Gatherings

1. Should Mom and Dad give us the house as a gift now so that they don’t have to “give it to the government” later?

This is a common question that involves technical medical assistance rules. Generally, the best way to answer this question is “no,” and, “You should talk to a lawyer who specializes in this area.” These rules are very complex and often misunderstood.

If you give a home to another person as a gift, that person will receive the home with a tax basis that is the same as your tax basis. In some cases, this can be a very low basis and the built-in capital gains very high. In addition, as the owners are no longer the primary residents, the recipient of the gift will no longer get any kind of exemption on paying some of that capital gain when the house sells. In contrast, if your parents die owning the house, the house will get a fresh tax basis. And if they sell the house while they still own it, they are exempt from paying much of the capital gains.

Further, transactions within a certain period of time are ignored. Your parents could end up without a house, and still be excluded from some government assistance.

Finally, if you and your siblings receive their house as a gift, YOU NOW OWN A HOME WITH YOUR SIBLINGS. And their spouses, really. Who gets along well enough with their siblings to start going into real estate investing? Overall, this is rarely a good idea. 

2. When our daughter, Susie, gets married next year, should we give the couple a down payment on a house?

Again, this is very generous; you have a great family. On the other hand, it can be difficult to navigate the marital property rules, and you could be sharing family assets in a way you don’t intend.

Sometimes a simple traceable gift like cash can be harmless, but if a gift is actually—for example—an interest in an operating business, or a job for a new son-in-law, such a gift should only be made with a prenuptial agreement attached. Especially if someone is going to own a growing business that he or she (or his or her new spouse) will be working at, consult a lawyer about the safest way to make that gift. Any family with operating family businesses or family wealth should discuss the possibility of an agreement or an estate plan that ensures you are protecting the family’s assets and preparing the young couple to be good stewards of that wealth.

3. When grandma died four years ago, she had a will, so we didn’t need to go through probate, right?

Probate is a court-supervised process that transfers property after someone’s death. Even if you have a will, probate is necessary to properly transfer property to the beneficiaries after someone dies. The beneficiaries are either determined by the terms of the will or by state law, but probate is a necessity either way. The only way to avoid probate is to transfer all of your property through beneficiary designations or through a living trust. If any asset is still in the decedent’s name and does not have a designated beneficiary, the only way to transfer it is through probate. Also, if it has been four years, you have to go through a slightly more complex court proceeding instead of the typically simple probate process.

Some people also ask why they need a will if they don’t have millions of dollars. A will does not avoid probate, but it does allow you to select the people who will be in charge of your estate and the people who will benefit from the assets you do have. Your will allows you to select specific assets or dollar amounts and give them to specific people. If you don’t have a will, state intestacy law will direct where your stuff will go. This is based on your living descendants and whether you have a spouse. If you have children, your children will have some interest in your assets, even if you are married. Intestacy tries to mirror what most people may want, but it is rarely applied in the same way that you would choose.

It does matter that you have a will.

4. Speaking of grandma, I can just use her power of attorney to close her bank account, right?  Is having a power of attorney the same as being her executor?

A power of attorney is a document that authorizes someone to make financial decisions and transactions on your behalf, while you are alive. This document is no longer valid once someone has died.

Often, people think they can continue to close accounts or write checks for bills after someone has passed away because they were the power of attorney when that person was living. The executor—or personal representative, as it is called in Minnesota—is the person in charge of collecting assets, paying debts, and distributing a person’s assets after their death. That person has to be appointed by the court through probate, and that can take some time. There is often a gap in time where there is no one legally able to conduct financial transactions on behalf of the person who has died.

5. If I get in an accident, I don’t want to be a vegetable, so you can just pull the plug—right?

Making medical decisions for someone is a very serious matter. Often medical staff will consult with family when important decisions are to be made, but they are starting with the presumption that they should save your life at all costs.

If you have situations where you would prefer that you not be kept alive, you have to put that direction in a legal document, or you have to be sure that you have immediate family that will convey that wish without wavering, and without disagreement among them. A health care directive, or power of attorney for medical purposes, is the best document to outline these wishes and to designate someone to carry them out.

This is also the case if you wish to donate organs or be cremated instead of buried, things like that.  Further, “pulling the plug” could mean that you want to be taken off life support after certain conditions are met or that you do not want to be kept alive by way of a feeding tube, or it may refer to an order not to resuscitate you if that is necessary. A health care directive can cover the first two examples, but does not cover an order not to resuscitate, and that must be done in a separate and specific document.

Tuesday, December 23, 2014

What: Charles Dickens, “A Christmas Carol” (in the public domain, originally published in 1843)

Why: More than just a feel-good story, this classic holiday tale offers insights into what motivates the entrepreneurial spirit.

This time of year, we are bombarded with seemingly numberless versions of this classic Christmas tale. Indeed, this story is the stuff of many an entrepreneurial venture in the entertainment industry—in the film industry alone, everything from The Muppet Christmas Carol (a personal favorite) to Scrooge to Mr. Magoo’s Christmas Carol.

Few people know that the story is itself an entrepreneurial work product. Dickens was reeling from the commercial failure of his novel Martin Chuzzlewit (You’ve heard of it, right? Yeah, neither had I.)  His wife was once again pregnant and he needed cash fast. Putting pen to paper, he completed the manuscript in less than six weeks and, declining a lump-sum payment from his publisher, covered the publication costs himself in hopes of reaping a huge profit from sales. Sadly, the work was not an immediate commercial success.

It isn’t surprising, then, that nuggets here and there in the story reveal his views on the entrepreneurial life in general and his personal struggles with entrepreneurism in particular. For example, turn to the scene where the Ghost of Christmas Past forces Scrooge to revisit his last meeting with Belle, the love of his young life.

Belle expresses her sense that Scrooge has changed, that he has become too much concerned with money and material things. Out of Scrooge’s mouth comes the following response: “There is nothing on which [the world] is so hard as poverty; and there is nothing it professes to condemn with such severity as the pursuit of wealth.” Poor Scrooge. Stuck between a rock and a hard place.

But Belle understands his deeper motivation. “‘You fear the world too much,’ she answered gently. ‘All your other hopes have merged into the hope of being beyond the chance of its sordid reproach.' "

And so we see entrepreneurism as defense mechanism. Some food for thought this holiday season.

Thursday, December 18, 2014

College Football’s Annual Bonus Program

For a college football fan, it’s the most wonderful time of the year. Fresh off conference championships and the Heisman Trophy presentation, momentum is building to New Year’s Day and the shining star atop the tree—kickoff of the inaugural College Football Playoff (CFP). The bottom line: College football is big business. But how does the CFP make it even bigger?

It all starts with a Delaware LLC. CFP Administration, LLC, was organized to manage the administrative operations of the CFP. Its 11 members include the 10 Football Bowl Subdivision (FBS) conferences (American Athletic (f/k/a Big East), Atlantic Coast, Big Ten, Big 12, Conference USA, Mid-American, Mountain West, Pac-12, Southeastern and Sun Belt) and Notre Dame. The LLC is governed by a Board of Managers, consisting of a university president or chancellor nominated by each member, and its day-to-day operations are managed by a Management Committee of the FBS commissioners and the Notre Dame athletics director. The Management Committee appoints an Athletics Directors Advisory Group and the Selection Committee–the group with the real power.    

The Selection Committee consists of 13 individuals, each of whom fits in at least one of five categories: (i) coaches, (ii) student-athletes, (iii) administrators, (iv) journalists, and (v) athletics directors. The Selection Committee met regularly throughout the 2014 season, and on Dec. 7, using criteria such as strength of schedule, head-to-head results against common opponents, and championships won, determined the (supposed) top four teams in college football: #1 Alabama, #2 Oregon, #3 Florida State, and #4 Ohio State.  

The CFP is a four-team playoff. The two semifinal games will rotate annually among the Sugar, Rose, Orange, Cotton, Peach, and Fiesta Bowls. On Jan. 1, 2015, Oregon will take on Florida State in the Rose Bowl, and Alabama will take on Ohio State in the Sugar Bowl. On the line: a trip to the college football National Championship on Jan. 12, 2015 in Arlington, Texas.    

From a revenue standpoint, how does this compare to the final year of the Bowl Championship Series (BCS)? According to the CFP website, “all FBS conferences and independent institutions will receive significant increases in revenue from the CFP.” It’s anticipated that each of the 10 FBS conferences will at least double its annual revenue from the BCS arrangement, in which the baseline distribution in 2013-2014 to the Atlantic Coast, Big Ten, Big 12, Pac-12, Southeastern and American Athletic Conferences was $27.9 million. The CFP revenue distribution plan contains four components: (i) revenue to conferences based on the number of teams meeting the NCAA’s Academic Progress Rate (APR) for participation in a post-season football game, (ii) a base share, (iii) a share for participation in one of the CFP games, and (iv) expenses for participating institutions. The following are estimates from the CFP website of the 2014-2015 revenue distribution: 

  1. Each conference (or independent institution) receives $300,000 for each of its schools whose football team meets the APR. For example, if 10 teams in the Big Ten meet the requirement, the Big Ten receives $3 million.  
  2. Each of the 10 FBS conferences receives a base amount. For those conferences with contracts for their champions to participate in the Orange, Rose, or Sugar Bowl, the base share combined with the full APR is approximately $50 million per conference. Conferences without contracts for participation in these bowls will receive an aggregate of approximately $75 million. Notre Dame receives a payment of $2.3 million if it meets the APR, and the other three independent institutions (Army, Navy, and BYU) will share $922,658.
  3. A conference receives $6 million for each of its teams selected for a semifinal game (i.e., the Big Ten receives $6 million for Ohio State’s participation in the Sugar Bowl), and a conference receives $4 million for each of its teams playing in a non-playoff bowl (i.e., in 2015, the Cotton, Fiesta, and Peach Bowls), with no additional distribution for teams playing in the National Championship.
  4. Each conference with a team participating in a playoff semifinal, Cotton, Fiesta, or Peach Bowl, or National Championship, receives $2 million per game to cover expenses.

Those are some pretty astronomical numbers, especially when you consider they represent earnings almost exclusively for post-season play and fail to factor in each conference’s regular season football revenues or the post-season TV revenue, ticket and merchandising sales, and sponsorship deals. Now that’s a pretty generous annual bonus.

Tuesday, December 16, 2014

It’s Beginning to Look a Lot Like…

Each year, I look forward to two significant commercial events:  the ads during the Super Bowl and the December November October roll-out of things to buy for Christmas. With the Super Bowl ads, it isn’t about the products, but about the presentation. My Christmas thing is about the gadgets.

I don’t necessarily buy them–I give gift cards–but they are fun to look at. Back in the day, this meant marveling over the Mattel® Vacuform™ machine or Chatty Cathy™ doll, an 8-track tape player, or a color TV. Today, it means personal drones, surround-sound chairs, and robots that do everything but clean the dog kennel (which really should be at the top of someone’s development “to do” list).  

For those on your gift list not satisfied with their smartphone camera, there is the Jaunt VR Camera boasting 28 cameras mounted around the perimeter and on the top and bottom of a spaceship-like contraption.  Although it isn’t yet publicly advertised for sale (price is unknown), Wired magazine included it in its list of "15 Futuristic Gifts for the Super-Early Adopter".  For the more price-conscious shopper, there are high definition video recording sunglasses such as those offered by  Lorex and Hammacher Schlemmer. The perfect way to film any activity where your hands are otherwise occupied, such as skiing, sky-diving or surfing, or for the less adventurous, to film your road trip–literally. And while you use your sunglasses to film what is in front of you, the IRIS+ quadcopter (a drone fitted with a camera) can be programmed to shoot aerial views, or film you from behind using the “Follow Me” mode. 

In keeping with one of the trending items this year–speakers/sound systems–Hammacher Schlemmmer offers the Optimal Resonance Audiophile's Speakers ($60,000) that are designed to “deliver optimal sound quality” by, among other things, eliminating the cabinet and thus the unwanted sound that comes from the vibrations of sound bouncing off the cabinet walls. They look cool, but for that price, there must be more to the technology than just the absence of cabinets. For half that price, you can buy the Immersive Audiophile Pod ($32,000)–a semi-enclosed chair with built-in speakers that lets you “feel” the music. It looks like a giant beauty shop hair dryer (think Truvy’s beauty parlor in Steel Magnolias).  Contrast this with The Tranquility Pod that looks like a dog bed inside a big egg, but in fact is a temperature controlled waterbed covered with a memory-foam cushion. This pod is designed to exclude exterior noise while the built-in sound system generates “gentle vibrations and soothing sounds” ($30,000).  

If you’re into “pods,” check out the HI-MACS® Kitchen Pod–a self-contained portable kitchen that looks like a one- or two-person plastic submarine.  It has only a sink, stovetop and a couple of drawers, so doesn’t qualify as a fully functional kitchen, but if it can be closed with dirty dishes in the sink there is some appeal.

On a more practical level, particularly for those of us whose lives are filled with electronic devices, there are the “any device” charging docks, multi-device chargers, car chargers, bike-mount chargers, chargers contained in speakers, clock radios and phone cases, and even a four-device charging paper towel holder “topped with a decorative wine stopper.”  For the person on your list who is completely electronic-dependent but still wants to commune with nature (or whose greatest fear is losing electrical power in a storm), there are portable power stations with solar panels and hand cranks. There are even portable power supplies that not only charge your phones and tablets, but jump start your car without the need of a second vehicle.

For that special person on your list who has everything else, take a look at the Choc Creator V2  (who knew there was a V1?). As the name suggests, it is a 3D chocolate printer. At about $6200, it probably isn’t for everyone–certainly not chocoholics who might be reluctant to eat their fabulous creations–but it would definitely be a conversation piece.

While these items are all interesting, I think that my favorite toy is the Rapid Beverage Chiller/Cooler, a nifty little device that will chill a can of the beverage of your choice in 60 seconds or a 12-16 ounce bottled beverage in minutes. It looks simple to operate, doesn’t take much counter space and you only need to add ice. How great is that?

As for your four-legged friends and family members, our border collie wants (in her words) “AniFetchAutomaticBallLauncherandtheGoDogGoG3FetchMachinebecausetheythrowdifferentkindsofballsdiferentdistancesatreadmillLEDcollar(pink)achipactivateddogdooranyofthetrackingdevicesthatmonitoreverythingIdoincludingthePuppyTweetstagfromMattelthatsignalsyourcomputereverytimeIdoanythingandsendsatweettomyTwitterpage.  If you would let me have a Twitter page…”  Our pit bull wants a really big box of Milk Bones, some thermal socks, and rubber caps for the border collie’s teeth.  If anyone knows where I can get the last item, let me know.