Usha Viswanathan

Wednesday, 20 September 2006 20:00

Patent trolls

A U.S. Supreme Court decision last May handed a victory to patent reform advocates who long have argued that courts should not automatically award injunctions blocking the use of a technology after juries find a patent violation. Observers note the decision comes at a time of widespread misuse of the patent system, particularly in the electronics industry.

“An industry has developed in which firms use patents not as a basis for producing and selling goods, but instead, primarily for obtaining licensing fees,” wrote Justice Anthony Kennedy in the decision. “For these firms, an injunction and the potentially serious sanctions arising from its violation can be employed as a bargaining tool to charge exorbitant fees to companies that seek to buy licenses to practice the patent.”

Smart Business spoke to Anthony Dain, a partner in the San Diego-based law firm of Procopio, Cory, Hargreaves and Savitch, about the significance of the decision to local businesses and why the decision could make it tougher to exact large settlements or license fees from productive businesses.

Will the recent U.S. Supreme Court decision make it harder to file a case of patent infringement?
It shouldn’t have any effect on legitimate lawsuits. However, it will have an affect on lawsuits brought by ‘patent trolls’ — those who only acquire patent rights so that they can exact license fees.

The problem had been that patent trolls would look at major manufacturers and sellers of consumer products as revenue sources, threatening them with injunctions that would effectively stop them from manufacturing the products. Because injunctions were virtually automatic upon a finding of infringement, companies threatened by a patent troll couldn’t risk their companies by defending even questionable patent assertions.

Additionally, many litigation forums favor the patent trolls.

First, a patent certified by the United States Patent and Trademark Office is presumed valid. Therefore, a district court judge starts with that precept. It is up to the defending company to overcome the presumption; this is very difficult to do. In reality, however, an overworked and understaffed United States Patent and Trademark Office has validated many patents even though they do not meet the novelty and non-obviousness requirements for validity.

Second, patents can be very technical, and difficult for non-practitioners to understand. Most district court judges, while masters of the law in general, have little technical or substantive patent background.

With this in mind, most companies could not previously take the risk fighting patent trolls. Now, however, the main arrow in the quiver of the patent troll has been sheathed. Even if a questionable infringement claim is upheld, and even if the presumption of validity is not overcome, the questions now become, ‘Does equity require shutting down the defendant? Why are damages not sufficient to compensate the plaintiff?’

How did the ‘patent troll’ come into being?
Patent trolls spring from weaknesses in the patent system. They have become widespread in the last five to 10 years. Certain enterprising CFOs and lawyers saw that it was easier and more profitable to gain and use patent rights as a revenue source, rather than as a means for gaining competitive advantage in an industry.

Most patent owners are from the industry that their patent supports. They obtain patents as a means to gain a competitive edge. Even though the research and development is expensive, because they work in the industry, they understand the market forces that dictate both cost thresholds and price points the public will bear. Therefore, if industry patent holders charge others to license important technology, they know that they can only charge reasonable royalty amounts to their vendees and competitors.

For example, to manufacture and sell a cellular phone, a company must license literally 1,500 to 2,000 patents. If licenses for these patents are not maintained at reasonable levels, cellular phones would have to be priced at thousands of dollars, clearly not acceptable to the public.

How can a firm defend itself against claims of patent infringement?
A company must first internally or externally assess any assertion brought against it for both validity and infringement. If the assertion has merit, the firm should begin negotiations to license the technology. What results as a fair license will take into consideration such things as exclusivity and whether the holder of the patent rights is offering tangible technology as well as the mere right to practice the patent. On the other hand, if the assessment reveals that the patent(s) asserted are invalid, or that the company does not infringe, the company must prepare to defend itself vigorously.

ANTHONY DAIN is a partner at Procopio, Cory, Hargreaves and Savitch. Reach him at (619) 515-3241 or ajd@procopio.com.

Wednesday, 31 January 2007 19:00

Wellness programs

Wellness programs have long been a mainstay of the insurance industry’s efforts to educate customers about ways to maintain and improve good health. Today, outreach methods are more sophisticated and effective in developing a consciousness about healthy behavioral change habits.

Lunchtime lectures, redesigned cafeteria menus, and wellness services accessible through assessments and media such as online tools, Webcams and podcasts are some of the ways that employees are kept informed about maintaining weight, reducing stress and identifying risk factors that contribute to creating a healthier lifestyle and managing or mitigating chronic conditions.

Smart Business spoke with Rose Gantner, Ed.D., senior director of health promotion for UPMC Health Plan of Pittsburgh, about how businesses can work with the health insurer to improve eating habits and why this is important.

Why is a wellness program important in a company setting?

Research supports that having a work-place culture in which everyone is on board about the measures they can take to improve health saves the company money, increases productivity and helps with employee creativity and retention. A national study conducted by the University of Michigan concluded that for every dollar invested in a wellness program, a firm reaped the equivalent of three dollars in savings. Health promotion programs are a hot trend now as businesses have realized that keeping people healthy is not only good for morale, but has a major influence on their ability to operate with fewer disruptions while engaging employees to mitigate risk factors as well as decreasing health care costs.

What are some ways to spread the word about the importance of eating well?

You can offer a series of different programs after conducting assessments on everything from food served in the company cafeteria, products stocked in vending machines and the level of employees’ knowledge about everything from calorie and fat intake to exercise. Your aim should be to make sure that you target specific interventions that address healthy living. Many of the features of some programs are free while others — such as a weight management coaching program that allows session telephone consultations regularly for up to one year and with follow-up — have an added fee. Reports provide employers with defined goals and outcomes from employee participation and completion.

What does it take for programs such as these to be successful?

Senior management must buy into the effort. Among other factors, their support and leadership demonstrates to the work force that the insurance company is not individually targeting people in order to lower health care costs but reviewing the aggregate data of their population and, more importantly, determining what strategies and incentives can be implemented to improve the employees’ well being. We approach our task in an interdisciplinary way by finding internal champions who can promote the benefits of sustaining healthy weight management throughout an organization.

Sixty-five percent of the American population is overweight, creating far-reaching consequences for most companies. Employers want a work force that continues to perform at its optimal best, but poor eating habits give rise to a whole host of circumstances that affect profitability. Workers’ compensation and disability claims drop, absenteeism is lowered, presenteeism — the ability to focus on the work for longer periods of time — improves and productivity rises.

Studies have shown it takes $45,000 on average to train and retrain a new mid-level worker. If a company can provide the tools that allow an employee to implement a healthy lifestyle or change his eating behavior, the cost of refilling a job that’s lost to illness is lowered substantially.

How do you teach healthy eating?

We’ll go into a company cafeteria and, working with the firm, help redesign the menu so that it offers more items that are high in fiber and a wide selection of foods that is both lower in calories and fat. We will create ‘dining smart’ cards; labels placed adjacent to a food item that show the nutritional information of each serving. Of course, the extent to which we redo the menu also depends on how much a firm is willing to spend to improve an often already-subsidized cafeteria program. We have seen that many companies will charge less for healthier foods, in order to encourage their consumption, and more for high-calorie and fat-laden products.

We offer lunch and learn programs during which UPMC nutritionists and certified health coaches lead discussions on healthy eating during the lunch hour and after work, and as the program spreads companywide, we often find that a number of workers have become enthusiastic about developing healthy eating habits. We then find these champions to show others how they, too, can lose weight and more importantly, maintain the sustainability of weight loss.

ROSE GANTNER, Ed.D., is the senior director of health promotion for UPMC Health Plan in Pittsburgh. Reach her at (412) 454-8571 or at gantnerrk@upmc.edu.

Wednesday, 31 January 2007 19:00

When employees turn

Employment practices liability (EPL) suits have mushroomed since the early 1990s, following Anita Hill’s allegations of sexual harassment during the Clarence Thomas Senate confirmation hearings and the passage of certain amendments to the Civil Rights Act — both of which occurred in 1991.

EPL claims can include a wide range of allegations, but most involve some form of wrongful termination/discharge, sexual harassment or discrimination. Due to the restrictions contained in most Commercial General Liability (CGL) policy forms, stand-alone EPL policies have become an important component of a company’s overall insurance portfolio.

Smart Business spoke with Jim Lopiccolo, vice president of DLD Insurance Brokers Inc., about the value of employment practices liability insurance to today’s business owner.

Why did CGL insurance become insufficient for most companies in providing protection for EPL claims?

The Civil Rights Act of 1991 substantially increased the liability exposure to employers by, among other things, giving the complaining party the right to a jury trial and awarding compensatory and punitive damages. This resulted in a dramatic increase in the potential frequency and severity of EPL claims, which CGL policies were not designed to address.

For example, many CGL policies have relatively low premiums and pay defense costs outside of (or in addition to) the basic limit of liability. Early on, because EPL claims often include allegations such as emotional distress, mental anguish and/or humiliation, some CGL carriers were forced to respond under the bodily injury or personal injury portion of coverage.

However, most Commercial General Liability carriers now have specific exclusions to clarify it is not their intent to cover claims arising out of the employer-employee relationship.

What does EPL insurance cover?

EPL insurance typically covers the directors, officers, employees and the company itself for defense costs and any resulting damages arising out of claims brought by employees alleging wrongful termination, sexual harassment and/or discrimination. Coverage for punitive damages may also be included, where insurable.

Do claims from nonemployees ever trigger EPL coverage?

Claims brought by nonemployee third parties alleging discrimination and harassment are on the rise — as evidenced by some very large cases against national rental car companies, restaurants and others. Customers, vendors, tenants or anyone who does business with your firm could be potential plaintiffs. In response, EPL carriers will selectively include third-party discrimination and harassment coverage — typically for an additional premium charge.

Who buys EPL insurance?

Although cases against big public companies tend to get the most press, employment claims can be among the most frequent faced by private companies and nonprofit organizations. Many of the key federal employment laws apply to employers with more than 15 to 20 employees; however, many states have laws that apply to smaller employers, create additional protected statuses (like sexual orientation, marital status and residency), and allow for broader damage awards.

The attorneys’ fees to defend a claim by a single plaintiff alone can reach in excess of $50,000, with an additional $100,000 or more paid in damages. These amounts can be much higher if the case alleges particularly egregious behavior. As such, we believe it is prudent for employers of all sizes to at least explore EPL coverage.

Is EPL insurance expensive?

Due to substantial competition in the EPL insurance marketplace over the past several years, this coverage has become very affordable for most employers. Numerous specialty carriers are set up to provide coverage for companies with fewer than 100 employees, and coverage for the smallest employers can start at $2,500 in premium with deductibles of $2,500 to $5,000.

How difficult is it to obtain a quotation?

It is actually quite easy in most cases. Many carriers have short-form applications available, which simply inquire about the location of the insured, nature of operations, number of employees and claims history. Larger employers would be required to provide a copy of the company’s financial statements, employee handbook, employment application, EEO-1 report and other supporting materials.

JIM LOPICCOLO is vice president and director of executive liability and financial services at DLD Insurance Brokers Inc. Reach him at (949) 553-5681 or jlopiccolo@dldins.com.

Sunday, 31 December 2006 19:00

High-pressure area

The powerful hurricanes that struck the nation’s Gulf Coast and Southeastern states in recent years remain an undying memory for those who survived the fierce gales.

In Florida, recovering from the financial blows wreaked by the disasters has been equally tough. Scores of commercial interests are bereft that many insurance companies will no longer pledge support to salve the financial wounds that will rise from a natural disaster, leaving building owners and their tenants frantically searching for carriers willing to take on risk in a state constantly ravaged by fierce storms. According to C. Graham Carothers, Jr., a partner in the Real Estate and Institutional Lending Practice Group at Shumaker, Loop & Kendrick LLP, insurance issues are headed to court.

Smart Business spoke with Carothers about the challenges faced by Florida’s legal community due to the recent rash of weather-related damage.

How have insurance and real estate disputes impacted your firm and the legal community at large?
In our state, a commercial building owner typically passes through the cost of property taxes and insurance to tenants on a pro rata basis. We have seen cases where tenants are called in default under their leases because they have been unable to pay the increased insurance costs. Commercial lenders are not always willing to negotiate with their borrowers when it comes to the coverage levels required under existing mortgages, and many require ‘full replacement value’ coverage, which under the new underwriting models require much higher coverage levels than have been required in the past. Many in the commercial sector have resorted to self-insuring when allowed by their lenders, or to seeking coverage from international underwriters due to the crisis faced by domestic insurers.

We have seen some cases in which tenants, property owners and borrowers are in situations where enforcing existing obligations would be commercially unreasonable and/or impossible to perform.

These disputes are of a different type than what we’ve historically faced. We certainly do everything possible to avoid litigation, but these issues have started to spark litigation in many circumstances. In instances where tenants or potential buyers try to negotiate, landlords and lenders are not always willing to.

Under these difficult conditions, how must the businessperson plan his efforts to do business in Florida?
Several months ago, our state government created a special committee of businesspeople, insurance industry representatives and government officials to study the situation and issue a comprehensive set of findings and recommendations to the governor. The committee’s report may recommend a special legislative session specifically devoted to addressing the current crisis.

Until then, property owners, investors and commercial tenants all need to focus on the cost of insurance in budgeting for the coming years. The biggest challenge in selling, leasing and financing property in Florida today is obtaining adequate insurance coverage at prices that make sense.

How then do businesses manage to operate in a state that is routinely touted as one of the nation’s fastest-growing?
It is becoming increasingly difficult for many property owners. The state-run and state-subsidized program, Citizen’s Insurance Co., was designed to be an ‘insurer of last resort,’ but is now viewed as one of the very few available options for many people. The huge payouts following the hurricanes of the last two years, which amounted to billions of dollars, revealed that many properties were underinsured and thus resulted in the modifications to underwriting risk models used by insurers. At the same time, premiums for windstorm coverage have climbed by 200 percent or more in the last year.

In my own practice, we have seen a number of commercial transactions fall through in the last few months because either the buyer is unable to secure property insurance or the costs of obtaining such insurance is prohibitively expensive. It often takes weeks to obtain binders for property coverage whereas in previous years insurance could have been bound within a few days.

What recommendations are you making?
We’ve been making recommendations that buyers allow enough time in their due diligence period to shop around for insurance, because it’s taking more time than it has in the past. We also recommend that they try to get quotes for property insurance before they spend large sums of money on other due diligence issues.

The experts are saying that there are no easy solutions for the insurance crisis; we'll have to fix this over the course of a few years.

C. GRAHAM CAROTHERS, JR., is a partner at the Tampa offices of Shumaker, Loop & Kendrick LLP. Reach him at (813) 227-2349 or at ccarothers@slk-law.com.

Wednesday, 31 January 2007 19:00

Packaging applications

Making money is hard work, and raising the capital to get a business going can be equally challenging, unless you know how to package a loan application. The path to lending is strewn with stories of people with right intentions and none of the know-how of how to sell themselves on paper.

Organizing data, paying attention to details and demonstrating that you, the borrower, understand your business always appeals to a banker, says Patrick Ramsier, managing director of commercial lending at ViewPoint Bank. It’s all in the packaging, he says.

“It’s not a case of form over substance,” says Ramsier. “It’s a matter of being thoughtful, of giving the lender all the information needed to effectively assess the risk he or she plans to take on.”

Smart Business spoke with Ramsier about the do’s and don’ts of commercial lending and tips he could provide a prospective borrower to successfully obtain a loan.

The availability of financing is strong. How can this feature of the marketplace influence a borrower’s mindset?

It all depends on how sophisticated the borrower is. If he reads many business and trade publications, he might get the view that there is a lot of capital floating around and that obtaining financing should be easy. But he shouldn’t think this way.

A shrewd borrower will always want the best deal, and he will shop around for that. In doing so, he will go into a banker’s office prepared, having in hand a set of documents over and beyond a loan application — one that convinces the banker of his business acumen and creditworthiness. What we look for is a detailed and organized presentation that makes our review easier.

How can a borrower demonstrate to the lender that he or she represents a good risk?

We’re often looking at more than the financial numbers. We’re also looking for subjective information, such as the history of the firm; rsums of the firm’s top officials and a summary of their industry experience; an overview of their long-and short-range marketing goals or a description of the demographics they are targeting. Such pieces of information help fill in the picture and help us to see whether the borrower makes a good risk.

In effect, the process we undertake is not much different than if you were to lend money yourself. Surely you would want to see some numbers as well as to learn the background of the person you’re lending to.

For example, a borrower could request money to cover a payroll. But if he does not fully explain the circumstances that create a shortfall in cash flow, I’m not comfortable with that presentation. Instead, if he was to explain in writing that he’s experiencing a timing issue with receivables from his biggest national customers — that these clients, be they the U.S. government, FedEx or whomever, are paying every 90 days, for example — then I’ll better understand the conditions he’s operating under. I’ll eventually come to learn that he has a solid business model, and that he could be a good risk.

Do borrowers sometimes get overconfident that — having successfully secured loans in the past — laying out the numbers every time is not necessary?

The bottom line is that the strength of a business is affected by its borrowing costs. Any time you can lower your borrowing costs, it’s going to be in your benefit. To do that, you need to be as prepared as possible, and that will help you get the best deal possible.

Sure, banking is a relationship business. But that fact should not make you overconfident that you’ll both get a loan and get it at the best price. Always be prepared to present the best possible picture of yourself and your business. For example, if your company has done better than expected and you show that you understand your business, say so confidently.

Banks want your business, but you want a loan that works for you. Your best chance at the best deal is to tell the banker the whole story.

How often do you see a poorly thought-out loan application?

We see it about 25 percent of the time. I can’t say enough about how a borrower is affected by sound loan package. It takes a lot of guesswork out of the equation when we see an application with relevant supporting documents. I don’t mean one that just looks pretty; it has to be something that speaks to the management of the business. It shows me that the borrower knows what he or she is doing and is determined to both grow the business and to pay back the debt.

PATRICK RAMSIER is managing director of commercial lending at ViewPoint Bank. Reach him at (972) 801-5832 or patrick.ramsier@viewpointbank.com.

Sunday, 31 December 2006 19:00

Buy or lease?

As businesses grow and seek additional space to house their expanding operations, a question they must frequently consider is whether to buy a building and enjoy the benefits of a rising real estate market or lease a structure and leave the chore of maintenance to someone else.

Business owners often make a default assumption that leasing is the best alternative, says Kenneth Dill, vice president at Cresa Partners Orange County, a corporate real estate advisory firm. But purchasing a building could be a wiser choice, and only a thorough financial analysis can reveal the risks and benefits of ownership.

“Most executives know the ins and outs of their business line extremely well, but are less skilled at making conclusions about the real estate market and developing strategies that help them get the best deal on a property,” Dill says.

Smart Business spoke to Dill about how companies should approach the decision of owning versus leasing commercial property.

Why would someone want to lease a property instead of purchasing it?
Basically, leasing seems attractive because you can execute a lease with no money down, you have no responsibility for the management of the building, and you often have the right to find a sub-tenant to absorb unused space. Also, there are some tax benefits to leasing, and the monthly payment — even with escalation clauses — is predictable.

However, more and more leases are created with increases of 3 percent to 4 percent a year, regardless of where inflation stands. Even under such a scenario, for someone who needs a new building right away, the whole approach just appears less cumbersome. In fact, a business owner who would never consider renting an apartment for his personal use will often consider leasing a building.

What are the benefits of ownership?
In some ways, it’s no different from you or me deciding to buy a house. But often the value is not readily apparent to a business. Among the most obvious benefits are that you can make renovations to the structure; the operating hours are flexible; the problem of complaining neighbors is eliminated; and the costs are better defined and static because your payments stay the same while the mortgage interest is tax deductible. Additionally, you can enjoy the benefits of depreciation, even if it is spread out over decades. And you never have to worry about the landlord not renewing your lease, an especially common problem in markets with strong demand. Remember that there might be someone who will be willing to pay more for your space.

If you believe that the market for real estate will increase, and you can project your company’s space needs for the next five to 10 years, it’s to your benefit to buy.

What are some of the barriers to buying?
The biggest hurdle is securing a down payment while the next-biggest challenge is managing the building. The first issue could be overcome with Small Business Administration loans and other financing mechanisms. However, the key determinant in the decision to buy or lease is the ability of a business to keep generating a good cash flow. What we do is make projections over a 10-year horizon based on market conditions and a firm’s cash flow to determine which option is the best.

How do you do that?
We look at a number of factors such as maintenance costs, the cost of servicing a loan versus a lease, and the net present value of future cash flows. In other words, by understanding all the risk parameters that we can, we’re able to break out in a spreadsheet the costs associated with each option.

Then, there’s the matter of ‘kicking the tires.’ After we personally identify a series of properties, we preview these alternatives to arrive at a short list. The next step is to send out an RFP to select building owners that asks a series of questions about the possible uses and condition of their building. This is valuable because we always want to have something in writing from them in which they assess the quality of their structure. Based on their answers to our questions, we narrow down the facilities to consider. We will tour the building jointly with our client, allowing him to ask the owner questions such as how to re-configure the building to house his operations while we then pinpoint the various real estate issues that could arise from the deal. We also get experts to evaluate the integrity of the buildings under consideration. In the process, we hope to identify areas of concern to a buyer, such as the state of the HVAC units or the electrical wiring.

KENNETH DILL is vice president at the Newport Beach offices of Cresa Partners Orange County. Reach him at (949) 706-6630 or KDill@cresapartners.com.

Sunday, 31 December 2006 19:00

The value of innovation

Industry constantly trumpets the value of innovation. Consider the path that microchips followed in the years between the introduction of the personal PC to the miniaturized music players that clip onto collars of millions of tech aficionados worldwide.

But studies show that between 50 percent and 90 percent of new products fail to reach their potential of meeting company expectations and fall ignominiously into the category of an “also-ran” product. But does innovation always need to happen within the space of a brilliantly conceived, heretofore unseen product that captures the fancy of millions?

According to Venkatesh Shankar, Coleman Chair in marketing at Texas A&M University’s Mays Business School, developers cannot expect to hit a home run with every product or service they create. “Look to add incremental value to existing lines, generating in the process a mixture of products and services that provide even higher benefit to end-users,” he says.

Smart Business spoke with Shankar about the nature of innovation in today’s competitive marketplace and how businesses can help achieve a higher rate of success with their new product introductions.

How differently can we view the concept of innovation today?

Only rarely does a company develop a good or service that creates an entirely new market or so reshapes a market that it experiences unforeseen profits for a considerable length of time. Innovation is not just coming up with a new gadget, which is the way people typically think about the concept. Innovation also can occur in business models, existing processes and overall marketing strategy. Many times, adding a few bells and whistles that are incremental in nature to the mixture of existing product lines will generate significant benefits to the bottom line.

What is really needed in most organizations is a culture of innovation that gives the kind of autonomy that allows people to become ‘intrapreneurial’; that is, a system of incentives that motivates employees to build upon the strengths of what already exists. Some of these innovations can be hybrid — an innovation that combines product and service lines to create new applications.

Essentially, the concept involves the exploitation of an idea for a performance by both good and service that is perceived by customers to offer new benefits that results in monetary gains for the innovator from both the good and the service.

Where have we seen examples of hybrid innovation?

In the business-to-business sector, we see many cases in which goods marry with service offerings to create an even stronger brand. Consider Xerox, which first built copiers and printers but then added supplies, maintenance contracts, and configuration and user support. Or 3M, which has institutionalized a culture of innovation. Today, it has more than 60,000 SKUs, the result of building upon an existing slate of products. And there’s Google, which asks its work force to come up with a Googlette; a new business idea one day in the week.

In all cases, the firms have set in place an incentive system to motivate employees to contribute to the overall growth of the organization. A significant amount of revenue can be generated from a hybrid innovation; but the trick is to be clear on which of these hybrid solutions will work.

What does it take to implement such a concept?

Firstly, your staff needs to be customer-focused and approach its work with a mindset we call ‘adaptive innovation.’ Firms must closely scrutinize their customers to discover what drives their business success. In doing so, you have to be able to find your customers’ ‘pain points.’ That is, discover problem areas that exist within a client’s organization and seek solutions to those problems. Many businesses have been born to address pain points, and often such efforts have succeeded to a far greater level than attempts to create an entirely new product.

The notion requires you to align your marketing strategy to focus on customer needs and tie the innovation strategy around it. Which new products ought to be developed to satisfy market needs, how to test them, and how to quickly get new developments out into the market. This could mean encouraging your R&D team to focus solely on pain points and getting your sales and marketing team more attuned to the weaknesses in their customers’ operations. Such a mindset allows you, the product or service provider, to get out of the problem of having to develop too many products, many of which could fail. Instead, the method asks you to focus on products or solutions that can fill an immediate need.

VENKATESH SHANKAR is the professor of marketing & Coleman Chair in marketing at the Mays Business School at Texas A&M University. Reach him at vshankar@mays.tamu.edu or (979) 845-3246.

Friday, 24 November 2006 19:00

Mergers and acquisitions

Most merger and acquisition deals (M&A) start with a letter of intent, with one party (usually the buyer) submitting its proposal to the other, to lie down the foundation of the transaction. Letters of intent are generally short and informal, and, accordingly, often are drafted and negotiated directly by the principals to the transaction. However, parties would be well-served to consult their lawyers prior to executing the letter.

“All too often, clients give up significant negotiating leverage by signing a letter of intent without running it by their lawyer,” says Julio C. Esquivel, a partner at Shumaker, Loop & Kendrick LLP.

“These miscalculations can often complicate and prolong negotiations and sometimes lead to the failure of the transaction or even to litigation.”

Smart Business talked to Esquivel about the importance of the letter of intent and how it can most effectively be used in M&A transactions.

What is the purpose of the letter of intent?

The letter of intent memorializes the preliminary agreement of the principals and in that fashion allows them to take their negotiations to the next level. It does so by not only summarizing the parameters of the proposed transaction, such as price and closing conditions, but also by setting forth certain safeguards that promote continued dialogue such as nondisclosure and no-shop provisions.

Additionally, letters of intent may allow the parties to begin the process of obtaining governmental and other third-party approvals necessary to close the transaction.

What is the most common mistake that parties make when it comes to the letter of intent?

Often, having reached a handshake agreement, the parties want to maintain the momentum of their negotiations, so they rush to sign the letter of intent. This is especially true when one of the parties is eager to publicly announce the agreement. But even though the letter may be meant to be preliminary, the words in that letter can have a profound impact on the subsequent negotiations, providing one party with a psychological — if not legal — advantage over the other.

For example, sellers often sign letters of intent that contemplate an asset sale without fully appreciating the tax implications of such a structure. Later, having conceded that point in the letter of intent, it becomes very difficult to convince the buyer to restructure the deal.

Are letters of intent generally nonbinding?

They can be drafted to be either binding or nonbinding, but most commonly are a combination of the two, with some provisions being purely a reflection of the parties’ preliminary intentions and others having the weight of contract. It is critical that the letter specify which provisions are intended to be binding and which are not; otherwise, the parties may find themselves litigating this issue.

Which provisions are typically binding?

Typical binding provisions include confidentiality and other limitations on a party’s ability to publicly disclose the negotiations, as well as the standstill or no-shop provision, which is a provision that limits the seller’s ability to solicit or accept competing offers for a certain period of time. This allows the buyer time to complete its due diligence and to negotiate the definitive documentation without fear that the seller may simultaneously be negotiating with others.

What about the purchase price?

The purchase price in the letter of intent is typically nonbinding. Yet, for the reasons already mentioned, and because it is usually the key term to the deal, particular attention should be paid when drafting this provision.

In an all-cash deal, drafting the purchase price should be straightforward. However, when the circumstances merit it — for example, when the purchase price is complicated by the existence of an earnout, holdback or equity kicker — the parties should carefully consider how much additional detail should be included so as to avoid later disputes. Should the letter include the strike price, vesting schedule and termination date for any warrants to be paid at closing? Additionally, should the parties specify whether the earnout will be calculated before or after interest and taxes or based on generally accepted accounting principles (GAAP)?

Legal counsel can assist clients in identifying these and other significant issues that may need to be addressed in the letter of intent and can ensure that the letter meets the client's objectives. For these reasons, parties should discuss their objectives with their counsel prior to signing a letter of intent.

JULIO C. ESQUIVEL is a partner at Shumaker, Loop & Kendrick LLP in Tampa. Reach him at jesquivel@slk-law.com or (813) 227-2325.

Friday, 24 November 2006 19:00

Foreign taxes

When a U.S. firm enters into an international joint venture while conducting business within American shores, the tax implications that arise from the partnership grow substantially complex. Thus, businesses need to be aware of when their foreign partnerships will create a taxable situation. Could a manufacturing agreement, a sales and distribution contract or a financing agreement with a foreign-based company create a partnership for tax purposes?

Patrick W. Martin, head of the tax team at San Diego-based Procopio, Cory, Hargreaves & Savitch LLP, notes that the answer may not be clear to the U.S. business owner. But one thing is certain: such firms likely will engage in a higher level of reporting, both of an informational nature and in an effort to meet IRS rules concerning reportable events.

Smart Business spoke with Martin about business arrangements between U.S. companies and their foreign counterparts and some of the scenarios under which an American entity would face a taxable situation.

When might a partnership exist for U.S. tax purposes?

The words ‘joint venture’ and ‘partnership’ are often used interchangeably. Generally, a joint venture is a partnership that has one specific project or goal. An international joint venture or ‘partnership’ for U.S. tax purposes may exist when a U.S. firm has some sort of contractual arrangement with another non-U.S. firm. For example, a distribution arrangement in the U.S. that’s conducted with a foreign country could be considered a partnership for U.S. tax purposes. Or a joint venture with a company that assembles products for distribution to the U.S. could also be considered a partnership for U.S. tax purposes — especially when the entities have some sort of sharing of profits and losses.

A case in point is the maquiladora, a Mexican manufacturing entity created under Mexican law, which allows a factory to receive imported materials and equipment free of duties and tariffs. The maquiladora then either assembles or manufactures the product for resale to the foreign partner. At one time, the American company that sold material to the Mexican entity paid U.S. taxes and taxes to the Mexican government.

Depending upon how the joint venture is structured, there may be no foreign tax credit to the U.S. entity, creating a double taxation problem against the American firm. Ideally, income taxes paid to the Mexican or other foreign government should be structured to offset — and can be credited against — U.S. taxes.

A U.S. tax partnership could also exist when the U.S. partner and the foreign partner wholly operate in the U.S. or when they operate exclusively in another country. The consequences then include the need to meet information reporting requirements in the U.S. of both the domestic and possibly the foreign partner.

When is a joint venture not a partnership for U.S. tax purposes?

Businesspeople often talk about having partnerships with another firm, usually an industry leader or other brand-name foreign company, when actually all they have is a relationship to provide a good or service at a set price. This is different from a partnership for tax purposes because the situation does not give rise to specific tax-filing requirements.

If the business relationship is a partnership for U.S. tax purposes, how will it be treated under the laws of another country?

One country may not treat an enterprise as a partnership; rather it may view the business as a separately taxed entity. Such businesses, for tax purposes, are referred to as a hybrid entity. One country sees it as a partnership and the other as a corporation. In a hybrid circumstance, you might not get credit for foreign taxes paid, thereby subjecting the enterprise to double taxation.

Such inconsistencies in the tax system make it necessary to carefully plan any joint venture that crosses any national border. You first have to understand the tax consequences your business activity will create, and then plan accordingly so that you get the cross-border tax results you want.

When might U.S. income tax treaties with other countries apply to an international joint venture?

Income tax treaties typically reduce tax rates from flows of incomes, royalties and dividends. But income from certain forms of business activity do not garner treaty benefits. For example, a U.S. developer may be able to credit income taxes paid to Mexico from the gain of the sale of real property on the U.S. return. But the tax rates are different in the two nations. As a result, the American firm will still have to pay a different tax rate. If the effective tax rate in one country is 35 percent but in the home country the top rate is 28 percent, the business owner may have to pay the difference to his country’s government. Also, each country treats depreciation and realized income differently, which results in a lot of mismatches in the amount of income you report.

PATRICK W. MARTIN is a partner in the San Diego law offices of Procopio, Cory, Hargreaves & Savitch LLP. Reach him at (619) 515-3230 or pwm@procopio.com.

Friday, 24 November 2006 19:00

On the cutting edge

California’s wealth of top research institutions and the talent they attract have given rise to scores of companies whose names have morphed into household words in just a few years.

In the life sciences and biotech industries, upstarts of a decade ago are now industry leaders, having cracked through a once-lofty barrier through product innovation, strong management skills and the backing of venture capitalists.

Unlike tech firms that moved from basement bedrooms and garages into high-rises, these scientific firms have less flexibility housing their operations. Zoning ordinances, community sentiment, plumbing, electrical and other infrastructure issues all influence where they can establish business. Because of their unique needs and the occasional obstructions that towns and cities may place in their paths, setting up shop can be harder for them. Needed are the skills of a seasoned commercial real estate pro if firms in these sectors are to take their business concepts and turn them into reality.

Smart Business spoke with Jonti Bacharach, vice president at CRESA Partners Orange County, a real estate advisory firm that represents tenants and space users, about the value that professionals bring to the “house-hunting” process for life sciences and biotech companies.

Why can’t life sciences and biotech companies just move into a high-rise or other available office space?

At the most basic level, life sciences companies do not consider high rises an option because their occupancy costs are so high. Also, because these are rather traditional office environments, a landlord likely will not allow them — because of unique space needs — to operate there.

Life sciences and biotech firms almost always require a significant build-out of raw space. Their biggest cost arises in constructing labs within an existing space. Here we need to adequately manage significant reconfiguration of standard building construction systems to accommodate the demands, unique to biotech/lab operations. Service or consulting firms, which typically occupy high rises, almost never face these challenges.

Because biotech companies work with material that area residents could feel would have an adverse effect on the environment, they must be housed in a community that accepts the nature of their work. Landlords, other tenants and civic leaders must be supportive of their business.

A good adviser can also point out the many benefits these firms bring to the community, including higher tax rolls and the prestige they have garnered as they sit on the cutting edge of their industries. A skilled real estate adviser and systems specialist can provide insight and leadership that will result in many hundreds of thousands of dollars in savings to the organization.

How do you find life sciences companies the structure they need?

It’s very rare for a life sciences company to move into a building without making some modifications. Generally, we’re looking at a ‘box,’ such as a warehouse or a flex building, which is a structure designed to accommodate businesses as disparate as light manufacturing companies and wet labs.

Several factors must be taken into consideration when determining the optimum facility solution, including geographical parameters of the requirement. Does the company need to be close to airports, research institutions or hospitals? Cost is always a consideration, as well as zoning restrictions and waste disposal, among myriad other issues.

How can life sciences companies reconfigure raw space?

First by asking the right questions, illuminating unforeseen cost considerations, and then creating a strategic plan designed to effectively address each issue. Most such companies have unique operational requirements that must be addressed in the context of their specific business. Our approach is to provide a broad base of highly specialized senior level specialists who will oversee and manage this process in order to reduce facility and operational-related expenses, while also ensuring that maximum efficiencies are realized. This also ensures that the project will come in on time — and, often, under budget.

JONTI BACHARACH is vice president in the Newport Beach offices of CRESA Partners. Reach him at (949) 706-6600 or at jbacharach@cresapartners.com.

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