Stubbs Alderton & Markiles, LLP announced that it advised client Beats Electronics LLC in its definitive agreement to reacquire the minority stake in Beats held by HTC Corp.  Stubbs Alderton also represented Beats in a minority investment transaction by The Carlyle Group (NASDAQ:CG), the global alternative asset manager.  Carlyle will work with the Beats management team to continue expanding the brand and building the business both domestically and internationally. The transaction is expected to close in the fourth quarter of 2013.

Beats Co-Founder and Chief Executive Officer Jimmy Iovine said, “These transactions represent the evolution of the financial strength and significant growth prospects of Beats. Carlyle is a fantastic investment partner and we look forward to building the next chapter of Beats.”

SA&M Partner Scott Galer advised Beats Electronics LLC in this transaction.

To read the full press release, click here.

Stubbs Alderton & Markiles, LLP announced that it advised client Equipois in its acquisition by Granite State Manufacturing,  a leading contract manufacturer of specialized equipment for the defense, medical, semiconductor, and industrial market segments.  Equipois is the award-winning developer of zeroG and X-Ar exoskeletal arm technologies.

Equipois' patented technology enables workers to maneuver tools and other objects as if weightless, boosting productivity and eliminating workplace injuries for a wide range of industrial applications. The technology has won recognition for its innovation, including a 2011 Wall Street Journal Technology Innovation Award. Naval Sea Systems Command (NAVSEA) has utilized Equipois technology in their efforts to create a modern-day "iron man", providing sailors with the ability to minimize the time and effort required for labor-intensive maintenance such as preservation work on a ship's hull. Many of the world's largest companies in aerospace, defense, automotive, heavy machinery, and other manufacturing industries are implementing the technology as a significant enhancement to human performance and safety.

Eric Golden, CEO of Equipois Inc., said "Granite State Manufacturing enjoys deep expertise serving the industries where our technology adds the most value. I am delighted that Equipois has found an owner that will invest in the capabilities of the technology and bring the products to the next level."

SAM Partner Louis Wharton advised Equipois in this transaction.

 

Update: 

The Origin Humble Bundle offer has finished, with over 2 million bundles sold and over $10.5 million raised, the majority of which will go to charity.

The Humble Bundle Twitter account confirmed the figures last night.  "The Humble Origin Bundle has closed with 2.1+ mil bundles sold & $10.5+ mil in sales! Thanks for helping make Humble Bundle history!"

Congrats HB!

Original Story

SAM Client Humble Bundle, has raised $7.2 million for charity with nearly 1.4 million sales of their Humble Origin Bundle.  While proceeds of these sales usually go directly to EA, money will instead be given to charities chosen by both EA and Humble Bundle, including the Human Rights Campaign; Watsi; the San Francisco AIDS Foundation; the American Red Cross; or the American Cancer Society.

To read the full article on this incredible effort, click here.

For more information about our Interactive Entertainment & Video Games practice, please contact Greg Akselrud at (818) 444-4503 or

Los Angeles, August 22, 2013 -  Stubbs Alderton & Markiles, LLP has announced that it advised client Morphlabs, Inc., the leader in efficient and powerful OpenStack(R) solutions for service providers and the enterprise, in its $10 million Series D financing.  The round, which was led by Tallwood Management and Entropy Research Lab and also included existing investor G2iG, brings the total capital raised by the company to $22.5 million since inception. Morphlabs will use the proceeds from this round to extend the company's leadership position in the Asia OpenStack market through an aggressive training and seminar program, and through its partnership with NEC.

To read the full press release regarding the funding, click here.

 

Louis Wharton is a Partner of the Firm. Louis' practice focuses on advising startup, emerging growth and middle market companies across a spectrum of industries in securities compliance, corporate finance, mergers and acquisitions and general corporate matters.  He counsels clients in the technology, internet/e-commerce, pharmaceutical, apparel and entertainment industries, among others.

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Q.  I’m considering engaging a finder to help me complete my capital raise.  What issues should I bear in mind when discussing the engagement?

 A.  The staff of the Securities and Exchange Commission (SEC) has stated that a proposed arrangement whereby a finder provides to an issuer services related to raising funds to finance its operations and development, including making introductions to individuals and entities interested in providing such financing, where the finder’s compensation is based on a percentage of the capital raised from such investors, requires the finder to register as a broker-dealer.  The Securities Exchange Act of 1934, as amended (Exchange Act), provides that any broker effecting transactions in securities, or inducing or attempting to induce the purchase or sale of securities, must be registered with the SEC, and defines a broker as any person engaged in the business of effecting transactions in securities for the account of others.  The staff has indicated that a person may be ‘engaged in the business’ by receiving transaction-related compensation or by holding itself out as a broker-dealer.  A person may ‘effect transactions’ by assisting an issuer to structure prospective securities transactions, by helping an issuer to identify potential purchasers of securities, or by soliciting securities transactions.

       The staff also noted that a finder’s intention to introduce only those persons with potential interest in investing in the issuer’s securities implies that the finder anticipates both pre-screening potential investors to determine their eligibility to purchase the issuer’s securities, and pre-selling the issuer’s securities to gauge the investor’s interest.  Moreover, the staff has indicated that the receipt of compensation directly tied to successful investments in the issuer’s securities by investors introduced by the finder (i.e. transaction-based compensation), would give the finder a “salesman’s stake” in the proposed transactions and would create heightened incentive for the finder to engage in sales efforts.  Pre-screening and pre-selling activities, along with the receipt of securities commissions or other transaction-based compensation, are hallmarks of broker-dealer activity, requiring registration.

       Accordingly, any person receiving transaction-based compensation in connection with another person’s purchase or sale of securities typically must register as a broker-dealer or be an associated person of a registered broker-dealer.

 Q.  What are the consequences of engaging an unregistered broker as a finder?

 A.  Engaging an unregistered broker-dealer may create a rescission right under federal and state law in favor of the purchasers of the issuer’s securities, potentially requiring the issuer to return the money it received in its capital raise.

      Section 29(b) of the Exchange Act provides that every contract made in violation of the Exchange Act and every contract the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of the Exchange Act, shall be void, as to any persons who, in violation of any such provision, rule or regulation, shall have made or engaged in the performance of any such contract, provided that that no contract shall be deemed to be void by reason of this section in any action maintained in reliance upon this section, by any person to or for whom any broker or dealer sells a security in violation of the Exchange Act’s requirements regarding registration, unless such action is brought within one year after the discovery that such sale or purchase involves such violation and within three years after such violation.

      While Section 29(b) directly applies to the finder, with the possibility of voiding the finder’s engagement agreement, the language also refers to claims maintained by investors to whom the finder sold securities in violation of the Exchange Act’s broker-dealer registration requirements, creating the possibility that an investor could assert a claim for rescission of their investment within 3 years after the date the securities are purchased by the investor and one year after discovery of the violation.

       California Corporations Code Section 25501.5 also provides that a person who purchases a security from or sells a security to an unlicensed broker-dealer may bring an action for rescission of the sale or purchase or, if the plaintiff or the defendant no longer owns the security, for damages, providing a direct right of rescission to investors.

       The use of an unregistered broker-dealer could also result in difficulties subsequently registering the issued securities for public sale.  Most registration statements require the issuance of a legal opinion indicating whether the securities being registered will, when sold, be legally issued, fully paid and non-assessable.  The issuer’s use of an unregistered broker-dealer and issuance of securities in transactions that violated the requirements of the Exchange Act will prevent the issuer’s counsel from issuing the required opinion.  In addition, the unregistered broker-dealer’s contact with unaccredited investors in violation of available federal and state securities laws could result in the loss of exemptions from registration.

       Accordingly, given the risks of rescission rights, the inability to subsequently register the issued securities and the potential loss of available securities exemptions, issuers should refrain from engaging finders for transaction-based compensation unless such finders are registered broker-dealers.

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For more information on this or other related topics, contact Louis Wharton at (818) 444-4509 or

 Do you have a question for one of our attorneys?  Send your questions to to be featured in future Questions columns.

Canada, because of its geographic proximity to the United States, shared language and similar business culture offers a logical expansion opportunity for companies that have successfully developed, marketed and sold a product or service in the United States.  In 2012, bilateral trade between the United States and Canada for goods and services totaled approximately $742 billion, representing more than $2 billion of goods and services crossing the border every day, and Canada is currently the United States’ largest goods trading partner. There are a number of ways to export your products or services to Canada, each of which require differing levels of management, capital commitment and expertise.

Selling to domestic buyers, who export your product

Selling to domestic buyers who export your product offers a simple way to sell into Canada, since the domestic purchaser handles all aspects of export administration and assumes all risk associated with exporting.  Examples of domestic buyers that purchase for export include parties who represent Canadian customers, such as Canadian government agencies, distributers or retailers.  Another class of buyers includes intermediaries, such as export management companies, who are responsible for finding Canadian purchasers for your products.  Better export management companies specialize by product or by market, and because of their specialization and existing networks, can significantly reduce the time and resources required to enter a new territory like Canada.

Direct Exporting

Accessing the Canadian market directly provides a number of significant benefits for a company, including enhanced control over the export process, the ability to gain valuable insight into foreign customers and competition and potentially higher profit margins.  Direct exporting, however, can be much more labor and capital intensive as foreign representatives need to be identified, and working relationships established.

One method of direct exporting is entering into an arrangement with a Canadian sales representative, who then locates and introduces your company to potential customers.  As an alternative, direct exporting can be achieved by locating foreign distributors who purchase your products (usually at a discount to wholesale prices) and then resell your products to retailers or dealers in the territory.  If your company has sufficient resources, it may attempt to locate and sell directly to retailers or to the ultimate end consumer in Canada.

Legal Challenges

In the event your company uses intermediaries to achieve its export objectives, careful thought will be required in the selection of your partners and your agreements with any such party.  For example, will your agreement with such party be exclusive in Canada or in certain channels of distribution?  If the arrangement is exclusive, thought has to be given to the circumstances under which the arrangement will become non-exclusive—for instance if the party fails to fulfill certain sales requirements over a specified period of time.

When entering into a business relationship with an intermediary, it is also important to think about safeguarding the reputation of your brands.  At a minimum, your agreement with a third party representative should include pre-approval rights with respect to marketing strategies and advertising campaigns.  To enhance the reputation of your brands in Canada, you may also negotiate that your third party representative incurs minimum marketing expenditures on your behalf to promote your products.

A well structured relationship should also address the resources you expect the third party to provide during the term of your agreement.  For instance, how many people will be devoted to the sale of your products in Canada and will the efforts of a particular person in the organization be required?  Also, will the third party be required to provide customer support on your behalf, and if so, to what extent?

Perhaps most importantly, it is essential to provide escape clauses in your agreement to enable you to terminate the relationship in the event it does not develop as expected.  For example, you may want to limit the term of the agreement to a period of one year, which agreement will automatically renew for an additional specified period unless either party gives notice.  This will allow you to evaluate the performance of the third party without getting locked into a long term commitment.  Your contract should also specify the circumstances under which you can terminate for non-performance or for breach.

When entering into a relationship with a third party representative, thought also has to be given to your needs upon the termination of the relationship.  For instance, will a distributor have the right to continue to sell products in Canada to deplete their existing inventory or alternatively, will you have the right to repurchase unsold inventory?  The agreement should also mandate the return of confidential information and other property following its expiration or termination.

Although exporting may seem daunting and fraught with risk, it is possible to export to Canada with minimal resources and capitalize on new growth opportunities for your products.  The key lies in carefully selecting third party representatives for your brands and relying on your advisors to help you properly structure your commercial arrangement with such third parties.

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For more information regarding cross border transactions and similar inquiries, please contact Jonathan Friedman, attorney with Stubbs Alderton & Markiles, LLP ( . Jonathan’s practice focuses on venture capital and corporate finance, intellectual property licensing, mergers and acquisitions, securities law and general corporate and business matters.  Jonathan, a Canadian citizen, also specializes in Canadian/United States cross border transactions and sits on the board of the Canadian California Business Council.  Jonathan received his Bachelor of Applied Science in Mechanical Engineering in 1998, his M.B.A. in 2002, and his J.D. in 2002, all from the University of Toronto.

SA&M Preccelerator company Splash has announced that it has launched it's beta website.  To subscribe, visit http://splash.io

Rethinking mobile sharing:  following topics, not people.

You love the Ninja Turtles, Scottish Quilting and Extreme Marathoning. But do your friends? There are better sources for your passions that remain untapped by your social graph.

Splash finds it odd that social products source content mainly from who you friend/follow. Splash filters everything based on context, or topics. They determine which posts you see, and who you share with. Splash let's you share and consume content based only on what you are passionate about, and not who you know.

To follow Splash on Angel List, visit https://angel.co/splash-2

For more information about our Preccelerator Program, contact Heidi Hubbeling at (818) 444-4526 or hhubbeling@stubbsalderton, and visit our Preccelerator page.

Important Business News

from

Stubbs Alderton & Markiles, LLP

New U.S. Patent Law Awarding Patents on a First-to-File Basis Goes into Effect

What Every Entrepreneur Needs to Know to Turn the
New Law into a Business Advantage

On March 15, 2013, U.S. patent law will change favoring inventors who first file a patent application over earlier inventors of the same invention who file a patent application later.  This is a part of the patent law reform enacted in 2011.  With this change, entrepreneurs will need to change the way they think about obtaining patent protection for their inventions.  Here are some suggested business practices for adapting to the new law:

Companies should consult experienced intellectual property counsel to ensure their patent protection policies are up to date with the recent changes in U.S. patent laws.

How Stubbs Alderton & Markiles, LLP can help.  We are a business law firm with particular expertise in intellectual property law.  Our attorneys have extensive experience in developing intellectual property protection strategies to enable businesses to maximize the value of their inventions. We inform our clients how to best update their IP strategies, patent filing procedures and invention assignment agreements and how to use today’s U.S. patent laws to their competitive advantage.

Kevin D. DeBré leads the firm’s Intellectual Property and Technology Transactions Practice Group advising entrepreneurs and companies on how to use technology and intellectual property in building successful businesses.  Kevin is a registered patent attorney and has over 20 years of experience in structuring and negotiating intellectual property-driven deals.

For more information, contact Kevin at (818) 444-4521 or .

Below is an article from September 27, 2011 written by Kevin DeBré, Chair of Stubbs Alderton & Markiles' Intellectual Property Practice, regarding the America Invent Act and how it affected the protection of inventions.

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On September 16, 2011, President Barack Obama signed into law the most sweeping changes to U.S. patent laws in nearly 50 years. These changes included:

• Giving patent ownership to inventors who are the first to file a patent application instead of those who were the first to invent the same invention (beginning March 16, 2013).
• Recognizing a defense to patent infringement based upon having manufactured or sold the patented invention in the U.S. at least one year prior to the patent application filing date.
• Implementing new procedures within the U.S. Patent and Trademark Office (USPTO) for third parties to challenge pending patent applications and granted patents.
• Allowing patent holders to satisfy patent marking requirements by marking patented products with the Internet address where information about their patents can be found.
• Limiting the ability of patent owners to bring industry-wide infringement actions against multiple unrelated companies in a single lawsuit.
• Requiring the USPTO to implement a process for reviewing business method patents when requested by parties charged with infringing these patents.
• Enabling assignees of inventions to file patent applications if the inventor refuses to cooperate.

A copy of the America Invents Act can be found at http://www.gpo.gov/fdsys/pkg/BILLS-112hr1249enr/pdf/BILLS-112hr1249enr.pdf.

Why are these new laws important? Companies will need to adopt procedures to avoid losing patents on their inventions to competitors. Until now, U.S. law awarded patents to first inventors of novel, useful and non-obvious inventions. This will change in 18 months – the inventor who is the first to file a patent application will be entitled to the patent for an invention that somebody else invented earlier, leading to a race to the patent office. Those who are not first will need to employ new USPTO proceedings to try to win patents for their inventions or invalidate those awarded to competitors.

What should businesses do? Any business that creates inventions will need to update its intellectual property protection procedures to reflect these recent changes in U.S. patent law. Companies should consult experienced intellectual property counsel to:

• Devise and implement an internal IP strategy and procedures for identifying patentable inventions and minimizing infringement risk, including liability risk of willful infringement.
• Update employee, independent contractor and joint development agreements to reflect the “first-to-file” patent ownership rule.
• Understand the USPTO’s new procedures for challenging competitors’ patent applications and issued patents.

How Stubbs Alderton & Markiles, LLP can help. We are a business law firm with particular expertise in intellectual property law. Our attorneys have extensive experience in developing intellectual property protection strategies to enable businesses to maximize the value of their inventions. We inform our clients how to best update their IP strategies, patent filing procedures and invention assignment agreements and how to use today’s U.S. patent laws to their competitive advantage.

Kevin D. DeBré leads the firm’s Intellectual Property and Technology Transactions Practice Group advising entrepreneurs and companies on how to use technology and intellectual property in building successful businesses. Kevin is a registered patent attorney and has over 20 years of experience in structuring and negotiating intellectual property-driven deals.

For more information, please contact Kevin at (818) 444.4521 or

Congratulations to SAM Partner Scott Alderton who has been named to Southern California Super Lawyers 2013.  Super Lawyers magazine names attorneys in each state who received the highest point totals, as chosen by their peers and through the independent research of Law & Politics.  Super Lawyers magazine is published in all 50 states and reaches more than 13 million readers.

A real estate investment trust (a “REIT”) is a corporation or an association otherwise taxable as a domestic corporation intended to own interests in real property or in debt secured by real property.  The principal advantage of a REIT for holding real property is the deduction for dividends paid that enables a REIT to avoid corporate level taxation.

 To qualify as a REIT, a corporation must satisfy a number of, shareholder, income and asset tests, including income tests requiring that at least 75 percent of its gross income must be derived from real estate sources, principally (i) rents from real property, (ii) interest on debt obligations secured by mortgages or deeds of trust on real property, (iii) gains from the sale of real property; and that at least 95 percent of the corporation’s gross income must be derived from interest or dividends as well as real estate income qualifying for the 75 percent of income test.

 As a statutorily favored entity, REITs are often the objects of generous revenue rulings and private letter rulings.  For example, in late 2012, the Internal Revenue Service released several favorable private letter rulings on the issue of REITs holding an interest in a passive foreign investment company (a “PFIC”) or a controlled foreign corporation (a “CFC”), ruling that the Subpart F Income of a CFC (CFCs are foreign corporations at least 50% of whose stock, by vote and value, is owned by US shareholders and are subject to federal income tax on their undistributed “Subpart F Income”) and the foreign personal holding company income of a PFIC in each case recognized by a REIT owning interests in a CFC or a PFIC may be treated as qualifying for the 95 percent of income test under Section 856(c)(2).[1]  A PFIC is a foreign corporation, at least 75% of whose income is “passive income” and at least 50% of whose assets are held for the production of passive income.  For that purpose, “passive income” is generally dividends, interest, royalties, rents, annuities, and gains from the sale of property.  US shareholders are required to include in income their share of certain of the PFIC’s excess distributions.

 In addition to the income tests described above, to qualify as a REIT, at least 75% of the value of the corporation’s assets must consist of real estate assets, cash and cash items and government securities as of the last day of each calendar quarter.  In a recent private letter ruling, the Service held that the value of deferred organizational expenses carried as an asset on a REIT’s balance sheet would be considered zero for purposes of the quarterly asset test.[2]  By so ruling, the IRS enabled the REIT not to have to consider the deferred organizational expenses in comparison to the value of its real estate, government securities and cash and cash items.

 The Service has long treated various fixtures as real estate assets for REIT qualification purposes, going back to 1973 when it held that a building’s “total energy system,” powered by turbines, would qualify as a real estate asset.[3]   More recently, relying in part on that 1973 revenue ruling, the Service agreed to treat an offshore oil drilling platform (exclusive of machinery) as real property.[4]

The Service has also been issuing favorable “infrastructure” rulings for REITs engaged in owning wireless cell towers.  In those rulings, the cell towers are held to qualify as real property and the income attributable to tenants’ payments for power generated by the REIT’s on-site generators is treated as includible in rents from real property.[5]

 The Service also provided a favorable published revenue ruling to the effect that investments in money market funds qualify as “cash items” for purposes of the 75 percent of assets quarterly REIT qualification test.[6]  In reaching its favorable conclusion, the Service looked to the Investment Company Act of 1940.[7]  While the Investment Company Act itself does not define the term “cash item,” the Securities and Exchange Commission issued a no-action letter, upon which the Service relied in issuing its private letter ruling, to the effect that an investment in a money market fund is a cash item under Section 3(a)(1)(C) of the Investment Company Act.[8]

 In addition to the income and asset tests, the REITs dividend distributions must be pro rata within the meaning of Section 562 in order to be deductible.  In Private Letter Ruling 201244012 (Nov. 2, 2012), the Internal Revenue Service issued a favorable ruling on the issue of whether dividends distributed among three different classes of stock of a REIT would be deductible.  In order for a REIT to be able to deduct dividend distributions, a REIT’s distributions must be made pro rata among the shareholders in accordance with the rights and preferences set forth in the REIT’s corporate charter.[9]  REIT “distributions must not prefer any shares of stock of a class over other shares of stock of that same class. The distribution must not prefer one class of stock over another class except to the extent that one class is entitled (without reference to waivers of their rights by stockholders) to that preference.”

In that letter ruling, the subject REIT adopted some of the liquidity features of a mutual fund.  The REIT had issued shares of its common stock (the “Class E Shares”) to accredited investors in a private placement on its formation.  Thereafter, the REIT filed a registration statement to register the sale of two new classes of its stock, Class A and Class M.  The Class A Shares and Class M Shares were to be offered for sale on a daily basis at the net asset value (“NAV”) for shares of such class plus, with respect to Class A Shares, applicable selling commissions and would be repurchased by the REIT at the NAV for such share class. Subject to certain limitations, the REIT intended the share repurchase plan to allow holders of Class A Shares and Class M Shares to request that the REIT repurchase their shares in an amount up to an agreed percentage of the REIT’s NAV after such shares have been outstanding for at least one year.  The Class A Shares would be subject to a selling commission (“Selling Commission”) to the extent not otherwise waived or reduced and paid directly by the shareholder, in addition to the NAV for such shares. No Selling Commission would be charged with respect to the Class M Shares.   Despite the differences among the three classes of stock, the Service held that dividend distributions on all of the classes of stock would be deductible as pro rata according to the terms and preferences stated in that REIT’s charter documents.[10]

The Service continues its long-standing practice of issuing favorable rulings, private as well as published, on REIT qualification issues, including assets constituting real property, and the types of income qualifying for the 75% of income and 95% of income REIT qualification tests.  Because of the Service’s willingness to accept reasonable pro-REIT analyses in issuing private letter rulings, practitioners may feel more comfortable relying on the analysis set forth in private letter rulings when opining on REIT issues, especially in the context of a REIT that is not publicly issued and traded.

Michael Shaff joined Stubbs Alderton & Markiles, LLP in 2011 as Of Counsel. He is chair person of the Tax Practice Group.  Michael specializes in all aspects of federal income taxation. Mr. Shaff has served as a trial attorney with the office of the Chief Counsel of the Internal Revenue Service for three years. Mr. Shaff is certified by the Board of Legal Specialization of the State Bar of California as a specialist in tax law. Mr. Shaff is the past chair of the Tax Section of the Orange County Bar Association.  He is co-author of the “Real Estate Investment Trusts Handbook” published by West Group. Michael’s practice includes all aspects of federal and state taxation, including mergers and acquisitions, executive compensation, corporate, limited liability company and partnership taxation, tax controversies and real estate investment trusts.

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[1]   Priv. Ltr. Rul. 201246013 (Nov. 16, 2012).

[2]   Priv. Ltr. Rul. 201236006 (Sept. 7, 2012).

[3]   Rev. Rul. 73-425, 1973-2 C.B. 222.

 [4]  Priv. Ltr. Rul. 201250003 (Dec. 14, 2012).

 [5]  Priv. Ltr. Rul. 201301007 (Jan. 4, 2013); see also Priv. Ltr. Rul. 201129007 (Jul. 22, 2011).

 [6]   Rev. Rul. 2012-17, 2012-25 I.R.B. 1018 (June 15, 2012).

 [7]  15 U.S.C. §§80a-1, et. seq.   I.R.C. Section 856(c)(5)(F) so authorizes (“All other terms shall have the same meaning as when used in the Investment Company Act of 1940...”).

 [8]   Op. Off. of Chief Counsel, No. 200010241124 (Oct. 23, 2000), available at http://www.sec.gov/divisions/investment/noaction/2000/willkiefarrgallagher102300.pdf.

 [9]   Treas. Reg. §1.562-1.

 [10]   See Treas. Reg. §1.562-2(a).

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For more information regarding REIT or about the Tax Practice at Stubbs Alderton & Markiles, LLP, please contact Michael Shaff at or (818)444-4522.

The Bush tax cuts. The Bush tax cuts primarily enacted by the 2001 and 2003 Tax Acts under President George W. Bush were extended through 2012 as part of the Tax Act of 2010.  The Bush tax cuts currently set to expire at the end of 2012 include:

The Bush tax cuts also gradually reduced the estate tax over 2002 to 2009, leading to its repeal in 2010. The 2010 Tax Act reinstated the estate tax for after 2010 and enacted a $5 million exemption (adjusted for inflation in 2012), a top estate tax rate of 35%, and a step-up in basis through 2012. The 2010 Tax Act also introduced the new “portability” feature allowing a deceased spouse's unused exemption to be shifted to the surviving spouse.

Post-2012 scheduled changes. If the above provisions are allowed to expire, for tax years beginning after Dec. 31, 2012:

Additionally, after 2012, the estate tax exemption is scheduled to fall to $1 million and the top rate will revert to 55%.

AMT. For 2012, absent another patch, the AMT exemption amounts are $45,000 for married individuals and $33,750 for unmarried individuals, and most nonrefundable credits won't be allowed against the AMT. A Congressional Research Service report estimates that, unless Congress acts, 30 million plus taxpayers, or roughly one-fifth of all taxpayers, could be hit by the AMT in 2012.

Payroll tax cut. The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed workers—one for Old Age, Survivors and Disability Insurance (OASDI; commonly known as the Social Security tax), and the other for Hospital Insurance (HI; commonly known as the Medicare tax).

To help stimulate the economy by increasing workers' take-home pay, the 2010 Tax Relief Act reduced by two percentage points the employee OASDI tax rate under the FICA (from 6.2% to 4.2%) and the OASDI tax rate under the SECA tax for the self-employed (from 12.4% to 10.4%) on the first $106,800 of wages. The temporary reduction was originally scheduled to expire at the end of 2011.

Current law. The 2-point reduction was ultimately extended through 2012.  For the first $110,100 of remuneration received during 2012, the 4.2% and 10.4% rates apply.  Absent Congressional action, the OASDI rates will revert to normal levels after 2012.

Obamacare investment tax.   A Medicare contribution tax will be imposed after 2012 on the net investment income—generally interest, dividends, annuities, royalties, rents, and capital gains—of individuals meeting an income threshold. The tax will be 3.8% of the lesser of (a) net investment income or (b) the excess of modified adjusted gross income over $250,000 for joint return filers and surviving spouses, $125,000 for separate return filers, and $200,000 for other taxpayers.  This special tax on investment income will only apply to taxpayers with adjusted gross income in excess of $250,000, taxpayers who also face the reinstated 39.6% top federal income tax bracket.

California Changes.  California voters approved Proposition 30 and Proposition 39.  Proposition 30 increases personal income tax rates for high-income earners by creating three new tax brackets. These brackets are effective for taxable years beginning on or after January 1, 2012, and before January 1, 2019.

Taxpayers, except heads of households and married filing jointly taxpayers, are subject to personal income tax:

The above thresholds for married filing jointly taxpayers are double those for single taxpayers.

Proposition 39 requires the use of single-factor apportionment for most businesses for taxable years beginning on or after January 1, 2013. An apportioning trade or business must apportion business income to California by multiplying the business income by the sales factor, unless the taxpayer is primarily engaged in agriculture, mining or drilling or banking businesses.  The property and payroll factors will now only apply to those industries.  The new rule is intended to have the effect of taxing a higher percentage of the net income of out-of-state businesses.

A lot can still happen on the federal side.  Congress may reach an agreement to extend some of the Bush tax cuts before the end of the year or even in the new year as part of an overall budget reconciliation.  In addition, an AMT “patch” is somewhat more likely to occur.

Michael Shaff Stubbs AldertonMichael Shaff, Of Counsel with Stubbs Alderton & Markiles, LLP discusses the Bush tax cuts and the post-2012 scheduled changes. Michael specializes in all aspects of federal and state taxation, including mergers and acquisitions, executive compensation, corporate, limited liability company and partnership taxation, tax controversies and real estate investment trusts.

Should you have further questions or concerns about the post-2012 tax cuts or our Tax & Estate Planning Practice, please contact Michael Shaff at or (818) 444-4522.

 

What is a convertible promissory note? 

A convertible promissory note is a debt instrument that is convertible into equity at a future date either automatically upon the occurrence of certain events or at the choice of the investor.  Even though it is a debt instrument, investors who purchase convertible promissory notes issued by a start-up company are expecting the notes to convert into equity at a future date, since equity (unlike straight debt) allows investors to participate in the upside of the company.  A simple return of principal and interest is not attractive to an early stage investor who is taking tremendous risk in funding a start-up.  To compensate investors for the risk they are taking, the notes sold are often convertible at a discount to the price of the next preferred equity round and will also contain a “cap” – or a maximum conversion price - on the price at which the note will later convert.

What is preferred stock?

Preferred stock is an equity ownership interest in a company with certain features that are designed to protect an investor’s investment.  For example, investors in preferred stock typically receive cash distributions before holders of common stock and also receive certain rights relating to the control of the company, such as board representation and the right to veto certain company activities.

Why do start-up companies and investors sometimes prefer the sale of convertible promissory notes over equity to finance a startup?

Convertible promissory notes are sometimes used to finance start-up companies when the prospective investors lack the sophistication to properly price an equity round, when the size of the financing does not warrant the costs of a traditional preferred stock financing or when the company and the investors want to avoid pricing an equity round.  In addition, convertible note financings are often used because they are perceived to be quicker and cheaper to structure and document than preferred stock financings.

What are some of the risks for investors financing a start-up through a convertible promissory note?

Even though convertible notes often contain price discounts to the next equity round and conversion caps, purchasers of convertible notes are often not sufficiently compensated for the risk they are taking in financing a start-up.  Caps are often set at a premium to the company’s value at the time the notes are issued and discounts may not be adequate, especially as the time between the issuance of the notes and the priced equity round increases.  Moreover, initial investors are subject to the risk that later investors, who often have greater bargaining power (especially if a company is in dire need of financing), will attempt to renegotiate the terms of the promissory notes to their detriment.

Convertible notes also may not adequately compensate early stage investors to the extent the investors provide resources to the company, such as key customer or supplier introductions, or otherwise add credibility or other value to the company.  If the value of the company rises substantially as a result of the investor’s efforts, the investor is ultimately increasing the price they will pay for their own equity in the company, which is clearly a perverse outcome.

What are some of the risks a company that issues convertible promissory notes faces?

Convertible notes work well for start-up companies when the value of the company increases between the time of the debt financing and a preferred stock financing.  However, if the value of the company falls, investors who purchased convertible notes may end up owning more equity in the company then the company anticipated at the time of the debt financing.  This occurs because the price discount feature often included in the notes enables the investors to purchase equity at a price below what they would have paid at the time they purchased the convertible notes.  Moreover, because the purchased equity often contains a liquidation preference, in addition to obtaining a larger equity position in the company at the expense of the founders, investors will also likely obtain an increased preference over the founders to the cash of the company in the event of a sale, dissolution or winding up of the company.  Another downside of convertible notes is that, in the event a convertible note is not converted into equity prior to its maturity, investors could demand that the note is repaid with principal and interest, or potentially force the company into bankruptcy if the loans cannot be restructured.

Conclusions

The issuance of convertible promissory notes can be an effective means for start-up companies to raise capital.  However, before raising capital through the issuance of promissory notes, investors and companies need to carefully evaluate the risks associated with the issuance of promissory notes in comparison to other financing alternatives.

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Jonathan Friedman discusses how convertible promissory notes often provide a fast and cheap way for start-up companies to raise capital.  However, before raising capital through the issuance of promissory notes, companies need to evaluate the potential impact of convertible debt on the company’s future capital structure, and investors need to evaluate whether a straight equity investment is preferable to the purchase of debt.  Jonathan’s practice focuses on venture capital and corporate finance, intellectual property licensing, mergers and acquisitions, securities law and general corporate and business matters. Jonathan has represented corporations and other entities in a wide variety of industries, including Internet and e-commerce, apparel, medical devices, entertainment and high technology.

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For more information regarding promissory notes, raising capital, or similar inquiries, please contact Jonathan Friedman at (818) 444-4514 or .

Stubbs Alderton is featured in the November 12th LA Business Journal story: "Catching the Wave - Service providers flock to Westside to shore up Silicon Beach clients."  The article specifically features SAM PartnersLouis Wharton, Greg Akselrud and Kevin DeBré, as they discuss our launch of a Santa Monica office and commitment to the LA startup scene.  See more here.

AttorneysSanta Monica, Calif., November 8, 2012 – Stubbs Alderton & Markiles, LLP, a leading Southern California business law firm, announced today the opening of its Santa Monica office. The firm, already boasting a broad practice representing emerging growth and technology companies, large technology, consumer electronics and internet companies, and entertainment and video game companies, now has a second Los Angeles office to serve the area’s robust and growing technology, digital media and start-up community in Silicon Beach.

Stubbs Alderton & Markiles also announced the launch of its Preccelerator program for startups looking to access accelerators and venture capital. The Preccelerator will offer on a rolling basis 5-6 entrepreneur groups or start-ups free co-working space as well as the ability to leverage the firm’s resources, including access to legal services, business plan reviews and introductions to sources of capital and service providers offering targeted expertise.

“Since founding the firm more than 10 years ago, we have been committed to the growing venture capital and start-up communities in Southern California, and in Silicon Beach specifically,” said Scott Alderton, a founder and managing partner of Stubbs Alderton & Markiles. “As this area continues to foster the growth of startups, accelerators and venture capital firms, we wanted to demonstrate our commitment to Silicon Beach. We believe there is no better way to do that than being there full-time.”

Founded in 2002 by Joe Stubbs, Scott Alderton, Murray Markiles, John McIlvery and Greg Akselrud, Stubbs Alderton has grown to 17 lawyers and possesses a broad practice representing emerging growth and technology companies, middle market public companies, large technology, consumer electronics and internet companies, investors, private equity funds, investment bankers and underwriters, and entertainment and video game companies in all aspects of business formation, corporate transactions, seed and venture capital finance, securities, mergers & acquisitions and internet, mobile and other intellectual property transactions. Partners Joe Stubbs, Scott Alderton, Kevin DeBré, Greg Akselrud and Louis Wharton will have offices in Santa Monica.

The firm understands the business challenges faced by companies and provides contextual representation throughout the growth and life cycle of its clients.

“Our Preccelerator program is not intended to compete with the existing Silicon Beach accelerators that are doing so much for our community, or provide initial funding to startups, “ added Alderton. “Rather, we will provide a platform for them to get interim office space and sophisticated legal services, and to ultimately grow their ideas from business concept to funded startup. We hope that the platform will allow entrepreneurs a streamlined transition to an accelerator program, financing or to otherwise launch their businesses.”

For more information, or to apply to the Preccelerator program, visit our Preccelerator site.

About Stubbs Alderton & Markiles

Stubbs Alderton & Markiles, LLP is a business law firm with robust corporate, public securities, mergers and acquisitions and intellectual property practice groups focusing on the representation of venture backed emerging growth companies, middle market public companies, large technology and internet companies, entertainment, video games and digital media companies, investors, venture capital funds, investment bankers and underwriters. The firm’s clients represent the full spectrum of Southern California business with a concentration in the technology, entertainment, video games, apparel, consumer electronics and medical device sectors. The firm’s mission is to provide technically excellent legal services in a consistent, highly-responsive and service-oriented manner with an entrepreneurial and practical business perspective. These principles are the hallmarks of the firm.

V. Joseph Stubbs is a founder and partner of the firm and co-chair of the Venture Capital and Emerging Growth Practice Group. Joe practices in the areas of corporate and securities law, emphasizing the corporate representation of both publicly-held and privately-held growth and middle-market companies, venture capital firms, angel investment groups and investment banks. He acts as outside general counsel to numerous emerging growth and technology companies, advising on a wide range of legal and strategic issues at each stage of a company’s evolutionary path.

Scott Alderton is a founder and partner of the firm, and co-chair of the Venture Capital and Emerging Growth Practice Group. Scott is a corporate and technology lawyer who focuses exclusively on advising middle-market, technology, emerging growth, and development stage companies in the areas of corporate and securities, mergers and acquisitions, high technology, business, licensing, intellectual property, the Internet and multimedia.

Kevin DeBré is chair of the firm’s Intellectual Property Group and advises entrepreneurs and companies engaged in building businesses based upon technology or intellectual property assets and he has particular expertise in structuring and negotiating intellectual property-driven deals. A business lawyer, a registered patent lawyer and a former engineer, Kevin handles a wide range of transactions, develops IP protection strategies and advises management teams on compliance with privacy and data security laws and regulations.

Greg Akselrud is a founder and partner of the firm and chair of the firm’s Internet, New Media and Entertainment practice group. Greg acts as outside general counsel to entertainment, Internet, apparel, digital media and other technology companies in a variety of corporate, financing and transactional matters; serves as strategic counsel to clients, representing their interests in investment transactions, joint ventures and mergers and acquisitions; and serves as primary counsel to publicly-held companies, providing advice on all aspects of their business activities, securities filings and public and private offerings.

Louis A. Wharton is a partner of the firm. Louis’ practice focuses on advising startup, emerging growth and middle market companies across a spectrum of industries in securities compliance, corporate finance, mergers and acquisitions and general corporate matters. He counsels clients in the technology, internet/e-commerce, pharmaceutical, apparel and entertainment industries, among others.

Contact:
Heidi Hubbeling
Director of Marketing
(818) 444-4526

Stubbs Alderton & Markiles, LLP – Office Locations

Santa Monica
1453 3rd Street Promenade
Suite 310
Santa Monica, CA 90401

Sherman Oaks
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20th Floor
Sherman Oaks, CA 91403

Prudent investors often request some protection against the risks associated with a decrease in the value of companies in which they invest (referred to herein as the issuer).  Investors typically obtain this protection by including in the issuer’s charter provisions facilitating a reduction, in certain circumstances, of the price at which they will convert the preferred stock they purchase into shares of the issuer’s common stock.  Anti-dilution protection ensures that in the event of a down round (i.e. a subsequent financing in which the issuer sells shares at a price below the price the investor paid) the investor will suffer a more limited amount of dilution (i.e. a smaller reduction in the percentage of the issuer’s stock that the investor owns).

The typical provisions relate to weighted-average anti-dilution protection.  Broad-based weighted-average anti-dilution protection takes into account all securities that are convertible into, exercisable for or exchangeable for shares of the issuer’s common stock.  The typical formula adjusts the conversion price for the issuer’s outstanding preferred stock (i.e. the shares purchased by the investor) by reducing that price by an amount based on the ratio of the number of shares of the issuer’s common stock that would be issued in the down round at the then existing conversion price, compared to the number of shares of the issuer’s common stock that are issued in the down round at the lower offering price.

Narrow-based weighted-average anti-dilution protection takes into account only certain of the securities convertible into shares of the issuer’s common stock.  These typically include outstanding preferred securities, but typically exclude options, warrants and shares issuable pursuant to stock incentive pools or reserves.  Like broad-based weighted-average anti-dilution protection, narrow-based weighted-average anti-dilution protection reduces the then current conversion price by an amount based on the ratio of the number of shares of the issuer’s common stock that would be issued in the down round at the then existing conversion price, compared to the number of shares of the issuer’s common stock that that are issued in the down round at the lower offering price, however, the investor obtains greater protection from dilution (through a lower resulting conversion price) since the shares of the issuer’s common stock that are issued at the lower offering price are more heavily weighted in the calculation.

Less typical is full-ratchet anti-dilution protection, which adjusts the conversion price of the issuer’s outstanding preferred stock to the lower price at which the issuer sells new shares.  This form of anti-dilution protection is rarely granted to investors for typical angel and/or VC investments, but may be negotiated in later transactions when valuations have significantly increased between financing rounds.

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AttorneysLouis Wharton, Partner with Stubbs Alderton & Markiles, LLP gives a brief primer on anti-dilution protection. Louis’s practice focuses on advising startup, emerging growth and middle market companies across a spectrum of industries in securities compliance, corporate finance, mergers and acquisitions and general corporate matters.

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For more information regarding Anti-Dilution Protection or similar inquiries, please contact Louis Wharton at   or (818) 444-4509.

 

 1.   General Rule.    Section 409A calls for the annual taxation of a nonqualified deferred compensation plan that violates the provision of Section 409A. (IRC §409A(a)(1)(A).)  Amounts deferred and subject to inclusion under Section 409A(a)(1)(A) are also subject to a penalty tax of 20% of the amount included (the additional 20% tax) in income.  (IRC §409A(a)(1)(B); Prop. Reg. §1.409A-4.)  As a general rule, for purposes of Section 409A, a deferred compensation plan is any written or oral, vested, legally binding right to receive compensation in a later year. (Treas. Reg. §1.409A-1(b)(1).)

 2.   When is deferred compensation not subject to tax under Section 409A?  If the deferred income would not be included in income when paid, such as a right to receive a payment under a cafeteria plan, it is not subject to Section 409A.  (Treas. Reg. §1.409A-1(b)(1).)  Vested rights in a qualified defined benefit retirement plan (such as pension and profit-sharing plans, IRAs and government retirement plans) are outside the ambit of Section 409A.

In addition, as long as the deferred compensation is subject to a substantial risk of forfeiture, it is exempt from Section 409A.   That rule can exempt from the scope of Section 409A income that is subject to vesting.

 Also exempt from the inclusion rules of Section 409A are short term deferrals that meet either of (a) deferrals of up to 30 days in the case of the employer’s normal pay periods or (b) deferrals of up to 2 ½ months after the end of the taxable year.

 Options, stock appreciation rights and other equity based deferred compensation are subject to additional tests for exemption from Section 409A.  Nonqualified stock options do not result in current taxation under Section 409A if the exercise price may never be less than the fair market value of the stock on the date of option grant, the number of shares for which the option is exercisable is fixed at grant, the transfer or exercise of the option is subject to taxation under Section 83 and Regulation 1.83-7, and the option does not provide a feature for the deferral of income beyond the date of exercise or transfer or the date that the stock received on exercise become substantially vested under Regulation 1.83-3.

Stock appreciation rights must set the base for sharing in the appreciation in the value of the stock at the current fair market value on the date of issuance of the rights.

Section 409A effectively put an end to phantom stock and dividend equivalent rights as an effective form of deferred or incentive compensation.  Section 409A would tax the annual appreciation on phantom stock and unpaid accruing dividend equivalent rights.  (Treas. Reg. 1.409A-1(b)(5)(i)(D) and (E).)

Statutory options, even those issued under a Section 423 plan that are issued with an exercise price at less than the fair market value of the stock on the date of grant, do not create deferred compensation for purposes of Section 409A.  (Treas. Reg. §1.409A-1(b)(5)(ii).)  Stock options that qualify for incentive stock option treatment by definition are issued with an exercise price no higher than the stock value on the date of issuance of the option.

Publicly traded stock is easily valued based on one of several methods, the last sale before the option is granted, the closing price, the arithmetic mean of the high and low trading price or other method described in the plan, including a thirty day averaging method. (Treas. Reg. §1.409A-1(b)(5)(iv)(A).)

If the stock is not traded on an established securities exchange, the stock’s fair market value may be based on a reasonable valuation method, which may be based on “the value of tangible and intangible assets of the corporation, the present value of anticipated future cash-flows of the corporation, the market value of stock or equity interests in similar corporations and other entities engaged in trades or businesses substantially similar to those engaged in by the corporation the stock of which is to be valued, the value of which can be readily determined through nondiscretionary, objective means (such as through trading prices on an established securities market or an amount paid in an arm's length private transaction), recent arm's length transactions involving the sale or transfer of such stock or equity interests, and other relevant factors such as control premiums or discounts for lack of marketability and whether the valuation method is used for other purposes that have a material economic effect on the service recipient, its stockholders, or its creditors.” (Treas. Reg. §1.409A-1(b)(5)(iv)(B)(1).)

There is a presumption of reasonableness, which the Service may try to rebut with a showing that the method or application was grossly unreasonable (Treas. Reg. §1.409A-1(b)(5)(iv)(B)(2).), if the value of the stock on grant is based on an independent appraisal meeting the test for an independent appraiser for valuing employer securities to be purchased by an ESOP.

A value reached by agreement of the parties will not qualify for the presumption of reasonableness.   Section 409A has its own set of option modification rules very similar to the ISO modification rules of Section 424(h).   An option or other stock right deemed modified is treated as a newly issued right and must satisfy the requirements of Section 409A, including the requirement that the exercise price must not be less than the value of the underlying stock on the date of grant.

 3.   Substantial Risk of Forfeiture.  Compensation subject to a substantial risk of forfeiture is not treated as deferred compensation under Section 409A.  Under the Section 409A regulations, compensation is subject to a substantial risk of forfeiture if entitlement to the amount is conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation, and the possibility of forfeiture is substantial. (Treas. Reg. §1.409A-1(d)(1).)  The concept of “substantial risk of forfeiture” is borrowed from Section 83, but the definition is not identical.  Not any substantial contingency will suffice; the only acceptable condition must be the performance of future service under the Section 409A regulation.  A covenant not to compete would probably not qualify as a substantial risk of forfeiture for purposes of Section 409A as it requires the forbearance from services, not the performance of services.

 4.   Performance based compensation is not treated as deferred compensation subject  to Section 409A.  The term “performance-based compensation” means compensation the amount of which, or entitlement to which, depends on the satisfaction of pre-established organizational or individual performance criteria that relate to a performance period of at least 12 consecutive months. Performance criteria are pre-established if established in writing no later than 90 days after the service period begins, provided that the outcome is substantially uncertain when the criteria are established. However, performance-based compensation doesn't include any amount or portion of any amount that will be paid regardless of performance or based upon a performance level that is substantially certain to be met when the criteria are established.  (Treas. Reg. §1.409A-1(e)(1).)

 5.   Deferral Election.  A service provider may elect to defer compensation without creating deferred compensation under Section 409A if the deferral election is made before the beginning of the year in which the services are performed.  (Treas. Reg. §1.409A-2(a)(3).)  In the first year that the service provider is eligible to elect to defer compensation, an effective deferral election may be made within the first thirty (30) days that the service provider is eligible to defer compensation.  (Treas. Reg. §1.409A-2(a)(7).)

 6.   Corrections.  There is an opportunity for correcting a “plan” subject to Section 409A by December 31, 2012 (IRS Notice 2010-6, 2010-3 IRB 275) for a plan provision that is eligible for correction under any other section of that Notice.

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Michael Shaff, Of Counsel with Stubbs Alderton & Markiles, LLP discusses the ins and outs of Section 409A, which regulates taxation of nonqualified compensation plans. Michael specializes in all aspects of federal and state taxation, including mergers and acquisitions, executive compensation, corporate, limited liability company and partnership taxation, tax controversies and real estate investment trusts.

 

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Should you have further questions or concerns about deferred compensation or our Tax & Estate Planning Practice Group, please contact Michael Shaff at or (818) 444-4522.

Sherman Oaks, CA - November 1, 2012 -Stubbs Alderton & Markiles, LLP announced that it advised IRIS International, Inc. (NASDAQ: IRIS) in the completion of its acquisition by Danaher Corporation.  IRIS, a leading manufacturer of automated in-vitro diagnostics systems and consumables, and a provider of high value personalized medicine solutions was acquired by Danaher at a purchase price of $19.50 per share.  Upon completion of the merger, IRIS has become a wholly-owned subsidiary of Danaher.

The Stubbs Alderton & Markiles, LLP team advising IRIS included John McIlvery, Partner and Chair of the Public Securities PracticeJonathan Friedman, and Sean Greaney.

To view the full press release, click here.

About Stubbs Alderton & Markiles
Stubbs Alderton & Markiles, LLP is a business law firm with robust corporate, public securities, mergers and acquisitions and intellectual property practice groups focusing on the representation of venture backed emerging growth companies, middle market public companies, large technology companies, entertainment and digital media companies, investors, venture capital funds, investment bankers and underwriters. The firm’s clients represent the full spectrum of Southern California business with a concentration in the technology, entertainment, videogame, apparel and medical device sectors. Our mission is to provide technically excellent legal services in a consistent, highly-responsive and service-oriented manner with an entrepreneurial and practical business perspective. These principles are the hallmarks of our Firm.

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