Issues

Republicans Release Their Party Platform

Republicans Release Their Party Platform

As the Republican National Convention kicked off this Monday, the GOP also released the final draft of their party’s platform. The platform, which was written with input from the party’s base sourced via www.platform.gop, included generous mentions of issues important to the startup community.

Engine Submits Comments with Top Tech Companies in Copyright Inquiry

Engine Submits Comments with Top Tech Companies in Copyright Inquiry

On New Year’s Eve 2015, while most people were out celebrating, the Copyright Office quietly issued an notice of inquiry seeking public input on an incredibly important topic: the effectiveness of Section 512 of the Digital Millennium Copyright Act (DMCA). For those who didn’t skip their New Year’s Eve party to brush up on copyright policy, here’s a refresher: the DMCA is a law from 1998 that, among other things, grants online service providers (OSPs)—basically, all your favorite websites—a legal “safe harbor” from facing lawsuits arising from user copyright infringements.

The VENUE Act: It's Time to Get Patent Trolls out of East Texas

The VENUE Act: It's Time to Get Patent Trolls out of East Texas

This week, Senators Flake, Gardner, and Lee introduced a piece of legislation targeting one of the most egregious—and, frankly, ridiculous—problems with our current patent system. Specifically, the Venue Equity and Non-Uniformity Elimination  (VENUE) Act would get patent cases out of the Eastern District of Texas, where patent trolls most commonly file their specious lawsuits. Together with the comprehensive reform legislation found in the PATENT Act, this bill would help put an end to a dangerous patent troll problem that continues to prey on this country’s startups and innovators.

Apple, Encryption, and the Future of Digital Security

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This week, a U.S. District Court judge ruled that Apple must assist the Federal Bureau of Investigation (FBI) by providing technical assistance to help the Bureau unlock the iPhone used by one of the San Bernardino shooters. While a resolution to this litigation is far off (due to likely appeals), the case has suddenly catapulted the debate over privacy, security, and encryption into the headlines of nearly every major news outlet in the United States and beyond. And though this case is specific to Apple—the manufacturer and licensor of the hardware and embedded software—the ramifications of the final decision in the case may have a profound impact, both in the technology industry and beyond.

While this isn’t the first time that policymakers have grappled with serious questions related to encryption and digital security—just last year, the White House backed away from a proposal seeking “backdoors” into encrypted devices after a multitude of stakeholders spoke out about the dangers of such anti-security measures—it is likely the most difficult case yet involving such issues. Certainly, the FBI has a strong interest in thoroughly investigating terrorist activity and preventing such acts in the future. Technology companies also care deeply about stopping criminal activity, which is why this is such a difficult problem: though the FBI’s request is tailored to investigating a specific terrorist activity, it will ultimately weaken security standards and may lead to serious vulnerabilities that will put countless consumers at risk.

In the past, Apple has cooperated with law enforcement to unlock phones in order to gain access to information, at least when doing so was technologically feasible. This situation is slightly different, as the court order requires Apple to create an entirely new version of Apple’s operating system (OS) to allow the government to circumvent security features that Apple built into its OS to prevent brute force attacks. This software will effectively make brute force attacks on encrypted devices possible—whether it’s the FBI attempting to brute force the phone or anyone else that has access to the software. Though the FBI says it intends to use this modified OS in this situation only, the spate of high-profile hacks and data breaches over the past year (including a breach of sensitive government information) should cast doubt on any such guarantees.

And, while some may argue that Apple’s strong opposition to the FBI’s request in this case demonstrates that any future requests for similar security circumvention activities will be limited to only the most extreme circumstances, that only holds true if the company being tasked with providing access to encrypted information has the resources to mount such a robust legal challenge. The startups that are responsible for so much of the tech sector’s growth have nowhere near the legal resources needed to fight spurious requests for dangerous encryption backdoors. Establishing a precedent that obligates companies to undermine the security measures that keep millions of consumers and their data safe from criminals will only increase the chances that these security circumvention technologies are employed in spurious cases or, worse, fall into the wrong hands.

Law enforcement is fully justified in attempting to do everything possible to prevent future terrorist attacks, just as Apple is fully justified in arguing that what the FBI wants could have serious negative repercussions for the security of its users. But, the security vulnerabilities that could arise by forcing Apple to undermine the strong encryption technologies it has built into its products should make anyone think twice about establishing such a dangerous precedent.

So You Want to Hack the Patent System

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Are you a startup or inventor wondering what to do about our broken patent system? Want to know what your options are? Check out Hacking the Patent System, an updated white paper published in partnership with EFF and students from the Juelsgaard Intellectual Property Clinic at Stanford Law School.

This paper includes important and timely advice for technology entrepreneurs attempting to navigate a dysfunctional and unfair system because, unfortunately, patent trolls remain a grave threat to startups and innovators. This is despite multiple attempts to pass reform legislation through Congress and an active Supreme Court working hard to fix a broken system. Not only does the threat of extortionary patent trolls still exist, but it’s actually getting worse. Lawsuits filed by patent trolls are up and significantly more than half of those cases are filed in the notorious Eastern District of Texas.

Despite these problems, startups often find themselves filing for patents, either because their investors tell them it’s a good idea or they plan to later use them defensively against lawsuit threats. This has led to a dangerous culture of “patenting up”—getting as many patents as possible in as short a time as possible.

To really fix the problem, a handful of things need to happen:

  1. Congress must pass patent reform legislation that addresses fundamental inequities in the patent system that favor large patent holders and litigation plaintiffs.
  2. Patent quality must be improved. Removing low-quality patents from the system will also remove the trolls’ deadliest weapon.
  3. We must change the culture of “patenting up.” Big companies, investors, startups, and inventors need to come together to take a stand and return the system to its roots, which—as the Constitution provides—is meant to promote the progress of science and useful arts.

That all might take awhile. In the meantime, there are things that startups can do to navigate a broken patent system without hiring an expensive patent lawyer or even filing for a patent itself. We lay out some of those options here in an updated version of our Hacking the Patent System white paper, originally released in 2014. The paper takes a deep dive into alternative patent licenses: specifically, patent aggregators, patent pledges, and (new this year!) patent insurance.

Thanks to partners EFF and the Juelsgaard Intellectual Property Clinic at Stanford Law School—especially former students Marta Belcher and John Casey—for all their hard work.

2015 Year in Review: Regulating the New Economy

This post is one in a series of reports on significant issues for startups in 2015. In the past year, the startup community’s voice helped drive notable debates in tech and entrepreneurship policy, but many of the tech world’s policy goals in 2015, such as immigration and patent reform, remain unfulfilled. Check back for more year-end updates and continue to watch this space in 2016 as we follow policy issues affecting the startup community.

by Anna Duning and Evan Engstrom

The ever-increasing pace of technological development and expanding reach of innovative enterprises into well-regulated industries has put considerable strain on the nation’s policymaking apparatus. As new technologies (such as recreational drones) become more popular and new platforms integrate everyday activities (such as transit) with technology, policymakers are faced with difficulties in crafting forward-thinking policies or adapting existing regimes to new technologies. In 2015, we saw this phenomena play out in a variety of ways all across the country at the municipal, state, and federal levels.

New Devices, New Rules

In 2015, the drone market grew exponentially, with more than 400,000 drones sold. The increasing presence of unmanned aircrafts—and the corresponding rise in reports of rogue drones posing safety hazards to commercial aircrafts and stoking privacy concerns—prompted the Feds to introduce new regulations for recreational drones this year. The Federal Aviation Administration, along with the Transportation Security Administration, ultimately came up with a drone registry for hobbyists, requiring recreational pilots enter their devices into a new national database. Commercial drones from the likes of Google, Amazon, and even Wal-Mart are also expected to take to the skies in the new year. These companies have all been part of a lobbying effort to keep new regulations limited and reasonable.

As the age of widely-available autonomous vehicles nears (Tesla says within two years), state lawmakers are grappling with how to establish the appropriate safety and regulatory standards for what will surely be one of the most disruptive technologies deployed in recent memory. Cybersecurity, accident liability, and basic road rules are all pressing concerns. Several states have already approved the testing of autonomous vehicles with varying degrees of regulations. Most recently, California introduced proposed rules that would require a licensed driver to be present in the vehicle. This requirement could limit some of the more promising uses of these new vehicles (such as transportation for the young or disabled) and even threaten the vehicle’s safety, but the state will take comments before instituting the final standards. We’ll be monitoring closely as state governments continue craft new regulations. These new rules won’t just impact the big manufacturers, as autonomous vehicles could spawn an entirely new sector of startups creating software for these cars.

Blockchain Rising

Though Bitcoin and the blockchain technology that powers it are relatively old developments by tech standards (2009!), cryptographically-secure distributed ledger technologies came to the attention of the mainstream in a big way this year, drawing interest from large financial institutions and regulators alike. While this increased scrutiny may rankle some of Bitcoin’s techno-libertarian old guard, the relatively cautious approach policymakers have taken to regulating the Bitcoin sector is a promising sign for the future growth of cryptocurrencies and blockchain technologies.

As Federal regulators have been content to monitor the development of cryptocurrencies, state policymakers have taken more proactive steps to regulate the sector. New York enacted its BitLicense rules this summer, which obligate financial intermediaries that hold or control virtual currencies on behalf of New York residents to obtain a license and follow certain customer monitoring and reporting requirements. The rules were meant to apply to just those companies that handle funds on behalf of customers and not impact software developers and entrepreneurs that don’t actually control customer money, but since the Bitcoin system looks so radically different from traditional financial systems, the rules necessarily have created some confusion as to how they will apply in practice. Fortunately, New York regulators appear to be cognizant of the need to avoid overregulating this nascent industry and will hopefully work to rectify any overbroad regulatory issues that may arise. As other states begin to consider regulations like New York’s regime (California for one debated a similar Bitcoin license bill this year before it died in the legislature), the need for a more uniform Federal standard will quickly become a priority for the sector. With more and more money pouring into blockchain startups ($500 million in 2015 alone), digital currency regulation will likely become a more pressing issue in 2016 and beyond.

The New Sharing/Gig/On-Demand Economy

No one seems to have agreed upon the best term to describe the collection of technology startups building platforms that connect customers to workers, homeowners, and drivers. Call it the sharing economy, the gig economy, or the on-demand economy; regardless, this new technology is shaking up well-established industries and the regulatory frameworks in which they’ve long operated.

Startups including Uber, Lyft, TaskRabbit, Handy, and Instacart (to name just a few) are restructuring how a wide variety of services are provided, and with that, challenging the existing labor standards that by and large rely on two narrow designations—employee or independent contractor. Many of these companies now face a slew of lawsuits about that classification, including a class action against Uber in California. Just weeks ago, Seattle became the first city in the nation to allow on-demand drivers to unionize. This legislation, too, will likely be contested in courts. The outcomes of these cases could dramatically reshape the 1099 economy and will surely impact the startups who’ve built their companies around existing worker classification rules. We’ll be paying close attention as they’re debated into 2016 and beyond.

Beyond the labor market, many of these startups are providing new (and in many ways, better, faster, and more efficient) services within highly regulated industries. This year, ridesharing companies, came up against major challenges in cities throughout the world. The New York City Council proposed rules this summer that could have put a freeze on all for-hire vehicles. Another requirement—that ride-sharing apps pass government approval before making changes—was also floated, though ultimately struck down. Meanwhile, San Francisco voted on a ballot proposition to limit Airbnb rentals in the company’s home city, a measure that ultimately failed, but cost the company $8 million to fight.

Ultimately, the trend of startups beginning to compete in heavily-regulated sectors of the economy accelerated in 2015 faster than many had predicted, resulting in an all too common struggle to fit the square peg of new innovations into the round hole of existing regulations. Not surprisingly, given the slow pace at which our nation’s regulatory bodies operate, the many policy debates that came to the fore in 2015 are nowhere near resolution. Next year will almost certainly see these policy debates escalate, and it is imperative that the startup community engage in this policymaking to ensure that the incredible potential of new technologies isn’t stifled by ill-fitting regulations.

 

2015 Year in Review: Telecom

This post is one in a series of reports on significant issues for startups in 2015. In the past year, the startup community’s voice helped drive notable debates in tech and entrepreneurship policy, but many of the tech world’s policy goals in 2015, such as immigration and patent reform, remain unfulfilled. Check back for more year-end updates and continue to watch this space in 2016 as we follow policy issues affecting the startup community.

by Emma Peck and Evan Engstrom

The net neutrality debate that dominated the tech policy conversation in 2014 was once again the top telecom issue in 2015, peaking at the end of February with the Federal Communications Commission’s (FCC) passage of its new Open Internet Order, which contained the strongest non-discrimination rules ever put in place to protect the Internet economy in the U.S. The telecom excitement didn’t end there, as policymakers and courts dealt with a huge number of issues related to promoting telecom competition, limiting ISP discrimination, and building out the next generation of telecommunications services. In short, the momentum in 2014 carried over into 2015 in a big way, and looking ahead, 2016 is poised to be yet another landmark year in telecom policy.

In addition to the FCC’s net neutrality order, the startup community saw big wins with the termination of the Comcast-Time Warner Cable merger and the FCC’s decision to undo anti-competitive broadband laws in Tennessee and North Carolina. We weighed in on debates around next year’s incentive auction and continued to push for increased unlicensed spectrum allocation. Lastly, we articulated our hope to see legislation move next year that would open up more federal airwaves for commercial use.

Net Neutrality

After more than a year of campaigning, the tech community won one of its biggest policy victories ever with the FCC’s decision to reclassify broadband as a telecommunications service in order to pass the strongest net neutrality rules this country has ever seen. Net neutrality advocates had little time to rest, however, as the rules immediately came under fire in Congress and in the courts. Republicans used their control of both houses of Congress to push legislative tricks meant to undermine the FCC’s work, including riders to various unrelated appropriations bills that would have blocked the FCC from using any funding to enforce the new Open Internet Order. While the net neutrality community effectively neutralized those threats, a legal challenge to the net neutrality rules is still playing out in the courts. Filed by a consortium of ISPs immediately after the FCC’s February vote, the lawsuit argues that the FCC overstepped its statutory authority in reclassifying broadband under Title II and that—despite more than 4 million public comments—the FCC did not provide adequate notice of the regulatory changes it made. An appellate court heard oral arguments in the case in December and is expected to issue a ruling early next year. Whatever the outcome, the Supreme Court is likely to weigh in, ensuring that the net neutrality debate will continue in 2016 and beyond.

Municipal Broadband

In another high-profile legal battle, the FCC is fighting to uphold its authority to preempt state laws that inhibit municipal broadband build-out. At the same February meeting where the historic Open Internet vote took place, the FCC acted to improve broadband access and competition by undoing anti-competitive broadband laws in Tennessee and North Carolina that prevented local communities from providing Internet access for their citizens. But those states have pushed back against the FCC’s decision in a lawsuit that will continue to play out into 2016. The outcome may impact the FCC’s broader authority to encourage broadband deployment, and we are tracking.

Telecom Mergers

The startup community won another victory in April when Comcast’s plan to merge with Time Warner Cable (TWC) collapsed under regulatory pressure. The proposed merger would have given Comcast monopoly control over Internet access for a huge swath of the country, effectively removing any incentives to increase speeds, lower costs, or expand coverage. The same enthusiasm that drove the effort to pass strong net neutrality rules helped convince regulators at the FCC and in the states to take a hard look at whether allowing this type of consolidation in the market for Internet access would end up doing irreversible harm to the nation’s high-speed broadband market. Recognizing that promoting competition between ISPs is the only way to help put the U.S. back on par with international peers in terms of broadband affordability and quality, the FCC hinted that it would block the merger, prompting Comcast to walk away from the deal. While the merger’s demise meant that ISP competition didn’t deteriorate further, there is still a long way to go before there is adequate competition in broadband markets.

Spectrum

Incentive Auction

Broadcasters, potential bidders, and regulators spent 2015 gearing up for next year’s spectrum incentive auction. With enormous sums of money at stake (an auction of less valuable spectrum brought in more than $40 billion in 2014), stakeholders have been aggressively lobbying for favorable auction rules over the past few years, and this spring saw a particularly heated debate around the size of the auction’s spectrum reserve. As competition is so important for startup growth, the startup community weighed in on the importance of establishing auction rules that promote competition. While we didn’t win the fight for a larger reserve, next year’s auction still has the potential to re-shape competition in the mobile broadband market. We’ll be watching when March rolls around.

Unlicensed Spectrum

Licensed frequencies weren’t the only airwaves getting attention this year. 2015 saw an explosion in the “Internet of Things” and continued growth in the use of Wi-Fi, attracting the attention of policymakers and underscoring the importance of access to unlicensed spectrum. In November, Engine supported legislation introduced by Sen. Schatz that would ensure that unlicensed spectrum is central to any future spectrum strategy. We hope to see that bill or something similar move next year, possibly with a larger spectrum package (more on that below).

Federal Spectrum

The AWS-3 spectrum auction ended in January, netting almost $45 billion and demonstrating that there is still a critical need (and willingness to pay high dollar) for spectrum. In an effort to free up more of this valuable resource, members in both the House and Senate introduced bills that would incentivize the federal government to give up its inefficiently used spectrum. While neither bill was able to move before year’s end, there is hope that a larger spectrum package that includes these provisions, as well as a number of broadband deployment provisions, will be taken up sometime in the new year.

CISA Resurrected: Bad Policy, Broken Process

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News yesterday that a dormant and much maligned cybersecurity bill—the Cyber Information Sharing Act—had not only resurfaced but was on a fast track towards becoming law by virtue of being appended to a large spending bill came as an unfortunate surprise for the tech sector, privacy advocates, and anyone who cares in transparent policymaking. In the last few weeks of 2015, all of Congress’s remaining legislative capacity was directed towards passing the bloated mish-mash of policies known as the “omnibus.” In theory, the omnibus is a “must-pass” spending bill (“must-pass” in the sense that signing it into law is necessary in order to fund the government) that combines a number of different appropriations bills into one, streamlining what could otherwise be a tedious effort to pass spending bills piece-by-piece. But, in what has become a commonplace practice in DC, this year’s omnibus crams in piles of unrelated legislation (more than 2,000 pages in all), effectively ensuring the passage of controversial bills that would likely have faltered if exposed to the normal legislative process, public debate, or a straightforward Presidential veto.

Ultimately, this means that groups and individuals without significant influence or lobbying power often find themselves pushed out of closed-door conversations about what unrelated bills get appended to the omnibus. While this closed process doesn’t always result in terrible legislation (the removal of anti-net neutrality riders to this year’s omnibus being a prime example of good policy emerging from the omnibus mess), when bad legislation does find its way into the omnibus, it’s almost impossible to get it out. It is through just this backwards process that the ill-fated Cyber Information Sharing Act (CISA) found its way into the omnibus and on a seemingly unstoppable course towards a Presidential signature.

CISA essentially creates a framework for companies to collect and share user data with government in a way that may circumvent basic privacy protections. While the bill is supposed to help government and industry cooperate to prevent cyber attacks like the high-profile hacks that targeted Sony, Target, and the federal Office of Personnel Management, critics argue that the bill creates more problems than it solves by jeopardizing user privacy, incentivizing companies to secretly monitor user activity, and allowing the government to obtain consumer data without a warrant. By moving CISA through the omnibus, these critics have been shut out of the recent negotiations. It’s no surprise then that the language that ultimately made it into the omnibus is worse in terms of privacy protections than other iterations of the bill.

For startups, CISA’s inclusion in the omnibus is bad for a few reasons. First, enacting significant legislation via amendment to unrelated must-pass bills limits the voice of small business in government. As this becomes more commonplace, startups who do not have the resources or relationships to participate in closed-door discussions are boxed out. Second, any bill that weakens privacy protections for user data threatens to undermine consumer confidence in Internet services. This, in turn, decreases the market for startups that provide such services. Finally, considering the European Court of Justice recently invalidated a crucial safe harbor by which US companies—startups included—were permitted to import EU consumer data precisely because of US laws that gave government access to user data without any real privacy protections, pushing a bill like CISA only threatens to make things harder for US companies operating overseas.  

As policymakers consider a variety of cybersecurity and privacy issues, it’s crucial that the startups and technologists that understand how key technologies actually work are a part of these conversations. Congress’s decision to move CISA through the omnibus spending bill is a move in the wrong direction for the startup sector’s participation in DC.

Senate Bill Requiring Terrorist Activity Reporting a Flawed Approach

As terrorists increasingly exploit Internet and social media platforms to mobilize followers, disseminate propaganda, and coordinate attacks, working to diminish militants’ capacity to organize through social media is critical. And in the wake of the recent, horrific attacks in Paris and California, a renewed push to improve these efforts is understandable. But the Requiring Reporting of Online Terrorist Activity Act, introduced by Senator Dianne Feinstein earlier this week, is not the answer.

Every day, startups and tech companies voluntarily work with law enforcement to combat terrorist threats. FBI Director James Comey noted in a July Congressional hearing that even absent a legal requirement to do so, Internet and technology companies “are pretty good about telling us what they see.”

Sen. Feinstein’s bill would require tech companies to report “any terrorist activity” they have knowledge of to law enforcement. This obligation seems innocuous on its face, but as often happens, difficulties arise in determining how to actually apply this standard. Crucially, nowhere in the three page bill is “terrorist activity” adequately defined. The legislation is modeled after a law requiring the reporting of child pornography, but unlike child pornography (which is intrinsically unlawful, generally easy to detect, and never constitutionally protected speech), “terrorist activity” is vague and undefined. Under the bill, companies would have to independently determine what “terrorist activity” encompasses—a difficult task for startups without large legal teams or a deep understanding of this complex landscape. Startups are neither qualified nor equipped to comply with these onerous requirements.

Beyond its burdens, the bill’s incentive structure is illogical. Because of the overbroad definition of “terrorist activity,” there will be a strong incentive for companies to over-report poor quality information, lest they miss something for which they will later be held liable. This will create a needle-in-the-haystack conundrum, swamping law enforcement with useless information.

On the flip side, the bill could also discourage some companies from reporting anything at all. The bill’s sponsors emphasize that the bill would not require companies to monitor customers or undertake any additional steps to uncover terrorist activity. But if companies are only required to report activity when they see it, there is an incentive for some to simply turn a blind eye, arguing that if they did not have “actual knowledge” of the activity, they were not obligated to report it.

Simply put, Sen. Feinstein’s bill could potentially do more harm than good. It would chill innovation and create a compliance nightmare for startups. The bill’s flawed approach has already been debated, and an almost identical provision was removed from the Intelligence Authorization Act earlier this year due to similar concerns.

The startup community stands at the ready to partner with the government to combat those who want to harm our nation. But any policy solution should be balanced, well defined in scope, and grounded in evidence that it will truly make Americans safer.

EU Commission Seeks Input on Major Policy Regarding Online Intermediaries

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Though the EU’s economy is the largest in the world in terms of GDP, its innovation economy has historically lagged behind the US and other international peers. Investment in EU startups has risen slowly but steadily in the past decade, but, the EU is home to only four of the top 20 cities for startups in Compass’s 2015 rankings. This is not just bad news for the EU economy, but also for US startups looking to expand overseas.

The sluggishness of the EU’s startup sector is due in no small part to the significant regulatory burdens involved in conducting business across member state boundaries. In fact, our research shows that how a country regulates its technology sector has an enormous impact on early stage investment in startups. In a study we published earlier this year, 88% of worldwide investors said they would be uncomfortable investing in digital content intermediaries in countries with an unfavorable or murky regulatory environment.

Fortunately, the EU is already well underway in devising a fix for its complicated regulatory hurdles in the form of the proposed EU “Digital Single Market”—essentially a uniform, trans-Europe market for digital goods and services. As part of its effort, the EU Commission recently issued a consultation asking for information and commentary regarding the value of online platforms and intermediaries in promoting innovation and economic growth. Since the Commission’s Digital Single Market strategy is still somewhat in flux, there is no guarantee that the new regulations it puts in place will work if the Commission doesn’t receive enough feedback explaining how crucial online platforms are in a well-functioning Internet economy, and how dangerous restrictive regulations would be to the viability of the EU’s burgeoning startup sector.

To maximize the potential of the Digital Single Market and foster startup growth throughout Europe, the EU Commission should ensure that its Digital Single Market strategy focuses on policies that support online platforms and intermediaries. Online platforms are critical to a healthy Internet economy by virtue of the core services they provide in connecting Internet users and facilitating the flow of information, but as the US tech sector shows, their real economic value lies in their ability to support interoperable startups that use larger intermediaries to build and promote their services. The Google Play and Apple App stores feature more than 1.8 and 1.5 million apps, respectively—a great many of which were created by the startups responsible for virtually all new net job growth. The economic value of this market is significant; by 2017, worldwide mobile app revenue alone is projected to exceed $77 billion. Assuming the EU doesn’t hamper the growth of this market by crafting regulations that impose undue costs and restrictions on online platforms, Europe stands to gain a significant portion of the app economy’s growth. Projections estimate that employment from the app market in Europe will increase from 1.8 million in 2013 to more than 4.8 million in 2018.

Of course, the app market represents just a small fraction of the value that online intermediaries provide in spurring startup activity. Social media platforms and search tools allow startups to easily and cheaply connect with customers and online payment platforms help lower startup costs by outsourcing payment systems; together, these intermediaries give entrepreneurs the ability to reach customers and turn their ideas into business realities. Online platforms are the hubs off of which countless startups have built their businesses, and the low cost of operating a business in this symbiotic, open model of innovation allows new entrepreneurs to build ventures with few resources. In this sense, allowing online platforms to operate effectively across the EU is critical to growing the EU’s startup ecosystem, not to mention to US companies looking to expand into international markets. As the EU collects information regarding the role online intermediaries play in Europe’s startup market, it’s important that the Commission hear from entrepreneurs and innovators on the ground who can speak to the value freely operating intermediaries provide to fledgling enterprises. The consultation closes December 30; interested parties can fill out the EU’s survey here.

UPDATE: The EU Commission is holding an event this Thursday in San Francisco at the Consulate General of the Netherlands (120 Kearny St.) with key stakeholders to discuss the implications of its online platform regulation strategy. This is an incredible opportunity to help shape the future of EU tech policy, so sign up while there’s still space.

The Good and the Bad in the SEC's New Crowdfunding Rules

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It’s been almost a week since the SEC released its long-awaited rules implementing the investment crowdfunding framework established under the JOBS Act more than three years ago. Now that everyone has had a chance to digest the nearly 700 page document, we can begin to evaluate the merits of the SEC’s rulemaking. While the mere fact that investment crowdfunding is legal in the U.S. is an historic accomplishment that startups everywhere should take time to celebrate, there is more work to be done to ensure the crowdfunding market achieves its full potential.

At a high level, the rules the SEC released last Friday are a definite improvement on the proposed rules from 2013. The final rulemaking clarifies a number of the proposed rules’ ambiguities and inconsistencies and corrects a few important deficiencies. The most important change is probably the SEC’s decision to permit funding portals—the sites that host crowdfunding campaigns—to selectively curate which issuers may list on their sites. Because funding portals are barred from providing “investment advice,” the SEC originally planned on barring portals from applying subjective criteria to decide which issuers to list, as this curation could have been perceived as an implicit recommendation that the listed issuers were better investments than those the portal rejected. As we’ve written previously, so long as portals provide clear disclaimers about the inherent risk in investing in any startup, weeding out obviously bad companies would only serve to improve investor safety. Failing to permit funding portals to take on this important investor protection function could have spelled disaster for the nascent crowdfunding industry.

The SEC also made the wise decision to permit crowdfunding portals to take equity stakes as compensation from the issuers they list. For cash-strapped startups, awarding stock in lieu of cash is a common practice for employee retention and even third party vendor compensation. Allowing portals to take equity helps lower upfront costs for startups seeking funds through the crowd and helps align portals’ incentives with those of issuers and investors. Similarly, the SEC made incremental steps to help lower certain reporting costs for crowdfunding issuers. The Commission removed the requirement for issuers to file audited financials in annual reports and permitted first-time issuers seeking higher crowdfunded raises to submit reviewed—rather than fully audited—financial statements prior to launching a campaign.

Any rule change that lowers the cost of raising capital for crowdfunding issuers will help make crowdfunding more attractive to startups. This in turn, will make crowdfunding safer for investors, as an unduly high cost of capital will mean that only the riskiest of companies will use crowdfunding to satisfy capital needs. However, the SEC failed to go far enough in addressing the high cost of capital, particularly for deals at the lower end of the market. Despite small changes to the disclosure requirements, the cost of submitting pre-campaign financial statements and filing annual reports in perpetuity will likely make crowdfunding too expensive for issuers seeking less than $100,000. Considering the small startups that would most benefit from using crowdfunding as a source of initial seed capital will not have any financial history to report in formal financial statements, requiring such companies to expend scarce resources preparing such useless documents seems foolhardy. The cost to small issuers is compounded by the SEC’s failure to include a “testing the waters” provision that would allow startups to informally gauge investor interest before committing the time and money to launching a campaign. Considering around two-thirds of crowdfunding campaigns fail, incurring high upfront disclosure costs is an even riskier proposition for young companies.

The startup community should be thrilled that the SEC finally acted to make investment crowdfunding a reality and that in doing so, it addressed some of the concerns that entrepreneurs and investors raised with the original proposed rules. But, unless and until policymakers take steps to lower the cost of raising seed capital through crowdfunding, the impact of investment crowdfunding on the startup market will likely be modest. Nonetheless, a slow start to investment crowdfunding in the U.S. shouldn’t be taken as a sign that the promise of crowdfunding was overstated; rather, it should serve as a reminder that more work needs to be done to realize crowdfunding’s full potential. We’ll be watching closely.

SEC Passes Historic Investment Crowdfunding Rules

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After more than three years of delay, the SEC has finally passed rules making investment crowdfunding a reality. Considering it’s been so long since Congress passed the legislation authorizing investment crowdfunding, it’s easy to forget how significant of an achievement today’s news represents. For the first time, entrepreneurs can raise capital from everyday investors over the Internet, opening up a vast new pool of funding for startups throughout the country. For the 20% of entrepreneurs who have identified a lack of adequate capital as one of the three biggest challenges they face, the SEC’s passage of final rules couldn’t have come at a better time.

Grand pronouncements about investment crowdfunding’s potential shouldn’t be dismissed as mere hyperbole. Simply put, investment crowdfunding has the potential to revolutionize startup financing and enable new groups of entrepreneurs to participate in the startup ecosystem. The success of rewards-based crowdfunding platforms like Kickstarter and Indiegogo suggests that investment crowdfunding will make it far easier for startups outside of traditional tech hubs in New York and California to raise funds. Consider this: the average venture capital investor resides within 70 miles of his or her portfolio companies, while the average crowdfunding backer resides, on average, 3,000 miles away from the companies they support. With traditional venture funding concentrated on the coasts (75% of all VC funds go to companies based in California, New York, or Massachusetts), investment crowdfunding will enable more capital to flow to emerging startup hubs throughout the country. Similarly, investment crowdfunding has the potential to help fix the tech sector’s troubling lack of diversity. While women entrepreneurs have been excluded from traditional venture funding (female-owned companies are 18.7 percent less likely to raise a successful venture round than male peers), they have found far greater success through rewards-based crowdfunding platforms.

While investment crowdfunding has great promise, much work remains to be done for crowdfunding to reach its full potential. As outlined more fully in the white paper we released earlier this month, a few key changes to the investment crowdfunding regime could go a long way towards making crowdfunding a viable option for smaller companies and the investors supporting them. For example, the current rules impose significant disclosure obligations on issuing companies that may increase the cost of raising crowdfunded capital to a point where all but the riskiest companies will turn to other forms of financing for low-volume raises. As demonstrated by the success of the investment crowdfunding market that developed in the U.K. as the U.S. market waited on the SEC to pass final rules, these additional requirements are unnecessary for investor protection and may unduly inhibit the growth of the crowdfunding sector. Though the SEC’s final rules improve on the disclosure rules in earlier drafts, there’s still more work to be done.

Hopefully, today’s announcement is just the first step towards perfecting the U.S. investment crowdfunding market. For cash-starved entrepreneurs and everyday investors eager to join in the innovation economy, today is a seminal moment. For advocates and policymakers working to ensure that investment crowdfunding fulfills the ultimate promise of the JOBS Act, today is just the beginning. We look forward to working with Congress and the SEC in the future on this important issue.

DOE Pilot Improves Student Access to Tech Bootcamps

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Last week, the Department of Education announced a pilot program that will allow federal financial aid to be used toward coding bootcamps and similar “nontraditional” educational programs. The EQUIP (Educational Quality Through Innovative Partnerships) program will make it easier for students who rely on federal aid to access these in-demand educational programs. It will also provide an opportunity for the Department to evaluate the effectiveness of these programs and explore how to best monitor their quality.   

In recent years, the prevalence and popularity of coding bootcamps and other nontraditional education programs have skyrocketed. According to the Education Department, coding bootcamps will graduate 240 percent more students in 2015 than they did in 2014, up from 6,740 to over 16,000 graduates.

This growth is not surprising—as the 21st century economy requires an increasing number of skilled workers, these institutions have risen to meet demand. The courses they offer help to alleviate current pipeline problems by channeling talented individuals into open, high-paying positions. General Assembly, one of the largest and most established bootcamps, reports a 99 percent placement rate in the field of study. And overall, 75 percent of coding bootcamp graduates are finding employment in their field of study and see a 44 percent increase in income according to a 2014 study.

However, there is still a significant roadblock in place: students of most of these nontraditional programs do not qualify for federal financial aid.

Imagine this: you’re a single parent working in an entry-level programming position. You’re looking to advance your career and have read about the emerging field of data science. You don’t have the resources—time or money—to attain a four-year degree in data science, but you find an interesting immersive “bootcamp” program that will train you in data science in just twelve weeks.

Even though this specialized program will train you at a fraction of the cost and duration of a traditional degree, in most cases you would not be able to obtain a federal student loan to help pay for it.

There are two main reasons for this: First, in order for an institution to be eligible for federal aid, it must be accredited. The accreditation process is complicated and ill-equipped to assess these sorts of innovative programs whose courses are constantly evolving based on market demand. As we’ve written before, nearly all modern coding bootcamps and schools lack accreditation.

Compounding the problem is a restriction on accredited colleges that limits the types of partnerships they can have with nontraditional education groups. For example, colleges offering federal aid cannot outsource more than 50 percent of any given program to third party institutions. So, if a resource-deprived community college wants to partner with an outside institution to offer a new program in an emerging field like data analytics, they can only do so if the outside institution offers less than 50 percent of the curriculum, assessment, or faculty.

These limited partnerships have been successfully attempted by several educational companies—General Assembly with Boca Raton's Lynn University; edX with Arizona State University; Galvanize with the the University of New Haven—but there is still huge untapped potential being stifled by overly-restrictive and outdated rules.

The EQUIP program aims to change this by loosening restrictions on schools that want to do innovative work with an alternative education provider. The program waives the existing 50 percent outsourcing prohibition for selected institutions under two conditions: a third party “Quality Assurance Entity” evaluates the outside partner and the college’s accreditor approves it.

While the scope of the pilot will be relatively small, this balanced step will allow the Department to evaluate a model that could later be expanded to cover any partnership between an accredited institution and a nontraditional program.  

Right now the innovation economy desperately needs skilled individuals. Creative initiatives like the EQUIP program are a sensible way for the federal government to rise to meet this challenge and we hope to see more efforts like this one in the future.

 

Making Investment Crowdfunding Work Better for Startups and Investors

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The Jumpstart Our Business Startups Act (JOBS Act) was signed in law over three years ago and in that time, it’s had a notable impact on the startup economy. The IPO “on-ramp” has made it easier for private companies to go public, general solicitation has allowed startups to openly solicit investment from high net-worth investors, and the new Reg A+ has revamped another channel for capital formation for expanding companies. But the JOBS Act’s most exciting and promising achievement—investment crowdfunding open to all Americans—has languished at the SEC, held up in the commission’s rulemaking process. This delay has been frustrating to the entrepreneurs, new crowdfunding platforms, and to everyday investors ready to participate in this exciting new market. We even echoed those frustrations ourselves earlier in fall when we gathered over 200 signatures urging the SEC to act. However, since then, we’ve also gathered additional intel on how similar forms of crowdfunding have flourished, and the regulatory frameworks that have facilitated their successes. Evidence from these ancillary markets suggest the proposed policy framework would benefit from a modified approach.

Our latest white paper, “Financing the New Innovation Economy: Making Investment Crowdfunding Work Better for Startups and Investors,” addresses these concerns. In the paper, we analyze activity from similar crowdfunding markets including rewards and donation-based crowdfunding; accredited investor crowdfunding under Title II of the JOBS Act; as well as investment crowdfunding in the United Kingdom, where everyday investors have been able to invest in emerging companies in exchange for equity since 2012. These crowdfunding markets have experienced exponential growth in the past few years, offering important lessons for regulators as we move closer to launching investment crowdfunding for retail investors in the U.S. One of the most salient takeaways is that fraud has been virtually non-existent, even though issuers are subject to few, if any, of the disclosure requirements that typically accompany public capital raises. Conversely, the current policy framework for investment crowdfunding under Title III includes substantial, onerous disclosure requirements that we believe could be detrimental to the long term growth and sustainability of investment crowdfunding.

Identifying lessons for policymakers from similar crowdfunding regimes, we propose several improvements to the current Title III regulatory framework. These changes will help ensure that investment crowdfunding for non-accredited investors is a successful, sustainable, and efficient market and most importantly, that it attracts quality companies without debilitating costs.

Enabling investment crowdfunding for all investors is critical for expanding capital access to emerging entrepreneurs and startups across the country. Raising capital is often the greatest challenge an entrepreneur faces when getting his or her business off the ground, and too many potential business leaders are left behind because they lack adequate personal finances or can’t tap into sources of angel financing or venture capital. Because investment crowdfunding will allow millions of new people to easily provide capital to startups, it has the unique potential to drive much-needed capital to underrepresented groups of entrepreneurs.

It’s with these entrepreneurs in mind that we believe more work remains to be done to perfect the investment crowdfunding regime. With the Securities and Exchange Commission rumored to finalize rules for Title III by the end of the year, we hope this paper spurs a productive dialogue with policymakers about how to continue improving upon the statute and the forthcoming rules, especially as we garner new insights from the impending U.S. crowdfunding market.

What the EU Data Safe Harbor Ruling Means for Startups

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This week’s decision from the European Court of Justice (ECJ) vacating the European Commission’s “safe harbor” rule that allowed U.S. companies to quickly and easily import consumer data from European users has left many in the tech community unsure about exactly what went down and what happens next. While the ultimate impact of the ECJ’s ruling is hard to predict, the incident serves as an interesting lesson on the often poor fit between policy and technology.

What exactly happened?

Unless you’ve recently taken a course in EU civics, figuring out precisely how things got to this point and what it all means is rather difficult. To summarize: the EU’s data protection laws are more stringent than those in the much of the rest of the world—the U.S. included. Under the EU’s Data Protection Directive, data from EU citizens can only be transferred to countries that provide certain protections for said data. Recognizing that compliance with these data protection rules could create a giant bureaucratic headache for companies and countries, in 2000, the European Commission created a “safe harbor” that allowed any U.S. companies to self-certify that they complied with the Directive and thereby legally import EU consumer data into the U.S. This safe harbor rule is at the heart of the present dispute.

In 2014, an Austrian citizen filed a lawsuit in Ireland, claiming that U.S. laws permitting the NSA to surreptitiously collect and analyze vast amounts of consumer data violate the Directive. The Irish court then referred the case to the ECJ, the highest court in the EU, to consider the application of the safe harbor rule. Ultimately, this week, the ECJ held that the safe harbor doesn’t prevent individual member states from considering whether U.S. rules allowing government data collection render U.S. companies in violation of the Data Protection Directive and that the safe harbor itself fails to provide adequate data protections. With the ruling, the most commonly used legal pathway for importing EU data to the U.S. disappeared.

So what happens now?

With the rule allowing U.S. companies to import EU consumer data eviscerated, do EU-U.S. data transfers suddenly stop altogether? Did EU citizens wake up to find they couldn’t access their email accounts run by American companies? Not quite. The ruling will impact different companies in different ways.

Different legal pathways for data transfers

The safe harbor isn’t the only way that U.S. companies can import EU customer data. For example, companies can craft “binding corporate rules” (essentially, intra-company privacy policies) that, once approved by the data protection authorities in EU member states, allow for EU to U.S. data transfers outside of the safe harbor. But, since crafting such policies and getting member state approval is an arduous, time-consuming process, only large, well-funded companies can afford to explore these alternate data transfer protocols, leaving startups functionally unable to comply with data transfer rules.

Local data storage

If a company can’t legally transfer data from the EU to the U.S., the other option is to simply keep the data in Europe by building or leasing new data storage facilities overseas. Some companies, like Box and Pick1 are taking this approach, but this strategy comes at significant financial and time costs for companies, and startups operating on tight budgets may not have the resources to relocate servers or the time to develop new ways to handle foreign data.

Do nothing?

If a startup can’t find alternate legal mechanisms to import data or European data centers to handle EU data, it’s left with a difficult choice: stop handling EU customer data or continue to do so and face legal risk. The former tactic has obvious drawbacks. For one, it can be challenging to determine whether or not particular data belong to an EU-based user, rendering compliance nearly impossible. And, even if it is possible to altogether stop handling EU data, losing such a huge market will likely doom a great number of companies.

Startups could (and many probably will) simply continue business as usual and hope that they don’t get sued. A company that struggles to find the resources to establish alternative data importation frameworks or overseas servers may be too small for regulators and plaintiffs to worry about. Obviously, this isn’t a particularly comforting option for a company that wants to follow the rules. But, with such a sudden and dramatic shift in the rules, it may be the only course forward for some companies.

How long will this problem persist?

While the decision came as a surprise to many, policymakers in the EU and U.S. have been trying to shore up the safe harbor framework for a while. The ECJ’s ruling will add some urgency to their work, and U.S. and EU officials have given assurances that alternative data export pathways will soon become available. Of course, “soon” means something very different to bureaucrats than it does to entrepreneurs. And, even if the EU and U.S. can craft a new safe harbor framework, it’s unclear how these new rules will avoid the same fate as the prior safe harbor. That is, if the ECJ’s decision was predicated largely on the U.S.’s NSA-enabling legislation, any new safe harbor framework will similarly run afoul of the Data Protection Directive unless and until the U.S. passes significant surveillance reform legislation that limits the NSA’s reach. But, since a new ECJ ruling throwing out this replacement safe harbor could take several years, it may buy enough time for the U.S. or EU to craft other sensible data transfer rules.

Broader Lessons

The ECJ’s elimination of the safe harbor could pose an existential threat to some companies or it may simply end up being a temporary distraction, but it has helped crystalize a few issues facing the Internet economy. First, the notion of enforcing territorial data restrictions makes little sense in a globally interconnected digital world. Sure, national governments have an interest in making sure that their users’ data are protected, but trying to restrict the flow of information across national boundaries creates more problems than it solves, particularly for the startups that are responsible for building the global Internet. Creating insurmountable bureaucratic hurdles for companies that want to comply with their international obligations serves no one.

Second, the ruling highlights the need for surveillance reform in the U.S. Simply put, if users do not feel that their data are adequately protected, they will be less inclined to use online services—services often provided by fledgling startups. While the logic of the ECJ’s decision itself seems peculiar (if the U.S. fails to adequately protect user data because it allows the NSA to obtain authorization from FISA courts to secretly collect data, why are countries like France, Germany, and the U.K.—which do not require intelligence agencies to get court approval before collecting data for national security purposes—exempt from scrutiny? Is consumer data really any safer from NSA collection if it’s stored in the EU rather than in the U.S.?), the notion that consumer data should be protected from government surveillance is difficult to dispute.

Finally, the safe harbor fiasco is a prime example of how policy struggles to keep up with technological realities and the problems that arise when regulatory compliance becomes too complicated for otherwise upstanding companies to easily navigate. Many companies simply have no idea what they’re supposed to do while national governments try to hammer out an interim fix to data transfer rules, and even this temporary uncertainty can cause companies to go under altogether. As the Internet economy becomes ever more global, policymakers should strive to make the rules governing global commerce as frictionless as possible.

Will 2015 Be Our Last Real Best Chance for Patent Reform?

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Earlier this month, the White House hosted its first ever Demo Day, inviting startups from all over the country to celebrate entrepreneurship. At that event, the President eloquently pointed out just how important the startup community is for our nation:

"Startups, young firms account for almost 40 percent of new hires.  And as we’ve fought back from the worst economic crisis of our lifetimes, those firms have helped our private sector create more than 12.8 million jobs over the last 64 straight months, which is the longest streak of private sector job growth on record."

With numbers like those, you would think all elected leaders would be racing to support pro-entrepreneurship policies. Yet Congress continually fails to move patent reform legislation, threatening the future of the startup community and the good jobs it creates.

The patent troll threat is not an abstract problem. And it’s not a problem that’s getting better. In fact, abusive patent litigation is becoming more prevalent: patent lawsuit filings are on track to break a new record this year (with a forecast of more than 6,000 suits) and 68 percent of suits so far have been filed by trolls. Furthermore, 82 percent of troll activity targets small and medium­-sized businesses, and 55 percent of troll suits are filed against companies with revenues of less than $10 million.

This fall presents an important opportunity—maybe our last—for patent reform to become law.

Where are we?

In June, the Senate Judiciary Committee voted 16-4 to move the PATENT Act to the full Senate floor; later that same month the House Judiciary Committee likewise voted, 24-8, to move the Innovation Act to the full House floor. Both bills represent comprehensive solutions that would address a dangerous patent troll problem; neither is perfect, but both would go a long way to fix a broken system. You can read more about the House bill here and the Senate bill here.

We were very excited when both bills were introduced. Since then, however, provisions in each have been watered down. Compromise and revisions are inherent to the political process, so to some extent this was expected. Questions remain, however, about how much is too much.

There are four primary issues that remain open to debate: venue, pleadings, discovery, and inter partes review (IPR). For political watchers, the last—inter partes review—is the most important. All of the other provisions of the House and Senate bills deal with litigation reforms, but inter partes review is a Patent Office procedure that allows for efficient and effective review of patents outside of federal court. That means the process is particularly good at weeding out bad patents and addressing patent quality, a huge problem that patent trolls have been able to exploit. Originally, the House and Senate bills barely addressed inter partes review, which we were glad about, since by and large the process has been quite successful.

Enter Kyle Bass. The well-known hedge fund manager’s most recent enterprise involves using the IPR process to challenge weak pharmaceutical patents and then short the stock of the company that owns the patent. The pharmaceutical industry, which relies heavily on patent rights, is far from pleased. And despite the fact that the IPR process contains significant protections for patent holders and the fact that Mr. Bass’ actions can already be addressed by the SEC, the pharmaceutical industry has been able to shoehorn its issue into the larger reform efforts.

As a practical matter, this means that long-standing Capitol Hill players, like PhRMA and BIO, are holding up patent reform efforts unless changes are made to weaken the IPR process. (We explain in more detail here why those changes are not only unnecessary, but in fact quite dangerous.) Senators Schumer, Cornyn, Grassley, and Leahy—the primary authors of the Senate bill—are still hammering out a so-called deal on IPR, details of which we should see soon. Even with such a deal, it’s unclear if PhRMA and BIO will decide to support reform efforts.

In the meantime, the House originally planned to move forward with a full vote on its bill in July, but at the last minute, Republican leadership pulled it from the calendar, claiming they needed more time to get the deal done. There is no real way to sugarcoat what happened: the delay shows a slowing of support and momentum for an important bill and we were disappointed that it happened.

Is there a path forward?

There is still a path forward. In September, when Congress comes back, the Senate is slated to pick up its efforts. We understand that Senate reform champions are close to a deal on IPR and that such a deal could create a framework for the bill to pass out of the full Senate. (This would be a particularly interesting turn of events, because in 2013 a strong patent reform bill passed the House 325-91 and then languished in the Senate in 2014.)

Using the momentum from the Senate, the House would be in a good position to revive its own efforts. Given the fact that the House did pass a bill in 2013 with a wide, bipartisan majority, we are confident that the bill would make its way through that chamber easily.

The White House has made clear its support of patent reform and we have every reason to believe that President Obama would happily sign a strong piece of patent reform legislation into law.

Is that path worth it?

Probably. There are two things to watch closely: IPR (see above) and venue (see more here). Right now, the House bill includes a strong venue provision that would help prevent trolls from filing so many cases in the notoriously plaintiff-friendly Eastern District of Texas. This would in turn make it easier for patent troll targets to fight back.

So, to simplify: anything that weakens IPR is bad (this should play itself out first in the Senate bill). Efforts to fix venue are good (see the House bill for this). Some combination of the two is probably liveable, though—as always—the devil is in the details, details we will be watching very closely over the next couple of months.

We’ll continue fighting to make sure that startups and inventors see legislation that will actually protect them from patent trolls and will need to call on you to help make our case. So watch this space closely and stay tuned.

Chicago’s New “Cloud Tax” Raises Questions Around Process, Policy

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It’s no secret the winters in Chicago are brutal—anyone who has lived through a January in the Windy City can attest to this fact. Long periods of Netflix-aided hibernation are common for Chicagoans in the depths of winter. This is perhaps why the news last month that city residents will begin paying a “cloud tax” on their monthly Netflix bill didn’t go over well. As more business activity migrates online and consequently outside traditional tax protocols, cities and states are being forced to modify their tax regimes to adapt to these changing circumstances. While governments are certainly justified in their concern about dwindling tax receipts, digital commerce is fundamentally different than traditional brick-and-mortar enterprise and requires a thoughtful, unique approach to taxation in order to properly protect public interests without stunting business growth. Unfortunately, Chicago’s approach to digital taxation appears to be precisely the sort of hastily considered, ad hoc policy that could end up doing serious harm to the digital economy.

The ruling from the Chicago Department of Finance imposes a 9% tax on “electronically delivered amusements,” defined as “any exhibition, performance, presentation or show for entertainment purposes.” Essentially, this means that any electronically delivered television shows, movies, or music consumed for rental by customers in the city will be taxed. Technically speaking, the tax itself isn’t “new”—rather, it’s an expansion of Chicago’s existing amusement tax which covers concerts, sporting events and other activities. The ruling requires online digital content distributors to collect amusement taxes for digital amusements. While other cities have similar amusement taxes for brick-and-mortar establishments, Chicago’s application of the tax to digital content distributors is novel.

Chicago realized the tax money it was collecting from brick-and-mortar enterprises like movie theatres and video stores was evaporating as consumers stopped frequenting such establishments in favor of Netflix and other streaming services. So what’s the problem if Chicago is merely taxing digital video rentals in the same way it had traditionally been taxing physical video rentals? For one thing, the ruling took most people by surprise because there was little if any public participation in the decision. Instead of passing a new city ordinance or going to the voters to approve a new tax—both of which would have involved robust opportunity for public comment—the Department of Finance chose to quietly broaden an existing law. It’s hard to imagine a similar tax policy with such a wide impact not being publicly debated. Sidestepping voter approval suggests (not surprisingly) that there may have been public opposition to the new tax.

Beyond the process questions this new regulation raises, it highlights a broader issue around taxation of digital commerce. While a local brick-and-mortar business only has to worry about complying with tax laws of the jurisdiction in which it operates, online businesses may be subject to taxation in any jurisdiction in which its customers reside—that is, anywhere in the US.  For larger companies like Netflix, setting up the infrastructure to comply with a variety of tax jurisdiction is possible (though still expensive and onerous). For the small businesses that have historically driven the growth of the Internet economy, such compliance obligations would be insurmountable. According to the US Census, Illinois has 6,994 separate local governments. If each one chose to implement unique taxes on various internet goods and services, compliance would be significantly convoluted. For small businesses operating in an online marketplace with limited margins, such requirements could potentially put them out of business.

It’s no surprise cities struggling with reduced tax revenue are looking for new revenue streams. Indeed, discussion and action needs to take place around fair online tax policy, but it needs to take into account the uniqueness of the online environment. Chicago’s recent action highlights the need to have these conversations soon, and at a national level. Congress has put at least some effort into addressing the problem of e-commerce taxation, introducing the Marketplace Fairness Act three times, and discussing alternate proposals from Reps. Chaffetz, Goodlatte, and Eshoo. However, the current legislative climate—coupled with opposition from large Internet businesses—makes legislative action before the 2016 election unlikely. In the interim, other cities and states may follow Chicago’s lead, attempting to raise tax revenues in the short term, while jeopardizing the long-term health of the Internet economy.

Why Broadband Competition Matters to Startups

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Last week, at the annual U.S. Conference of Mayors meeting in San Francisco, Minority Leader Nancy Pelosi identified the two policy issues she most wanted the mayors in attendance to focus on: sequestration and spectrum. As Pelosi noted, issues surrounding sequestration will hopefully get sorted out relatively quickly, but adjusting our national broadband infrastructure to maximise innovation and economic growth is a far more difficult task.

In most markets in the country, consumers and businesses have access to only one or two wired Internet access providers. The situation isn’t much better in the fast-growing mobile Internet space, where the two dominant wireless companies, AT&T and Verizon, control nearly 75% of the low-band spectrum in the country—the type of spectrum most valuable for mobile Internet use. Given this concentration of key resources in the hands of a few companies, it is no surprise that the U.S. recently ranked 26th out of 29 countries in terms of wireless broadband speed.

As Leader Pelosi noted, in a country where “only 37 percent of our nation’s schools [have] enough broadband for digital learning,” increasing broadband access and affordability would help grow the economy by training a generation of entrepreneurs with the technical skills needed to thrive in the digital world. But, improving wireless broadband speed, price, and coverage through greater competition would grow the economy in myriad other ways, perhaps most profoundly through its impact on the startup sector.

We at Engine are fond of reminding policymakers that startups are responsible for virtually all new net job growth in America, and in light of this reality, policies that help increase startup activity are policies that create jobs. Simply put, actions that increase competition in broadband markets—like expanding the spectrum reserve in the upcoming low-band spectrum incentive auction—will go a long way towards spurring startup activity and the economy more generally. That’s because better competition in mobile broadband helps startups in a number of key ways:

1) A bigger customer base. At any pitch meeting, one of the first questions an entrepreneur will get from potential investors is about the size of the company’s addressable market. That is, how many consumers will your business reach? The bigger the market, the higher the company’s potential value. Citizens that are either not online at all or do not have access to broadband of adequate speed or capacity are citizens not participating in the startup economy.

According to the FCC’s Seventeenth Mobile Wireless Report, in 2014, 0.3 percent of the U.S. population “lived in census blocks that received no mobile wireless broadband coverage.” That may seem like a small percentage of the population, but it amounts to approximately one million people without any mobile wireless access. Amongst people with access to some mobile broadband coverage, a huge percentage of the population is dramatically underserved. A recent Pew study found that seven percent of the public—or more than 22 million people—have no home broadband service and have a limited number of ways to get access beyond their cell phone. Considering how poorly U.S. mobile broadband fares in terms of speed, data availability, and affordability, many if not all of these citizens likely cannot use any of the amazing technologies and services that startups provide. Giving these folks access to better, cheaper mobile broadband will greatly expand startups’ addressable market and consequently boost startup activity. And, increasing competition amongst mobile broadband providers is really the only feasible method of improving broadband penetration.

2) Lower costs for startups. The archetypal image of the startup as one or two scrappy inventors in a garage isn’t all that far from the truth for most companies. While there are a few outliers that find substantial funding early in their life cycles, most startups have to get by with minimal funding as they develop their core business. Failing to raise adequate seed funding to launch an enterprise is one of the most common pitfalls for entrepreneurs. Since every dollar counts, lowering the amount of money it takes for entrepreneurs to start businesses directly results in more startup activity. And, according to a report from the Internet Innovation Alliance, access to quality broadband can save startups an average of more than $16,000 annually—a significant number for startups trying to get off the ground. Making mobile broadband more efficient and affordable will further help drive down costs for startups and in turn improve competition in the startup sector.

3) New technologies. It’s impossible to predict precisely how the innovators that drive our startup sector will harness the power of faster broadband technologies like gigabit WiFi, but it’s a guarantee that they will find ways to generate entirely new companies and services that take advantage of whatever broadband resources are available to them. This innovation represents the real economic growth potential from increased mobile broadband competition. Just look at the value of startup products and services riding on unlicensed spectrum technologies like Bluetooth and WiFi, which are estimated to add $222 billion to the U.S. economy each year. If startups had access to ubiquitous, ultra-high speed mobile broadband, the value of the technologies and services they could create would be staggering.

 

The importance to the startup economy of advanced broadband infrastructure is hard to overstate, and yet opportunities to promote the type of competition necessary to spur faster and cheaper networks are in short supply. The upcoming FCC low-band spectrum incentive auction represents one such opportunity. Failure to take adequate steps to promote competition through auction safeguards will put at risk the untapped economic potential of future generations of startups and the millions of jobs they could create.