March 4, 2021

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How to position your startup so that the IP you develop becomes an investment, not...

How to position your startup so that the IP you develop becomes an investment, not a cost. By Joshua Van Hoven, Counsel and Peter Hale, Partner, at Haley Giuliano

As an early stage company, you may be a disruptor or seek to advance a key technology in which your team has particular expertise. No matter the driver, even the most idealistic startups fail to achieve their goals if they do not position themselves for investment funding of some kind. Those investments are typically based on the potential financial return of a subsequent acquisition or public offering.

At each stage of the investment cycle, your investors and business partners will scrutinise your people, technology and operations. A robust intellectual property (IP) programme will ensure that the efforts of your people are owned by your company, that your technology is safe from theft or copying and that your operations (such as branding, goodwill and customer relationships) are protected from free riders. In short, a sound IP strategy adds value to your business – IP is an investment, not a cost, if handled well.

Establishing IP best practices

Founders often think of IP in terms of monopoly rights, such as patents and trademark registrations. In fact, virtually all early stage agreements a company will sign – whether with founders, employees, contractors, business partners, suppliers or customers – will have a core IP element. An established recognition of IP in your systems and business practices, from founding through funding, will dictate whether the benefits of your business-building efforts accrue to your company, other companies or the general public.

The following are subjects to address with founders, employees and contractors:

  • If possible, obtain a forward-looking assignment of all pre-existing IP that is related to the company’s business. As a second-best option, obtain a licence to use the IP. Otherwise, the IP holder may hold the company hostage later, particularly if relationships sour.
  • Obtain assignment of all IP developed by personnel while employed or retained by the company. If possible, include related developments from employee side projects.
  • Require confidentiality and non-disclosure obligations for any non-public information related to the company or derived from company information.
  • Where allowable (check laws in local jurisdictions), obtain a reasonable noncompete clause (reasonable as to time, scope and geography) at the beginning of engagement to address subsequent separation from the company. Depending on local laws, consider limitations on the use of retained information in human memory (residuals).
  • Require ongoing obligations to co-operate in the acquisition, enforcement and/or defence of IP.
  • Require compliance with approved device policies that limit where, how and with what devices employees can access company information.
  • For contractors, ensure by contract that any creative works (including source code) are explicitly works made for hire on behalf of the company.

All of these rules are equally likely to also apply to agreements with third parties, such as suppliers, joint venture and business partners, distributors and customers. In addition, you should also consider the following:

  • disclosure of IP and establishment of licences to use IP of suppliers, joint venture partners and other business partners;
  • allocation of jointly developed IP rights for joint venture and business partners – either ongoing rights to use or co-ownership;
  • indemnification and defence obligations for infringement due to company use of supplier and business partner products and technology, and for infringement by business partners and customers through use of the company’s products and technology; and
  • limitations on liability incurred due to IP indemnification, IP defence or breach of any other obligations.

Suitable agreements can be provided by your business or IP counsel. As a practical matter, early stage companies are generally able to obtain pragmatic IP terms from employees and contractors, while larger established firms often attempt to impose unfavourable IP terms on early stage companies. In the latter instance, the established firms’ lengthy ‘form’ documents often include onerous buried terms that may compromise your company’s core IP. Identifying and addressing those terms can secure the company’s long-term prospects. In our experience, most large firms know that some of their terms are onerous (even unenforceable) and are willing to walk those terms back during negotiations. If an agreement sacrifices too much of your company’s IP and the large firm is unwilling to negotiate, you must be willing to walk away.

While the right agreements establish that you own and control your IP, proper business practices are key to creating IP in the first place. Our next section addresses the types of IP and how they are established in more detail, but as a general matter the company should consider at least the following steps:

  • Establish and enforce standards for electronic storage systems, physical document retention and device usage.
  • Document code and product development activity and revisions, and establish protocols for storage and maintenance of these materials.
  • Maintain reasonable access controls to facilities and documents, particularly for key technology, customer lists, supplier information, business plans and financial data.
  • Establish onboarding and exit procedures to ensure that employees sign required agreements, have appropriate access to company-related information and remain informed of their ongoing obligations to the company.
  • Establish branding and marketing guidelines that ensure consistent messaging, provide notice of copyright and trademark ownership and prevent inadvertent loss of trademark rights through dilution.
  • Establish invention disclosure processes to establish a record of invention, and initiate reviews for considering patent versus trade secret protection.
  • Perform pre-disclosure reviews before technology is disclosed to any third party or prior to any sales efforts (even under a non-disclosure agreement [NDA]) to prevent inadvertent disclosure and loss of trade secrets or patent rights.
  • Periodically monitor for third-party use of company IP (including by business partners) to identify problems early, when resolution is more likely and less costly.

One brief note on dealings with investors: venture capital firms (VCs), and even seed investors, do not typically sign NDAs. It is therefore recommended that you work with your IP counsel to distinguish your business idea from your ‘special sauce’ that uniquely addresses that business idea. The former is suitable for initial discussions, while the latter should either be covered by a patent filing prior to discussions or held for a later meeting, when the investors are willing to sign an NDA that protects your trade secrets and potential patent filings. As with all bad business deals, if a VC requires that you give away your special sauce to get a meeting, you need to stand your ground.

Acquiring IP assets

You might ask: why address IP best practices before introducing the different types of IP assets and how they are acquired? The simple answer is that companies automatically acquire most IP as a result of following these best practices. As for IP that requires the grant of rights from a government agency (e.g. patents) or that is enhanced by such approval (e.g. trademarks, design rights and sometimes copyright), following these best practices establishes the baseline for registration.

For each of the four core types of IP, the table provides examples of protected subject matter, how the IP rights are acquired and international considerations.

Assuming a company establishes and maintains IP best practices, the next step is to establish a strategy for securing IP by patents, trademark registrations, copyright registrations, design rights and domain name registrations. This strategy will vary depending on the technology area, type of business and available funding. The IP strategy should be developed with an IP professional to provide a realistic cost–benefit balance. As a rough rule of thumb, a product company will typically file provisional patent applications prior to product release or sales efforts, obtain trademark clearance for company and product names well before launch, and register core trademarks, domain names and copyrights as necessary. Most international filing regimes provide a grace period (around 6–12 months) from an initial filing, and international protection is typically pursued as these deadlines approach and the company has further considered product development and its likely international footprint.

While the basic concepts of protecting IP around the world adhere to a common format, there are wrinkles that can trip up the unwary. For example, the average US company will often want to rely on the protection afforded under US patent law on the effect of the sale of goods subsequently covered by a patent application. However, much of the rest of the world (China, Europe, Japan and Korea, for example) will regard such sales as a potentially public disclosure of the invention, which could invalidate patent rights. The general advice is not to assume the law is uniform and check with IP counsel in advance.

Types of IP: What they protect, how they are acquired and international considerations

Trade secrets

What is protected? Confidential information that has value to the business, such as source code, schematics, business plans, customer lists, suppliers and sourcing and pricing. Trade secret rights last as long as the information is kept secret.

How is it acquired? The company must engage in reasonable commercial efforts to keep the information secret. No government registration is available. Trade secrets require documentation of efforts to maintain secrecy, including agreements and business processes.

International considerations: Standards of proof and enforcement mechanisms vary worldwide. When partnering with overseas firms, consider local trade secret provisions before disclosing secret information, even under NDAs or other conditions of confidentiality.

Patents

What is protected? New inventions in technological fields, including electronics, software, pharmaceuticals, compositions, biotechnology and mechanical devices. Patents are a monopoly right with a limited term (typically 20 years).

How is it acquired? The company must apply for a patent by filing an application prior to a filing by a third party and prior to any public disclosures of the invention, often including sales. Patent filing and examination is generally not cheap, although there are strategies for deferring costs until later in the patenting process.

International considerations: An initial filing in an appropriate country (consult an IP attorney on foreign filing licence requirements) can serve as the basis for follow-on filings worldwide.

Trademarks, design rights and domain names

What is protected? Branding and goodwill from company name, advertising, taglines, product design, user interface design and domain names.

Trademarks may be maintained as long as the mark is in use and used properly, while design rights have a limited term.

How is it acquired? Some jurisdictions establish ‘common law’ rights through use in the jurisdiction, with enhanced rights through registration and notice. Other jurisdictions require registration as a prerequisite to bringing a trademark action. Design rights and domains typically must be registered, but exceptions exist.

International considerations: International treaties are in place that establish mechanisms for filing for these forms of IP in numerous jurisdictions around the world. Coverage is not universal, and time limits counsel for early consideration of the IP’s likely international footprint.

Copyright

What is protected? Creative works, photographs, videos, source code and unique user interface elements. Copyrights have a limited term, but that term is lengthy in many instances.

How is it acquired? Copyright is established with the creation of the work and enhanced in some jurisdictions through registration and notice. Costs of registration are generally minimal, although costs can escalate for businesses with an extensive corpus of creative content.

International considerations: International treaties are in place that establish mechanisms for recognising these forms of IP in numerous jurisdictions around the world.

Funding events

Fancy lunchrooms and company jackets aside, founders, early stage employees and investors are compensated and motivated by an eventual return on their company stock due to acquisition or a public offering. But until that day comes, the company’s operations must be funded. At each stage of your journey, from notes on a napkin to acquisition or initial public offering (IPO), sophisticated third parties considering investing will scrutinise your IP.

The level of scrutiny will vary depending on the stage of your company and the investor or purchaser. For example, early stage investors typically know or are connected to the founders and may be willing to sign on to convertible notes (a type of ‘loan’ in which the investor receives equity instead of principal and interest in return) on a handshake or based on a high-level view of the IP position. By the time of your first venture capital roadshow, expect to get into the weeds on your IP portfolio and operations. The company may be expected to make numerous representations and warranties, for example:

  • ownership of IP, including IP developed by employees, contractors, joint venture partners, etc.;
  • confirmation that employees and third parties are subject to appropriate confidentiality obligations;
  • licences necessary to operate the company’s business, and a lack of obligations to third parties who may compete with or impede the company’s operations;
  • non-infringement of third-party IP, particularly in technical areas related to the company’s core business and technology; and
  • IP rights obtained to create barriers to entry for third parties, IP rights obtained legitimately from the relevant IP authorities and IP rights still being valid.

It may be entirely reasonable to include a qualifier (e.g. ‘To the company’s knowledge, it does not infringe . . .’) for any of these representations and warranties, which, if incorrect, can form the basis for a later lawsuit against the company. Depending on the transaction, the company may also be required to provide detailed schedules listing relevant IP assets, pending or threatened infringement litigation, employment status of key inventors and key licences.

Particularly for later venture capital rounds, acquisition or IPO, companies will typically work with outside IP counsel to negotiate the IP portions of the deal and put together these schedules. The counterparty will scrutinise your disclosures very closely, typically with a team of lawyers and consultants. Particularly in the US, a company’s IP disclosures may also be reviewed by national regulatory agencies, such as the Securities and Exchange Commission.

Many companies have failed to attract funding or suffered a significant drop in valuation due to a lack of attention to the IP details. So investing in an IP strategy early more than pays for itself.

This content is taken from the second edition of Yes Business Can from Lloyds Bank and Bank of Scotland – a collection of expert articles from a range of trusted sources offering information and inspiration on starting, growing and exiting a business. The new second edition has been updated with chapters on cyber risk management, women in business and integrating sustainability into your business strategy.
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Read more:
Building an IP strategy: IP as investment

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