When conducting due diligence, investors are primarily concerned with two things: a) who owns the company, and b) does the company actually own its intellectual property (IP). In the competitive landscape of startups, IP stands as a cornerstone of success and sustainability. This is especially true for companies supported by venture capitalists (VCs), where the valuation and scalability of a business often hinge on robust IP management. Here, we delve into six IP concerns that VC-backed startups must navigate.
1. Why investors are so concerned about IP ownership
For VCs, the clarity of IP ownership in a startup is a critical factor in their investment decisions. This scrutiny stems from the need to ensure that the startup’s competitive advantage, often rooted in its unique IP, is legally secure and defensible.
Uncertainties in IP ownership can lead to potential legal disputes, negatively impacting the startup’s market valuation and future growth, investment, and acquisition prospects. Moreover, from a risk management perspective, VCs aim to minimize risks associated with IP disputes and infringement claims, which can be both costly and detrimental to the startup’s operational continuity.
Simply put, VCs will not invest in companies that have uncertain IP ownership. Additionally, clear IP ownership is paramount when considering exit strategies, such as acquisition or initial public offerings. A well-documented and legally sound IP portfolio is essential to potential acquirers, who are themselves typically successful companies with deep pockets that are potentially prominent targets of IP infringement claims. Startups hoping to be acquired or to receive VC investments must be careful about about securing their IP ownership.
2. IP assignments from employees and co-founders
A fundamental aspect of managing IP in startups is securing IP assignments from employees, contractors, and co-founders. This involves formal written agreements stating that any creations or innovations made by team members during their tenure are the property of the company.
The absence of such agreements can lead to complex legal disputes over ownership rights, potentially hindering future fundraising efforts or acquisition deals. Establishing standardized IP ownership protocols from the outset is crucial.
This includes having all team members, including founders, agree that any IP developed as part of their employment is owned by the startup. Such practices are not only essential for internal clarity but also play a significant role during due diligence processes undertaken by VCs. Incomplete or missing IP assignments can act as a significant impediment to securing investment.
3. IP Law nuances
Given the high cost of lawyers, it is often tempting for founders to use online templates or write their own IP provisions without the benefit of legal counsel. This is a dangerous proposition and particularly dangerous when it comes to IP law.
For example, there is a legal distinction between whether an employee “hereby assigns” or “will assign” their IP rights. This distinction, while seemingly minor, can have significant legal implications. “Hereby assign” is a present-tense assignment, effectively transferring IP rights immediately upon creation of the IP. This means that as soon as an invention or creation is conceived or developed by an employee or co-founder, the ownership automatically and immediately vests in the startup. In contrast, “will assign” is a promise of future action, indicating that the rights to any future IP will be transferred to the company at a later date. Courts have found that the future-tense language “will assign” was not always sufficient for conferring IP rights and that “hereby assigns” was necessary for the actual assignment.
The law is such subtleties and founders should be careful to consult an attorney to navigate such intricacies. Lawyers who help startups will have standard forms to help founders avoid these types of mistakes.
4. Patent protection and infringement risks
Patents serve as a shield, protecting a startup’s innovations and granting exclusive rights over their commercial use. For VC-backed startups, holding patents can significantly enhance their market valuation and provide a moat against competitors.
However, managing patent portfolios is not without challenges. Startups must be vigilant to ensure they are not infringing on existing patents, which necessitates comprehensive patent searches and legal assessments of their freedom to operate in specific domains.
Additionally, as startups mature and begin evolving and diversifying their offerings, maintaining an active and forward-looking patent strategy becomes imperative. This involves regular reviews and updates of their patent portfolio to align with their evolving product lines and services.
5. Trade secret management
Effective management of trade secrets is a critical component of intellectual property strategy for startups. Legal protection for trade secrets hinges on the owner’s proactive efforts to maintain their secrecy.
Generally a trade secret is information that derives economic value from not being generally known and is subject to reasonable efforts to maintain its secrecy. Owners need to take reasonable measures to keep the information secret so implementing robust protective measures is crucial. Startups need to actively protect their trade secrets or risk loosing them.
6. Licensing agreements and IP ownership in collaborations
In the realm of innovation, startups frequently engage in collaborations with other entities like universities or research institutions. These partnerships can give rise to new IP, necessitating clear and explicit licensing agreements.
These agreements must detail the ownership rights and usage terms of any co-developed IP, avoiding ambiguities that could lead to future disputes. Striking a balance in these agreements is crucial, ensuring that the rights of all parties are respected while safeguarding the startup’s core IP assets. Such clarity not only facilitates smooth collaborative efforts but also ensures that the startup’s IP remains a solid foundation for its growth and scalability.
Effective IP management is a must
Efficient and effective IP management is not merely a legal obligation for VC-backed startups, it is a strategic imperative that underpins their growth, innovation, and market competitiveness. By adeptly navigating these six key IP concerns, startups position themselves not just for success in the present, but also for sustainable growth and profitability in the future. In the rapidly evolving landscape of technology and business, those who master the art of IP management invariably stand at the forefront of innovation and success.
Aerial helps founders stay on top of critical legal issues by leveraging AI to automatically organize legal documents. In particular, Aerial helps founders by ensuring all employees have signed IP Assignment Agreements and notifies you in real time if a document is missing.
For more information, visit Aerial.