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Structuring your start-up and protecting its intellectual property

by

Partners, Lowndes Jordan

There are a number of phases that any successful start-up will go through, and the path and timing is always different.  However, some of the more common stages are:

1. The great idea is born.

2. To develop the idea, and find a way to make money from it, various skillsets are identified and a team forms.

3. Beta models are developed, market validation is carried out, business and revenue models are formed and an early-stage business gets underway.

4. To grow, and develop the product and the business, capital is needed – so new investment is sought.

In this post we talk about structuring start-ups and protecting intellectual property.  You won’t have much time for either of these issues at StartUp Weekend, but if you decide to take the business forward you will need to deal with them.

Structuring your start-up

Most start-ups begin with a small number of individuals, but rapidly grow into a larger team as the need for different inputs (cash, expertise, etc.) becomes apparent (at StartUp Weekend this happens in the first couple of hours!).

It is important that the members of the team have a common view as to their objectives, and the basis on which they have come together.  You need to minimise the chance of in-fighting which is often fatal to fledgling businesses.

As soon as a core team is formed, and the business concept is validated to a point where the team considers it has a viable business proposition, you should take the following steps:

1. The ownership of the business and IP (see below) is moved out of the hands of the individuals and into the ownership of a company, the shares in which are owned by the individual team members (or trusts or special purpose investment vehicles associated with them).

2. The shareholders enter into a shareholders’ agreement and a related constitution is adopted, governing their relationship with the company and with each other.  A good shareholders’ agreement will deal with fundamental issues such as:

    • The up-front contribution that each shareholder must make to the company, whether in cash, assets or “sweat equity”, in return for that shareholder’s shares
    • How decisions concerning the business and the company will be made
    • How the profits of the business (if any) will be treated
    • How a shareholder can exit the company
    • How future investment will be made, either by existing shareholders or by new investors

The number one benefit of a good shareholders’ agreement is that it takes the emotion and uncertainty out of issues that confront you as shareholders, greatly reducing the risk of disagreement and freeing you up to get on with developing the business.  Paradoxically, a successful shareholders’ agreement will almost never be referred to once it is signed, because you all have a clear understanding of your positions relative to the company and each other, and are comfortable with those positions.

As the business grows, and particularly where external investors join, your company structure will need to change, and you’ll need more sophisticated governance documents.

Intellectual Property

The assets of every business include intellectual property.  For most start-ups, intellectual property is the most valuable business asset and it must be protected if the start-up is to survive.  If nothing else, when external investment is sought, smart investors will want certainty as to intellectual property ownership.

Ownership of patents, trademarks, designs, plant variety rights and the like is obvious since they are registered.  If they are in the founder creator’s name, they will need to be transferred though to the company.

Copyright is a little more complicated.  Because copyright arises automatically and is not registered (in New Zealand at least), ownership can be overlooked.  The default rule is that it will be owned by the creator (the author in copyright parlance).  So, for example, the creator of an original website will be the owner of copyright in that website.  There are four very common traps here:

    • Employees – Copyright in a work created by an employee in the course of their employment is automatically assigned to their employer (an exception to the default rule).  However, there can be real argument around the in the course of employment condition when employees are working outside normal office hours or locked away in the proverbial garage.  Finding out that the core intellectual property is owned by people who turn out not to be employeescan be a real problem since there is no way of forcing them to transfer it to the company.
    • Founder creator – if you, as founder creator, are not an employee of the company, then the copyright will belong to you; not the company, even though you may be a director and shareholder.
    • Contractors – since they are not employees, the default rule applies to everything they create for the company – the contractor will own the copyright; not the company.
    • Collaborators – this category includes situations where you perhaps build on something that a colleague has done or use a third party core application on which to build further functionality. Ownership may belong to the third party or some parts may even be jointly owned or subject to open source licensing.

The best ways to avoid these traps are:

1. Make sure the work in question is clearly identified (including any iterations right from the start of its creation) and make an assessment of what form of IP protection might be necessary and/or available.

2. Enter into written agreements to transfer the copyright (and all other rights) to the investment target company.  If that is not possible (as it often won’t be with collaboration efforts), make sure it is licensed to the company on terms which allow all anticipated commercialisation  As far as possible, do this at the start of the relationship (employee, contractor, collaborator).   Make sure you and investors understand use of open source components if they are critical.

The danger in not agreeing ownership or licensing at the start is that the founder creator can be held to ransom by those third parties as soon as they know the investment hangs in the balance.

Worse still, they either refuse to transfer or licence the copyright altogether or cannot be found, leaving a big hole in your company’s asset base and, quite likely, turned off investors.

Notes: 

    • You’ll not need to consider company structure until you decide to proceed with your business, but, at start-up weekend, you need to have given some thought to IP protection issues (and threats from competitors) if IP forms the core value of your proposition.  Don’t let that distract you from the primary task of developing and validating your business strategy and revenue model though!.
    • This post is not legal advice in any jurisdiction.