Nuts & Bolts of Intellectual Property for New Startups
So you’ve chosen a name for your startup, product, or both. Having covered all the bases to ensure that your corporate name is available, the domain name can be acquired, and the name doesn’t infringe any existing trademarks (as we discussed here), now is a good time to look at the categories of intellectual property (IP) that are relevant to most startups.
Most traditional, bricks-and-mortar businesses have substantial, often enormous hard assets, such as raw materials and supplies, work-in-process, inventory, manufacturing equipment, real estate and more, as well as armies of employees. Tech startups are at the other extreme. The gulf has widened with the proliferation of social Internet / user-generated content and mobile application startups (Instagram is a good example). It’s possible to have a company with literally millions of customers (users) that employs only a handful of people, working in a small rented office, with hardware and software costing in the tens of thousands rather than millions of dollars.
Most of our early-stage startup clients fit this description. Even in purely online businesses, to scale from zero to millions of users:
- In the 1990s, an Internet company might have had to build a whole data center from scratch (as we did at Excite@Home, only to ultimately shut it down in bankruptcy).
- In the 2000s, the company might rent space at a colocation facility; buy, install, provision and maintain its own servers, storage and networking equipment (as we did at MySpace, putting several new servers online per day); and enter into a series of contracts for ever-changing amounts of bandwidth.
- Today, it can sign one deal with a cloud service provider such as Amazon Web Services (AWS) to replace all of the above.
After eliminating all of these types of assets, what remains? Intellectual property. Second, in importance only to talented people, IP in all its forms is the key asset comprising most of the value of any tech startup. Nevertheless, even industry veterans are often fuzzy on the definitions and boundaries between different types of IP and the ways they can be protected and exploited. Hence this “Cliff’s Notes” refresher, to be followed by a discussion of why it matters.
- Trademarks, which we touched on last week, are brand and product names, graphic logos, slogans, taglines, and other indicators of origin of the goods or services in question. In the Internet era, trademarks and domain names are closely interrelated, and both can be or become extremely valuable. (What do you suppose the market value would be of the trademark “Facebook,” its lowercase “f” symbol, or the Facebook.com domain?)
- Copyright is the right to control reproduction and distribution of original works of authorship fixed in tangible forms of expression. Every original work is automatically copyrighted under US law upon creation, whether or not registered (although there can be significant benefits to registration). This includes website content and software code as well as the more obvious examples in media and publishing.
- Patents are property rights granted by the government to exclude all others from making, using, selling or importing anything that uses or incorporates the patented invention (usually described as a new, useful and non-obvious method or process, described in enough detail that it can be reduced to practice). Patents are highly technical, hard to get, and the process is slow and expensive, but for those who succeed, the payoff is a 20-year government-sanctioned monopoly over the patented technology.
- Trade secrets are everything else that would be considered confidential or proprietary. Trade secrets in the US are governed by state law, which can vary, but in general, can include anything from clever ways of solving technical or business problems to formulas, algorithms, internal pricing or financial data, or just about any other valuable business information, provided that it’s treated as confidential by the company.
Each of these categories is a deep subject that can be explored in a future post. For now, focusing on the early stages of getting a startup off the ground, it’s worth understanding the basics of the IP assets that are dumped into the empty receptacle of a newly incorporated business entity. If all goes well, the value of those assets will grow geometrically over time to eventually be worth millions or even billions.
Here are a few key questions and observations that I offer to any newly incorporating startup:
- Who are the founders? Has anyone already left the picture? Were outside advisors, contractors or consultants involved? Every person who has touched the new business in any way has a potential claim to related IP rights. This may never amount to much if the business fails, but for a highly successful growth company, “minor” claims have a way of coming back at the worst time with more zeros.
- One common mistake is to equate “IP” with “code” or other technical contributions. At a startup, the concept of IP should be viewed expansively: The business is new, the team is small, branding/UI/UX is in flux, and as a matter of practicality, anyone can have input on nearly anything, from business and marketing plans to product design decisions. As an extreme example, that graphic designer or photographer who was paid as an independent contractor to create an image for the website may have also offered some input on other aspects of the user experience after reviewing a demo or mockup. If that’s the case, without a proper contract in place, it wouldn’t necessarily be sufficient to take down the picture. Get a contract, if only a simple one-pager, stating that everything the contractor produces on the company’s dime is the property of the startup. This is often referred to in the creative community as a “work-for-hire agreement.”
- Who on the team, if anyone, is moonlighting, and how closely related is their work to the startup’s business and technology? In general, if a startup team member is employed elsewhere, any work on the startup should be done on his or her own time, using entirely separate equipment and none of the employer’s assets (IP or physical) whatsoever. Laws regarding IP assignments vary by state and this is an area that should be reviewed carefully with legal counsel if there are any concerns.
How does all of this translate into legal documents for the typical startup? Apart from registration issues, which are beyond the scope of this post, there are three main tools commonly used:
- Non-disclosure Agreements (NDAs or confidentiality agreements) are used (some would say overused) for many reasons, but one of them is to maintain trade secret status when sharing information with external parties. Proprietary information can lose trade secret protection if the company doesn’t make reasonable efforts to treat it as such.
- Stock Purchase Agreements with founders require them to assign all IP rights they may have already created or acquired (for example, code written or domain names purchased by the individual) to the corporation in exchange for their shares of founders’ stock.
- IP Assignment Agreements with founders, employees and consultants clarify ownership of all IP created going forward (the work-for-hire concept described above) and cover many other bases related to preservation of IP rights going forward. These often go by a long-winded title such as “Confidential Information and Invention Assignment Agreement.”
Apart from all the other benefits of good corporate hygiene and risk management, handling these IP issues carefully from inception can go a long way to allay the concerns of investors or their counsel may have in doing due diligence.
This article is for general informational purposes only, not a substitute for professional legal advice. It does not result in the creation of an attorney-client relationship. All opinions expressed are those of the author, and do not necessarily represent those of Gust.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.