Inadequate understanding of the issues at stake when it comes to IP ownership can literally bring your startup down in full flight!

In the infancy stage, innovative technologies developed by tech startups are often their most valuable assets and future bread-and-butter, as their business will revolve around that unique technology. However, too many startups neglect from the outset to address internal IP management, which is essential to set the stage for a successful launch. In fact, where a startup value is highly dependent on its proprietary technology, dreams could go up in flames if control over IP rights is lost.

The motto: before aiming for the stars, make sure to clean up your backyard!

Pre-incorporation stage:

It is not uncommon to see startup founders working independently on building their project upstream, before the creation of any formal legal entity, turning initial ideas into valuable IP.

Upon incorporation, any IP that has been generated to this date should be owned by the newly formed corporation. Therefore, assignment of IP rights from the founders to the corporation is a crucial step. Otherwise, IP ownership will remain with the founders.

By doing so, founders should not worry about losing the benefit of the value assigned to the underlying IP since as shareholders of the corporation they will still receive the value generated by their innovations (such transfer generally occurs in consideration for shares in the corporation).

Shareholders agreement:

By establishing a set of ground rules governing their relationship, shareholders agreement is the bedrock of shareholders’ rights and obligations within the corporation. A well-drafted shareholders agreement should leave no place for ambiguity or grey areas, and provide for all contingencies in relation to IP rights during the life of the agreement.

Given the strategic and commercial value of the technology for the startup, a recommended best practice is to have a shareholders agreement put into place from the beginning in order to mitigate the risk.

A dispute over flight direction? A member deciding to leave the crew in mid-air? Certain situations can expose the startup and adversely impact the business if their are not properly addressed (loss of control over key technology, payment of financial compensation to « get rid » of the shareholder while keeping the technology, acquisition and use of the technology by competitors, risk of potential infringement suits).

Shareholders shall undertake to execute all necessary documentation and agreements to convey to the corporation the sole and exclusive right, title and interest in and to the existing technology as well as in future innovation to be developed.

A shareholders agreement should also contain clauses providing for the automatic redemption of shares in the event of a departure, full and final release of all claims regarding any IP rights, covenants not to sue/bring any infringement action.

Employment agreements:

Certain key employees will be involved in the development of the business’ technology. It is thus essential for the startup to maintain exlusive rights over said technology. By signing an employment contract, employees generaly recognize that the corporation will own the rights in and to any innovation (work, invention, design) generated in the course of their functions (crucial if the employee decides to leave).

Employees’ cooperation is also key to ensure proper assistance in the protection and registration of those IP rights. Internal policies must be put in place, providing for the monitoring and recordal of the work related to the creation of IP, and requiring employees to make available any data, notes, code, prototypes, drawings, etc., notably to support patent prosecution processes.

Confidentiality:

Shareholders agreements as well as employment agreements shall include appropriate confidentiality clauses preventing dissemination of sensitive informations. Beyond the risk of seeing confidential information fall into the hands of competitors, disclosure could also adversely impact patentability.

Given the costly and time-consuming process of developing valuable proprietary technology, it is crucial to make sure that confidential information will only be used for the exclusive benefit of the corporation. It is also important that such confidentialily obligations remain in full effect for a certain number of years after termination of the employment, shareholders agreement or after the departure of a shareholder.

Material breach:

Confidentiality and non-disclosure obligations must be accompanied by enforceable sanctions in case of a material breach. Consequences must be clearly addressed up front, generally including the payment of deterrent liquidated damages (a fixed penalty set in advance), additional compensation for any exceeding damages, as well as the right to redeem the shares of the breaching shareholder (redemption of shares by the corporation).

« Clean » ownership of IP is critical when it comes to raising capital.

Aside from maximising the smooth and successfull operation of your startup, « clean » IP ownership is the way to attract investors and skyrocket to success.

From the perspective of maximizing returns and minimizing risks, sophisticated investors and VC firms will evaluate their investment opportinuty – IP being at the core of tech startups’ business value. Due diligence will be conducted to ensure that everything is in order and that the startup owns all the key IP.

Ready for take off?

(This paper provides a general overview of some basic principles and does not constitute legal advice. Feel free to contact me for more information on the subject :ismael@benoit-cote.com)