Seedcamp has teamed up with JAG Shaw Baker (a technology focused law firm based in London) to produce a series of short articles highlighting some of the key intellectual property (IP) issues that affect startups. By underlining some of the common issues and providing practical advice, this Understanding Intellectual Property series will touch upon the protection of IP, ownership, data protection and privacy, infringement and web / domain name issues.
This article, the first in the Understanding Intellectual Property series, highlights probably the most important (but frequently misunderstood) issue: ownership. Ensuring that your company fully owns and controls all of its IP is of fundamental significance; failure to get this right is often not just a costly mistake but can also seriously jeopardise the company’s success.
Ownership issues often only come to light during an investment round or acquisition, by which time it may be too late. The risks can, however, be minimised by making yourself aware of the common issues and following the practical steps outlined in this article.
1. Who owns ‘your’ IP?
The first point to understand is that your company will not necessarily own the IP that has been developed just because it has paid for, or instructed, the work to be created. In fact, the legal position differs vastly depending on who created the work. For example:
Founders: typically, founders create, develop and register IP rights (or other similar rights) before the incorporation of their company. They might, for instance, coin brand names, formulate algorithms, register domain names, develop the website, etc. Any IP created by the founder(s) prior to the incorporation of the company will be owned by the founders, not the company. Founders also tend not to enter into employment or consultancy agreements with the company for their services. As a consequence, IP developed by founders during the performance of their services after incorporation of the company will not ordinarily be owned by the company.
Employees: the basic rule is that the company will own the IP that its employees develop, provided it is created in the course of his/her employment. Exceptions exist, however, and employment agreements should always contain comprehensive provisions to ensure that IP is owned by the company.
Consultants (also known as independent contractors): unless there is a written contract in place that transfers ownership, the consultant will almost always own the IP that he/she/it creates. This is a very common issue and often requires the consultant to enter into a written contract to transfer ownership of the rights if such an agreement does not already exist.
Third parties: startup and early stage companies will inevitably contract with third party companies to help develop their product or services (for example, a web-development company, product design specialist, software development provider, etc.). Even though your company has paid for the services, the third party will own the IP unless there is a contract which provides otherwise.
2. Moral rights
In addition to IP rights, ‘moral rights’ might also exist. Moral rights are separate legal rights that arise automatically in favour of the author(s) of a work (i.e. a founder, employee, consultant, etc.) and may prevent your company from exploiting its IP as it wishes, even if it is the sole legal owner.
Unless there is a contract which provides otherwise, moral rights remain with the author even after he/she has transferred the IP to your company. This can be problematic and it would not be wise to proceed without the security of moral rights waivers from all relevant parties. Although waivers are best obtained before the creation of a work, they can be obtained at any time thereafter.
3. What happens if your company does not own / control all of its IP?
The potential consequences can be profound: at best, your company may be held to ransom; at worst, your company may be prevented from carrying out its business. Four of the most common direct consequences include:
a) the company is forced to pay over-the-odds for IP that it should have owned in the first place. This typically occurs where a disgruntled consultant leaves and is unwilling to transfer the IP, except for a hefty fee;
b) the company is sued and/or prevented from exploiting certain rights as doing so will infringe the IP owned by the commissioned party / consultant;
c) the company is unable to prevent competitors or counterfeiters from using IP rights that it does not own; or
d) one of the founders leaves the company and sets up a competing business that makes use of the IP that the founder created.
It is also important to appreciate that potential investors / acquirers will expect your company to have full and unencumbered ownership and control over the IP that it requires to conduct its business. In fact, potential investors / acquirers will likely spend a significant amount in legal fees to ‘due diligence’ your company’s IP ownership. If a potential investor / acquirer discovers that a company does not own the IP that it should, typical consequences include:
a) your company may suddenly become a lot less attractive and substantially more risky. Potential investors / acquirers might not be interested or walk away early on;
b) the transaction may collapse, particularly if the issue is serious or is not capable of remedy. This happens more frequently than you may expect, even after a term-sheet has been signed and the deal has been agreed in principle;
c) if the deal does not collapse there will be an unavoidable delay to the transaction until the issue is resolved. This can be particularly troublesome if the company is in desperate need of financing and also increases costs, fees and expenses; or
d) the potential investor / acquirer may dramatically lower its valuation of the company and seek to renegotiate the terms of the deal.
The position may be worse still if an investor / acquirer discovers an issue after the completion of the transaction as the founders will typically have provided warranties and indemnities in their personal capacity that the company has full IP ownership. You may therefore find yourself the subject of a legal claim for the investors’ / acquirer’s damages.
4. How to ensure your company (as opposed to its founders or workers) owns its IP.
It can be extremely difficult for your company to claw-back the IP that it needs, particularly if you allow a lengthy period of time to pass. Needless to say, getting your ducks in a row early on is essential to minimise the risks. Dealing with the issues as soon as possible will also help.
The following practical steps will also help to identify the issues:
a) keep a written record of who created or helped create the IP important to the company’s business and ensure that suitable contracts are in place with each of them;
b) enter into written IP assignments with each of the founders to transfer ownership of all past IP to the company (visit the Seedsummit website for a free IP Assignment Agreement template);
c) check that the company has entered into written employment agreements / consultancy agreements with each of the founders to ensure all future IP developed is transferred to the company. If not, enter into such agreements;
d) ensure that all employees have signed an employment contract that: (i) assigns all IP to the company immediately on creation; and (ii) waives all moral rights to the fullest extent permitted by law. If not, enter into written employment agreements;
e) ensure that all consultants have signed a consultancy agreement that: (i) assigns all IP to the company (ideally with “full title guarantee”); and (ii) waives all moral rights to the fullest extent permitted by law. If not, enter into a written IP assignment or moral rights waiver with the consultant;
f) check that all third party companies that have developed products / services: (i) have assigned all IP to the company (ideally with “full title guarantee”); and (ii) provided a warranty that all moral rights have been waived to the fullest extent permitted by law. If not, an IP assignment and/or moral rights waiver will be needed;
g) have your lawyer perform an IP audit to ascertain what the issues are. It is advisable to have this done frequently as well as in preparation for investments or another corporate transaction.
JAG Shaw Baker is a firm dedicated to advising entrepreneurs, companies, and investors in high-growth industries. The firm advises on all aspects of venture and growth capital, as well as other corporate finance transactions, corporate structuring, intellectual property and growth and exit strategies. It also acts as general counsel for high-growth companies.
Seedcamp is Europe’s leading pre-seed and seed investment fund and mentor network, and provides its startups with an ongoing Learning programme, known as Seedcamp Academy. Sessions are provided on a variety of topics; from marketing, to product development, to fundraising, to legal. Ambitious startups with disruptive products/services and global aspirations are invited to apply.
This article contains general information only. It does not constitute legal advice. You should consult a suitably qualified lawyer on any specific legal matter or issue.