Startups and IP Ownership Issuesby Scott Edward Walker on November 22nd, 2015
For many startups, intellectual property (IP) is their most valuable asset. Below are the three most common IP-related mistakes that startups make — the first of which I discuss in this brief video with Jason Calacanis.
Mistake #1 – Moonlighting at a Prior Employer. Startups must ensure that none of the founders’ prior employers have any rights to the venture’s IP because a founder was working on the venture while previously employed. This is a particular concern if the startup is in the same space as a founder’s prior employer. Even a founder’s use of a prior employer’s computer or telephone in connection with the new venture could be a problem, depending upon the particular state in which the founder resides and the documentation he executed.
Accordingly, each founder should carefully review any agreements with his prior employer and the employee handbook to determine if there are any provisions that may give the prior employer rights to the startup’s IP. Founders should also make sure that when they leave their prior employer they don’t take anything with them (e.g., electronic files, prototypes, customer lists, etc.).
Under California law (regardless of what the agreements say), an employee owns any “invention” that that he developed entirely on his own time without using the employer’s equipment, supplies, facilities or trade secret information, except for those inventions that either: (i) relate to the employer’s business, or actual or demonstrably anticipated research or development of the employer; or (ii) result from any work performed by the employee for the employer.
Mistake #2 – Not Assigning to the Company Any IP Created Pre-Incorporation. The second most common mistake startups make is not assigning to the company in writing all of the IP that was created or acquired prior to the company’s incorporation. Any IP created or acquired by a founder (e.g., code, a patent, etc.) prior to incorporation is typically assigned to the company as part of the founder’s restricted stock purchase agreement (or a separate assignment agreement).
Indeed, the IP is usually contributed or assigned by founders as full or partial consideration for the shares of common stock issued to them in a tax-free transaction under Section 351 of the Internal Revenue Code. A problem arises, however, if one of the founders leaves prior to incorporation and takes his rights to certain IP along with him.
Another problem often arises with respect to IP created pre-incorporation by outside developers or consultants (i.e., non-founders), particularly if the developers or consultants are located outside of the United States. The IP created often never gets assigned to the company at all either because there was no written agreement or because the company was not a party to the agreement (because it did not exist at the time). This is, of course, what happened with Mark Zuckerberg and the Winklevoss twins.
Mistake #3 – Not Executing Confidential Information and Invention Assignment Agreements. Once the company has been formed, the company’s ownership of the IP is protected by requiring each of the company’s founders, employees and consultants to execute a Confidential Information and Invention Assignment Agreement. The principal purpose of this agreement is to ensure that any IP created by a founder, employer or consultant is automatically assigned to the company. Unfortunately, a lot of startups do not require founders, employees or consultants to execute this kind of agreement and run into significant problems with respect to IP ownership.
IP-ownership problems often arise in the context of a financing, when the investors are unable to establish a clear chain of title to the startup’s IP as part of their legal due-diligence investigation. Moreover, I recently saw this problem in the context of the sale of startup we were representing. Indeed, during the course of the acquiror’s due diligence, it was discovered that certain code was created early-on by a foreign third-party developer that never assigned his rights to the company. The developer could not be located, and the acquiror thus walked.