The current economic situation has created severe pressure on corporate earnings and made it harder for companies to raise new rounds of investments. There are important issues that companies and their investors need to watch in order to guard valuable intellectual property in this climate.
Investor and lender focus on IP: If a technology company does not succeed, the most significant remaining assets are likely to be its intellectual property. Investors and lenders typically end up with the ownership of the company’s assets, and will hope to recover some value from this IP, through licensing or sale to third parties. Consequently, both investors and lenders have become much more critical in their analyses of intellectual property, with a key focus being the verification of ownership by the company during the due diligence process.
New lending practices: Banks and other lenders are more frequently insisting on having loans to companies backed by “security interests” – essentially, a mortgage – in the company’s intellectual property. The company can’t meet this requirement unless it has clear ownership, which is a key reason for acquiring ownership as discussed below.
Employee “invention agreements”: It is always essential for a technology company to have written agreements with its employees and contractors specifying that the company owns the technology developed by the employees and contractors. These agreements should be signed at the very beginning of the relationship. If there is a sudden layoff, it will be hard to get people to sign the documents then. This can cause significant problems with investments and lending. It is also important for companies to conduct “exit interviews” with terminated employees, to ensure that the company has full knowledge of the technology developed during the course of employment and that the possession and ownership is fully secured.
“Hold backs” of technology from start-up companies: When each step of financing becomes a struggle, the founders who are contributing technology to a new company are understandably concerned about ownership passing to investors, lenders and company creditors if the company runs out of funds. Some founders will attempt to license the technology to the company, with the thought that if the company does not succeed, the founder will be able to revoke the license. However, this approach is in direct conflict to the needs of the investors and lenders and is rarely possible to sustain.
Personal ownership of trademarks and domain names: Because applications for trademarks and domain names can be filed on-line, there is a growing tendency for individual employees to file these for their company. Unfortunately, this leaves ownership of the application or domain name in the hands of the individual. The company can then have problems obtaining ownership if the employee is terminated, and the problem has to be corrected in order to satisfy the requirement of lenders and investors that the company own its intellectual property.
Bankruptcy risks in licensing: If a licensor of technology enters bankruptcy proceedings, it is legally able to terminate licenses it has granted, even if the licensee has paid in full. There is a provision of the bankruptcy code, section 365(n), which if carefully followed by including certain language in the license, will mitigate this risk. However, even this does not protect the licensee when, as is often the case, some of the licensed technology is owned by another licensor further up the chain. For mission-critical technology, the licensee should seek back-up licenses directly with the owner of the technology, so that if the licensor goes bankrupt, the licensee will have a license directly from the ultimate owner of the technology.
“Stealth Mode” companies: A new business trend is to quietly build sales and financial strength for a new company rather than create unreasonable expectations from excessive early publicity. Because trademark applications and domain name registrations are public documents, filing these can reveal the company’s plans before it is ready. As a result, we are seeing more companies form holding companies for the applications, under disguised names.