Avoiding Common IP Pitfalls: What Every Startup Needs to Know

Startup companies often face significant risk and liability with respect to Intellectual Property (IP) on their path to success. The failure to adequately address IP issues can lead to the permanent loss of IP rights and create a litigation risk. Furthermore, insufficient or nonexistent IP protection can hamper business transactions, including seed funding, partnerships, and status as a desirable acquisition target. This article discusses common IP pitfalls and outlines steps that startups can implement to protect IP assets while reducing the risk of litigation.  

A. What are IP Assets?

Conceptually, the term “intellectual property” can be thought of as creations of the mind that are given legal rights commonly associated with real or personal property and can have economic value. These property rights are generally a function of federal and/or state laws and include patents, trademarks, copyrights and trade secrets. All businesses have some form of IP that provides a competitive advantage and helps generate profits. Many companies mistakenly believe that patent protection is the only form of IP protection and ignore the value of non-patent IP. However, it is imperative that startups identify patent and non-patent related IP assets when evaluating their IP portfolio. Information describing the various forms of IP (e.g., patents, trademarks, service marks, copyrights, and trade secrets) can be found on the U.S. Patent and Trademark Office website.[1]

B. Common IP Mistakes

Investors typically conduct due diligence to evaluate the strength of a startup’s IP portfolio for valuation and negotiation purposes.[2] Generally, investors seek to ensure a return on their investment by identifying factors that can impede development of the startup’s commercial product or service.[3] The strength of a startup’s assets, including IP assets, informs valuation, influences negotiations, and significantly impacts a startup’s ability to secure funding, establish partnerships and enhance acquisition. Common pitfalls that negatively affect the valuation of a startup include underestimating IP importance, a lack of confidentiality protections, failure to establish clear IP ownership and third party rights, and poorly drafted IP agreements.

1. Underestimating IP Importance and Failure to Create an IP Plan

Startups, from conception, need to determine the role of IP in their business, the IP tools that support their business model, and their IP strategy. In many instances, a startup’s intangible assets may be the only assets and failure to fully consider IP during launch is the source of many IP missteps and oversights. In contrast, a well-structured IP strategy is a proactive step towards seed funding and avoiding loss of IP assets while minimizing the risk of third party IP infringement.

The IP plan should identify existing and future IP assets; provide a strategy for maintaining and protecting the IP assets; outline a strategy for conducting freedom-to-operate (FTO) searches; and establish an IP-related budget. The initial step of identifying existing and future IP is critical as it can help the startup develop a plan for allocation of resources and capital to support the IP assets. Importantly, the information can be cross-referenced against the startup’s business and product development plans to develop, maintain, protect, and leverage IP assets. For instance, if the IP assets include trade secrets, the IP plan should include procedures to protect the information such as marking the documents, establishing check-in/out procedures, limiting access to documents, and storing the documents in a secure facility or network section.[4]

The IP strategy should also include a plan for periodic review of agreements to ensure all necessary legal IP safeguards are in place for new and departing employees, consultants, developers, and contractors.[5] Importantly, the IP plan needs to be continually reviewed and revised as the business evolves. Finally, a strategically thought out IP plan may include a business’s conscious decision not to pursue registered IP rights; however, oversight resulting in failure to protect IP rights can be devastating.

2. Not Establishing Confidentiality Protections

Startups should consider a risk reward analysis before publicly disclosing confidential and sensitive IP information. For example, startups often misstep and publicly disclose patentable subject matter at investor meetings, pitch events, or on company websites prior to filing a patent application. Unfortunately, public disclosure of an invention prior to filing a patent application can limit or destroy patent rights. Public disclosure can also destroy a company’s trade secrets.[6] Third-party conversations with those not under legal obligation to maintain confidentiality, a public pitch or presentation, a trade show, and publication are common examples of public disclosure. If such disclosure is necessary, the startup should file a patent application or have third parties sign a written Non-Disclosure Agreement (NDA). However, venture capitalists generally avoid signing NDAs because they deal with many startups and believe confidentiality obligations limit their contact and investment opportunities.  Furthermore, while speaking at tradeshows or making a pitch, securing an NDA may not be feasible. In such instances, to avoid disclosing confidential information, the revealed information should be limited to generalities. Alternatively, a precautionary filing of a provisional patent application can protect information from any accidental disclosure that would otherwise interfere with IP protection.[7]

3. Failure to Establish Clear IP Ownership

Failure to establish IP ownership rights can be a deal breaker in business transactions. Due diligence analysis generally seeks to verify the startup’s ownership rights to each piece of IP as well as determine if there are any restrictions on its use. Typically ownership issues can be averted if addressed early, sometimes even before the incorporation of the startup.

A. Startups and Current Employment

Founders of many startups continue to work for a third-party employer. In many instances, companies require that employees sign confidentiality and invention assignment agreements in which the employee agrees to assign all new ideas and inventions related to the employer’s business to the employer. This is particularly problematic if the startup product or service is closely related to the employer’s business as the employer may be able to claim rights to the startup’s IP. Thus, it is important that founders carefully review their current employment agreements and fully understand employment obligations, including IP assignment clauses and non-compete language. Employees should also consider discussing personal projects/inventions with their employer upfront to avoid ownership issues. Generally, employer resources or company time should not be used to develop projects for the startup company without the pre-approval of an employer and without the employer’s agreement not to claim ownership rights.[8]

In many instances, multiple stakeholders contribute IP to the startup. As a general rule, IP rights belong to the individual who conceived of an invention or created the work first, absent any agreement to the contrary.[9] Well-crafted written agreements between stakeholders and the startup can ensure all rights are assigned to the startup. For IP created before pre-incorporation, IP transfer via written agreement, in exchange of company shares or for money, is recommended. If co-founders are involved in the formation of the startup, a founder agreement may be important in ensuring that the startup owns the IP. Such an agreement can prevent issues with respect to a departing co-founder later claiming IP ownership.[10]

B. Startups and Independent Contractors/Employees

Startups often misconceive that hiring a contractor to create work for a business automatically gives the startup ownership rights of the work.[11] This is not always true and to ensure the startup owns all IP in all startup-funded work, the startup should have employees and independent contractors enter into “work-for-hire” and assignment agreements that explicitly confer rights in the works to the startup.

Additionally, startups frequently hire independent contractors to create websites, software, marketing materials and prototypes for instance. Failure to implement written work-for-hire or consulting agreements with suitable IP clauses that clearly establish the startup’s ownership rights to the IP prior to commissioning the contracted work can be devastating. This is particularly important if the startup plans to sublicense the work to others, make multiple copies of the work for sale, or hire others to modify the work.[12]

Startups should also have employees sign confidentiality and invention assignment agreements with clauses that clearly state their obligation to assign all developed IP to the startup. Failure to include such clauses can create ownership problems for the startup, especially if the employee leaves the company to work for a competitor or cannot be subsequently located.[13]

The agreements should state that the startup’s confidential information is only for use for the benefit of the startup; require disclosure of ideas, inventions and discoveries related to the agreement or employment; and include a statement of ownership rights over ideas, inventions and discoveries. Recordable assignment of IP rights should be required to show clear ownership of inventions and other IP developed by its contractors and employees.

4. Failure to Identify Third Party IP Rights

Startups should be cognizant that IP commercialization may be blocked by a competitor who holds a patent for a technology incorporated within a product. Accordingly, startups, at an early stage, should commission a “freedom to operate” (FTO) clearance search to assess litigation risks. An FTO is performed to make sure that commercial products, marketing and use of the product, process or service does not infringe the IP rights of third parties.[14]

An FTO analysis begins by searching issued patents or pending applications and obtaining a legal opinion as to whether the product, process, or service may be considered to infringe one or more patents owned by others. Patents that limit the startup’s FTO can be addressed by buying or licensing the patent, cross-licensing the patent, or “inventing around” the patented invention by altering the product or process to avoid infringement.[15]

In software development, a startup may choose to incorporate open source software into its code. However, open source licenses need to be carefully reviewed to ensure compliance with license terms. In some instances, the use of open source code in a startup product may transform the startup’s proprietary code into open source software resulting in public disclosure of the proprietary code.[16]  

Startups sometimes consider using third party photographs, images, or text in marketing or product support materials. In such cases, the startup should investigate if permission is required to use the material, identify the rights needed, and contact the owner for permission or a license. Startups should make sure the copyright permission or license agreement is in writing.[17]

Comprehensive trademark searches should be conducted early in the business planning process to make sure that the desired business, product, or service name does not conflict with a registered trademark. A startup that fails to conduct a proper trademark search risks being sued and may need to rebrand itself after launch and incur the tangible and intangible costs associated with rebranding.[18]  

Businesses need broad awareness when hiring new employees, especially those that may have knowledge of competitor’s trade secrets. New employee agreements should include clauses that prohibit employees from transferring or using proprietary information or materials from previous employers. The startup should also verify that the new hire is not subject to any binding non-compete agreements from former employers.[19]

In dealing with third party rights, startups are well-advised to consider their options at an early stage. In some cases, minor product or service changes, payment of a small licensing fee to the patent or copyright owner, and/or changing potentially problematic trademarks early on and implementing careful employee hiring practices may be sufficient to avoid future disputes and can improve a startup’s chances of attracting business partners and investors to support its business development plans.

5. Using Poorly Drafted IP-Related Agreements or No Agreements at All

The valuation of a startup is based on IP as well as agreements with IP clauses. Examples include employment, consulting, funding, collaboration, settlement, licensing, research, and material transfer agreements. Thus, poorly drafted or non-existent IP-related agreements can be problematic for a startup. Because of a lack sufficient funding, many startups attempt to save legal expenses by using template IP-related agreements from a variety of non-professional sources, including the internet. However, such agreements can fail to include clauses that adequately protect the startup’s interest and in many cases, can include clauses that jeopardize a startup’s IP. Thus, when using IP-related agreement templates, the startups should have such agreements vetted by professionals.

Many IP-related agreements, particularly research agreements, generally include confidentiality, publication, and IP clauses. The startup should review confidentiality and publication clauses to ensure that confidential information, including trade secret information, is protected from disclosure and that the startup has the right to review manuscripts and other materials containing confidential information before publication. With respect to the IP clauses, the startup should make sure the language allows for retaining its own IP and for protecting jointly developed IP.

Furthermore, with respect to patent license agreements involving a third party licensor, startups need to make sure that the license agreement provides all the rights needed to commercialize the licensed technology, includes future improvements to the technology, and retains the right to sublicense the technology. The agreement should also have a sufficient termination clause in the event the startup needs to opt-out of the agreement.

The agreement should also specify the relevant field of use and possibly other fields for future expansion. Importantly, the startup should review patents to ensure that the commercialized product materials, methods, and tools are properly claimed with patent life remaining. This will most likely require review by an IP attorney.

Conclusion

The process of bringing a new startup business to life to launching new products to the marketplace can be an exciting time. However, many startups are so focused on bringing a new product or service to market that they fail to take the necessary steps to protect the associated IP. Failure to put an IP plan in place can cripple valuation and expose the startup to potential third party infringement risk. In contrast, startups can protect and exploit their IP assets to build value and revenue by developing an IP plan as part of their conception, creating an action plan to protect IP assets including protection of confidential information, securing ownership rights to the IP, conducting freedom-to-operate searches, and ensuring properly drafted IP-related agreements are in place.

© 2018 McDonnell Boehnen Hulbert & Berghoff LLP

snippets is a trademark of McDonnell Boehnen Hulbert & Berghoff LLP. All rights reserved. The information contained in this newsletter reflects the understanding and opinions of the author(s) and is provided to you for informational purposes only. It is not intended to and does not represent legal advice. MBHB LLP does not intend to create an attorney–client relationship by providing this information to you. The information in this publication is not a substitute for obtaining legal advice from an attorney licensed in your particular state. snippets may be considered attorney advertising in some states.

[1] A) For more information from the USPTO regarding patents, trademarks, and copyrights, see What Are Patents, Trademarks, Servicemarks, and Copyrights?, USPTO (Oct. 2015), https://www.uspto.gov/patents-getting-started/general-information-concerning-patents#heading-2. B) For additional resources for learning about the difference between patents, trademarks, and copyrights, see Basic Facts: Trademarks, Patents, and Copyrights, USPTO (Apr. 27, 2017), https://www.uspto.gov/learning-and-resources/uspto-videos/trademarks/basic-facts-trademarks-patents-and-copyrights. C) Trade secrets provide an alternative form of protection and can be an important IP asset for startups since they are cost effective relative to patents. Trade secrets derive value through secrecy and last for as long as the trade secret maintains its confidential status. No registration is required for trade secrets but reasonable efforts to maintain secrecy are required. For a discussion of trade secret policy, including an in-depth background and video, see Trade Secret Policy, USPTO https://www.uspto.gov/patents-getting-started/international-protection/trade-secret-policy (last modified Jul. 11, 2018) [hereinafter “Trade Secret Policy”].

[2] For a review of how venture capitalists view the importance of IP, see Mary Juetten, Do Venture Capitalists Care About Intellectual Property?, Forbes (Aug. 11, 2015), https://www.forbes.com/sites/maryjuetten/2015/08/11/do-venture-capitalists-care-about-intellectual-property/#45ce28195b87.

[3] Michael D. Anderson and Alexander D. Georges, Intellectual Property and the Venture-Funded Startup, snippets (Summer 2016),

https://www.mbhb.com/pubs/xpqPublicationDetail.aspx?xpST=PubDetail&pub=332.

[4] Pamela Passman, Eight Steps to Secure Trade Secrets, WIPO Magazine (Feb. 2016), http://www.wipo.int/wipo_magazine/en/2016/01/article_0006.html.

[5] For tips for protecting trade secrets when employees leave, see Jennifer Williams-Alvarez, Protecting Trade Secrets When Employees Leave the Company, Corporate Counsel (Mar. 15, 2017),

https://www.law.com/corpcounsel/almID/1202781384186/Protecting-Trade-Secrets-When-Employees-Leave-the-Company/ and Peter Daisyme, A Startup’s Guide to Protecting Trade Secrets, Startup Grind https://www.startupgrind.com/blog/a-startups-guide-to-protecting-trade-secrets/ (last visited Aug. 28, 2018).

[6]See Trade Secret Policy, supra note 1.

[7] Stephen Key, Don’t File that Patent Yet. File a Provisional Patent Application First, Forbes (Jan. 8, 2018),

https://www.forbes.com/sites/stephenkey/2018/01/08/dont-file-that-patent-yet-file-a-provisional-patent-application-first/#67deb0c557fe.

[8]Law Regarding the Right to Inventions Made by Employers, FindLaw

 https://smallbusiness.findlaw.com/intellectual-property/law-regarding-the-rights-to-inventions-made-by-employees.html (last visited Aug. 28, 2018).

[9]Richard Harroch and Neel Chatterjee, 10 Intellectual Property Strategies for Technology Startups, Forbes (Jun. 6, 2017), https://www.forbes.com/sites/allbusiness/2017/06/06/10-intellectual-property-strategies-for-technology-startups/#4960a1e4ab1b.

[10]Ben Rashkovich, Why a Founder’s Agreement Could be one of the Most Important Documents, Fundera (Mar. 10, 2017), https://www.fundera.com/blog/founders-agreement.

[11]Alicia B. Oliver, Top Ten IP Concerns When Working With Independent Contractors, ACC (Jan. 16, 2015), http://www.acc.com/legalresources/publications/topten/ip-concerns-with-independent-contractors.cfm.

[12]Andrew Stockment, Copyrights and Works Made for Hire, ABA https://www.americanbar.org/groups/young_lawyers/publications/tyl/topics/intellectual-property/copyrights_and_works_made_hire.html (last visited Aug. 28, 2018).

[13] Joshua R. Rich, Trade Secrets in 2018: The Law is Still Trying to Catch Up, snippets (Spring 2018),

https://www.mbhb.com/pubs/xpqPublicationDetail.aspx?xpST=PubDetail&pub=373.

[14]Freedom to Operate: Everything You Need to Know, upcounsel 

https://www.upcounsel.com/freedom-to-operate (last visited Aug. 28, 2018).

[15]Y. Philip Zhang, Around the Block (Oct. 21, 2010), Nature

https://www.nature.com/bioent/2010/101001/full/bioe.2010.10.html.

[16]Richard D. Harroch, David A. Lipkin, and Richard V. Smith, 13 Key Intellectual Property Issues in Mergers and Acquisitions, at #3 Open Source Software Issues, Forbes (Mar. 17, 2016), https://www.forbes.com/sites/allbusiness/2016/03/17/13-key-intellectual-property-issues-in-mergers-and-acquisitions/.

[17]See Copyright Licenses and Assignments, BitLaw 

https://www.bitlaw.com/copyright/license.html (last visited Aug. 28, 2018); Ross Kimbarovsky, Everything Marketers Need to Know to Avoid Violating Copyright Law, crowdspring (Oct. 12, 2016),

https://www.crowdspring.com/blog/marketing-copyright-law/.

[18]Harroch and Chatterjee, supra note 9, at #5: Make sure you have a great name.

[19]See Rich, supra note 13.