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Handling Intellectual Property of Founders

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Handling Intellectual Property of Founders

Postby Pinskylaw.ca » 27 Jan 2016, 10:35

Before a startup is formed, the founders often have developed intellectual property that will be a central asset of the startup once it is formed. At the time of incorporation, it is important to make sure that all of this intellectual property is properly contributed to the corporation. Failure to properly make and document these transfers can have serious later consequences to the corporation, especially if one of the founders leaves the startup. For example, angel and venture investors will be interested in evaluating the ownership of any intellectual property of the startup in connection with their due diligence and will likely find any defects in this initial transfer process to be a concern.

This transfer is generally accomplished by means of a transfer and assumption agreement pursuant to which the contribution is made, often as consideration for the equity issued to the founders. Often, this intellectual property is transferred to the startup in exchange for all or part of the founder's initial share allocation. If a founder has any intellectual property that might be construed as related to the business of the startup but that is not intended to be transferred to the startup, it is advisable to make this explicitly clear in the instrument of transfer, usually by specifically listing the intellectual property of the founder that is not being transferred.

Finally, to properly transfer certain types of intellectual property to the startup, filings may be necessary with the Canadian Intellectual Property Office and the U.S. Patent and Trademark Office (and, if Internet domain names are being transferred, compliance with any filing or other process requirements of Network Solutions, Inc. or another appropriate registration authority). To ensure that this property is properly transferred, a qualified intellectual property lawyer should be consulted. To minimize the risk that the contribution of appreciated property will result in taxable gain, a tax lawyer should be consulted to make sure that the contribution is, if possible, tax-free. A tax lawyer should also help the founders appreciate the risk that the Revenue Canada could take the position that the shares being received is more valuable than the consideration being paid for the shares, resulting in immediate gain and taxable income to the founders. This so-called cheap stock issue is generally a greater concern when the startup is formed shortly before the startup closes a financing round, which, if negotiated on an arms-length basis, serves as the best evidence of the value of the shares at that time.

Another ownership problem common in the early stages of a startup's life involves intellectual property developed by individuals who are independent contractors because the startup does not formally employ them. As a general rule, in the absence of a written agreement between the startup and the contractor that states that a work product is a “work made for hire”, the contractor and not the startup owns the intellectual property rights to the work product, even if the startup paid the contractor for the work. In the absence of a proper written agreement, the startup will, at most, possess only an implied license to use the intellectual property created by the contractor. Thus, it is essential that all work involving intellectual property be performed by employees of the startup or by contractors working under a written agreement that assigns all of the contractor's right, title, and interest in the intellectual property to the startup.
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