Kyle Graves
Conventional startup perspectives on intellectual property rights and exit events often recite the anecdotal experience of software founders operating in industries dominated by strong network effects and natural monopolies. These unique circumstances often lead to first-mover advantages that displace consideration of intellectual property protection strategies.
However, overreliance on conventional wisdom also allows valuation destroying time bombs to hide within successful businesses, only to detonate during a liquidity event as the buyer or investor counsel begins due diligence.
At hardware startups or startups in markets without natural monopolies, stronger appreciation of intellectual property strategies may inoculate companies against these mistakes. Non-software startups frequently receive advice that — perhaps inadvertently — pushes them along a favorable path for massive exit valuations.
However, as an IP and deal lawyer, I have seen a few recurring false steps that harm valuation across domains, even if hardware startups often avoid the worst offenses.
With this in mind, here are a few cost-effective IP strategies that you may employ to optimize your exit valuation.
Use advanced patent strategies to preserve rights and “keep doors open”
Beta testing activity often triggers patent filing deadlines that cannot be unwound. The practice is understandable, as cost management is typically critical during pre-revenue beta activity.
However, startups should consider using provisional patent applications followed by Patent Cooperation Treaty (PCT) patent applications to defer patent costs when pre-revenue and avoid the negative effects that missing these critical patent deadlines will have if the beta proves to be successful.
Filing cheap provisional patent applications early and often, then combining them in tranches within a fewer number of PCT patent applications, allows startups to defer the expensive “back-and-forth” prosecution part of patenting for as long as 30 or 31 months from the time the initial provisional patent application was filed.
The goal is to allow the product to mature sufficiently so that you can focus on only the IP that will spur revenue. Companies following this strategy typically obtain fewer, higher-quality patents and often see better value because fewer good patents often cost less than many, lower-quality patents.
This strategy also maximizes flexibility if an acquirer, investor or early significant customer takes the product in a new direction. Because it can be worse to obtain patents that cover a product that the market, investors or customers no longer want than to obtain no patents at all, this strategy uses legal, procedural strategies to manage the patent timeline and facilitate later-stage pivots.
Audit early prototyping activity and ensure everyone involved signs an assignment of rights
Many deals have been stymied by an early independent contractor who signed an NDA form the founder found online but omitted an assignment of rights clause.
Sometimes, critical early vendors become more important to the success of a product than was initially appreciated, and agreements with these vendors may have deal-killing clauses. For instance, a hosting provider may have a non-assignment clause that limits future stock or asset sale transactions. You should find out if you have such agreements right now not on the eve of a huge exit.
Freelance contractors are huge vectors of copyright issues
Contractors in other countries enjoy different moral or copyright rights associated with their art or code.
Freelancers may utilize libraries or other code with difficult associated license terms. Surprise open source code with copyleft terms has sunk many deals. I have worked with hosting providers to shut down very big websites on behalf of clients who discovered that a rogue freelancer copied code and art from competitors in secret.
You do not want your acquirer or investor to discover this before you. In fact, with proper upfront disclosure, it is possible that a friendly investor can help fund efforts to refactor the code base.
Students are huge vectors of licensing issues
Every university has its own set of agreements that govern student intellectual property rights, and these agreements can vary widely. In some instances, the university may have a claim to intellectual property developed with university resources.
Be very careful of the work habits and digital “hygiene” of university students involved with your startup. Ask IP counsel to provide free training for your employees and contractors on best IP practices, and to help develop an “IP disclosure program” that you can use to document the provenance of different intellectual contributions.
The goal is not just to minimize litigation risk — which may not be an issue if you have a great relationship with the relevant university. You also want to minimize unpleasant questions from due diligence counsel who may be looking for reasons to diminish your exit valuation.
A distinctive UX is a goldmine of design patent, copyright and trademark protection
Many of the scammy hanger-on apps in the app stores can be culled with a single demand letter if you develop a UX protection strategy in addition to protecting the underlying technology.
An IP lawyer with broad cross-domain experience can counsel you on whether a design patent application, a copyright registration of on-screen artwork or potentially free and common law trade dress rights are appropriate tools.
If there is a way to raise a DMCA claim in a demand letter, you should consider doing so, as these tend to receive quick responses from app stores.
Avoid playing amateur lawyer
I’m a former electrical engineer and embedded-C programmer with old-school experience in analog RF circuits. This gave me an unhealthy attitude about business and pre-law majors when I was inexperienced in business. That did not make me very good at getting deals done — being an IP and deal lawyer who has done many deals made me good at it.
I meet many founders who have not learned this lesson yet. Sometimes, I meet them when I’m advising an investor I am representing to walk away from a deal. Success in building a product and success in closing a great deal are different things.
Hire someone who has done lots of deals to represent your startup and get your deal over the line.
Ask an IP lawyer to do a flat rate “IP audit” if a liquidity event’s coming up
By identifying, documenting and resolving every issue before the buyer’s counsel discovers it, you can avoid valuation-burning surprises. There are a thousand little oopsies that can become big oopsies when word gets out that a big payday may be coming. Suddenly, necessary signatures from long-gone contributors may require more than a polite request.
Investors and acquirers do not like buying autographs on the eve of close.
Do not throw away nastygrams or unfounded threat letters from troll lawyers
Discuss these with your own counsel, not because you intend to feed the trolls, but because you want to answer “No” when the buyer’s counsel asks if there is any litigation or threat of pending litigation.
A new form of trolling, called “Made in USA” trolling, is now a real concern for clients making tangible things. Troll lawyers accuse companies of falsely marking the origin of products, relying on supply chain confusion to frustrate companies into paying some “go away” money.
Know where your contractors and vendors are located and document everything.
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