VC and tech have become inextricably linked in the public imagination, but also in reality. There is a fairly simple reason for this: the ability to scale massively and quickly with low marginal cost is a key advantage that VCs are looking for in a portfolio company and one that tends to accrue to digital products. One corollary of this is that the most valuable assets of most venture-backed startups are intangible, in the form of knowhow and IP. These need to be protected. Unfortunately, because of the frequently haphazard way that startups come into being, grow beyond an idea into an MVP and go about securing initial funding, they often are not.
The consequences of this can be disastrous at fundraising or exit. Cutting a few corners on what may seem like an irritating distraction and cost-centre at pre-seed has suddenly led to a deal-breaker. There are a number of ways that IP, in particular, can be mismanaged. In the UK, software is protected by copyright which accrues to the person who created the software, unless it has been expressly assigned to another party. This can be a bear trap for early stage companies. For example:
- It is common for non-technical founders to commission, or beg as a favour, some software work from a friend. Nothing is ever committed to writing regarding ownership of the IP. The friendly developer’s work finds its way into the heart of the product, where everyone forgets about it. Then due diligence on fundraising reveals that it’s not clear who owns the rights to some key part of the code base, which is both valuable and hard to separate from the value of the company generally.
- It is also common for a technical founder to build a lot of the MVP him/herself. If that founder remains involved with the business, it can be easy to overlook the fact that the ownership of legacy IP is unclear. Fundamentally, the company could now be a hostage to the technical founder, who could have a blocking right in relation to key intangible assets central to the company’s value. From an investor’s perspective, this can be both problematic in terms of control and expensive to resolve.
- Founders may assure you that the software they have built is proprietary, often with a sincere belief that this is true. For many founders and investors alike, if the product works and there is nothing like it out there, it can be easy to resist the temptation to dive too deeply into the thorny details of the tech stack. However, this may run the risk that the defensive moat of proprietary IP you thought you had bought is really just a bit of architecture connecting some out-of-the-box SAAS tools. And if that’s the case, what do you do?
While the specific answers to these sorts of questions are usually bespoke, it is generically correct to say that early engagement is a good idea. The choice can boil down to dealing with these issues in the light of a liquidity event, when ransom rates may have to be paid to buy out someone’s leverage, or in a less hot-blooded moment in time, when problems can be fixed more affordably.
If you found this article interesting, please check out the other one’s in this series:
“Be prepared” a series of practical articles aimed at disputes in a venture capital context
Co-investor disputes: on shareholders agreements and sausages
Stick or twist? The dilemma with struggling founder teams
Treasure in the wreck: IP, insolvency and yesterday’s next big thing
