Technology and insolvency—how can startups protect their IP?

What are the insolvency implications that relate to technology startups? Frances Coulson, senior partner and head of insolvency litigation at Moon Beever, and Indradeep Bhattacharya, intellectual property associate, and Jonathan Little, partner at Jones Day, consider the issues.
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The early stages of a tech startup can be a whirlwind. Amid the essential startup activity, intellectual property sometimes takes a back seat. What do tech startups need to understand about the different types of IP and how to protect them?

Indradeep Bhattacharya and Jonathan Little (IB & JL): For a tech startup, IP can be one of the most valuable (if not the most valuable) asset for the company. It may provide the foundation of the business, differentiate its offering from its competitors, and can often be used as leverage to secure funding to take the business to the next step.

Tech startups therefore need to have a clear understanding about the nature and scope of the IP assets the company owns and put in place robust systems to protect and commercialise the IP. The following points are key:

  1. It is important to formulate an IP protection strategy—early. If the company does not acquire appropriate and adequate rights to the IP right at the outset, the service or product offering can be compromised from the start. Fixing things later on can be tricky and very expensive.
  2. Companies should use appropriate ‘clean room’ procedures for handling third party IP. Some of the most common disputes in this arise in relation to competing claims for ownership of IP.
  3. The company should ensure that it has appropriate licences for the use of third party IP and that these allow the use of the IP by the company, and also apply to any end customer products.
  4. Watch the use of open source software as this will often have disclosure obligations and the licensing restrictions for derivative software.
  5. Put in place escrow protection from the outset.
  6. It is also essential the company not only puts in place the right procedures but also documents these appropriately. When the business is looking for investment or for an exit the investors will want to see executed agreements.

What are the relevant IP assets in technology startups?

IB & JL: Typically, the most important IP asset for a startup is the developed software, which may encompass patents, copyright and/or database rights protection. There is also likely to be a significant body of confidential information (trade secrets) underlying the use and operation of the software and technology which needs to be protected. It is also important to realise that the ability to market the business effectively and through the right channels will be key, and that it is therefore prudent to seek early trade mark protection over the chosen brand/business logos.

What are common problems for tech startups that lead to insolvency situations?

Frances Coulson (FC): Like any startups, companies may underestimate the investment needed to maintain cashflow in the early days. The old adage ‘cash is king’ holds true across businesses. Ensure proper capitalisation or a decent line or funding, and be realistic with your business plan and the time it will take to get into the black. R&D relief can be claimed to alleviate tax, and most startups will make losses in the first year or so. It is a false economy not to get proper advice in creating your plan and funding line. Protect your IP or you are pouring money into a black hole for someone else’s benefit.

It may be wise to hold the IP in a separate vehicle subject to taking detailed advice and considering directors’ duties. Ensure employee and officer contracts are tight—particularly restrictive covenants. Ensure data is properly managed and relevant consents obtained (where appropriate) for the right range of uses.

What options are out there for tech startups facing insolvency?

FC: Tech startups face similar issues, more often than not, to those that professional practices face in an insolvency situation. Depending on the extent of product development achieved, it is possible that there is little in the way of tangible assets to sell, and the value of the business is tied up in the minds and ideas of those who started the enterprise. The lack of assets can make restructuring a difficult prospect.

If creditors won’t be patient (and bear in mind potential personal liability for trading insolvent for too long), then take advice from an insolvency practitioner or solicitor. If the advice is to continue trading, this will protect the directors and if not, they can best advise on the options. However, innovation and entrepreneurs were intended to be encouraged by the Enterprise Act 2002 and so an administration (probably a pre-packed admin) would be recommended, allowing the rescue of the business and the continuation of the idea. Other alternatives would be a company voluntary arrangement (CVA) (but creditors may be unlikely to agree as they will have zero track record with the company); or a liquidation where the directors could seek to buy the assets from the liquidator. The benefit of the admin over the liquidation would be to allow continuity and retention of key staff.

In the event of insolvency, what do insolvency practitioners need to take into account—for example when selling off IP assets such as databases and licences?

FC: Data protection can be an issue if personal data is held (eg customer data) and insolvency practitioners must consider what data they hold (electronic and manual); the permissions given by the individuals when the data was supplied; whether the company was notified as a data controller—and other issues. Different considerations apply depending on the type of appointment, so take advice if unclear. IP must be properly valued by someone experienced in the relevant area and the insolvency practitioner needs to take care to ensure there is no current intellectual property right infringement. Licences may be non-transferable or contain certain qualifications, depending on the specific area—so be very careful about the details.

Interviewed by Nicola Laver.

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