Do You Have The Rights? How to Maintain Investor Confidence When Using Third-Party Intellectual Property

Imagine the following scenario: You, as the founder of a business, have spent the past three years building your company.  You have been bootstrapping until now, but the company is at a crossroads and in order to grow the company to its full potential, you have decided to turn to venture capital to attract additional funding.  Because yours is a younger company, and therefore a riskier investment, your potential investors have decided to conduct thorough due diligence to allay some of their concerns.  You suddenly think about the third parties whose intellectual property your company uses in its regular operation – you paid for access to that intellectual property so you are free to use it however and whenever you want, right?

A company’s ability to use intellectual property created by any third party, including employees and independent contractors, is dependent on the rights such company was granted by the third party.  Failure to obtain and retain the necessary rights could be disastrous when your company seeks investments, becomes a target for acquisition, or even simply continues to conduct business as usual.  While some companies place greater emphasis on intellectual property than others, intellectual property ownership is not solely a concern for those companies whose entire business model revolves around intellectual property.

What is Intellectual Property?

The term “intellectual property” refers to intangible assets of the mind, such as inventions, designs or other creative works, which enjoy particular legal rights and are subject to ownership.  The main categories of intellectual property are patent, trademark, copyright and trade secret.

·       Patents are granted by the United States Patent and Trademark Office (“USPTO”) to bestow upon the patent holder the exclusive right to exploit an invention commercially.

·       Trademarks are devices, such as a name, symbol, word, color, sound, or even smell, used to (1) align a particular good or service with its source of origin, and (2) distinguish such good or service from other sources or parties.

·       Copyright is the protection of original authored works fixed in a tangible medium.  Such a right permits the owner of such work to exclusively (1) reproduce the protected work, (2) create derivative works, and (3) distribute copies of the protected work.

·       Trade Secret is a broad intellectual property type that includes any kind of confidential information existing in any form (1) that provides the owner with an advantage, whether competitive or economic, because it is not generally known or available information (2) where the owner has taken reasonable precautions to maintain the secrecy of such confidential information.

While the ownership of some intellectual property rights, like patents, some trademarks and some copyrights, can be searched in relatively accessible databases, it would be a grave mistake to assume a third party does not have rights to particular intellectual property if such intellectual property is not listed in the relevant database.  For example, while a trademark can be registered with the USPTO to receive protection, an unregistered trademark is similarly protected in any territory in which it has been used.  Additionally, copyright is established as soon as the work is fixed in a tangible medium regardless of whether the work has been registered.  Therefore, it is crucial for a company to legitimately obtain rights to any third-party-created intellectual property that the company uses.

How Do Companies Use Third-Party Intellectual Property?

Regardless of the industry your company operates in, or the products generated by the company itself, it is crucial for companies to scrutinize any third-party intellectual property from the commencement of the engagement of the third party.  Consider the following:

·       Did your company engage a vendor or other third party to create any intellectual property, such as the company logo or website design?  

·       Did your company retain the rights to use such intellectual property, for example through a license or assignment?  

·       Was any intellectual property created by an employee (including a founder) or independent contractor?  

·       Was the intellectual property properly designated as a work made for hire?  

·       Does the company use third-party products, like software, in the everyday operation of the business or in the products sold by the company?  

Answers to these questions and more should be clearly addressed in agreements with the respective third-party producers to ensure business operations may continue unimpeded, and so that any potential investor can confidently verify the company will not hit a road block due to an inability to use third-party intellectual property.

How Can a Company Retain Rights to Third-Party-Created Intellectual Property?

Transferring the ownership of, or the rights to, intellectual property cannot always be accomplished with a simple cash exchange. Instead, the details of such a transfer should, and in many cases must, be plainly set out in the relevant written agreement.  The nature of the intellectual property, and how your company intends to use such intellectual property, will guide whether you choose to obtain the desired rights through assignment or license.

·       Assignment transfers the ownership of intellectual property from one party to another.

·       Licenses grant a party the permission to use intellectual property owned by another party, according to specific limitations.

Alternatively, under the 1976 Copyright Act, a company may outright own a copyright if the intellectual property was created by an employee or independent contractor and was designated as a work made for hire.  However, there are restrictions on what kind of work may qualify as a work made for hire, as well as additional factors that must be met, so agreements that include the work made for hire designation will often also contain an assignment or license provision to guarantee the rights have been properly transferred.

Keep in mind that the rights to intellectual property created by a founder, like any third-party intellectual property, are innately owned by the founder and not the company itself even if such intellectual property serves as the foundation and purpose for the company.  In such a situation, the company should collect the rights to such intellectual property upon formation of the company in order to claim legitimate ownership of such intellectual property and related rights.

A common agreement used by companies to obtain intellectual property rights of employees, consultants, advisors and contractors is the Proprietary Information and Inventions Assignment Agreement (“PIIA”) (also referred to as a Confidential Information and Inventions Assignment Agreement).  The main elements of PIIAs are the following:

·       Confidentiality;

·       Assignment of inventions and related proprietary information created (1) within the scope of employment or (2) during the term of employment, subject to limitations set by state law;

·       Carve-Outs for preexisting inventions; and

·       Non-solicitation or non-competition provisions, subject to limitations set by state law.

What Are Some Potential Business Implications of Improperly Obtained Intellectual Property Rights?

At the end of the day, potential investors want to have as much information as possible to make an informed assessment of the risk in their investment.  Before any reasonable investor legally commits to invest money into a company, they will perform due diligence to properly understand exactly what the company is, how it operates and how it is organized.  Often, investors will require companies to possess signed PIIAs containing required assignment provisions from every applicable employee and consultant as confirmation that the company owns the necessary intellectual property rights and related products.  If such company has failed to obtain the right to use the third-party intellectual property necessary to operate the business, then such company’s likelihood of attracting investments will greatly diminish because the return on such an investment will be far more risky if the company may be forced by a third party to alter its operation strategy.

Investors similarly do not want to sink money into a company destined for a lawsuit.  If a company uses third-party intellectual property without obtaining or retaining the rights to do so, such a company could be subject to a lawsuit from the third-party intellectual property owner.  Such a lawsuit could force the company to spend time, money and other resources fighting this lawsuit, and the company could be impacted by large monetary fines or injunctions, all of which may inhibit the company’s growth and success.

Whether your company has experienced numerous rounds of venture capital financing or you just started your business last week with private funds, properly obtaining rights to the intellectual property your company uses is an important step to avoid a potential obstruction down the road.  At a minimum, including the relevant rights provisions in agreements with third-party intellectual property owners and producers will place your company in a better, more organized position to freely evolve according to your vision and will help your company become a more desirable candidate for investment.