I hear a lot about intellectual property, but how do I know if my startup has real intellectual property? What constitutes intellectual property and how would I present this to a potential investor?
by Ethan Stone, Stone Business Law
First, a quick but important clarification: I’m not your lawyer and this answer doesn’t establish a lawyer-client relationship. I’m giving a generic answer to a generic question to educate the users of this site. The information below is general in nature and should not be understood as a substitute for personal legal advice.
Your question is well phrased, in that you’ve asked if you have “real” intellectual property. By “real,” I’m going to assume you mean “valuable.” The reason I emphasize that is that, as I’ll discuss in more detail, it’s not hard to create intellectual property. Most of it, however, has little or no value. Unfortunately, it’s impossible to give a general rule as to whether intellectual property is valuable or not. Its value depends on a lot of factors, including how useful it is in general, how well it can be defended against imitators, and how capable the people who own it are of realizing any potential value by building a business around it or selling or licensing it. That said, I’ll go through the main types of intellectual property and give a few pointers and then finish with some general thoughts.
Trade secrets are the most likely kind of valuable intellectual property in a startup. Generally speaking, a trade secret is anything that you take reasonable measures to keep secret and that has commercial value because it’s kept secret. The classic example is an algorithm. You come up with a great way to compress video and use it to create a video compression program that’s better than anything else on the market. If you keep the algorithm to yourself, i.e. you’re the only one who knows how it works, people will pay you to get the benefit of your program’s function.
Trade secret won’t cover anything that you can’t exploit and keep secret at the same time. So, for example, you can keep an algorithm secret by embedding it in your source code and then distributing its function either as object code or on a “software as a service” model, both of which hide the inner workings of your code from users. By contrast, if you come up with an efficient shape for a racing boat hull, you won’t be able to protect it as a trade secret. The “secret” will be apparent to everyone who sees your boats.
To keep your trade secrets, you have to keep them secret. At a minimum, that means that everyone who gets access to them (including anyone who creates them for you) should have a legal duty to keep the information confidential. Usually, that means signing a “non-disclosure agreement” (NDA). You should also put some effort into making sure you take other reasonable steps to make sure you keep it under wraps. For example, you might make sure sensitive files are encrypted and limit access to them. As with other kinds of intellectual property, it’s also crucial to make sure that anyone who contributes to development (whether as an employee, contractor or consultant) has agreed, in writing, to assign their rights to the company.
You probably have something protected by copyright. Copyright, generally speaking, protects creative expressions such as writings, music, and sound and video recordings. Not every writing or sound is protectable, but I’ll skip the details. For most startups, there are only three things that copyright might usefully protect: computer code, webpages, and other digital “content” (such as music, pictures and video).
Although copyright protects most code (not all, for example databases are generally not covered) it doesn’t usually provide very good protection. Copyright only prevents people from copying your precise code or creating close variations on it. It won’t prevent them from writing their own code from scratch that precisely mimics the functions of your code. If you’re producing other kinds of “content” that’s valuable, copyright will provide much better protection. If you’ve got the exclusive rights to Eat, Pray Love or a short video of your child saying funny things after a visit to the dentist, for example, you’ve got something very valuable.
In any event, it’s important to own (or have a good license) for all of the copyrightable materials you use. Even if the copyright isn’t very valuable, failure to have a right to use your code or other content can severely diminish the value of your business. As a rule, anyone who creates anything copyrightable should have signed a written agreement either agreeing to produce it as a “work for hire” (employees) or agreeing to assign it to the company on creation (contractors and consultants). To the extent you use code (including “open source” code) or other content (e.g. pictures) that you and people working for you don’t create, you need to keep track of the licenses that allow you to use it and make sure you stay inside the uses allowed by those licenses.
Trademark is, essentially, your right to protect your brand. It’s different from other kinds of intellectual property in that the primary legal policy is to protect the public from confusion, not to protect your innovation from competition. One of the consequences of that policy is that trademark is a “use it or lose it” proposition. You have to be using a brand to get any rights and you have to keep using it to keep them. Likewise, you’ll get few, if any, trademark rights in something that doesn’t do much to distinguish you from others. For example, my firm’s name, Stone Business Law, isn’t very protectable. It’s just my name and a description of what I do. By contrast, my logo is protectable. It isn’t just a description and, so far as I know, no one else uses anything similar to brand legal services.
As soon as you start using a brand, you get some automatic (so-called “common law”) trademark protection. You get much better protection from registering your brand with the federal patent and trademark office (I won’t go into the details). The real value comes at the end of the registration process which takes several years to complete. So it’s worth starting immediately, but a startup won’t generally have the strongest federal protection of its brand.
As a startup, you will generally have a name and so you’ll have some trademark rights. Whether they’re valuable depends mostly on how well known your brand is. If you’ve created an app or website that’s getting a large amount of traffic and press, your trademarks might be your most valuable asset. If you’ve just chosen a name and logo but haven’t done much with them yet, the trademark rights are usually not worth much.
A related matter is registered domain names. You don’t have to have a trademark to register a domain name and registering one doesn’t necessarily give you any trademark protection. Likewise, it’s often possible for someone else to register a domain name containing your brand, even if you have trademark rights to your brand (there are limits that prevent “cyber-squatting”). There are two main reasons domain name registrations are valuable. The first is to make sure you have a domain that matches your brand, making it easy for people to find you. So, for example, I made sure I could register http://www.stonebusinesslaw.com before I decided to go with that name. The second use of domain name registration is to protect the domains you use against people who might (legitimately or otherwise) register similar domains and cause confusion. So, for example, I’ve registered http://www.wwwstonebusinesslaw.com and http://www.stonbusinesslaw.com (among others) to handle common typos.
Generally speaking, the value of a registered domain name is similar to the value of your brand: If it’s well known, it has value. Otherwise, it doesn’t. Some domain names, however, have a certain amount of independent value. The most valuable are short, common terms, like http://www.computer.com.
I’ve saved patent for last because it’s the least likely type of currently valuable intellectual property in a startup. Unlike the other types of intellectual property discussed above, you can’t get a patent on your own. You only have one if you apply to the U.S. Patent and Trademark Office (or the equivalent authorities in the EU and other countries) and it issues you a patent. So you’d know it if you had any patents and you probably don’t. If you get a patent, no one else can use your invention in the jurisdiction that gave you the patent (for example, the United States if you get a patent from the PTO) without your permission for a period of time. Under current U.S. law, a patent usually lasts twenty years from filing.
Patent applications and issued patents are published and must disclose enough information to let other people understand your innovation. So, going back to the examples I gave in discussing trade secrets above, patent would be a good way to protect an innovative hull design for racing boats. The patent might not disclose much that wouldn’t be obvious to a skilled person who examined a boat using the design. By contrast, you would want to think long and hard before seeking patent protection for an innovative algorithm, since you could normally protect it as a trade secret.
Although startups rarely have issued patents, they often have patentable inventions. Generally speaking, you can patent an invention if it’s new, useful and non-obvious. You need to go to experienced patent counsel to determine if any of your ideas constitute patentable inventions. Don’t trust your gut on this and don’t, under any circumstances, try to write your own patent application.
The first requirement, that the invention is “new,” often trips people up, so it’s worth dwelling on. For something to be new, there can’t be a history of it in public. So, for example, if someone else published an article describing the same invention 50 years ago, you can’t patent it now, even if you came up with it independently. Likewise, if you spill the beans in public, you can make your own invention unpatentable. Generally speaking, you have one year to apply from the first date on which your invention is published. In this context, you should take a paranoid attitude to what constitutes publishing. For example, if you tell a friend about it and she describes it in her blog, it’s been published, but you might not know it. So until you’re ready to file a patent application, you should treat patentable inventions like trade secrets. As with other kinds of intellectual property, it’s also crucial to make sure that anyone who contributes to development has agreed, in writing, to assign their rights to the company.
A patentable invention can be very valuable, even if a patent hasn’t issued and even if you haven’t yet applied for one. Its value depends on what it protects, your plans (and abilities) to use it, and how likely the PTO is to issue a patent.
After all of this detail about specific types of intellectual property, it’s worth taking a step back and talking about the role of intellectual property in the valuation of startups. With a few notable exceptions, the value of a startup is not the resale value of its intellectual property. The value of a startup usually depends on having a good plan to produce, market and deliver a good or service the market wants and, most importantly, a credible team to execute on that plan. Intellectual property is mostly important in the negative sense: If you don’t keep on top of your intellectual property, you expose your business to unnecessary risks. But if you start relying on your intellectual property as your business model, you’ve left the innovation business and gone into real estate.
I hope that helps. Good luck!