Whether you are a startup or an acquiring company, there are several steps you should consider ahead of an exit to protect your deal and avoid issues later on. In this episode, Salt Lake City partners Spencer Glende and Scott Young, along with host Julian Dibbell, discuss measures companies can take with respect to IP and commercial agreements in order to avoid future friction in an investment or acquisition. Tune in for practical advice on navigating these contractual challenges.
Transcript
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Welcome to Mayer Brown's Tech Talks Podcast. Each podcast is designed to provide insights on legal issues relating to Technology & IP Transactions, and keep you up to date on the latest trends in growth & innovation, digital transformation, IP & data monetization and operational improvement by drawing on the perspectives of practitioners who have executed technology and IP transactions around the world. You can subscribe to the show on all major podcasting platforms. We hope you enjoy the program.
Julian Dibbell
Hello and welcome to Tech Talks. Our focus today is on
startup companies, tech startups, and the steps that they can take
now with respect to their IP and commercial agreements to avoid
future friction in an investment or acquisition. I'm your host,
Julian Dibbell. I am a senior associate in Mayer Brown's
Technology & IP Transactions practice. I'm excited to have
here with me today two partners from our Salt Lake City office,
which opened just over a year ago in Utah's booming tech hub.
Spencer Glende and Scott Young are both partners in the Technology
& IP Transactions practice and the Emerging Companies &
Venture Capital practices. Our EC/VC Group is a cornerstone
practice of the Salt Lake City office.
Spencer and Scott, welcome to the podcast.
Scott Young
Thanks Julian. Grateful to be here.
Spencer Glende
It's great to be here.Thanks, Julian.
Julian Dibbell
Well, we're glad to have you.
Spencer can why don't you give us some background on this topic and why it's important for startup tech companies?
Spencer Glende
Happy to. Scott and I both deal a lot with these tech
startups and typically with the focus on their IP agreements,
licensing agreements and commercial contracts.
And we also have the chance to see and be involved in investments and acquisitions, M&A transactions involving startups. And from that perspective, we've had a chance to see where these IP and commercial agreements sometimes can bog things down or even kill off a deal. So we wanted to share some ideas for tech startups to use that they should not postpone so that they're ready for a clean exit when the time comes.
Scott Young
Well, Julian, I have to jump in and say when I told my kids that
I'd be doing the Tech Talks podcast, they said, OK dad, we got
one line of advice for you: Whatever you do, don't be boring.
And I said, wait a minute, it's a legal podcast, how am I
supposed to do that? And they said, OK, Dad, here's what you
do, you use a Top Gun Maverick analogy. So I'm going to give
you my best one here to start us off, and that is, if you remember
the movie, the Top Gun Maverick movie, they spend most of that
movie, in fact, preparing, getting ready for running through
scenarios, getting ready for their big event, for their battle
scene at the end. And the point I think that that makes is, you
just can't ignore the preparation. You have to think through
every scenario, you have to be prepared for what's coming, and
that's the way you find success. And the same really is true if
you're an entrepreneur and you get a tech company, you've
got to take steps now to be prepared for that exit.
Julian Dibbell
Now, and this sounds like it's going to be a really helpful
discussion particularly for tech startups, which is the focus of
your practice, but I'm also getting the sense here that the
questions that become complications in an investment or acquisition
are going to be the same questions for the more established
companies that are doing the acquisitions, right?
So in some sense we're focusing on startups, but this isn't really just a podcast episode for Startup Companies, right? We can ask our more established listeners to hang on and you might learn something useful as well.
Scott Young
Don't hang up yet. That's exactly right.
Spencer Glende
These are things that the acquiring company should be
thinking about as well from the opposite view. And, for that
matter, even we see some of these mistakes happen in the context of
pretty well established companies that are merging or being
acquired. So it's never too early or too late to be thinking
about these.
Julian Dibbell
Alright, let's get into it then, Spencer. What are the
particular issues? I imagine for startups, a lot of them are going
to have to do with intellectual property concerns. Is that
right?
Spencer Glende
That's right. In fact, probably the bulk of what
we'll talk about relate in one way or the other to IP ownership
and rights. A little later on we can focus on some more strictly
commercial contracting issues to be mindful of but on the IP
ownership side, probably the first thing that comes to mind is just
making sure you document your IP ownership well, and the 1st place
that usually comes up is in dealings with employees and independent
contractors. In the US there's this notion of work made for
hire in copyright law, but a lot of companies misunderstand that,
and they might even think that as long as I'm paying for
development, I will own the IP. That's only true in limited
circumstances, like when it's copyright authored by a true
employee, as opposed to a contractor. And although there are some
instances where you can contract for work made for hire with the
contractor. But, again, those are limited. And so the best practice
is to have, with anybody who contributes to your IP, a written
invention, an IP assignment agreement. Scott, you've probably
seen instances where the company says, "We don't get
everybody to sign those but the people who really matter signed
it".
Scott Young
Absolutely. You probably don't need the janitor or the cleaning
crew to sign, but you know it's best practice to try and get
that for anybody who's developing IP to get to sign that.
Spencer Glende
And erring on the side of having everybody do it makes it
even easier when the time comes to be acquired, and the acquirer
said, "Make me comfortable that everyone who matters signed
it". Well, every single person did so there's nothing to
worry about. A couple of things that we flag in these assignments
is, you have to get the wording right. Sometimes you see them
written as the company will own the technology I developed, and
that a lot of courts say is not enough, or, I will assign to the
company the IP I developed. What we really want to see to make sure
it's effective as a present assignment, the individual or the
contractor hereby assigns its rights, current and future, in the
development that it will provide.
Scott Young
Often we'll tell our clients there's no magic
language, but this time there really is magic language, Spencer,
you're absolutely right on that.
Spencer Glende
And we've seen that slow deals down where the investor
will say, hey, your invention assignment agreements aren't
really assignment agreements, go out, fix some, get amendments,
which can be really tough if people have left the company or maybe
even become hostile since they've worked at the company.
Scott Young
Speaking of mistake, I'll tell you, you're talking
about getting all the employees to sign, and sometimes the clients
and companies would be great about that but they'll forget
about getting the founders themselves to sign those - the founders
would be so focused on let's get everybody else taken care of
they forget their own. And especially when there are multiple
founders and one of them leaves, or one of them isn't
cooperative, then you get yourself...
Spencer Glende
That would never happen, Scott.
Scott Young
You have to be so careful on those too. And sometimes
those are a little bit unique too, Spencer, because the founders
sometimes have prepared their IP before the company was formed, and
so you have to have their invention assignments looking back, to
predate the company...
Spencer Glende
Which isn't always the case, most forms you see
companies using focus on development made while the individual is
with, or the consultant is with, the company. And in this case, you
have to look back before that engagement and maybe even before the
formation.
Scott Young
I have to tell you a quick war story I had. I was representing a
company that was getting at the time, a prepaid license in a sense,
so it's kind of an investment in this tech company and
fortunately got a lot of reps and warranties about that the company
that they were essentially investing in owned the IP. Well, it
turns out the founder didn't ever do a proper intellectual
property assignment, and so as sometimes things do, things go wrong
and the IP wasn't delivered. And so the company wanted to
foreclose essentially on that loan, and wanted to take the IP.
Well, when the IP's not in that company, it was a real problem,
and so to your point, Julian, you have to be aware of these issues
if you're on the investor side or the formation side. But it
turned into some real nasty litigation because that founder never
took care of, and that company never took care of, getting that IP
assigned.
Spencer Glende
I think your story illustrates another important point
that when you are bringing in technology, or IP, whether it's
something that you are getting ownership of, you think are getting
ownership of, or maybe a key inbound tech license that you're
going to rely on, make sure that the party you're dealing with
has the rights to give you, or a license to give you. And it's
great that in that contract you mentioned you had the
representations and warranties of the company saying, hey,
don't worry, we own this and that...
Scott Young
They were successful in the litigation, but you wouldn't have
had the litigation if you'd had done the proper due
diligence.
Spencer Glende
Even better to kick the tires, ask for those, if it's
important technology, ask to see the paper trail showing that they
own it. And this can be particularly complicated when you're
dealing with folks who are overseas.
Scott Young
Absolutely. You've got different rules, you've got
different laws. We're so used to dealing with U.S. law, but if
you've got employees or contractors or developers overseas, you
can sometimes run into problems. You had a situation like that
recently, didn't you, Spencer?
Spencer Glende
A company that was getting acquired had some of its key
software developed by a company using developers in Vietnam. And
when the acquirer looked at that contract, said, well in Vietnam,
they don't have work made for hire the way they do in the U.S.,
and even if those individuals were bona fide employees of the
consulting firm, there needs to be separate documentation to give
the consulting firm ownership in the copyright and the software
that the company being acquired ultimately needed to own. That was
a good reminder of the fact that you've got to be mindful of
the local jurisdiction where the development is being done because
the rules may be very different.
Julian Dibbell
Now, in all of this discussion so far, it sounds like
we're focusing on the kind of rights you can assign a transfer
and so forth. Copyrights. Patents.
What about those more less fungible types of rights, like trade secrets. How do you approach an intellectual property that's protected by trade secret regimes?
Scott Young
Well, Julian, you're absolutely right. You've also
got to worry about trade secrets, and one of the best ways, or most
important things you can do, and we're talking about
contracting here, is making sure you've got a great or an
effective nondisclosure agreement, and use that consistently. The
way you protect trade secrets is making sure it's always the
subject of reasonable efforts to protect its confidentiality, and
the way you do that is with an agreement. One of the things that I
will do and make sure that my clients have is a good nondisclosure
agreement anytime they're entering in discussions that could
involve their trade secrets or any of their confidential
information, for that matter.
Julian Dibbell
A good NDA? Aren't all NDA's the same? Hey, I
signed an NDA. We're done, right?
Scott Young
You think they're all the same. In fact, a lot of our clients
think they're all the same, but they're really not.
You've got at least a couple of different categories.
You've got mutual nondisclosure agreements when both parties
are disclosing their confidential information, both parties are
disclosing their trade certificates. You've also got one-way
nondisclosure agreements that are very appropriate when you're
dealing with your contractors, your developers, someone like
that, where the confidential information is only going one way.
Spencer Glende
And I've seen that bumbled, unfortunately, in an
acquisition it came up that the company our client was looking to
acquire had for some unknown reason put mutual agreements, mutual
nondisclosure agreements in place with each of its individual
overseas developers, independent contractors, and if you read the
agreement, basically it was saying that the software code that they
had hired these folks to create because it was being disclosed by
the developer to the company was treated as the developer's
confidential information. And so that we had to have that company
go back and amend each of those. We were lucky, I guess, that each
of those individuals was still around and was willing to replace
that improper NDA with the appropriate one.
Scott Young
That's really fortunate, because that could really
give your developers an opportunity to really hold you hostages in
a sense, if they didn't sign this contract, so it's not
just the type, it's also the language that's included in
those non-disclosure agreements that can be so important.
Julian Dibbell
Sounds like we've covered a lot of topics under the
heading of IP here, and it sounds like there could be a lot more,
but moving along, what about other types of considerations with
respect to agreements that startups are entering into, commercial
agreements, for example with suppliers or with major customers?
Scott Young
You're absolutely right, Julian, and just like there
are a lot of different topics you could be discussing on the IP
side, there are lots of different things to be looking for on the
commercial contract side. I'm just going to sort of give you
the takeaway right now. I mean, the takeaway really is, you've
got to be thinking about your exit. Have that in the back of your
mind when you're reviewing a commercial contract, especially
when you're a startup dealing with, oftentimes, a larger, more
well established contracting partner and you've got to be
thinking about that goal, have that end in mind when you review the
topic. But let us maybe give you our top four, five or six, or
whatever provisions or issues to look out for when reviewing.
Spencer Glende
These are the kind of things that could almost turn into
poison pills. As Scott said, they might seem fine when you're
contracting in the present, but they don't fit anymore when the
acquirer comes to town or when you become an affiliate of a larger
company, and probably number one is exclusivities. It might not
seem like a big deal, for instance, to grant an exclusive license
to somebody else in Europe, or to say to someone in South America,
"You're going to be our only manufacturer for our
product". Because who knows, the company that might want to
acquire you may have their own relationships in Europe or South
America, or they may want to exploit those markets in ways that you
didn't have the ability to do as the startup. And so those
exclusivities can really alter the going-forward business case for
the acquisition. So exclusivities is one. Number two is similar.
Most-favored nation clauses MFN pricing terms where again those
might conflict with commitments your acquirer has already made to
others. Minimum purchase commitments is another flavor of those
kinds of constraints that might fit now, but are not good when the
acquirer comes into the scene. And one thing that really
exacerbates all of these is any time that the other party asks for
these clauses to apply to affiliates. And so maybe as a fourth
example, distribution rights, sometimes you see the scope of
distribution rights, like if you're authorizing someone to
resell or distribute your product, it might say that you authorize
them to resell all of the products of the company and its
affiliates. Might be fine if you don't have affiliates or if
you only have three products right now, but if you're going to
get acquired by the 800 pound gorilla, all of a sudden they're
an affiliate and all of a sudden that distributor has rights to
represent them, which may not fit the needs of the acquirer.
Scott Young
Yeah, you've got to be, like I said, you've got to
be keeping that in the back of your mind anytime you're
negotiating these commercial contracts. In fact, just throwing in,
you know, that example I gave earlier of having the appropriate Rep
and Warranty, so often startup companies can get into the mode of
they're dealing with friends, they're small, small groups.
"Hey, we don't need the documentation. We don't need
the formalities of the contract", but you know, time goes on.
Founders leave, you need the basic reps and warranties to protect
you from the very situation, so make sure you have appropriate
representations and warranties. Make sure you've appropriately
documented transactions so that when the acquisition happens, those
can flow through. And the other things to think about, Spencer, as
you've got change of control provisions anytime you see a
change of control provision in your contract, you have to be
mindful of the future. What does that change to control look like?
What happens when that triggers? And then of course the big one of
the big ones for me is that assignment provision.
You will often see in these commercial contracts of prohibition on assignment and sometimes it can be worded in such a way that it would prohibit that contract from being assigned in connection with an acquisition.
Spencer Glende
Or it might even say an acquisition is deemed to be an abbreviated
assignment.
Scott Young
And so all of a sudden you've given and let's say it's
a big customer, right? A big customer represents so much of the
value of the company, and if that customer all of a sudden has a
veto over the assignment, it effectively gives them a veto over the
acquisition. And so you could be beholden to any one of a couple of
large customers for your whole acquisition, which is not a
situation you want to be in. So be really careful of those
assignment provisions.
Spencer Glende
And Speaking of change of control just to flip it around, one of
the solutions to some of these instances, like these poison pill
terms, if you really are being pressed into agreeing to something
you know favorable to a big customer or supplier, you can try it to
get in there a protective change of control provision that if we
get acquired, we get to renegotiate exclusivity or we get to the
MFN no longer applies. Those kinds of things and every now and then
can get those as a compromise.
Scott Young
One of the biggest mistakes Spencer, I see is from time to time
I'll see provisions that tend to go on forever. Pricing will
give you pricing and they don't think about it. Pricing will go
on forever because there's not a termination. There's no
expiration on the agreement. There's no termination right or
the other party controls that right to terminate, not the vendor.
And so you're stuck with a bad contract, and in fact, I just
had a client ask me the other day that they just acquired a company
that had some of these Evergreen or perpetual contracts saying how
do you get out of them because – you've got these
customers, now our customers of the acquiring entity - and
they've got these perpetual agreements that basically lock the
provider into providing the service at a certain fee and it's
bad news.
Spencer Glende
Yes, the acquirer might even want to discontinue the service
altogether. So be thoughtful about getting out of those
contracts.
Scott Young
Always make sure you think about a way to get out of contracts, not
just the way to get into it.
Julian Dibbell
Alright, so we've been talking here I think about kind of
critical agreements with major suppliers, major customers where
they may have a lot more leverage over the startup company.
You're dealing with their paper, their terms and obviously that
puts you on the alert to how are they taking advantage of us. But
then, hopefully there's also a whole category of agreements
that are just your standard agreements with customers, day-to-day
business ULAS, terms of service, that kind of thing.
Can you just rest easy and not worry about the terms in those or what's the approach?
Scott Young
Well, Julian, I think by asking the question you know the answers.
The reality is that so often, startups, of course, are strapped for
cash. They're trying to conserve every penny and one of the
ways they'll try and cut corners is "Let's just go
find a template." You say ULA, Master services agreement,
terms of service. These are on the Internet. You can go find them
anywhere, but the problem is they don't always fit the
business. They don't always have the terms that you need. They
don't always have the protections that you need, and so
it's one of the things you have to do as a startup, or really a
company of any size, frankly, is make sure that your form
agreements: (1) match the business; and (2) don't end up giving
you one of these poison pills that we're talking about when it
comes time for an exit.
Spencer Glende
And you should keep in mind that your business model may change.
All too often, companies start doing something different and
don't think to go back and update their standard terms of
service or master services agreement.
Scott Young
Or laws may change. Things change. You've got to keep them
fresh as well. Absolutely.
Spencer Glende
That's right. You mentioned how they could be almost a poison
pill, and that's partly a function of the fact that the
standard agreements are going to apply to many, many customers
usually or business partners which just multiplies even small
defects. Those defects could relate to not properly capping
liability exposure or ambiguous terms about IP ownership or rights.
Again saying that "we shall own it" instead of "you
hereby assign" was an example of that. Or fuzzy license
grants, even termination provisions that may not be sufficient
could leave you kind of locked into this whole class of contracts
and so it's always best to reserve the right in your standard
agreements. You have some way to modify the terms, modify the
pricing and if your customers don't like it their recourse is
that they can go elsewhere but you need to have some ability to
change and adapt those terms as circumstances change.
Scott Young
I think you made the key point Spencer, which is we might think
that any one template agreement may not be a huge deal but the
problem can become when you use that as your template and you
spread that over a large number of customers or a large number of
partners or whatever and then if there's one problem in it
you've got to rectify that problem over multiple contracts. It
can become a real nightmare when it comes time for the acquisition
of the investment.
Spencer Glende
So those templates are not where you want to cut corners because
every bit of time you saved by cutting corners, you're going to
pay 100 times over when if you have to go back and fix it.
Julian Dibbell
Again, you've touched on a number of topics. I sense this may
just be the tip of the iceberg. Lots to talk about here, but time
requires that we wrap it up. Any final thoughts on the whole
topic?
Spencer Glende
We're glad to have had a chance to talk with you Julian. I
guess we just sum up that, going back to the original analogy,
preparation and being proactive and having foresight, thinking
about your exit from the very earliest stages is important when
you're looking at your commercial and IP contracts.
Scott Young
If there's anything that you're going to hear when
it comes time for an exit from your client, from the acquiring
entity, from the entity to be acquired, especially going back to
our original analogy, they will say they feel the need for
speed.
Spencer Glende
That's right.
Julian Dibbell
Oh no, Scott.
Scott Young
Well, now I know I'm never going to be invited back to the
podcast.
Spencer Glende
It's going to go a lot faster if you've laid the ground
work.
Scott Young
That's right – preparation is key, Julian.
Julian Dibbell
That's helpful. Great insights, Scott and Spencer. Thank you
also for the major motion picture analogies. Listeners, if you have
any questions about today's episode or an idea for an episode
you'd like to hear about anything related to technology and IP
transactions and the law, please email us at techtransactions@mayerbrown.com.
Thanks for listening.
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