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Ownership Changes in Tech Companies

Many Technology businesses are created through people and businesses that know each other and work together, especially young companies or start-ups. More specifically, many businesses have multiple partners, investors and inventors. As time evolves there is often a need or desire to change the original relationship. The reasons for the change will be factors in determining the type and terms of the new agreement to be drawn.

After it has been determined that the parties wish to depart or have other interests which the parties may wish to pursue, in Technology Corporations, it is all too common that there will be a squabble over Intellectual Property issues.

However, Parting does not have to be sorrow, it can be sweet.

It isn't uncommon that the parties may want to work together or form some sort of a joint-venture/piggy back arrangement. With a creative arrangement, it is more likely that if the parties are willing to work together, not only will both parties leave the working relationship with each other in a well compensated or at least amicable relationship, but all parties may be able to offer their clients and customers more and better services.

The elements in these changes in ownership require an in depth understanding of not just the corporate issues, but also the technology and Intellectual Property (IP) issues. Some of the elements will be similar for each type of contract. Others will differ depending on their identifying nature (Buyout, Change in Ownership of the Business, etc).

In all modifications of Agreements a proper place to start is with the original contracts that formed the business relationship. Legal clauses are “terms of art.” It’s best to be consistent from document to document.

In the rest of this article, I will analyze a few examples of different elements and points for consideration in Technology Modification Agreements. More detailed articles will follow on each type. The examples are not meant to be exhaustive:

The Buyout. A Seller (the person or business leaving the Original Company) wants to sell their interest and then may want to work in unrelated fields or retire.

  1. The Seller’s interests. In this type of agreement the Seller is primarily concerned with getting fair market value for his interest. This can be a one time payment or payments over time. The forms of payment usually include cash and possibly some non-voting equity interest (such as stock) or a share of the profits on a regular basis with defined terms as to what profit means and when payment should be made. All of the benefits that the business offered during the business arrangement need to be considered. On leaving what happens to health insurance, the pension plans, etc? What else does the Seller get? Who does he contact if there’s a problem?
  2. The Buyer’s Interests. The Buyer's position is much more complicated. The Buyer (the Original Company) wants to ensure that its knowledge and Intellectual Property are preserved, and that any and all rights have been clearly assigned. Proprietary papers, business records, business methods, development and knowledge are all assets with value, and should be appropriately assessed in the negotiation.

With technology companies, special attention needs to be paid to all the data, back-ups to the data and knowledge of how to access that data. These issues must be negotiated. Once the Buyout agreement is done the Seller may be difficult or impossible to reach so it’s best to make sure everything of utility remains.

Unfortunately, more often than not, the interests of either (Buyer or Seller) are not always logically based, or in some instances, logically sound. Especially when the parties formed the companies together, a lot of emotional harboring towards some “parts” of an application or business method or functionality may have been involved. These “parts” will be valued at a higher level than others, and perhaps much higher than any financial consultant would deem applicable. It is important to gather as many reasonable and unrelated minds around you at this point. Map out what both parties interests are, both emotionally, and on a financial basis.

Buyout Examples. A common Buyout example is when somebody wants to retire or open up an unrelated business, for example a restaurant. Another example is when an employee or group of employees may be offered a buyout by the Company to reduce costs.


Change in Ownership of the Business.

Sometimes, Owners and Modifier (those seeking a change in ownership status) want to continue in the business but the Modifier wants to change his/her financial relationship with or obligations to the Original Company. This type of modification is not just a change in title (silent partner, equity partner, etc), but is also a change in obligations, interests, and control. In this type of modification both the Modifier and the Original Company want to define the new privileges and responsibilities of both Parties. It is important to identify what these rights and liabilities mean, who interprets any disputes as to their meaning and how they are going to be enforced, etc.

Special attention must be given to any change in the interest in any of the Intellectual Property in the business. Just as in the Buyout agreement all the data, backs-ups to the data and know-how to access that data have to be negotiated. The main difference is that the Modifier is still with the company, just in a different legal capacity.

Moreover, it is important to realize that just because they are taking a step back from the business, the Modifier(s) are still required to maintain and adhere to “fiduciary duties.” These duties should require any partners to ensure that they do not act in any way antagonistic to the company or its interests.

Change in Ownership of the Business Examples. A person wants to become a silent partner or the reverse. A non-equity partner wants to become an equity partner or the reverse.

Sharing Ownership of the Intellectual Property and or Data Sharing Agreements.

It is not uncommon (it is even hoped for) that the Original Company may want to continue the current business but also begin a new service or application. The Businesses involved are typically the Original Company (the business before any change is made to who can access the Intellectual Property) and the New Company (the second business formed by using some of the Intellectual Property of the first business.). The parties to this type of Contract are the Owners of the Original Company and the Owners of the New Company or their authorized agents.

In this type of contract it is essential to define:

  1. The Intellectual Property at stake,

  2. How that Property is going to be accessed,

  3. Who has the right to access,

  4. In what manner is it going to be accessed,

  5. What financial considerations should there be for access and

  6. The liabilities for unauthorized access and/or improper access which may damage the Intellectual Property.

These terms need to be defined for both the Original Company and the New Company.

Often times, this branch off would be jump started by licensing the Intellectual Property or forming some sort of Joint Venture. The more you know about how your Intellectual Property is created, how it is used and what benefits there are from using it, the better you will be able to address these questions.

New or Joint Venture Examples. In some cases this decision to begin a New Company may come from the top, where the Original Company may decide for legal or financial or conflict of interest or creative reasons that it is best to create a second business venture (the New Company). In other cases this decision may come from below where an employee wishes to go out on their own but wants to do so, on a friendly basis.

When a New Company Owner sells his shares back to the Original Company and leaves the Original Company to become an Owner of the New Company, the Contract is known as a Redemption Agreement.

A specific example of a Data Sharing Contract is when a New Company wants to begin a social networking site or an advertising business USING the contact information acquired in the Original Company.

Competition (New and Independent Businesses). With all types of separation agreements, and especially in the Technology Industry, individuals leave with a lot of business information, practices, methods, contacts, strategy and plans in their memory. Normally, contracts like non-compete clauses, non-solicitation, and similar restrictions are often implemented to protect these business interests. It is important to craft these restrictions carefully. The technology industry moves at a pace much quicker and with much more rapid change and development than other industries. Courts recognize this, and therefore it is important to structure these restrictions that are 1. legally binding and 2. easily understood and defined from both parties.

It is primarily important to identify if there is immediate or foreseeable competition. Is the Competitor leaving the area or is he going into a venture that complements the original business? Is the Competing product or offering something that the Original Company is considering offering or developing? Often a place to start is the competition clause in the original contract. In either case many of the issues in Item 3 (Change in Ownership of the Intellectual Property/Data Sharing Contracts) apply.

 

  1. Direct Competition. If competition is going to be direct then items such as fair market value, loss of profits, licensing agreements and more have to be considered. The Original Company will want fair consideration and fair protection (non-interference with his business contacts for example) for allowing the competition. The New Company will want the right to use the Intellectual property free from the worry of any litigation.

  2. Indirect Competition. The elements of the Competition should be defined first. Term, Business Interests at Issue, Geography, etc. After that the same elements as for Direct Competition should be considered – factoring in that the less the competition the less the Competitor will want to pay and the less the initial company will have a right to demand.

For more information on Competition see Non-Compete Language in Change of Ownership of Intellectual Property Contracts.

Combination.
Sometimes the contract will be a combination of the above. The list given is not meant to be exclusive.

Be careful with the agreements, clearly define the interests and licenses, and Remember that the other standard elements of a contract are also required: Consideration, Competence and it must be Lawful

 

 

Ten Tips to Technology Contract Drafting

Whether you are an attorney or are thinking of meeting with an attorney, or just going to draft a contract on your own, look out for these areas. The following tips are meant to help people cover over key concepts in drafting, so you don't miss the big issues.

(i) Offer/ Acceptance

Technology or not technology, basic contract principles apply. There needs to be a clear offer, and a clear acceptance. While the courts today are allowing more and more for emails to constitute acceptance, it is still best practice to get together in a room and sign the piece of paper.

Be clear in your terms, and clear in your contract. If there are things that you both expect which you "spoke" about, often referred to as an "oral agreement," both parties will be better served when you write it down on paper.

Ensure that everything is written down as specifically as possible. This includes accepted levels of performance, payment terms, and price.

(ii) Modification

It is important to ensure that there is a plan to modify and adapt the contract in foreseeable ways. It is very common for their to be fluctuation in the market, in the product, or in the supply chain, whether that be data feeds, inconsistent "up-time", delays in development, or increases in costs.

Although it is very common for technology contracts to be a fixed price, or on the traditional "time and expenses" model, it is important to build in the ability to be flexible. This will allow your contract to adapt and change the same way that your business relationship changes with vendors, suppliers, and customers.

(iii) Technology Specification

Ensure that the specifications are part of the contract. It is all too common for the specifications to be outside agreements, or addendum that can easily be changed or considered to not be part of the contract.

Furthemore, ensure that the specification is as specific as possible. Whether it is a guarantee in regards to latency, packet loss, "up-time", a delivery date, data integrity, or parity, it is important to place them in the contract as specific as possible. It is important to realize that leaving specification language out on purpose is not for anyone's benefit. It won't keep a client bound to the contract for longer because the terms of the contract are not as tight, nor will it protect the vendor or supplier from breach of contract.

iv) Intellectual property

Intellectual property goes beyond the standard copyright, trademark, and patent law that is commonly associated. Business practices, just general ideas, discussions should be discussed. Applying language similar to what one would use in a non-disclosure agreement.

Furthermore, anything that is core or key to a business model should be protected either through specific language, licensing language or agreement, and realize that there may be exposure of intellectual property from third parties, whether that be material a business has licensed, acquired, or information that is exchanged in other agreements.

(v) Licensing

It is important to clearly spell out the license and to inform the other party of the license and the rights associated with that license. There is a common misunderstanding that a piece of software, idea, patent, hardware, or section of code is licensed perpetually and for any use.

Not only is this type of licensing model very uncommon, it is rare that an intellectual property owner will "license" their intellectual property for any use at any time in any way. Remember to limit the license not just in regards to time, but also to as to scope. Clearly define how the product is to be used, and for what functions. Discuss with the other party in particularity the application of the intellectual property.

Lastly, do not forget to discuss and define the elements and ways in which the license can be terminated.

(vi) Limitation of liability

Limitation of Liability is the key issue in any supplier or vendor's mind. Review your insurance coverage, ways that the product could be utilized, and how the product could malfunction, including loss of business losses, destruction of hardware or dependent machinery.

There are ways to limit liability, and one key is, even if you feel it may be an egregious or possibly unenforceable limit of liability, if there is a bargain for and exchange for that limitation, whether the customer secures a lower price, longer license, or other feature in exchange for the limitation of liability, then it is a higher likelihood of being enforced, and therefore protecting the licensor.

(vii) Ownership

Label and identify all ideas or intellectual property involved in the exchange and who owns the intellectual property. If you are contracting with another party to develop a product, identify which party shall own the license, copyright or any other right to the deliverables. This includes whether the product can be used in portfolios or any other advertising.

(viii) Product Delivery, Testing, Acceptance, Denial

The optimism and confidence that you have when entering an agreement can quickly disappear as deadlines are missed and promises are not kept. How do you know the work is done? How do you get out of the deal if things don't work out? When should you have termination rights or get refunds? Should the vendor be obligated to help you transition to a new provider?

In most cases, you should be able to get a warranty that deliverables will perform in accordance with specifications. Have you adequately set out your specifications?

(ix) Termination

One of the most important things in any contract is clearly and easily defining how the contract can be terminated, and when it will end. It is rare that contracts are everlasting, although some automatic renewal contracts do seem to continue in existence well past their utility.

Clearly define ways of resolving dispute, how to give notice, and terms and situations which the contract will end. The smoother the exit strategy, the more likely companies will do business with each other in the future, and the less likely a lawyer will have to be involved.

(x) First Draft

It is one of the most strategic points for a lawyer to be the first to pen the agreement. In starting the contract and drafting the first round, a person gains the upper hand in shaping the negotiations, what is up for negotiation, and shaping the entire agreement.

With this upper hand, try and avoid as much as possible, one-sidedness. Obviously, the less debating and the quicker a deal is signed, the sooner business can move forward, generate more revenue, and apply the principles and ideas to running a successful company.