A Penny for your Software Licensing Thoughts?

Preliminary Thoughts for Founders When Licensing their Intellectual Property

What rights do you have in the Intellectual Property (IP) and what rights can you sell?

This may seem like an easy question to answer. As a founder, you own your IP, right?  Has proper care been taken in getting every employee and independent contractor who worked on the creation of the IP to assign their rights in the technology to the company?  Does the software include open source code that would require the company to also open source any derivative work product?  Is the software dependent upon a third party license that may require third party approval to sublicense the software?  Depending on the circumstances, there may be additional questions to ask and answer, but I think we have at least earned our preliminary penny here.

What should you sell?

Now that you have determined what you own and what you can sell, it is time to identify what you should sell, the parameters of the software licensing agreement.  The deal may not go through if you sell too little, but selling too much could have major adverse impacts on your company. Work together with your attorney to determine the proper limitations to the scope and duration of the license to protect your company.  Think – How do I use this IP?  How would use of the IP by a competitor affect my business?  Do I want the ability to sell the IP to more than one purchaser?  How can I ensure that my brand, marketing and goodwill are protected?  When in doubt, think small.  What is the smallest bundle of rights that the opposing party needs for its business purposes to close the deal?  Am I, as the seller, willing to sell that limited amount of rights in exchange for the purchase price? What would be the overall impact of the sale on my company?

Final thought. Sometimes a dollar spent on an attorney in the beginning, saves more than 100 pennies in the end.

This article is for informational purposes only and should not be taken as legal advice. It may not reflect the current law or the law in your jurisdiction. When acting upon the information presented herein, seek advice of counsel in the relevant jurisdiction.

Accelerated Vesting – Step on the Gas Pedal of Equity Ownership

I have discussed vesting in a prior blog post “Let’s Talk about Vesting,” now we can focus on acceleration of vesting.

What does acceleration of vesting mean?

Rather than waiting for equity to vest over time, a service provider’s equity can become partly or fully vested upon the occurrence of certain events.  These events and acceleration provisions are included in the company’s stock plan or in the grant or award to the individual service provider. Two common types of acceleration are discussed below.

There are two common types of vesting acceleration “Single Trigger” and “Double Trigger.” 

Single Trigger provides for acceleration upon the occurrence of a single event, i.e. the sale of the company.

Double Trigger provides that, upon a sale of the company (1st trigger), there is no acceleration.  Vesting accelerates on the 2nd trigger which is generally (a) a period of time passing after the 1st trigger, 12 months is common, and/or (b) the acquirer terminating the service provider without cause during a specific period of time after the 1st trigger. Note that the Double Trigger acceleration only works if the acquirer assumes the equity plan and the equity plan is still in existence at the time of the 2nd trigger.

Should founders argue for or implement single trigger acceleration?

Maybe.  Many founders believe that they should have a right to “cash out” upon the sale of their company.  They put in the hard work and deserve to profit from it; however, the purchase price of a company may be lower if the founders are not staying with the company after an acquisition.  Additionally, venture investors may not view the company as favorably with Single Trigger acceleration.  A company is often valued based on the strength and capacity of the founders and key service providers.  Have you watched Shark Tank?  How many times to the sharks say – I’m investing in this company because of you!  Start ups often change their product, strategy and revenue model; however, the ingenuity and drive of the founders remains the same.

Which type of acceleration is favored by venture investors?

Many VC investors favor Double Trigger equity awards because they feel that the founders are key to the company’s success and would like the founder to stay with the company, rather than give the founder the ability to cash out on a Single Trigger change in control.  VC investors may also believe that the acquisition purchase price would be higher if the acquirer has comfort that key service providers will stay with the company.

Should founders establish vesting terms prior to receiving venture investment?

In the case of multiple founders – YES!  Vesting avoids inequity, if there is no vesting in place and a founder leaves the company, they will still own all of the shares they are issued.  With vesting, the unvested shares would either be forfeited or repurchased by the company (at the low price that the founder paid).  The founder has to do the work over years to own the piece of the company. Vesting also avoids dilution (the reduction in value of shares due to the issuance of additional shares) because, if a company needs to replace the service provider that has left, they will typically need to issue some sort of stock package to the replacement. The repurchase or forfeiture of the stock avoids dilution from issuance of additional shares with the new hire.

This article is for informational purposes only and should not be taken as legal advice. It may not reflect the current law or the law in your jurisdiction. When acting upon the information presented herein, seek advice of counsel in the relevant jurisdiction.

What is the difference between stock, common stock, preferred stock, options, units and membership interests?

Stock

Stock is an ownership interest in a corporation. A share of stock represents a fractional ownership interest of the corporation in proportion to the total number of shares outstanding.  Stock may be classified as either common stock or preferred stock.

Common Stock

Common stock typically entitles the holder to vote for the corporation’s directors, approve significant events such as a merger or dissolution and gives the holder the right to receive dividends if and when they are declared.

Preferred Stock

Preferred stock typically has enhanced rights as compared to common stock.  This may include special voting rights, the right to receive dividends prior to the holders of common stock and the right to receive priority in distributions over that of the common stock upon the occurrence of significant events such as sale of the corporation or liquidation.

Stock Options

Stock options are rights to purchase shares of stock of a corporation at a future date at a specified price.

Units and Membership Interests

Ownership interests in a limited liability company, commonly referred to as an LLC, may be expressed as percentage interest or in amounts of membership units that are held by a member, and treated similarly to shares of stock in a corporation.  The Operating Agreement that members of the LLC enter into when they acquire the Units or Membership Interests provides the framework for the rights of the Units or Membership Interests with regards to voting and preference upon the occurrence of significant events.

This article is for informational purposes only and should not be taken as legal advice. It may not reflect the current law or the law in your jurisdiction. When acting upon the information presented herein, seek advice of counsel in the relevant jurisdiction.

Let’s talk about vesting.

What does vesting mean?

Founders and key employees are often granted shares of stock or options to purchase shares of stock with vesting.  Vesting means that the founder/key employee will earn the shares over time by continuing to provide services to the company. 

How does vesting work?

Startups are generally set up with shares vesting over four years with a one year “cliff”.  The one-year cliff means that 25% of the shares will vest after the founder/employee completes one year of service to the company.  Each month thereafter, the founder/employee will vest 1/48th of their shares until they are fully vested into the shares by continually providing services to the company for four years.

Why do companies issue shares on a vesting schedule?

Vesting is optional, but many companies choose this option to incentivize founders and key employees to stay with the company and give them a stake in the ownership of the company commensurate with the time they have expended in developing the company.  At the same time, vesting protects the company, by allowing the company to retain control of the unvested shares if a founder or employee “leaves early,” as opposed to granting the founder/employee a large ownership stake in the company outright.

What if I leave the Company before my shares have vested?

If the service provider leaves the company before the shares have vested, typically, the Company has the right to repurchase the shares at the original purchase price, or rights to the unvested shares are forfeited.

Where can I find the terms of my vesting?

Typically, the vesting schedule is found in the Limited Liability Company Operating Agreement.  In the case of a corporation, vesting can be included in the Stock Purchase Agreement, an Equity Incentive Plan and/or an Award under the Plan.

This article is for informational purposes only and should not be taken as legal advice. It may not reflect the current law or the law in your jurisdiction. When acting upon the information presented herein, seek advice of counsel in the relevant jurisdiction.