Protecting software and technology: why acting early pays dividends
Clearly defined and documented IP rights are vital to protect the value of software-based companies.
Today the world runs on code. There’s an app for everything from shopping and entertainment to public services, with new virtual worlds opening up in the metaverse offering advanced digital experiences.
At the forefront of creating those experiences are the companies and developers who are working at break-neck speed to build the next big thing that captures public attention and market share.
For many start-up founders, the dream is to build value in their business and either secure major investment, or achieve an exit through sale or acquisition.
However, the intense speed at which software-based businesses operate can pose a problem when it comes to company valuation if the intellectual property rights to the software are not clearly defined from the start.
A lack of early IP rights governance can cause considerable difficulties later down the line, as Stephen Green, Rob Eakins and Nathan Hughes of Bermans recently explained in a fascinating webinar for CITMA members where they offered essential advice on software and technology due diligence to ensure there are no nasty surprises in the future.
Be ready when opportunity knocks
The goal of software due diligence is to ensure that the ownership of IP rights to software is clearly defined and documented so that, when opportunity knocks in the form of investor interest or an exit opportunity, there is no ambiguity around who owns what within the business.
If there is uncertainty or any third parties have a potential claim to ownership, this can negatively impact valuation and derail any investment or purchase.
As Stephen put it: “The more you can do early on, particularly around securing your rights, the easier it is later when you are looking for investment or exit.”
Types of IP rights relating to software
When conducting software due diligence, it is important to identify all the possible rights associated with the business, exploiting them to the best effect and ensuring that they are documented and packaged into a form making them easily distinguishable and defined so it is possible to transfer or sell them.
The primary IP right concerned with software is copyright, which is typically found in the source code, but could also be applied to product documentation and website content.
Other possible rights include database rights, domain names, social media handles, and goodwill.
Who owns the code?
Above all, it is essential that the business acquires the relevant rights to its code.
In software, the first author is typically the owner of the right, so the business needs to understand which author created it.
This is usually the developer who wrote the code, meaning it is important to carry out the correct transfer of that right to the business that employed the developer on the project.
This can become quite a complex undertaking, especially if the developer who built the code wants to include it in another project – which may not look similar to the first project, but still uses the base code – for a different employer.
Assignment of rights therefore typically needs to include present and future works, due to the fast-evolving nature of software.
For companies wishing to allow their proprietary code to be used in other projects, it is possible to license it for use under the terms of its copyright.
The legal due diligence process for software
Having a clear understanding of ownership comes into its own when any potential purchaser or investor enters into the process of due diligence.
Nathan explained that this process typically plays out via questionnaires sent to the seller and their lawyers to determine that the target company is selling (and is entitled to sell) what it says it is selling.
Typical questions include:
- Is there is any litigation involving the target company?
- What are the existing share rights and share structure?
- What are the registered and unregistered IP rights within the business?
- Information about who created the IP – was it an employee or a consultant?
- Whether there is any infringement of IP – both of the target company’s IP and by the target company of another’s IP
- Has any IP been jointly created or shared?
- What licenses are offered and used by the target?
- Is there any open-source use in the code base and what are the terms of its use?
Ultimately, the purchaser wants to understand what IP there is vested in the business. That way, they know that they are buying the IP they need to operate the company as they want to.
The process of due diligence can take a very long time, which can be frustrating for sellers and buyers. But, as Nathan emphasised, everything is a lot easier if IP has been properly documented from the start.
This includes maintaining robust policies and registers of open-source software use, and ensuring the company follows the specific provisions of licenses for any open-source code incorporated into the software.
The future – Web 3.0 introduces more complexity
Rob explained how the advent of Web 3.0 moves the technology environment from a centralised to a decentralised structure. Blockchain is the foundation for innovations such as cryptocurrencies and NFTs, which are owned and transferred via peer-to-peer networks.
This puts control in the hands of users, rather than mediators such as banks, and creates even greater complexity around ownership.
Web 3.0 is “currently a bit of a Wild West”, according to Rob, as it is unregulated and largely undocumented so transactions taking place within it can be very difficult to trace. This can compound challenges around IP ownership and transfer.
Concluding the session, the team reiterated that ownership drives value in a software-based business, so it is essential that the company has fully documented evidence of the rights that it claims.
“Make sure that you own the IP rights that have been assigned and make sure everything is documented,” was the number one take away from this enlightening webinar.