Here you are – you’ve got this great idea, this innovation or thing that will change the world, revolutionize an industry, or otherwise positively disrupt the status quo. Now what?
Here are five key principles to help you succeed in getting your idea to market:
- Work with the right advisors
- Protect your intellectual property
- Form a company
- Know the enforcers
- Avoid bad contracts
Work with the Right Advisors
Advisors come in many shapes and sizes, including personal mentors, your college or university clinics, academic tech transfer offices, alumni research foundations, industry associations, incubators, accelerators, angel groups or networks, and professional advisors and consultants – just to name a few.
A solid core team of advisors often includes business, accounting, tax, legal and regulatory experts. These are folks who have already successfully walked (or helped others walk) on the path that you are about to venture onto, so leverage their wealth of knowledge.
One note of caution: Be careful about the “My Cousin Vinny” scenario (funny movie, scary reality). It’s great if your cousin’s ex is a real estate attorney – but that will not do you any good if you need a commercial lawyer to help get your company formed or equity financing contracts negotiated.
Instead, surround yourself with advisors who are subject matter experts in the field that is relevant to your idea – and do so right from the start. It is typically much easier to avoid missteps in the first place than it is to try to undo them later on (when it can be extremely costly if not impossible to do so). Your idea, company valuation, reputation and future are worth it!
Protect Your Intellectual Property Rights
Intellectual property differentiates you from your competitors and failing to protect it may result in the loss of your competitive edge all together. This in turn will likely negatively impact your ability to secure financing, your company valuation, and your exit strategy.
There are many forms of intellectual property protection, such as patents, copyrights, trademarks, trade secrets, and trade names. A patent is often the most sought-after form of protection for emerging companies (given that it is a grant by the Federal Government of a quasi-monopoly in a new invention). However, patent protection does have certain drawbacks, such as being relatively expensive and limited to a specified time period (20 years from filing). Further, in exchange for patent protection, the information will be disclosed to the public, meaning that your competitors can potentially use it as a spring board to design around your patent.
If your idea involves software, then copyright will be an important form of protection. A copyright protects the tangible expression of an idea but not the idea itself. For example, in the case of software, copyright protection would cover the source code as the tangible expression of an underlying computer algorithm (note that the algorithm itself may be protected as a patent or trade secret). It is important to protect your copyright at all stages – from development to out-licensing. For instance, include a “work made for hire” clause in your company’s employment agreements and an intellectual property assignment provision in your company’s consulting agreements in order to ensure that you will own all of the developed intellectual property rights. If you decide to out-license your software, a carefully crafted license agreement will help you preserve and extract maximum value.
In certain cases, a trade secret may be the preferred route – particularly if your idea can be kept secret and is not easily reverse-engineered (think of the top-secret Coca-Cola formula or the infamously-guarded Kentucky Fried Chicken “eleven herbs and spices” recipe). Compared to a patent, a trade secret is less expensive and does not have a pre-determined expiration date. However, you will need to take reasonable steps to maintain its secrecy and be able to document those steps.
In addition to protecting your own intellectual property, you will also need to make sure that your idea does not violate someone else’s intellectual property rights. An infringement lawsuit is serious (and very costly and disruptive) business. Having a good intellectual property lawyer to help optimize your intellectual property strategy and navigate the competitive landscape can make or break an emerging company. If you do not yet have a good intellectual property lawyer, ask your advisors for a referral – they will be happy to make the connection.
Form a Company
If you want to commercialize your idea, there are several reasons why you should consider forming a company, such as being able to limit your personal liability as well as to attract outside investors and top talent (with stock being a form of non-cash currency). Generally speaking, the State of Delaware is a good option to look into (even if you are physically located elsewhere) given that it has modern and well-developed corporate laws, provides flexibility, and is often preferred by institutional investors. Note that there may be some incremental costs (such as a local registered agent) if you are located outside the state where your company is formed, so carefully evaluate the pros and cons with your advisors in order to make an informed decision.
Limited liability companies (LLCs) and corporations are common options to consider. If you are at or near the stage when you are ready for an equity financing, consider whether forming a corporation from the start would make sense for you. Note that there are certain tax implications to consider, so be careful not to be nudged into a “cookie cutter” or “one-size-fits-all” scheme. Instead, consult with your tax and legal advisors to decide what is right for you. For example, using a corporation has the potential for double taxation (meaning you may be taxed both at the corporate and the individual levels) while an LLC is a pass- through entity from a tax perspective (meaning the LLC itself is not taxed).
If you decide to form a corporation, consider adopting a capital (aka stock) structure that is flexible enough to accommodate your anticipated financing needs. Given that investors are typically looking to receive preferred or senior stock in consideration for their investment, adopting “blank check” preferred stock at the point of formation (and then fixing the exact terms later as investors will want to negotiate those) could potentially save you the time and cost of having to formally amend your incorporation documents and getting shareholder approval later on. “Blank check” preferred stock is not allowed in every state and does not fit every circumstance, so please consult with your legal advisor. These are just some of the options that may help save you money and time plus look more attractive to investors.
Know the Enforcers
Knowledge is power. Specifically, knowing which regulations you must comply with, when, and how is critical to your success. Potential enforcers include not only the more-widely known players, such as the Department of Justice, Securities and Exchange Commission, Federal Trade Commission, Federal Bureau of Investigation, Food and Drug Administration (FDA), Office of Inspector General / U.S. Department of Health & Human Services, Internal Revenue Service, and the U.S. Supreme Court – but also the states (including their respective Attorney Generals and courts), whistleblowers, and competitors.
If the foregoing list was not already long (and scary!) enough, add to it the fact that the regulations themselves are not always intuitive. For instance, if your innovation is an FDA-regulated medical device, chances are that the “Sunshine” laws (both state and federal) will require you to report information about your financial relationships with physicians and hospitals – which other industry requires businesses to publicly disclose perfectly legitimate payments made to their customers and partners you may wonder? Also, if you want to proudly display a prototype or “next-gen” version of your medical device, you cannot take any orders or otherwise run afoul of the FDA’s pre-selling rules – can you imagine what a trade show in the automobile industry would look like with these restrictions?
At the same time, the enforcement statistics are sobering and continue to trend up in terms of number of actions (criminal and civil) brought as well as fines recovered against both companies and individuals. For example, take an industry that continues to generate news headlines – health care. In 2015, the Federal Government won or negotiated just under $2 billion (yes, with a “b”) in health care fraud judgments and settlements while the Department of Justice (just one of the many enforcers) opened close to 1,000 new criminal health care fraud investigations. In sum, what you don’t know can hurt you – especially in highly-regulated industries such as health care.
The good news is that you can successfully navigate these often choppy waters with the right legal and regulatory experts by your side. Big companies typically hire entire in-house teams whose sole job it is to keep the company out of trouble. While this is likely not a realistic option for an emerging company (from a cost perspective alone), your advisors may be willing to explore some cost-effective outsourcing arrangements (including part-time, fractional, on demand or virtual) that will enable you to get the expert help you need without having to hire full-time staff with salaries, benefits, and bonuses.
Avoid Bad Contracts
Your new company will want (and need) to enter into a variety of contracts in order to succeed, such as confidentiality, equity financing, collaboration/joint development, licensing, shareholder, and employment agreements – just to name a few.
A bad contract is like a rabies-infected raccoon: Sooner or later, it will come (back) to bite you. What is a “bad” contract? Here are a few examples:
- It is one-sided in that you end up taking on all of the risk – meaning you will be liable for completely unforeseen consequences (as if you were an insurance company – but without receiving the premium checks) or for paying steep fines (in essence a penalty) even for things that are outside of your control
- You cannot terminate it, even if the other side screws up – meaning you may be stuck, unless you are willing and (financially) able to take the other side to court and sue them for breach of contract
- It is not competitive – meaning your competitors have better (clearer, shorter, etc.) contracts and your customers tell you that you are out of sync and refuse to deal
- You are guaranteeing a specific outcome or result through the use of your product – while you should always stand behind the quality of your product, that does not mean you should write a blank check to cover user error or outright misuse
- You are giving up too many rights to your idea without proportionate compensation – thereby potentially enabling a competitor …
The reality is that contract negotiations often boil down to leverage. As an emerging company, you may not always have the upper hand in that regard. Also, you may be willing (and able) to take on more risk than a bigger, more established company. However, that does not mean you should throw in the towel and not even try to negotiate. Larger companies often look outside for innovation and your idea may just be the missing link in their development efforts, so don’t sell yourself short. Instead, identify which risks are smart ones for you to take (for example, if they are calculated and proportionate to the reward) and then negotiate accordingly.
Finally, bear in mind that bad contracts can negatively impact your company valuation. Institutional investors and buyers in a merger & acquisition (M&A) transaction typically hire an entire army of lawyers to pore over and analyze all of your contracts in order to flag any risks and liabilities as part of their due diligence assessment.
In closing, consider the five principles outlined above, follow your passion, and (when in doubt) trust your gut instinct. Also, don’t forget to “pay it forward” once you make it …
If you have any questions on this article, do not hesitate to reach out via email to Jana Gerken.
The information in the above article represents the author’s personal views and is not intended to be any form of legal advice