How do I protect IP created by contractors and volunteers before I incorporate?

Before any start-up is formally incorporated, there is always a period when the founders have developed intellectual property in the form of market research, the business plan,  perhaps trademarks, and often software code.   Sometimes formation of the business entity is delayed too long, creating unintentional claims on the ownership of the business or its assets.  But even when transition to the state-organized entity is timely, care should be taken beforehand not to create unintentional ownership claims on your intellectual property or your business itself.

First Caution: Don’t form an unintentional partnership. Unlike a corporation or a limited liability company, a partnership does not need to be formally organized with the state to exist as an entity.   Under Washington law, a general partnership is formed anytime two or more people associate as co-owners to carry on a business for profit, whether or not they intend to form a partnership.  A formal written agreement is not necessary.  See RCW 25.05.055.  As a founder, you will probably seek input and advice from many people as you are starting to form your business concept.  Friends and family may help you work on your business plan, create a web site, or even assist with writing code.  You may think they were donating their effort.  But they might think they were your partners.  Moreover, they will own the copyright to any work product , unless they assign it to you or the business.  A frequent issue arises when two friends start work on a project, but one loses interest and stops contributing.  The other keeps going but the relationship between them was never settled.  Then when the business grows and becomes valuable, the non-contributing partner comes back and wants a share of the business.  These kinds of situations are not unusual.  Indeed, the majority of start-ups probably experience them to some degree.

So what are your available strategies at the pre-formation stage?

  1. Don’t take any help.  (Not optimal and sometimes not even practical.
  2. Take help from only family members and close friends who you trust completely.  (Without taking further precautions, this strategy risks damaging relationships.  Any lawyer can give you examples of family members and friends whose relationships have been destroyed over business disputes.  If you do need to do business with family and friends, I advise more documentation rather than less.  Having an agreement in place beforehand can keep minor dissatisfactions from festering into real problems.)
  3. Use an independent contractor agreement with an IP assignment (see below), and pay the contributor a small amount for their work (even if payment is in something other than cash).
  4. In all cases, be very clear in your emails and other communications.  If you decide not to pay them for their work, state clearly in a written document that the contributor is donating the work to your project without expecting anything in return.
  5. Actually make them a partner.  If you do decide to make a contributor a partner, it may be a good time to consult an attorney or at least an experienced business person.  You should have a written agreement in place.   There are a host of issues that go into a forming a business with co-founders, not the least of which is how to divide up percentages in a fair way that leaves breathing room to issue stock in the future to financial investors, key employees, and other employees.  Other issues to work through are control, tax strategies, salaries and distributions, terms of departure, and so forth.  If you are ready to take on a partner, it’s probably worth the investment to consult a lawyer or accountant on entity choice.

Second Caution: Use Independent Contractor Agreements, even if you are not incorporated yet.   If you pay someone to develop software, you own the code, right?  Not necessarily so.  Non-employees (i.e., independent contractors), retain the copyright of works they create unless the work product falls into certain designated categories that qualify it as “work made for hire”.  17 U.S.C. § 101  Most software development projects don’t fall into one of the enumerated categories for work made for hire, which is why you should have the developer (or logo designer, etc.) sign an independent contractor agreement.   A well-drafted independent contractor agreement will have a work made for hire clause, and just to be safe, a backup clause that assigns the work product to the hiring entity.  If you are a founder who has not organized a business yet, you are the hiring entity.  The form of Independent Contractor Agreement that we have made available for downloading can be adapted to individuals who haven’t formed an entity yet.

Third Caution:  When you do form an entity, assign the assets and contracts to the entity.  One thing I see over and over again is that founders forget to assign their assets and contracts to the entity after it has been formed.  It is a fairly simple process to go to the Secretary of State website, set up a corporation or a limited liability company, get your business license, and start doing business.  But none of what you have created or produced before the company was formed is owned by the company unless it has been assigned to the company.  When it comes time to raise capital, sophisticated investors will look back to all of your material IP to see when it was created and by whom.   You will need to be able to show that it was created by employees of the company, or assigned by independent contractors to the company or to the founder, who in turn assigned it to the company.  Usually the founder assigns all of the IP of the business to the company at the time it is formed and initial stock is issued.   In addition to the business plan, market research, logos, trademarks, software and other IP,  other assets such as account balances, computer equipment, contracts and leases need to be assigned to the company at the time it is formed.

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