Editor’s note: Walter E. Daniels is a founder of and principal in the Research Triangle Park law firm of Daniels Daniels & Verdonik, P.A.
RESEARCH TRIANGLE PARK, N.C. – Intellectual Property (“IP”) issues occur in three stages in most venture capital transactions.
In the first stage the want-to-be venture-backed company (the “Company”) presents its business plan and provides a lot of general information about the Company to the venture capital firm (the “VC”). During this stage VCs generally will not sign confidentiality agreements, so it is important that the Company withhold information which would constitute trade secrets or would destroy its ability to secure important patent protection at a later time.
The second stage begins when the VC becomes interested in moving forward with the investment transaction and a term sheet is negotiated and executed. The term sheet may contain confidentiality provisions, or a separate non-disclosure and non-use agreement may be signed, but either way at this stage formal confidentiality obligations on the part of the investor are put in place.
It is at this point that formal “due diligence” begins and the Company will be asked to provide information pursuant to a “due diligence checklist.” The due diligence checklist will be several pages long and will, in the IP realm, cover such items as: all foreign and domestic patents, copyrights, and trademarks owned by the Company; claims or threats of claims of infringement on others’ patents, copyrights, trademarks or other proprietary rights; license agreements for patents, copyrights and trademarks running to and from Company; and secrecy, confidentiality and nondisclosure agreements. Addressing the checklist list indirectly requires analysis of the status of the IP rights of the Company, and in some respects, that of third parties.
The third stage involves documentation of the deal. Most venture capital investment transactions are based upon a principal document called a Stock Purchase Agreement or a Securities Purchase Agreement. In each such agreement there is an article, generally five to fifteen pages in length, that sets forth detailed representations and warranties, known in the trade as “reps,” of the company in which the investment is to be made. In some instances certain significant stockholders make reps as well.
Overall the subject matter of the reps will often mirror the subject matter of the due diligence checklist, with the exception that reps will be more comprehensive and designed to ferret out problems and force those making the reps to either disclose the problem or stand behind the statement that there are no problems. Within the rep article there will be one or more sections dealing with the IP of the Company, which sections will, of course, be of particular importance to a high tech company.
While the purpose of this article is not to address the intricacies of investor versus company positions on representations and warranties, the following general observations, which are taken from the perspective of one who represents the Company, are important:
The time to address matters encompassed within the IP reps is long before the term sheet is signed. If serious problems exist at the transaction stage, it may be too late to correct them. Sometimes it is difficult for entrepreneurs to focus on these issues early in the process of building a company, but it is the role of venture capital and IP counsel to work with their clients to make sure that adequate preparations are made, including, in some instances, performance of technology audits, and addressing loose ends that might be identified thereby.
Daniels Daniels & Verdonik, P.A. has been serving the legal needs of entrepreneurial and high technology clients for more than 20 years. Walter Daniels concentrates his practice in the representation of rapidly growing companies, most of which are technology-based. He serves on the Board of Directors of the Council for Entrepreneurial Development and the Statewide Advisory Board for the North Carolina Small Business and Technology Development Center. Questions or Comments can be sent to email@example.com