What Happens to Your Intellectual Property When Your Startup Shuts Down?
When a startup shuts down, managing its intellectual property (IP) - including patents, trademarks, copyrights, and trade secrets - is crucial. As intangible assets, handling IP correctly is vital for a smooth closure.
Clarifying intellectual property ownership at the time of company formation prevents disputes between co-founders later on.
The fate of your company’s IP assets depends on agreements contained within the founding documents and the company dissolution method.
Understanding and mitigating common IP challenges, such as unregistered assets and unclear ownership agreements, is safeguards a startup's intellectual property rights.
Who Owns IP in a Startup?
Intellectual property ownership for tech startups is based on the terms contained in the founding documents (also called Articles of Incorporation), and other agreements between the founders, employees, and stakeholders. Generally speaking, IP ownership for startups is based on the following guidelines:
IP created before the formation of a startup is typically owned by the founders individually. However, if the founders want, they can transfer the ownership to the company.
The company usually owns IP created by employees. This is true even if the employee created the IP on their own time or using their own resources.
In most cases, companies claim complete ownership of IP created by freelancers or contractors, and usually don’t work with individuals who don’t agree to such terms.
What Happens to IP When a Tech Company Shuts Down?
When a tech company shuts down, the IP assets usually go to the creditors, shareholders, or other stakeholders. These assets could also be sold, licensed, or abandoned (i.e., become part of the public domain), depending on the company dissolution method. Tech startups must have a plan for IP assets in case of shutdown to avoid potential legal liability and/or reputation damages.
When a startup fails, it must sell its assets to pay off its debts. However, if a company decides to wrap up operations – for whatever reason – without filing for bankruptcy, here’s how IP rights are transferred based on the business structure:
Sole proprietorship: When a sole proprietorship dissolves, the IP rights are transferred to the sole proprietor.
Partnership: When a partnership dissolves, the IP rights are transferred to the individual partners per the partnership agreement.
Corporation: When a corporation dissolves, the IP rights are transferred to the company's shareholders.
In the last scenario, this process is governed by several factors:
Shareholder Agreements and Board Decisions: The process of IP distribution does indeed depend on shareholder agreements and the decisions of the board of directors. These entities play a significant role in determining how assets, including IP, are handled during dissolution.
Creditor Claims: It's accurate that creditors' claims are usually prioritized before any distribution of assets to shareholders. In a corporate dissolution, outstanding debts and liabilities are settled first, and this may include liquidating IP assets to satisfy creditor claims.
Shareholder Equity: After debts are cleared, any remaining assets, including IP, are distributed to shareholders. The distribution is generally proportional to the shareholders' equity stakes, but specific shareholder agreements may dictate different terms.
Legal Compliance: Ensuring legal compliance during the dissolution process is crucial. This includes adhering to corporate laws, bankruptcy laws (if applicable), and IP laws.
With IP ownership concerns out of the way, let’s discuss how startups can protect their intellectual property.
Common Oversights in Protecting Intellectual Property for Startups
Tech startups can protect their intellectual property by documenting and registering all IP assets, ensuring employees, contractors, and third parties with access to confidential data sign NDAs, securing data using strong encryption methods, and proactively monitoring IP infringements.
Here are some common IP pitfalls businesses in the tech industry usually fall into.
Not Registering IP Assets
After creating intellectual property (IP), the next step is to register these assets by filing an application with the relevant government agency to obtain a legal record of ownership. Put simply, it’s the best way to protect and prove that you’re the rightful owner of these intangible assets.
For tech startups, IP also includes:
Software: Includes algorithms, and the source code the developers wrote for the software.
Data: Includes R&D findings, software/hardware prototypes, databases, and technical documentation that the company has compiled and organized over the months/years.
Domain names: A company’s website address is also considered part of IP and can be protected as trademarks.
Hardware designs: If the company was engaged in hardware development, then the physical product designs could also be considered IP.
Unfortunately, some companies ignore IP registration and focus all their energy on product development, marketing, and other concerns. Others recognize its importance but delay the process because of the high associated costs like filing fees and legal expenses.
Whatever the underlying motives are, delaying the registration of IP assets can have the following consequences:
Risk of theft: Competitors, employees, and other bad actors in the industry can steal your company’s IP, especially if it’s valuable or unique.
Brand identity takes a hit: Not registering trademarks dilutes your brand identity and confuses customers because competitors now use similar or identical branding elements.
Financial drawback: Tech startups can license or sell their IPs (including valuable software) when shutting down the company. Not registering IPs makes you miss out on such opportunities.
A common mistake founders make is not to set clear IP bylaws in the Articles of Incorporation. Although not required by the law, IP bylaws are crucial because they clarify who owns the IP assets created by the company and its employees (e.g., software code or website content). This deters potential disputes between the company and its partners/shareholders down the road.
Poor or Incomplete Documentation
A tech business with poor or incomplete IP documentation is at a disadvantage. For example, investors may hesitate to invest because the startup lacks the documentation to safeguard against infringement.
Also, without proper documentation, tech startups can incur higher legal fees to enforce their IP rights or defend themselves from infringement claims.
Failing to Implement Strong Cybersecurity Protocols
Implementing robust cybersecurity measures protects tech startups from data breaches, unauthorized access, and other security threats that could undo years of hard work and progress.
Regularly updating and patching software helps address vulnerabilities and safeguard the source code. Additional security measures include using safe network configurations, encryption, and conducting routine security audits.
Not Proactively Monitoring IP Infringements
It’s essential to monitor your IP assets regularly to make sure they aren’t being infringed by others. You don’t have to dedicate enormous time or resources; visit the United States Patent and Trademark Office (USPTO) website and scour the internet to identify any unauthorized use of your IP assets every so often.
What Happens to a Trademark When a Company Goes Out of Business?
When a company goes out of business, the trademark is sold, licensed, or abandoned. Also, if a company doesn’t use its trademark for three years, the USPTO could cancel it and make it part of the public domain (meaning anyone can use it). In some cases, company trademarks are transferred to creditors or shareholders as part of the dissolution process.
What Happens if IP Protection Is Violated by Another Company?
If another company infringes your IP rights, you should gather evidence of the infringement and send a cease and desist letter to the concerned company. If they don’t comply with your cease and desist letter, you can file a civil lawsuit (and, in some cases, a criminal complaint). We strongly recommend you consult an attorney before taking legal action.
Having read this far, you’ve probably gained an appreciation for how complex IP-related issues can be. Failing to deal with these issues makes closing your startup more complicated than it needs to be.
Business closure isn’t pretty – legal and financial obligations demand your attention and don’t give you time to deal with the emotions and stress associated with a company closure.
But it doesn’t have to be that way. SimpleClosure simplifies the business wind-down process by automating the bureaucratic and manual work. It saves startup founders from potentially wasting thousands of dollars and endless hours.
We’d love to talk – Get in touch today.