In a previous post I wrote about some of the ways in which a good attorney advisor can help a startup avoid some of the common mistakes made by early stage companies when contemplating formation. In this article, I address some of the additional IP and tax pitfalls that founders should keep cognizant of amidst the excitement of getting their new venture off the ground.
Assignment and Ownership of IP
Assignment and ownership of a company’s core IP from the pre-formation stages through funding and eventual exit are part and parcel of the nuanced advice provided by an experienced attorney. IP assignments must be clear and correct between the parties. Although the founders are focused on the success of their idea at the outset, if things go sideways it needs to be clear what the company owns and what the individual founders own. Does the founder’s agreement assign to the company all related IP from before incorporation as well as after incorporation? Is there a technical founder who wishes to retain rights to his personally developed IP until some specified event (e.g., funding) occurs? Founders agreements must contain clear and unambiguous terms in order to establish a chain of ownership for all of the company’s IP early on. This will be important later on to potential funders, partners and acquirors.
In situations where founders remain employed in other companies or have recently left a company, any IP ownership provisions in their current or previous employment agreements should be scrutinized. Don’t just assume that the individual owns all of the IP that they’ve create outside of work hours—make sure that there are no “moonlighting” provisions that can give rise to an IP claim from a former employer later on.
Contractors and employees should also execute agreements with IP assignment provisions, making it clear that the work product and IP being produced will be owned by the company, and not the respective contractor or employee. To facilitate this, contractor and employment agreements should contain clear confidential information clauses, similar to those signed by the founders themselves in their founders agreements. This will help to ensure that the company retains ownership of any IP created during performance of the services by these people. In situations where contractors will have access to sensitive company information and trade secrets, it may make sense to also have them enter into a nondisclosure agreement (NDA), containing language restricting both the use and dissemination of any proprietary information learned during the course of their engagement. I discuss some elements of an NDA for a startup to ponder in a recent post. A skilled attorney can provide reassurance on the terms of your nondisclosure, contractor and employment agreements.
Get it Filed (your 83(b), that is)
In addition making sure their IP assignments are clean, in situations where founders have contributed something of value (e.g., cash, IP) at formation for restricted stock and intend to use a vesting schedule, there are critical deadlines to be aware shortly after the shares are granted. Most critical, each founder must file an 83(b) election with the IRS within 30 days of the initial grant (without extension or exception) or there could be major tax consequences down the road as the shares rise in value. Section 83(b) of the Internal Revenue Code gives a founder the option of being taxed on the value of the stock when it was granted, rather than as it vests. The former scenario is almost guaranteed to result in a very small tax bill, while the results of the latter can be stunningly high.
The importance of this election cannot be overstated. For example, let’s say that founder X paid $1000 for 10% of a company’s stock, vesting evenly over four years. At the end of a successful first year, the company’s stock is valued at $10 per share. Without the 83(b), tax would be due and payable on the present value of your vested shares at the end of year one. Although you may not have received a penny in salary or compensation from your company, to the IRS you’ve received almost $250,000 of taxable income. Assuming a 36% tax bracket for a single filer, you would owe almost $90,000 in tax on your vested shares!
Keep these points in mind as you move forward with your new business, and if you have any questions, please feel free to reach out.