The founder of a company asked me whether he needs a buy-sell agreement. Having just granted shares to key personnel, he wanted to make sure that a departure from the team did not jeopardize the company’s operations.
A buy-sell agreement can apply to any type of closely-held business (one in which ownership and voting control are concentrated in the hands of a few investors). I will refer, below, to shareholders of a corporation, but most of the following information applies equally to members of a limited liability company and partners in a partnership.
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Before starting my law practice five years ago, I provided legal services in-house as VP and Legal Counsel at Visa International Service Association (now Visa, Inc.). Visa was a great place to work, and I considered myself fortunate every day that I worked there.
But now that I am removed from that experience, I realize that Visa and I were not a perfect fit. Financial services are about minimizing risk. I’m not. Although I am not foolhardy, I am willing to weigh risk vs. reward.
That’s why my clients are small, entrepreneurial companies, typically start-up or early-stage. Entrepreneurs balance risk and reward every day, making us a good fit. And that’s why my law practice gives me the greatest professional enjoyment of any position I have ever had. I consider myself even more fortunate, now.
More than 20 years ago, I was General Counsel of a small software company. The CEO – a successful serial entrepreneur – was always looking for opportunities to acquire, or establish strategic relationships with, other companies. The CEO was creative in identifying opportunities, yet highly attuned to potential problems. He told me, “If you think it smells bad now, wait until you dig into it.“ I was recently reminded of his warning.
A client (“Client”) had signed a letter of intent to acquire a much smaller company (“Target”) and asked that I represent Client in the transaction. I sent a Due Diligence Request List to Target, and with its reply I had my first clues that Target might have some problems. Target’s initial responses were superficial and incomplete. I did not know whether the company was being evasive or was merely naive. Either way, it appeared that Target lacked a lawyer’s guidance.
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As Alexander Pope wrote in An Essay on Criticism (1711), “A little Learning is a dang’rous Thing“. That certainly pertains to the legal concept of a “work made for hire” (WMFH).
People who have some knowledge of WMFH typically believe that it means the transfer of all rights in a work from the creator to a purchaser. So, for example, if an independent contractor writes software for a company, then according to this belief, the company will own all rights to the software if the parties’ contract says the software is a WMFH. This belief is wrong! The following is an explanation of what WMFH really means under copyright law and how parties actually can arrange for transfer of all rights in a work.
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On May 19, the American Law Institute approved the Proposed Final Draft of the Principles of the Law of Software Contracts. The 305-page document presents best practices that should be taken into account when software license agreements are drafted.
Here are some implications of the Principles that I find most interesting:
- Section 2.03(d) says, in part, that “in the case of standard-form transfer of generally available software, mere notice of a material modification sent by one party is insufficient to prove agreement by the other party, even if the original contract authorizes this manner of modifying the contract.” Implication: If a website’s terms governing use of software include a provision stating that the licensor (website owner) may change the terms of use merely by notifying the licensee (user) of the change, that provision would not be enforceable under the Principles.
- Section 3.02(b) says, in part, that “the transferor creates an express warranty to the transferee [by a]n affirmation of fact or promise made by the transferor to the transferee, including by advertising [or a]ny description of the software made by the transferor to the transferee [or a]ny demonstration of software shown by the transferor to the transferee on which a reasonable transferee could rely….” Implication: Software licensors should review the accuracy of their advertisements, product collateral, packaging and demonstrations to minimize the likelihood that any inappropriate express warranty will be created.
- Section 3.05(b) says, in part, “A transferor that receives money or a right to payment of a monetary obligation in exchange for the software warrants to any party in the normal chain of distribution that the software contains no material hidden defects of which the transferor was aware at the time of the transfer. This warranty may not be excluded.” Implication: While no one can reasonably expect software to be perfect, licensors should not conceal known defects that would result in the licensee not receiving substantially what it bargained for.
- Section 3.11(e) says “The cumulative effect of nonmaterial breaches may be material.” Implication: Many small software defects, together, can entitle the licensee to remedies for material breach.
The Principles are not binding law, like statutes or court decisions. Nevertheless, many courts find ALI publications highly persuasive. Accordingly, software licensors should review their existing license agreements and seriously consider modifying any provisions that conflict with the Principles.
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.
On June 18, I will make a presentation to the East Bay MashEx. The title: “The Top Ten Intellectual Property Mistakes of Small to Mid-Size Technology Companies”. (The handout is available as a Free Download using the Sign Up button in the sidebar.)
Here are the mistakes that I will talk about:
- Failing to use employee invention agreements
- Assuming that the company owns contractors’ work product
- Using another company’s license agreement
- Thinking that patents are the only IP that matters
- Filing for a provisional patent before the scope of the invention is clear
- Treating the federal government like non-government infringers
- Neglecting to identify and protect trade secrets
- Believing that “open source” means “no restrictions”
- Giving the “family jewels” to an overseas supplier
- Registering the wrong entity as the owner of IP
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.
A longtime client was delighted to receive an acquisition offer from a large, publicly-held company (“Acquirer”). Once the acquisition closed, the client’s founder (“Founder”) would become a management-level employee of Acquirer.
Although Acquirer’s proposed employment agreement generally was acceptable, Founder was concerned about its non-compete provision. That provision stated that for one year following termination of his employment, Founder would not “engage in any business activities that are competitive with the business activities of [Acquirer] or those of its subsidiary or parent companies”. The problem was that the business of Acquirer and its affiliates was so vast, and Founder’s expertise was so industry-specific, that the provision would have limited Founder’s ability to be employed elsewhere.
Acquirer’s General Counsel stated that the non-compete provision was non-negotiable - if founder did not accept that provision, the acquisition would not take place. In addition, the GC said that even though Founder lived in California and would be working at Acquirer’s offices in California, the provision stating that the agreement would be “governed by and construed in accordance with the laws of the State of New York” also was non-negotiable.
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Here are some intellectual property blogs that I like and some of the reasons why they impress me:
- Patent – Patently-O – Professor who says a lot without being too wordy or abstract.
- Copyright – Exclusive Rights – In-house attorney with a sense of humor.
- Trademark – The Trademark Blog – Private-practice attorney who provides case documents. Been blogging since 2002!
- Trade secret – Trade Secrets Blog – Law firm that includes an eye-catching graphic with almost every post.
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.
In the U.S., most employment is “at will”. This means that either the employer or the employee can terminate the employment at any time, for any legitimate, non-discriminatory reason, with or without cause. The typical senior executive, in contrast, has an employment agreement that runs for a number of years and allows termination only for cause. The reason: Attracting and retaining key executives is critical for any company’s success.
By the time I am called in, the parties usually are at or near agreement on salary and the amount of equity compensation (stock options or grants). In addition, the employer’s benefits program usually is well-defined. I have found that most of the negotiation effort goes into the following provisions:
Sure, you dream of venture capital to turn your great idea into entrepreneurial success. But guess what: The vast majority of startups will never come close receiving venture funding.
There are alternatives, however. Here are approaches that my clients typically consider:
- Personal savings – This approach is one of the safest, although not available to most entrepreneurs. If you have enough savings to get your company started while leaving some behind as a cushion against personal emergencies, you will be in a position to focus immediately on running the business and to achieve success that much more quickly.
- Personal loans – These loans usually are secured by a lien against the entrepreneur’s home (pursuant to either a home equity line of credit or a second mortgage / deed of trust). If you take this approach – which may be more difficult with the recent drop in property values almost everywhere – be sure that you can afford the monthly payments. The last thing you want is the anxiety of possibly losing your home on top of the anxiety of starting a new business.
- Services revenue – Some startups are fortunate that they can deliver revenue-generating services while developing their products. The downside: Delivering services may distract from, and thus delay, the company’s eventual success.
- Friends and family – These sources can contribute equity, debt, or debt that is convertible to equity. The important points are to make sure that (a) the proper agreements and related documents are in place (don’t accept money with just a handshake) and (b) the investors understand that they may lose their entire investment and, if that occurs, they will not suffer undue financial hardship (or hate you for years to come).
- Angels – These investors are affluent individuals who invest in startups and, often, provide helpful advice and contacts. Here in the Bay Area, there are many angel investor groups. Some of the most prominent include Band of Angels, Keiretsu Forum, Sand Hill Angels and The Angels Forum.
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.
Dana Shultz is a business-savvy lawyer located in Northern California's San Francisco Bay Area (in the East Bay, near Oakland) who has in-depth knowledge of law, business, technology, and the needs of startup and early-stage companies.