This is the first in a series of articles that summarizes the governance practices which early stage technology companies should employ at each stage in their corporate growth. The complete article is found at section 3.17 on the earlystagetechboards.com website.
The entire content of the site is designed to provide a manual and a set of best practices for early stage technology companies to obtain the best value from their Boards of Directors. Governance, however, is not static. Technology companies may start out with only a rudimentary, if any, governance system. As a company grows, its governance practices must evolve to ensure that the company and its management are performing to ever higher standards and receiving the oversight and advice that are appropriate to that stage of the company’s development.
Too often, governance is neglected amongst the rapid change and hard work that characterizes early-stage technology companies. The required documentation and oversight are not considered or implemented until a problem is uncovered, which may jeopardize a major transaction or an exit.
Problems with poor documentation:
For example, in a typical tech start-up, all of the focus is on the development of the new product and scant attention is paid to accounting. Shares and options are distributed widely because there is no cash to pay people. Later, when the founders look to angels to finance the company, they are stopped in their tracks when the angel asks to see the financial statements and the share cap table. The longer the gaps in the documentation exist, the greater the consequences. As the company progresses, it may look to negotiate a financing or strategic partnership. To close the deal, the company’s lawyer must write a clean legal opinion that all of the shares have been validly issued. If there is not a clear paper trail formerly authorizing the issuance of all shares and options, the lawyer cannot deliver a clean opinion and the deal may fall through as a result.
That said, early stage companies often don’t have the resources to put in place the sophisticated documentation and governance systems required of more mature companies. Let’s start with one practice essential to all companies, regardless of their stage of growth: the IP assignment.
Essential practice: IP assignment. To begin, from the date the technology company is founded, it is imperative that every founder, employee, director, contractor and advisor sign an intellectual property (IP) assignment agreement which assigns all rights and title to the company for any and all technical and business development done in the context of their association with the company. There is no touchier subject for investors and acquirors than IP. The company must be able to show that every person or company who ever contributed to the IP has assigned all rights to the company. This eliminates the possibility of some long-departed employee emerging years later to assert IP rights just as a transaction is about to close. It can be expensive and time-consuming to deal with those alleged rights, and many potential acquirors would rather pass. Best to eliminate the problem from the outset. Buy or beg someone for a template that you can use for everyone associated with the IP.
Also, it is advisable to have everyone sign non-disclosure agreements (NDAs) and non-compete agreements. This creates negative consequences for someone disclosing company secrets or using the company’s knowledge to complete with it. The IP assignment, NDA, and non-compete clauses can all be included in every employment agreement or contractor agreement. Again, buy or borrow a template.
Subsequent articles will explore other governance practices which companies should incorporate as they grow and can allocate more resources.
This article first appeared in the Spring 2013 edition of The Hire Standard – the newsletter of Corporate Recruiters, British Columbia’s leading recruiters of high technology talent. It was edited in Dec 2019.