Don’t Let Your Employer Own Your Startup

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Imagine that you work all day at your 9 to 5, then go home and work all night on your pet project. You pour yourself into your venture with impassioned fervor, your creation begins to take shape, and you sit up one day and say to yourself “by George! I think that this thing may actually be a real thing!” You leave your day job, start a new company, assemble your team, pitch to investors, and lo and behold your startup takes off. You start generating revenue, you get some media exposure, and the buzz rises to a fever pitch that inexorably propels you on an upward trajectory towards what appears to be inevitable success! Then you receive a letter: “Dear so-and-so, you invented your tech while working for us, so we own it. Give us all the money you made. Have a nice day.” Your eyes go wide while Homer Simpson echoes in your brain. DOH! DOH! DOH!

Glossing over the oversimplified depiction of this startup’s meteoric rise to success, this unfortunate scenario is all too common for startup founders. Many people ideate and begin to develop their startup while still working at a traditional day job. If you do that, and you’re not careful, there is a chance that your employer will own the Intellectual property (IP) related to your startup.

IP is one of the most important assets for any business or startup, and this is especially true for web startups because oftentimes the IP connected to the tech is the only asset the startup initially owns. On top of inviting costly ownership disputes and litigation, IP ownership concerns will scare the hell out of angel investors or venture capital firms. A credible investor customarily perform an in-depth due diligence review of all your IP documents and related agreements, and if they discover that a former employer has a credible claim to your core tech…..wait, what’s all that dust? Oh, yeah, that’s just your investor running for the hills. There are a number of IP issues that you, as a founder, will have to become familiar with, but the issue that probably comes up the earliest is the “work for hire” doctrine governing whether an employer owns your IP, which is the subject of this blog post.

US copyright law defines a “work made for hire” as:

(1) a work prepared by an employee within the scope of his or her employment; or

(2) a work specially ordered or commissioned for use as a contribution to a collective work, as a part of a motion picture or other audiovisual work, as a translation, as a supplementary work, as a compilation, as an instructional text, as a test, as answer material for a test, or as an atlas, if the parties expressly agree in a written instrument signed by them that the work shall be considered a work made for hire. For the purpose of the foregoing sentence, a “supplementary work” is a work prepared for publication as a secondary adjunct to a work by another author for the purpose of introducing, concluding, illustrating, explaining, revising, commenting upon, or assisting in the use of the other work, such as forewords, afterwords, pictorial illustrations, maps, charts, tables, editorial notes, musical arrangements, answer material for tests, bibliographies, appendixes, and indexes, and an “instructional text” is a literary, pictorial, or graphic work prepared for publication and with the purpose of use in systematic instructional activities.

The Supreme Court interpreted this statute in Community for Creative Non-Violence v. Reed, and determined that the first section applies to employees and the second section applies to independent contractors. Taken together, what this basically means is that if you are an employee, any work that is a part of your job (“within the scope” of employment) is a work for hire and is owned by the employer. Note that there doesn’t have to be a written agreement. If you are an employee, this is automatic. If you are an independent contractor, then the work must satisfy 3 factors to qualify as a work for hire: 1) it must be what you were hired to do, 2) it must fall under at least one of 9 categories of work, and 3) there must be a written agreement specifically stating that it is “work for hire” or “work made for hire.”

If you are an employee, the next question is whether the work on your startup occurred within the scope of your employment. This is not always straightforward. “Scope of employment” is determined based on common law principles as set forth in the Restatement (Second) of Agency § 228. The three criteria a court will consider when making their determination are:

  1. whether the work is of the kind of work the employee is employed to perform (including actions “incidental” to authorized work)
  2. whether the work occurs substantially within authorized work hours;
  3. whether it is motivated, at least in part, by a purpose to serve the employer.

Note that each of these factors are taken into consideration by the court, but they don’t all necessarily need to be satisfied. For example, you probably weren’t motivated in any way by a desire to serve your employer when you invented your cool new mobile app, but if your employer is a mobile app developer and you worked on it on your work computer, you better believe that your employer probably owns it.

Keep in mind that the principles above apply to employees regardless of whether you signed an employment agreement. However, chances are that your employer made you sign some employment/independent contractor documents before you started work. REVIEW THOSE DOCUMENTS, because they may have requirements beyond those laid out in the common law stated above. Such agreements generally contain two common clauses: 1) a clause stating that all work is “work for hire” and that all rights in it belong to the employer, and 2) a clause stating that if for any reason the work would NOT be considered work-for-hire for any reason under applicable law, then the worker agrees to assign all rights in it to the employer and to do whatever is necessary to help the employer secure their rights in the work. We see the second clause comes into play when the worker is an independent contractor and the work doesn’t fall under one of the nine required categories, in which case a court usually wouldn’t consider it a work for hire. These agreements may also more clearly define the scope of your employment. Many employers, recognizing the value of IP, will also include broad clauses that transfer all IP rights to creations, inventions, schematics, drawings, even pure ideas, to them if they originated during the term of your employment. There may even be a “trailer clause,” a clause tacked onto IP assignment agreements that says the agreement stretches into the future, essentially granting the employer rights in future inventions. Some states, most notably California, are very employee friendly and have laws that limit the enforceability of such over-broad clauses because they want to encourage innovation and startup culture that creates so much value.

Lets explore a fun example of these agreements in action, this time drawing from HBO’s Silicon Valley. SPOILER ALERT! In the Season 2 finale, Richard Hendricks (founder of Pied Piper and the show’s main protagonist) is sued by his former employer, software mega-giant Hooli. Hooli tries to claim ownership of Pied Piper’s tech, which Richard developed while working for Hooli, by arguing that it occurred in the scope of Richard’s employment and thus is a work-for hire owned by Hooli. Richard had used his work computer to work on Pied Piper a single time, and due to the terms of his employment contract with Hooli, which explicitly stated that work done on Hooli devices is owned by Hooli, the adjudicating mediator nearly declares that Hooli owns the tech. However, Richard is saved through sheer luck because the contract contains a non-compete clause that the mediator deems to be over-broad and, due to the absence of a severability clause (totally unrealistic by the way), the entire contract is thrown out as unenforceable. However, despite the favorable outcome of the mediation, the dispute had already caused serious damage to Pied Piper. In previous episodes, we saw Pied Piper struggle to get the venture capital funding it needs due to the looming threat of litigation from Hooli, and ultimately Pied Piper is forced to accept funding from a terrible investor, which leads to other shenanigans that nearly ruin their efforts. The lesson here is that, even if you ultimately retain ownership of your IP, the cost of litigation, the chilling effect it has on investors, and the valuable time and attention it makes you waste when you should be building your startup, can still kill your chances of success.

If your former employer tries to claim ownership over your IP, you have a coupe lines of defense: 1) argue that the creation of your IP did not occur in the scope of employment, 2) argue that you were actually an independent contractor and that the work did not satisfy the three requirements of work for hire (i.e. that it is one of the nine required categories, the work was commissioned, and a written agreement deemed it work for hire). Of course, the best defense is not to put yourself in that position in the first place. Review all of your employment or contractor agreements, and document all of your work, including when you started, what times you worked, and what computer or tools you used. You may even want to tell your employer that you plan to work on something and ask them to sign a waiver. Not every employer is a jerk, and many will gladly sign away their rights to something they probably don’t care about anyway in order to keep a valuable employee. Plus, this will help you lock down your IP ownership for the future. However, you should tread very carefully with this last option, and probably even consult a lawyer first.

If you want your startup to live long enough to confront the many other IP-related issues that will inevitably come up, be sure to avoid this first fatal mistake. Do not let your employer own your startup.

Disclaimer: This blog is not legal advice and is only for general, non-specific informational purposes. It is not intended to cover all the issues related to the topic discussed. If you have a legal matter, the specific facts that apply to you may require legal knowledge not addressed by this blog. If you need legal advice, consult with a lawyer.

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