Recently five members of the Boise Angel Alliance attended the annual meeting of the Northwest chapter of the Angel Capital Association in Seattle. We gather annually to network with other angels and to exchange information on the current state of the art in angel investing.
One of the sessions that I found most interesting was titled “Traps for the Unwary (issues that cost money to fix.)” Presented by KL Gates lawyers, I summarize below their practical advice about several early actions (or lack of action) that are likely to cause issues later. The issues were presented to angels as things to look out for when considering an investment. But their counsel is equally appropriate for entrepreneurs.
1. Mixing open source code with proprietary software. Open source code is free software which can be downloaded from the internet by anyone and included in their software product. Whenever you download such software, you are agreeing to a license that governs the use of the software. The problem is that you probably didn’t read or keep a copy of the license, and it may impact your ability to legally sell your software in which you have embedded the open source code.
Here are two potential problems. The open source license may require that you make your source code (the human readable software) publically available at no cost. Or the open source license may permit you to distribute it to others, but only if you don’t charge for it. Either of these problems can destroy the economic basis for your business.
If you are incorporating open source code in your software, make sure you read and keep a copy of the license to use it, that it does not restrict you from commercializing your product and that you document within your software your use of the open source code.
2. Failure to maintain proper corporate records. Your business entity is obligated to keep certain records such as shareholder ledgers, annual meeting minutes and board of directors’ actions. Many early stage businesses don’t get around to these necessary housekeeping issues. But someday you will likely want to sell your business or may want to sell stock or borrow money and will be required to produce these records.
3. Failure to get assignments of intellectual property rights. If someone contributed to your product, especially if they were not employees, they may retain some ownership in your IP, even if you paid them for it. Remember that neighbor who brainstormed with you when you were first starting your company? When you go to sell your company to Google, he may be back for what he believes to be his share. All companies should have assignments of intellectual property rights from all contributors, including founders, employees, board members and independent contractors.
4. Not having shareholder agreements. Shareholder agreements are like pre-nuptial agreements. The time to negotiate the resolution of potential problems is before they occur. Shareholders must be clear about such things as voting rights, when their approval is needed to borrow money and sell more stock, selection and dismissal of management, and a whole host of other issues.
Entrepreneurs want to get on with creating and selling a product. They don’t like to spend time and precious money on crafting legal agreements and other details. But a failure to pay attention to the details at the correct time can result in very expensive corrective action later, or worse may kill a deal because your investor or a purchaser may walk if these issues haven’t been handled correctly in the beginning. Seek competent legal counsel early and equally important, take the time to follow their advice.
[Update on the Treasure Valley Angel Fund. This new fund is nearly ready to have its first close of investors and start considering deals. Watch www.treasurevalleyangelfund.com for information. If you are an accredited investor and would like information on investing in the fund, please send me an email. ]
_____________________________Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund (www.boiseangelfund.com), and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to firstname.lastname@example.org or by phone at 208-426-3875.