This time the ‘idea’ part of starting a business gets the legal treatment...after all, whose idea was it anyway and does that really matter? Over to Thomas to explain all:
Businesses usually start informally rather than as planned commercial enterprises. Commonly, one person shares her idea for a project with a group of friends likely to be interested in or knowledgeable about the subject area. Together they develop it.
Most projects stop there and don’t become businesses. In many cases, the idea simply wouldn’t be profitable enough to continue work. In others, the business could be very profitable, but the friends fall out over who owns the intellectual property and therefore how ownership of the business should be split.
Intellectual property (IP) is often said to be the most undervalued asset in a business. The reason why businesses tend not to record their “true” value on the balance sheet is that it is usually very hard to place an exact value on it. Just like many physical assets, IP is only worth something when it is put to work, and doing that requires other inputs – typically labour or knowledge.
Here are two examples:
1/ Peter owns a list of potential customers that might want to buy the service a business called Unicorn offers.
Unicorn will pay Peter £10 for the name and contact information of any potential customer that asks to be sent Unicorn’s brochure. So all Peter has to do is to call each lead and get them to agree to being sent a brochure. After 100 calls, he has 5 expressions of interest – a 5% conversion rate. He thinks he can do better, so he asks Paul to help. Paul has experience of working in telemarketing in the industry and has a conversion rate of 10%. Paul asks for just £25 for his labour. When the IP is not being put to work (i.e. when no-one is using it to call potential customers) it doesn’t generate any money. With Paul’s help, it is far more valuable, even when Peter puts it to work himself, because Paul is able to use it more efficiently. A first hypothetical question: how much is Peter’s list worth?
2/ Jim has an idea for a dating website.
He has planned how the site will work precisely, including producing detailed sketches of each page. The key differentiator with other dating sites is how profiles are matched. But he doesn’t have any web development skills, so he asks Jane who has those skills to come in on the project with him.
Jane chooses to use a particular web development framework because of better compatibility with app development software if the dating site were ever to be made into an app. The dating service flops, but Jim and Jane pivot the project into business recruitment app.
A second hypothetical question: how should Jim and Jane split ownership of the new business?
Not being able to answer both hypothetical questions is exactly the reason why so many projects never become businesses. There are no right and wrong answers to the questions.
Peter’s list is worthless without Paul, but possibly more with someone else, and the recruitment app would not exist without the ideas (and work) of both Jim and Jane.
When you start your project, you need to agree with your partners not necessarily about the value of the IP now, but about the methodology for valuing it at any point in time, who might own it in the future (and any other IP that is created or derived from it), and what would happen if any one of the partners decided he or she wanted to leave the project. That is a big “what-if” planning exercise.
It is often easiest to “sell” the IP into a company for a very low value, and then deal with questions of ownership of the company rather than ownership of the IP. If held by a company, the value of the IP can be divided because the company is divided into shares. If any of the owners wants out, then he or she can sell his or her shares, but forfeits the right to use the IP in the future (because the IP is owned by the company and not the shareholders individually).
For example, all founders could have equal shares and contribute £1,000 of capital except David, who only has to contribute £500 for the same shareholding percentage because he brought in the idea.
Or perhaps everyone contributes the same but David owns 40% of the company and the other three founders could own 20% each to reflect that David had the idea. However, David must sell 5% to each of the others if certain conditions are met in the next year.
Or perhaps each of the founders could own the same percentage of shares and David could licence the IP to the company for a fixed fee plus 2% of sales each year.
Or perhaps David could employ all the others, own 100% of the business and keep all rights to the IP himself.
There are an infinite number of possibilities of rewarding the different ideas and skills that each person brings into a new project or business. You just have to think in advance what might work, and importantly, write it down (even if not immediately in a formal legal document).
The further down the road you get, the more difficult it will be to work out whose idea it was.
Thomas Taylor a director of Net Lawman, an alternative for small and growing businesses to using a solicitor to obtain legal documents. He is a qualified accountant (FCCA, FPA/FIPA).
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