Thoughts from Whitebeard the Wise
A sticky wicket is a metaphor used to describe a difficult circumstance (no, really…look it up!). On the White Summers Sticky Wicket we will illustrate and discuss those tough issues, sticky situations, and troublesome dilemmas that pop-up more often than not with entrepreneurs and hi-tech companies in the Silicon Valley. Our hero, Whitebeard the Wise, will weigh in on the situation providing his thoughts on how to navigate these sticky wickets. Each sticky wicket will be introduced early in the week by an animated short video illustrating the dilemma at hand. Our readers will have an opportunity to comment on the dilemma throughout the week. By the end of the week Whitebeard will provide his commentary. Of course, please remember that any comments or questions posted here are subject to the terms and conditions of our site.
WHITEBEARD THE WISE…THE STICKY WICKET
“YOU CAN’T DO THAT!”
Episode One – Season One – The Case of the Fired Founder
When we last left our hero, Whitebeard the Wise, he left us pondering the Sticky Wicket of how Charlie CTO can take the position that he can reclaim technology he assigned to the Company if he is unfairly terminated. Well, it’s a theoretical possibility that he can. Here’s how it works… When the Company is formed Charlie signs a Vesting Stock Purchase Agreement under which he assigns and transfers his technology into the Company in return for vesting shares of Common Stock. The stock vests based on Charlie’s services typically over a 4-year period, but usually less for founders. If Charlie is unfairly terminated by Joe CEO, then Joe and the Company have denied Charlie the opportunity to continue working and vesting his shares. As the technology assignment was the consideration for the shares, Charlie can take the position that if the vesting on the shares is unfairly terminated then the technology contributed for payment of the shares should be returned.
There is a certain logic to Charlie’s position, and this situation does come up – though rarely. The Company’s position will always be that the termination was not unfair, that Charlie is an employee at will and no reason is needed to terminate him, and the assignment of the technology is hard-wired and cannot be returned. If Charlie has been harmed, then he can collect money damages – but the return of technology is an unwinding or rescission of the original exchange of technology for shares which is not appropriate unless there is fraud or some other legal defect in the original transaction. A rescission and unwinding of Charlie’s assignment of IP is an extraordinary remedy that a Court could order, however, if indeed Charlie has been unfairly terminated. Though unlikely, it is possible. And if its possible, Boards and investors should be concerned. Is this concern unfounded, and a return of IP so remote that its not worth thinking about? Consider this. If Charlie’s IP is the core of the Company’s products, then a return of IP puts the Company out of business. Even if Charlie’s IP is peripheral to the Company’s products – or even if his patents are not embedded at all in current products, Charlie’s knowhow and contribution to early development taints the origin and technical foundation for current products. Certainly the mere fact that Charlie demands his technology back, even if he doesn’t sue the Company to get it, could be a problem for a downstream acquirer of the Company. Charlie’s threat would also be an issue for underwriters in an IPO. Basically, it’s a bad thing that should and can be avoided.
OK then, what’s the fix?!
Well, simple really. Don’t tie the issuance of stock to an assignment of technology. This means that the sale of stock to founders and everyone else should be for cash. Period. This should be mouse-nuts to the Company, as founder stock in a shell startup usually is priced extremely low – at $0.01 or $0.001/share (absent other factors). The key here is not to provide in any employee or contractor Vesting Stock Purchase Agreement that payment for the stock is the transfer and assignment of pre-developed IP into the Company. In fact, its probably also not a good idea to provide that the stock is sold for “services provided” consisting of technical development work. While this latter case is a bit more ambiguous, we don’t want Charlie to claim that his services resulted in a work product that was IP…essentially the same as an actual transfer and assignment of IP.
From a documentation standpoint, you’ve got to be careful here. The Vesting Stock Purchase Agreement should require cash for the sale of stock. If Charlie has separate IP to be transferred into the Company, then this should be documented in a separate Assignment Agreement. And what’s the consideration for the IP assignment? Well, it shouldn’t be the issuance of stock….and it probably shouldn’t be the goodwill tied to stock. Best is cash…again in a small amount. Charlie can’t unwind the Company’s payment of the cash later, and he can’t claim that a downstream unfair termination denied him the full benefit of the cash he got under the Assignment. Of course, things could get a bit sticky here… For example, if the Company paid Charlie $1 under the Assignment, then Charlie could say that the real consideration for the IP was the stock – as no one in his right mind would sell valuable IP for a lousy $1. This presents another sticky wicket as no Company wants to pay anything more for the IP – particularly a startup with no money.
So, what to do….
Well, for sure the stock should be sold for cash. No question on that one. As to the IP assignment, it should be under a separate Assignment Agreement and in return for cash would be ideal. Even if it’s a small amount (which is likely to be the case) it is consideration that is distinct from the stock – and Charlie’s going to have a hard time in Court showing the direct and clear connection between the stock and his assignment of IP. And, of course, its always a good thing to state clearly in the docs what the parties intend and understand…and not leave this as a mystery to be discerned by a Court 3 years later in the fog of litigation. Here, just say in plain English that the assignment is for $1, and that there is no other consideration including but not limited to a promise of employment or incentive compensation in the Company. To make matters clear, say in the assignment that it is irreversible, and any dispute of any kind regarding the validity of the assignment will be resolved for the payment of money – and specifically not a reversal of the assignment.
So, there you have it. Whitebeard did well to spot a real Sticky Wicket that virtually none of us think about. Even though this discussion is not legal advice, and we at White-Summers disclaim everything here under our Terms & Conditions……we welcome you to contact Mark White who worked with Whitebeard on this, for more info and debate. Here’s how you can find him:
Mark White
Direct dial 650-298-6001
The content and commentary in this Sticky Wicket is for educational purposes only and should not be intended to be legal advice or create an attorney/client relationship. Please consult an attorney to discuss how the content herein may apply to your specific information. This Sticky Wicket is subject to the Disclaimer set forth at www.white-summers.com.
