Perspectives: Opinions from our network of advisors, investors, operators and analysts on the risks and opportunities they see.
Just as journalists once viewed the internet as a place where “information wants to be free,” software developers have embraced open source software as a great democratic innovation.
Unfortunately, as those fashioning some media models have discovered, commoditizing key aspects of your business model has significant downsides. In the run up to an IPO or a new round of funding, investors will rightly ask “is your IP defendable?” The more open source development involved, the trickier that answer gets.
Rhonda Carnoil leads early startup advisory at the New Jersey law firm Chiesa Shahinian & Giantomasi PC. She’s seen this problem — and the lower valuations it can cause — first hand. Carnoil spoke with Karma Network’s Contributing Editor Michael Moran.
Michael Moran: Where do most startups go wrong with handling their intellectual property?
Rhonda Carnoil: Startups can go wrong from an IP standpoint, and such mistakes can significantly affect their valuation and the interest of investors.
One of the most common issues we see is when a startup picks its branding, its names, its logos, and if it doesn’t do searches at that time it could pick something that’s infringing.
In fact, two years ago a person called me too late. They had picked a name that was infringing and they actually were trying to fight the infringement claim against them, and they ran out of funds with such an argument. This is something you should just avoid.
Another thing that we see people do is they engage a contractor, it typically happens when they’re engaging a friend, and they don’t do an agreement with them. They have them develop something — a website, proprietary software — but there’s no agreement that assigned ownership to it, so then in fact the company doesn’t own it.
When they go to get investors or to exit, what they need to do then is go back to this person and get an assignment, and sometimes that actually costs them money. Sometimes the company refuses, so that is another error that people make.
Another thing is, you’re so excited when you get your first customer or your second customer. Sometimes I find that people getting their second customer is harder than getting their first. And you have a tendency to just want to do whatever the customer wants, but the problem is if you give up ownership of your IP instead of giving a license to the customer, then you’ve given up everything you own and you’re not worth as much, so you have to be very careful about not giving up modifications to your software and still keep ownership.
And one way to do that is to say to the customer, “What do you need this for?” And often you find out they only really need a license and that’s sufficient.
Michael Moran: What are the pros and cons of using an open source vehicle in your business?
Carnoil: Using open source is a real double-edged sword. There are pros and cons to its use. The first thing is it is easy to use. It’s there. It’s quicker. It’s less expensive.
So using it depends on what are you going to use it for. Let’s say you’re developing your website and it’s just being used for marketing purposes, with no proprietary applications on it. That’s a perfect use of open source. Why? Because it’s going to be cheaper and it’s going to be quicker.
Let’s talk about a place where open source could potentially make your business worth less.
That would be like when you were developing a proprietary software and you’re using the open source under something like a general public license, and then it could be viral and infect what you own, so in fact when you distribute the software that you made using the open source that was governed under a general public license, it’s required that the source code be made available when distributing the software, which means basically you don’t have anything proprietary.
However, there are some open-source licenses that if you use them carefully, you will own what you develop. For instance, like the MIT license.
So what I suggest that you do, if you’re using open source, is you need to track it. You need to have a chart that says this is the open source I used and this is what I used it for, and then if an investor comes in he can easily see this and determine what’s proprietary, what’s not, and how this has affected the value of your entity.