Skip to Content
Articles

The IP Landmine That Can Kill Your Startup’s Exit: Avoiding Common Ownership Pitfalls

Unclear intellectual property (IP) ownership can pose significant challenges for startups, especially during a sale process (i.e., M&A) or investment rounds. Investors and buyers meticulously examine the chain of title for IP assets, and any ambiguity can lead to deal delays, reduced valuations, or even failed transactions when the IP is a key component of the deal.

Impact on M&A and Investment Deals
One of the most critical aspects of M&A and investment due diligence is ensuring that a target owns the intellectual property required to operate the business and achieve the roadmap. Ultimately, your company should be able to document that everyone in a position to contribute IP—founders, contractors, employees—has assigned their rights into the company and is not under a conflicting assignment obligation to another entity. Further, ownership of these rights should be perfected through recordation for registered IP, like copyright and patents.

Investors and acquirers will scrutinize whether all patents, trademarks, copyrights and trade secrets legally belong to the company—not its founders, employees, contractors, universities or government entities. Gaps in IP ownership can result in serious consequences to sellers, including deal termination, reduced valuations, escrow holdbacks and post-transaction lawsuits.

To avoid these risks, startups need to proactively address IP ownership issues long before an M&A or investment process starts. Most of these issues are readily handled by standard, typically inexpensive forms available from experienced counsel. But you need to be organized and diligent. Below are key areas where IP ownership disputes commonly arise—and best practices for mitigating them.

Founder IP Developed Before Incorporation
 
The Issue: If a founder creates IP before officially forming the company, absent an assignment, that IP remains personally owned rather than company property. This can lead to ownership disputes, particularly if a patent or proprietary software developed by a co-founder before incorporation becomes central to the startup’s success and that co-founder leaves the company without having executed an assignment to the company.

Best Practice: Founders should promptly assign any pre-incorporation IP to the company through formal agreements in exchange for their founder shares. This is typically done using IP assignment clauses in formation documents, employment agreements or dedicated IP assignment agreements. Further, founders should be ready to explain why former employers do not own that IP, e.g., because it was developed well after leaving a previous job.

Contractor Contributions & “Work for Hire” Misconceptions
 
The Issue: Startups frequently hire contractors and freelancers to develop technology, design products or contribute to software development. However, many founders mistakenly believe that because they paid a contractor, the company automatically owns the resulting work as “work for hire.” In reality, unless a contract explicitly states otherwise, the contractor may retain IP ownership (even partial), which can create major complications in an exit. It is not enough to show that you would likely prevail in an expensive litigation with substantial uncertainty about whether the work-for-hire doctrine applies to code your contractor wrote. And work-for-hire does not apply to patents and trade secrets. You want it to be easy for parties to convince themselves you own the IP.

Best Practice: Startups should always use written agreements with contractors that include explicit IP assignment clauses. A standard Contractor Agreement should specify that any work of authorship created for the company is a “work for hire” and, to the extent it is not, the contractor “hereby assigns” their rights in the work. Further, such agreements should include clauses by which contractors “hereby assign” (not “will assign”) all forms of IP created for the company. If past work was done without such agreements, startups should seek retroactive assignment agreements from contractors before entering due diligence. The time to understand if this is a sticking point with a contractor is before the contractor begins creating IP.

Employee IP Assignments and Side Projects
 
The Issue: Without explicit IP assignment agreements, employees may claim ownership of inventions or creative work developed during their tenure—even if these were conceived using company resources. Employees working on personal side projects that overlap with company technology could create ownership disputes, particularly if the boundaries between company and personal work are unclear.

Best Practice: Startups should require all employees to sign Proprietary Information and Inventions Assignment Agreements (PIIAAs) as a condition of employment. These agreements should ensure that any inventions (or other forms of IP) created within the scope of employment or using company resources automatically belong to the company or are assigned to the company using proper assignment language, again with a clause stating that such IP is “hereby assigned” and not “will be assigned.”
It is important to tailor PIIAAs for local law. State laws vary regarding the enforceability of these agreements, unless their scope is properly tailored for local requirements. For example, California Labor Code § 2870 limits IP assignment clauses unless they state that employees retain rights to inventions developed under certain circumstances. Other examples of states with similar statutes include Washington and Minnesota. Employers should tailor agreements to comply with local laws while maximizing protection over company-created IP.

University-Affiliated IP Risks
 
The Issue: If a startup founder developed technology while working at a university, or retained the services of an advisor employed by the university, the institution may claim full or partial ownership of the resulting IP under an existing agreement. Many universities have strict tech transfer policies that require faculty, students or employees to assign ownership of innovations created within the university setting. Professors, post-docs and graduate students are often cavalier about these obligations, but you should not rely on their assertions that they are free to contribute IP. And to the extent it is unclear whether they are contributing IP, you will have to carry the burden of proving they did not in diligence.

Best Practice: Before accepting inputs from those affiliated with a university, founders should review (or ideally ask counsel to review) institutional IP policies and identify any agreements that might affect ownership. The university’s IP policy should clearly explain why, without relying on close judgment calls, the university does not own anything contributed to your company. For close calls, universities will often provide a waiver letter, confirming they do not claim to have an ownership interest in, for example, the result of a professor’s consulting services. Additionally, if a startup is licensing technology from a university, it should negotiate clear, exclusive licensing terms that avoid excessive royalty obligations, un-attainable milestones, or restrictive commercialization terms.

Government-Funded Research
 
The Issue: Startups that develop technology with government funding—such as SBIR/STTR grants or contracts with agencies like the NSF, NIH or DoD—may not fully own their IP or, if owned, that IP may be encumbered in various ways. Under the Bayh-Dole Act of 1980, the U.S. government retains certain rights to federally funded inventions. This includes a nonexclusive, royalty-free license to use the technology and potential “march-in rights,” allowing the government to grant licenses to third parties if the company fails to commercialize the invention. Further, failing to comply with administrative obligations under these contracts, like providing timely notice of subject inventions, can lead to the loss of rights.

Best Practice: Work with a government contracting legal specialist. Federal acquisition regulations undergird your contract in way that are complex and often not self-evident. Different government agencies have different requirements for assignments versus licensing, and some agencies have different contracting regimes that can provide more or less flexibility with regard to IP assignment.

Startups receiving government funding should carefully document which IP was developed under federal grants and understand the applicable ownership and licensing obligations. To the extent IP can be documented as having been developed prior to such contracts, e.g., with provisional patent filings, this can help limit the reach of these regulations into your IP portfolio. Structuring research in a way that keeps proprietary IP separate from government-funded work can mitigate these risks. Also important is having a process in place to track and comply with your reporting obligations for subject inventions, which often have relatively short reporting periods.

IP Issues in AI-Generated Content
 
The Issue: Startups often integrate AI generated content into their products. Generally, U.S. law does not recognize copyright in purely AI-generated works, but many acquirers will ask you to represent and warrant that you own the copyright in, for example, the proprietary code embodying your software product. Further, generative AI can output copies of works in the training set, which often are protected by a third-party copyright, potentially resulting in copyright infringement.

Best Practice: Keep a human in the loop, substantially contributing to the ultimate project, by arranging, augmenting and modifying AI-generated content. Guidance from the U.S. Copyright Office has confirmed that copyright protects the original expression in a work created by a human author, even if the work also includes AI-generated material. Human-authored prompts alone are typically insufficient to provide for copyright in the model output. But extensive human contribution intermingled with the output of a model can.

To mitigate the risk of model outputs infringing third-party copyrights of works in the training set, work with generative AI vendors that 1) indemnify you against this risk; and 2) have sufficient scale that they can plausibly afford to defend against such a suit and pay any resulting damages.

In the fast-paced world of startups, it’s easy for founders to prioritize product development, fundraising and customer growth over “back-office” legal hygiene. But when it comes to IP, overlooking foundational ownership issues can be fatal—especially at the moment that matters most: your financing or exit. Buyers and investors won’t simply take your word for it; they will demand proof that your company truly owns its most critical assets. Fortunately, most IP pitfalls are avoidable with planning, clear agreements and knowledgeable legal guidance. Don’t let sloppy documentation or unassigned rights derail years of hard work. By the time someone asks for diligence, it may already be too late.
 
Cookie Policy

This website uses cookies to maximize your experience and help us improve it. To learn more about cookies, how we use them and how to change your cookie settings please view our cookie policy. By using this site you indicate your consent to this.