Most people start businesses with the goal of making money. Whether it is a steady income or a lump sum payment following a sale of the business, most people hope that their business will appreciate in value over time. Foundationally, you increase the value of your business by creating a product or providing a service that is (a) either highly desirable, which allows you to charge a high price for the product or service (b) extremely scalable, which allows you to become profitable at scale, or (c) a combination of (a) and (b). To ensure that this value creation inures to the benefit of your business, and ultimately the equity owners of the business, there are some basic steps you need to take. First, you need to ensure that your business owns the products or services it is selling. Most of the time when someone forms a new business, they have been ruminating on the idea for the business for a while; or they may have even created an initial product or tested out the service. When it is time to form the legal entity through which you will operate your business, you want to make sure that anything that was created prior to the existence of the legal entity through which you will operate your business is transferred to such entity. Typically, this transfer is done through what is referred to as a “contribution agreement.” Under a contribution agreement you will contribute any interest you have in the business and any assets relating to the business to the legal entity through which you plan to operate the business on a going-forward basis. If you have already developed a new invention, formula, technique, etc. prior to forming the legal entity through which you will operate the business, then the contribution agreement will need to include an invention assignment provision that transfers any intellectual property rights you may have in such invention, formula, technique, etc. to the business entity. In exchange for contributing all of the foregoing assets to the legal entity, the legal entity will issue you equity (i.e., shares of stock, if a corporation, or a membership interest or membership units, if a limited liability company). The value of what you contribute to the legal entity will establish your basis in the equity you receive from the legal entity for tax purposes. If you contributed cash or an asset with an easily identifiable current value, then you will want to ensure that value is set forth in the contribution agreement.
After the business entity has been formed, you will want to ensure that you, any co-founders, and employees sign confidential information and invention assignment agreements (CIIAAs) that benefit the business entity. Each party to the CIIAA will agree (a) to keep the business’s proprietary information confidential and (b) to assign to the business entity any rights such party may have in any inventions relating to the business. Traditionally, CIIAAs have included non-competition and non-solicitation provisions. As discussed in more detail in this prior post, however, businesses will need to reassess any agreements that include non-competition provisions, because most employment-based non-compete clauses will be unenforceable as of September 4, 2024. This prior post summarizes the recent rule issued by the Federal Trade Commission (FTC) banning most employment-based non-compete clauses.
Once you have ensured that any pre-existing intellectual property rights have been transferred to the legal entity through which you are operating your business and taken steps to ensure any intellectual property rights generated by your employees and independent contractors belong to the legal entity, then you want to make sure that the legal entity is taking all necessary steps to protect those intellectual property rights. It can do that by making the appropriate filings with state and federal agencies. For example, to protect your business’s logo, you may want to file a trademark application for the logo. Alternatively, if your business has invented a new product, you will likely want to explore whether your business can patent either the whole or part of such product. Intellectual property counsel can help advise you on which of these filings to prioritize and when to make them.
In addition to making the necessary intellectual property rights filings, you will also want to protect your business’s intellectual property rights, by clarifying who gets to use them and how they get to use them when contracting with customers and vendors. The type of rights you grant others in your business’s intellectual property rights will largely be driven by the type of product or service your business provides. It is important to ensure your legal counsel understands the full nature of your business so that they can help you choose the appropriate agreements and intellectual property rights provisions to utilize.
While using the correct contract and intellectual property rights provisions will help protect your business’s intellectual property rights (i.e., preserve your business’s value), your business will create value by entering customer contracts with high dollar values and long terms. This is critical if your goal is to eventually sell the business as the primary way by which you extract value from the business. Potential buyers of your business will likely pay a premium for your business if your business has numerous high value customer contracts with long terms.
As you can see from the above, the value of your business is largely derived (or at least evidenced) by a series of contracts. It is critical to ensure that you have good legal counsel to help advise you on these various contracts.
