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I'm trying to raise a startup with three other people. The idea is to have a first prototype of the product and then seek funding. So far we have collaborated informally, but now we will go into the development phase, and we want to put on paper what each one of us want to get out of this.

The product has two distinct but complementary, easily separable parts. Each of them could be sell by itself, but we believe that what really makes the product powerful, is to have them working together.

My question has to do with the suggestion of one of the partners, which has already created a company (me and the other guys began to collaborate later). This person proposes to create a second company in which the four of us will have a stake. This second company would retain the intellectual property rights of one of the parts of the solution. The first company, the one already created, would retain the IPR of the other part, and that person would be the only stakeholder.

Finally, we would create a third company that would commercialize the products of the other two. This is the company where the money of the funding rounds will enter, and the other two companies will be stakeholders too.

I find this approach somewhat convoluted. Is it normal to do this when starting a new business? What should I consider to avoid trouble? Would it not be simpler that the three new people in the business entered the already created company instead of creating a new one?

Thank you for your answers.

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3 Answers

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If there is preexisting IP by company A, company A usually licenses out that IP to the 2nd company, company B. In your case, your friend's company seems to be that company A and he is suggesting everyone else create company B as the 'working entity'. Creating the 3rd company sounds like a total waste of time and money - the 2nd company should do all operations for it's products unless you have a REAL good reason (which you didn't state, so I assume you don't).

2 company approach

Pros:

  1. Ego: Avoids bringing up the question of diluting company A's ownership if 2 more owners are added later on. You will instead be doing this in company B, the one to be made. This way you leave his ego alone ("I don't want to lose ownership in my company") although it's the same at the end of the day.
  2. Fresh start: Allows you to freshly distribute the pie in company B without preexisting biases. You should be able to create a clean, fair structure here with vesting (keep everyone on a vesting schedule)

Cons:

  1. Potential to add friction between company A and B in licensing. So make sure the rights given by A->B are royalty free, perpetual and exclusive. Otherwise company A can decide company Z is more useful, abandon you and instead do business with them.
  2. Additional paperwork to document stuff usually assumed within a single entity. (non-compete etc)
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The idea behind creating a third company is to avoid diluting the ownership of the companies owning the IPR (A and B in your example). Investors will only have a stake in that third company, which will use the technology licensed by A and B and will be the 'working entity'. This way, the control of A and B will be always protected from ownership dilution. That's the reason behind creating the third company. I do not know if this really makes sense or not. – lightman Feb 1 '12 at 14:06
Makes sense in theory but not practically (IMHO). If you're getting an investor, this will be a red flag since you're really going out of your way to cut them out vs thinking of "all of us". Ask yourself, if investors don't see any IP, will they invest in an "operations" only company where the operations are non-existent? It'll be a hard-sell ... – Sid Feb 1 '12 at 19:10
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This setup does sound quite convoluted because of the amount of IPR licensing & reassignment paperwork you'll need to do. There's no need to separate R&D from the monetization.

If I understand you correctly, one of your partners owns a company and has developed some IP that will be used in the new project. That IP is already owned by that original company. If that's the case you have 2 potential ways of collaboration:

  1. That partner can add the rest of the team as owners to the existing company and you all work together to build the new product(s) as one happy family. The caveat here is in reassignment of ownership shares, which will lead to some legal and accounting paperwork. Thus, you need to talk to local lawyers & accountants to figure out the details.
  2. You create a second company where all of the partners own a stake. The new company develops & sells the new product(s). However, the old company that owns IPR to the old product needs to provide an unlimited and term-less license to use that IP. If the license agreement isn't properly structured, you'll introduce a serious business risk that will come up during the due diligence checks when raising funds. Thus, talk to a local IP lawyer to figure out the details.
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up vote 0 down vote

I would suggest you make a list of all the pros and cons, and decide which approach (one company or multiple companies) gives you the best outcome. Maybe this will not influence the direction for this project, but it helps you negotiate.

If you don't like the multiple companies approach, have specific reasons for this (for example, you can lose out on profiting from owning the intellectual property if the IP is licensed or sold). Then, negotiate with the others in order for you to give up certain things (maybe you get a bigger ownership share of the new companies, higher salary, more influence, whatever it is that you would be willing to accept in exchange for what you give up).

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