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We are in our seed round and the investors are asking for preferred shares of the company and terms that they own a percentage of the code/software and a percentage of the patent rights. We are looking for 300k from them.

I thought this was an odd request since my new Delaware C-corp would own the patent and the software anyway. Is this common practice that if the company failed there would be an attempt to sell the software and pay back the seed investors? Since its a marketing platform I'm more than sure it could be sold.

To me the investors do own a percentage of assets? Also, does this line item in the terms leave me open to risk?

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Definitely leaves you open to risk. They own the portfolio directly, meaning your company doesn't have complete control over its own source code. You'll have to license your own code and patents from them. – littleadv Nov 30 '12 at 5:38
They say its only a short term lean that goes away after the loan is paid back? ie the 300k gets paid back in series A financing – Devin Shavenoff Nov 30 '12 at 7:28
Is it a loan or equity? They're asking for shares - that's equity. When you buy them back (in series A financing, lets say), do they also commit to giving you back the assigned interest in the portfolio? or that they keep? Do you know what it means at all? Do you have a lawyer holding your hand through this whole process? – littleadv Nov 30 '12 at 7:36
Equity - they want to use it as a lien on the software - when the Series A comes in the lien is released. – Devin Shavenoff Nov 30 '12 at 12:07
It's also time to get a lawyer – Devin Shavenoff Nov 30 '12 at 12:07

3 Answers

up vote 2 down vote

That's an unusual term for a seed financing. What do they expect to do with a part ownership of patent rights? All that does is make the company less attractive in the future -- if you have a good business, a buyer won't want to have to negotiate with these seed investors for their patent rights. It also opens up your company to competition from your own investors using your own IP. If it were me, there's no way I'd agree to that.

Instead, you might consider putting a restriction in the company's articles of organization that say that the company won't sell or grant a security interest in its patents or code unless the deal is approved by either (a) a majority of the preferred stockholders or (b) [and this is probably preferred] a director appointed by the preferred stockholders.

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Without the docs, its a bit difficult to determine whats happening. If the patent is assigned to the company, IMHO they are double dipping if they are asking for royalties on the patent.

Consider using a standard seed series document - that theoretically can reduce your legal costs. Review these different articles on the ones out there - Here are specific links to series seed and founders institute documents.

Also become knowledgeable about convertible notes, caps and the hidden issues around them - Suster at GRP did a excellent recent post on this.

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up vote 0 down vote

Agree with both comments above - does seem very odd, and could significantly restrict your ability in the future to raise money from other parties, or secure funding using your IP/Assets as security.

As ever best advice is to take legal advice. I know many start-ups try and do the due diligence and paperwork themselves, but for the sake of your futures it's well worth getting an attorney to draft paperwork.

I guess though, at the end of the day it comes down to how desperately you need to do the deal with these guys. If you're dead in the water without the money in two months time, then I'd say it's something you have to live with. No point holding out against terms they want if it means you go bust!

Good luck and hope it gets resolved for you!

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