How to structure your business to protect your intellectual property

It was only after Dean signed one half of the shares over to his General Manager that he realised what he had done.  The intention when he sold those shares was to give away half of his Auckland business.  However, what Dean had inadvertently done was give away half of his dreams and aspirations for the brand which he had spent five years building up from scratch. 

A simple step taken before the share sale could have avoided this problem, but Dean was now looking at buying back the shares from someone who didn’t want to sell.

Why Dean wanted a business partner

Dean’s big hairy audacious goal was to franchise his business and create an Australasian brand.  Before doing that he needed to get the Auckland business profitable so that he could demonstrate to potential franchisees the value of his business model.  He needed additional capital to grow and his General Manager was willing to provide that capital in return for shares.  It seemed like a match made in heaven, particularly since the General Manager was an essential cog in making the Auckland business profitable and selling him shares would keep him incentivised.

However, the General Manager didn’t have Dean’s ambitions of franchising.  His only concern was making the Auckland business as profitable as possible to provide an additional dividend income on top of his salary.  From Dean’s perspective, he knew that he would be the one doing all the work to make the business capable of being franchised.  However, by selling half the shares in his company to his General Manager, Dean overlooked that he was selling more than he bargained for.

Dean forgot about the intellectual property

An essential part of franchising is that the franchisor, in this case Dean, licences the intellectual property in his business to franchisees so they can duplicate the business.  Dean had spent five years developing the IP in his business.  That IP included his trademark, the know-how and the systems which he had developed to run the business.  That IP was owned by his company and he had just sold half of it to his General Manager.  That meant that if he was going to franchise the business half of the proceeds would belong to his General Manager, even though Dean would be doing all the work to get it to that stage.

What Dean should have done was sell half of the Auckland business only but kept ownership of the intellectual property to himself or put it in another company (and IP holding company).  The Auckland business would then be in effect the first franchisee, with Dean and the General Manager as equal shareholders.  Dean would then have total control over how he developed the intellectual property and would alone realise the proceeds of any franchising.  Prior to the share sale, Dean should have assigned the intellectual property to his holding company and then licensed back the intellectual property to his trading company.  Since the intellectual property was still being developed by the trading company, the agreement would need to provide that any IP developed by the trading company in the future would belong or be assigned to the holding company.  The trading company would pay a licence fee back to the holding company for the use of the IP to run the business.

The effect of the licence fee

By doing this the value of the trading company is less than if it owned the intellectual property since the valuation would need to take into account the ongoing licence fee back to the holding company and the inability of the trading company to develop the IP further.  However, the business would still be valuable since it was a profitable trading entity and still had the potential to make more profit thereby achieving the General Manager’s goals.  The separate IP holding company in turn would allow Dean to develop his IP into a franchise model.

So by structuring the business to create an IP holding company, it was able to achieve both parties’ goals.  As it was, the General Manager had ended up with an asset which he didn’t really want but which could be quite lucrative for him in the future.

Dean was now stuck

Having sold half of his intellectual property, Dean now had a problem of how to get it back.  Whilst the General Manager didn’t need half the intellectual property he did see the future value and potential in having it and wasn’t going to give it up easily.  Whichever way Dean decided to get the IP back, he knew that it was going to cost him money.

 

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