Thursday, May 20, 2010

Asset Protection 101: Protecting Your Business’s Intellectual Property

Timely asset protection has enormous benefits. Especially, if these assets are very valuable, like certain intellectual property may be. In fact, for a technology or a media company, intellectual property, such as patents, copyrights, trademarks and trade secrets (IP) may be the essence of the business, i.e., its brand, its main source of income. The easiest way to protect the IP is to simply put it in a separate limited liability company (LLC) that has been properly structured. A business structure could, for example, look like this: founders own 100% interest in a holding company, a corporation, which in turn owns 100% of the IP LLC and 100% of the Operating Company (Opco) that has contact with the public. Alternatively, the founders can forego the holding company and hold directly the shares of the Opco and the interests in the IP LLC. Then, the IP LLC can lease or license its intellectual property to the Opco (it is important that the license agreement and money exchange be real and done at arm’s length). Of course, each case is different and one should seek professional advice on the entity structure and tax implications.

In case the Opco or the holding company is sued or goes bankrupt, the assets held by IP LLC cannot be reached by creditors unless only by the charging order. A charging order is a unique asset protection feature of LLCs. If an entity or an individual wins a law suit against the LLC entitling the creditor to damages, it can only obtain a charging order against the LLC, which means that the creditor does not get title to the assets held by the LLC but instead only the right to the distributions of the LLC allocated to the members. If the LLC has allocated profits but chooses not to distribute them, then the creditor with the charging order has to pay tax on this “phantom income”.

In addition to asset protection, placing intellectual property in a separate company may help the founders maintain long-term control over their companies. If the holding company or Opco receives outside funding, there is a chance that the founders may lose control over their companies. Holding IP assets in a separate LLC may allow the founders to gain leverage in any future battles over control.

This reminds me of a recent sale of Skype and the related lawsuits. At the time of the original sale of Skype to Ebay in 2005, the founders of Skype, Niklas Zennstrom and Janus Friis, kept the underlying source code of Skype’s peer-to-peer network in a separate company called Joltid, and instead of selling the source code, licensed it to Ebay. The 2009 lawsuits span from the alleged infringement by Ebay on the founders’ copyright to the source code, and later allowed the founders to settle for a 10% stake in Skype.

A little planning early on in a business’s life can go a long way…

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