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From Ireland's leading barristers.
Ireland is fast becoming a centre for technological innovation. In many cases, the brains behind the technology are based in Ireland while, in others, they are based abroad but decide to operate through an Irish company. While an influx of technology companies into Ireland is to be welcomed, it should come with the same warnings as apply to any other business. The most important of these – and I simply cannot emphasise it enough in the case of technology and software companies – make sure to get legal advice before entering into legal relationships! Emphasis on the word "before"!
I have recently advised in a number of situations where software developers have unfortunately been exploited to the point of losing their software altogether. By the time they sought legal advice, much of the damage had already been done. Below are a few observations which apply to all entrepreneurs but especially those engaged in developing software products.
A new idea for a software product is always exciting, but its development requires time and money. When it comes to the latter, there are a number of options available to entrepreneurs. First there is the old fashioned approach of going to a bank for a business loan. Then there is the option of a private investor eager for a slice of the action. When considering this latter option it is important to ask yourself some key questions. What exactly are you sacrificing for the money? Is the investor providing a loan? If so, will they be charging interest? Does the investor insist on receiving a stake in the product? After all, every investment comes with its own price tag.
Experience from my own practice has shown that software developers are motivated, enthusiastic people. Enthusiasm can sometimes be detrimental – so eager are they to bring their software to life that they sometimes ignore the potential pitfalls.
Let's suppose you find an investor who is willing to fund the entirety of the software development but insists that the funding will be a loan repayable at an interest rate of 5% per annum. The investor also insists that the project should be carried out by a company in which it should receive 50% shareholding. From a legal and commercial point of view, this is a bad deal for the entrepreneur. It is a bad deal commercially because there is no reason that a person providing a loan repayable with interest should also receive a portion of the business. They are already receiving a hefty return on investment in the form of annual interest. Why should they also receive 50% shareholding in the business? Think about it this way: would a bank insist on owning part of your business as a condition of its loan offer? Probably not.
From a legal perspective, it is a bad deal because you are essentially giving away 50% of your product. The software, once developed, will be owned entirely by the company in which you have given away a 50% stake. That's a significant percentage. Under Irish law, anything above 25% is significant since it carries a veto power to do certain important acts such as changing the company's constitution. If you intend to go down this route then you need to ensure that you have a watertight shareholders' agreement with your investor which sets out, in painstaking detail, the nature of your relationship. For instance, it may be a good idea to include a clause which allows you to buy - and compels the investor to sell – all of the investor's shares at a pre-defined price at some future date (a so-called "call" option). In that way, once your product hits the market and starts to make money, you could obtain finance elsewhere in order to exercise the option of taking full control of the company.
I have come across a number of situations where entrepreneurs are willing to enter into business with their investors after the latter promises them an important-sounding role in the joint venture company. The roles vary from "CEO" to "Senior Managing Director". The words sound great but the truth is that they mean nothing under Irish law. A "CEO", for instance, is essentially just another director who may have some additional powers and/or responsibilities delegated to him by the board of directors. But those powers can be taken away and indeed he can be dismissed altogether by the shareholders in the same way as any other director. The only way that the fancy titles amount to anything is if they are governed by a separate agreement – whether an employment contract or some other document – giving the office holder specific assurances in matters such as salary, tenure etc.
Once again, the advice is to ensure the details of the relationship are set out in a proper agreement signed by the relevant parties. More than that, the agreement should be forward-looking, making specific provisions for scenarios which can – and do – arise in practice. Thus, it should contain procedures for dispute resolution, sale of shares to outsiders and exit options for the existing shareholders.
It's not just the investment which software entrepreneurs need to consider. There is also the question of intellectual property and, specifically, who owns the IP rights in the software. In most cases, there will be a general assumption that the rights will be owned by the company through which the product is ultimately sold i.e. the new company in the case of a joint venture. In fact, that is not the default position under Irish law. Section 23 of the Copyright and Related Rights Act 2000 states that the copyright in a work is owned by the "author", which is defined for the purposes of software development in section 21(f) as "the person by whom the arrangements necessary for the creation of the work are undertaken". The author is therefore the person who actually writes the code – he/she is the owner of the copyright in that code. One exception to this is the situation where the code is compiled by an employee, in which case the employer is the copyright holder.
If you have a great idea for new software but rely on someone else to write the code (there are many companies providing such a service) then, unless that person is your employee, it is imperative that you sign an agreement whereby they will assign the copyright to you once the coding is complete. This may be conditional on payment of their fee I recently advised in a case where the absence of such an agreement left the entrepreneur scratching his head as to why the copyright was not deemed to automatically transfer to him. It is important to note that we are talking here about copyright in the code itself as distinct from IP rights attaching to the idea behind the product, which may separately be covered by a patent.
The above is a snapshot of just some of the considerations likely to be faced by software entrepreneurs before being able to bring their product to market. The law is an effective tool to protect their interests in a valuable asset. That is the purpose for which it should be used, rather than as a means of resolving disputes arising down the line from the failure to act at an early stage. Specialist, comprehensive legal advice ought not to be relegated to the bottom of the "to do" list. Neither should it be neglected for fear of the likely cost. Experience has shown that the wisdom of that initial cost will become clear if it serves to avoid the ever-increasing cost of litigation in the future.
Author: Mahmud Samad BL
Publication date: 14th August 2020