For startup companies, assessing their commercial potential and choosing the exact business model is the crucial starting block. Specialised skills are required for the numerous transactions involving the development, structuring, sales, and licensing of technology. Expertise in both intellectual property and commercial law is required, as well as business judgment and knowledge of the industry. Typically SMEs and tech startups do not have the benefit of vast resources to structure their businesses and intellectual property becomes underutilised as a result.   One question to be considered, is whether a startup is a suitable vehicle to exploit the technology or would it be preferable to be part of a new joint venture or other licensing arrangement?

Corporate finance for tech startups

From the outset, business goals have to be articulated in such a way as to attract funding. Not understanding the underlying service or product and/or overvaluing the business are some of the initial obstacles. The idea needs to be expressed in a way that investors will want to support the startup and the correct IP in place will make the proposition more attractive to potential investors.

Startups go through various financial processes. After the initial excitement of innovation and the pre-seed investment phase, historically startups often go through the slumbering “Valley of Death” – an expression used to describe the phase of negative cash flow in the early stages of a startup. If the startup is able to tread carefully, they are then able to aspire to grow to the so-called “mezzanine” and possible listing.

There are five main forms of funding:

• Angel investment: individuals or groups that invest their own money in early-stage companies
• Venture capital: early stage, high risk investment with high potential returns
• Seed-investment: investors are offered a part of the business, but the capital provided by the investors is much lower than with venture capital.
• Private equity: this differs to the more adventurous forms of funding, and focuses on investment with companies/startups when they have been established and possibly restructure to operate even more effectively
• Crowdfunding: this is a venture platform to allow investors to grow their portfolio by making smaller investments across a wide range of ventures, minimising risk and increasing potential for returns.

However, the Silicon Cape Survey of 2012 indicates that domestically, the majority of startups are self-financed. Only a small percentage of startups receive venture capital and private investment. Therefore, getting to know the South African landscape is essential.

South African landscape

South African government policies are not yet fully streamlined to the formation of tech startups.  Tech-development zones, where bandwidth is subsidised and policies that allow companies to capitalise on global trends for example, are not being endorsed. There are, however, various incubators that help facilitate and provide support.

The Venture Capital unit of the Industrial Development Corporation (IDC), for example, is investing heavily in local entrepreneurs and the opportunities are increasing. There are also many diverging initiatives, such as the Incubation Support Programme (ISP) of the Department of Trade and Industry (DTI), and aligning the startup can be an important building block.

Then there are regulatory obstacles to assess. One of the more prominent issues is how to deal with exchange controls, i.e. the ability to move currency and IP across borders.  Further, the cost of receiving small foreign currency payments and the ability to price goods in foreign currency.

Investing in tech startups

Research suggests that not only are startups looking for funding, but investors are also looking at opportunities to get involved, domestically and internationally. Private equity funds seeking to invest in startups are increasing whereas institutional investors often coming across as a bit tentative.

For investors, an understanding of the startups' market potential, completion of the technology, the operational requirements, and a path to effective production and profitability, are all considerations that have to be weighed up. It is also important to value the startup and to establish what the intellectual assets are showing with regards to the future developments. What is evident is that investors and tech startup companies are mutually beneficial. This is also reflected in the initiatives by multi-nationals and the various entrepreneurial programmes that are advancing throughout the provinces.

There are certain policies that have been implemented by the South African government to foster this developing field, for example, the South African Revenue Service (SARS) implemented section 12J containing tax incentives for venture capital companies. This could mean that up to 40% tax relief is offered on investments in venture companies that satisfy the legislative requirements.

IP protection, due diligence and audits

Is the invention a disruptive technology? How should it be categorised and valued? The potential applications for the IP in the technology and the market should be defined to get a better idea of the opportunities and challenges to exploit the technology.

Having a strategy does not only mean that IP has to be identified, but it also has to be developed and protected. Due diligence is therefore very important for tech start ups. Assessing a company's IP portfolio, with a view toward answering business questions, such as:

• Are the company's patent and trade mark assets valuable and if so, how do we use and protect them.
• Is the company likely to encounter problems with other patents in the future – both locally and internationally?
• Do we rely on patents or knowhow to protect and/or increase market share?

Important decisions are based on the answers to the questions and are vital for the survival of tech startups.

Innovative ideas and influential technology, often make up startups, and protecting intellectual property is therefore crucial.

After public disclosure of an innovative idea, obtaining a patent may no longer be possible and therefore filing a patent application on the invention before it comes public, is a very important step in protecting the company.

Other considerations brought about by a well designed due diligence process include:

• searching IP registrations in other countries for any infringement matters
• looking at the history of patents and designs to establish areas for collaboration or exploitation
• the legislative requirements eg. exchange control
• identifying gaps in technology
• tracking where competition are innovating
• establishing under utilised patents or trade marks not in use
• defining and the collation of knowhow
• understanding the legal implications of sub contracting, especially for copyright intensive industries

Licensing and franchising

Licenses, franchising and distribution agreements are also ways of exploiting technology. These arrangements can help create a bigger footprint in the market and stimulate growth. The legislation relevant to these practices is set out in the Consumer Protection Act, 2008, together with IP legislation.

Conclusion

South African tech startups are attracting much attention with interesting developments in Johannesburg and Cape Town. This is an exciting new field with many unchartered waters. Adams & Adams has the resources and knowledge to guide both tech start ups and investors alike through this somewhat unpredictable time, protect the intellectual property and show investors the various opportunities to become involved.

Links: Silicon Cape Survey 2012 Tech Startups. Available here

Written by Reinhardt Biermann, Candidate Attorney, Trade Mark litigation, Adams & Adams
Article verified by Darren Olivier, Partner, Trade Mark litigation and prosecution