Hi-tech startups are blossoming in China as a huge influx of capital pours in following incentives offered by the government; but the legal risks associated with the sector are significant and many of these startups have found out first-hand how important it is to heed these legal issues. 

Of particular concern is the important of protecting intellectual property. This IP, often innovative technology, can be the heart and soul of a company, so effective protection is important. Also important, however, is understanding that it is the technology itself that is key and that the aim of a well-designed legal IP strategy is to protect the technology. In other words, the legal requirements to protect IP are a means to an end. 

China has been putting a great deal of emphasis on innovation and the development of technology. 

In 2015, government-backed venture funds in China raised about RMB1.5 trillion (US$231 billion), tripling the amount under management in a single year to RMB2.2 trillion yuan (US$330 billion), according to data compiled by consultancy Zero2IPO Group. That’s the biggest pot of money for startups in the world and almost five times the sum raised by other venture firms last year worldwide. 

The sheers size of the funds raised may be a sign that Beijing, the second largest economy in the world, is actively restructuring its economy and industries while paving the way to become a global tech hub and innovation powerhouse. Premier Li Keqiang has repeatedly made remarks emphasizing the government’s aim to boost China’s economy through innovation and reduce its dependence on heavy industry. Since 2014, more than 1,600 hi-tech incubators for startups have been launched to support entrepreneurship. 

“The country should create a sound environment for promoting the growth of startup companies, injecting new impetus for the country’s economic growth,” said Li during a visit to a newly established hi-tech park in Dalian during the Summer Davos Forum last year. “The competitiveness of companies will take a leap forward with the increase of innovation.”

“We must implement an innovation-driven development strategy. Mass entrepreneurship and innovation are focal points that can stimulate more market vitality,” said Li during a cross-ministries meeting in August where he talked to key officials from the Ministry of Finance, State Administration of Taxation, State Administration for Industry and Commerce and Ministry of Science and Technology. 

LEGAL HURDLES 

Tech startups in China are often optimistic and looking towards a promising future; if they can overcome the legal hurdles. These hurdles ran the gamut from challenging documentation to the sheer cost of setting up legal teams.

“The best and most efficient way is to reach out to a legal professional, though there is no shortcut. In many cases, even for a moderately funded tech startup, hiring a good lawyer need not be expensive. What matters is whether it is willing to do so at the very beginning, which tends to be a critical stage for building the foundation for its equity structure and IP (intellectual property),” says Benjamin Qiu, a partner at Loeb & Loeb. “We’ve seen many cases where tech startups did not really want to pay for it when they started to do their business. However, the omission of legal considerations will bring them grief later.” 

A recent case Qiu handled involved the client’s prior use of free templates on the Internet to apply for trademarks, which led to flaws in the applications. The company’s trademark portfolio was only steered in the right direction after the company started consulting legal professionals. 

“IP protection and capital structure are the two main legal issues that I usually suggest tech startups to be extra cautious with, as we have seen many tech startups coming to us with disputes involving these two particular issues,” says Qiu. 

Sometimes problems arise when the distinction among founders, partners and employees is unclear, as well as how shares are assigned. 

“They often do not have professional contracts for it. What we have come across are usually decisions made through email or even just verbal promises. This causes complicated disputes later, especially when some founders back out or are forced out of the company when it has acquired high market valuation,” said Qiu. “This is very common as turnover tends to be high in tech startups.”

IP IN FOCUS 

IP protection is always a core focus in hi-tech companies as their research represents their core value and is the foundation of their future success. This is particularly challenging for new tech firms, as applying for patents requires money and time. 

“Technology startups see a fast-growing business as they usually have advanced skills or innovative business models that can tap unmet needs. However, the boom has a downside for companies as it puts much pressure on their handling of intellectual property. Usually, it takes quite a long time to create a decent IP portfolio, at least three to five years to have the invention patent rights granted after filing applications,” says Dragon Wang, vice president and partner of Beijing East IP Ltd. & Law Firm. 

There is no shortage of case studies to illustrate how important it can be to jump over these legal hurdles sooner rather than later. 

In 2014, for example, multinational Ericsson sued the upstart electronics manufacturer Xiaomi at the Delhi High Court in India on the grounds that the Chinese company infringed on Ericsson’s wireless technology and did not apply for licenses to use its technology. The Indian court temporarily banned sales of Xiaomi’s phones nationwide – a blow for a company looking to tap emerging markets as large as India. 

“Xiaomi, compared to those startups we talk to every day, was already not a small company in 2014, four years after it was founded. However, its business simply expanded too fast to have its IP strategy closely followed. Xiaomi still struggled with such legal issues at that time even though Xiaomi had established an outstanding IP team to work hard on different IP issues. Such legal issues have hampered its overseas expansion plan,” says Wang, whose firm is now helping Xiaomi with its overseas patent creation and prosecution. 

However, for small tech startups, even if they understand the importance of IP protection, finance is another issue, particularly in the early stage when they have to spend big bucks on research and development. 

One of Wang’s clients who is working on a simplified hearing aid is at that stage. 

“They have the prototype of the new hearing aid and is doing financing now. At this stage, they do not have to apply for patents for everything; instead, they need to have a plan for what type of IP they really need, which core patents are required to be applied in the first step, and how to establish a decent IP portfolio next. How to allocate their limited resources and better manage their IP is critical,” says Wang. 

He observes that painful lessons experienced by overseas and domestic startups have raised awareness on IP; however, some are not in the right direction. 

“If we had talked about this five years ago, what I would have wanted to emphasize would be the need to raise the awareness of IP. However, recently, particularly in these two years, IP has been talked about a lot in China. The topic sometimes has been discussed too much like water being overly boiled,” says Wang. “There is some misunderstanding that whoever gets IP [protection] wins the game. We’ve met many people coming to ask how to run an IP business. This is totally wrong. Innovative technology and products are the core competitiveness of a company, while IP only protects and assists the development and expansion of the business. It is not the basis.”