In recent years, we have witnessed a trend that is growing ever more common, in which various companies decide to “extract” from their ranks specific R&D works, and deliver their development to external companies that specialize in that specific field.
Mostly, there are two reasons for outsourcing R&D works: first, when the required work is not within the field of expertise of the company in need of development, e.g. a bank that engages in an agreement with a computing company for the purpose of developing banking software to be used at its branches; and second, when the client company lacks the resources compatible with performing the work by itself (this usually occurs in young technological companies and start-ups).
As a general rule, when a company decides to “extract” a certain R&D work to an external company, the principle agreement that regulates the relationship between the two is a development agreement. This agreement consolidates all of the commercial terms and legal tools required by both companies (but mostly by the client company) to preserve their rights to the fullest.
To reduce the exposure and risks involved (as shall be depicted below), it is common to set certain mechanisms in the development agreement that handles, among others, the timetables for performing the R&D works, issues of ownership in project-related intellectual property products (including derivatives works), payment method and dates, the possibility of having an escrow stipulation by which a trustee holds the product to be developed during its development period, the development company’s warrants that it shall not grant similar services to competing companies, confidentiality issues etc.
R&D Outsourcing Pros and Cons
One of the main advantages of outsourcing R&D works is using an entity that is supposed to be an expert in its field, and through that optimizing the quality of the product or development that the client company shall eventually receive. For instance, when a company decides to develop a product that it’s planning and/or development might not be directly related to its main field of practice, it would be preferable and more effective for such company to turn to an external entity, with expertise in the field to which the component is related, for the development of said component.
Another advantage is the streamlining of the client company through saving resources and manpower. In most cases, it is more effective and worthwhile to a certain company to hire an external company to perform a specific R&D work than to hire one or a number of employees to perform said work internally. This receives validation when it concerns young start-up companies which are not sufficiently founded and lack the resources required to perform the desired R&D works in-house.
Notwithstanding the advantages in support of outsourcing R&D works, there are also disadvantages, and the balance between them is not a minor issue.
The largest disadvantage, or risk, in the outsourcing of R&D works is the issue of product and product-related IP ownership. The mere extraction of the initiative and/or idea from within a company walls to an external entity poses a risk that is feared by many companies, sometimes justifiably. However, most development agreements include firm instructions on who’s the owner of the intellectual property (regarding the products and its derivatives) as well as a confidentiality clause, but the exposure is still much more significant than performing the works in-house.
Directly following the aforesaid, when a certain work is taken outside of the company to be performed by an external entity, the client company will have more difficulties in supervising that external entity, in contrast to where the work is being done in-house by company employees, who can be more readily supervised and controlled. As a side note, it shall be mentioned that usually when employees of a certain company perform R&D work for said company, the provisions of the law clearly specify that to the extent that there is no other agreement, the rights for that work belong to the company in which the employee is employed.[1]
R&D Outsourcing in Start-ups and Young Technological Companies
The balance between the advantages and disadvantages of outsourcing R&D works receives validation when it concerns young start-up companies, as the choice between outsourcing or performing the works in-house might be a fatal decision with direct implications to the company’s survival and success.
A young start-up company lacking the financial and human resources to perform R&D works in-house apparently must turn to an external company that will perform such works for it. However, turning to an external entity opens the young company up to multiple risks, including risks resulting from a situation in which a dispute rises between the former and the latter. Such a dispute (or even a delay in delivering the product or development) might bring about the total collapse of the company since, as a young company, it lacks the financial resources and support required to survive the difficult period.
Summary
When a company decides on whether to seek outsourcing for any R&D works, all the more so when it is a young technological company, it must consider the advantages and disadvantages inherent in such action and understand the potential exposure that comes with it. That and more, it must choose a performing company with proven reputation in the field, and also be familiar with and understand the complex issues in this matter so it could reach a development agreement that will maintain and protect all of its interests.
[1] 2007 Copyright Law, section 34; and also 1967 Patent Law, section 132.