Should I Apply for Patents in My Tech Start-Up? (Part 1)

Anybody starting a new technology venture based on some novel idea will need to address the issue of whether or not to apply for one or more patents to protect the idea.  In fact, the question is not merely whether to apply, but also when to apply and what to apply for.  Furthermore, these questions must be considered in the context of the overall business strategy of the start-up venture.

For the purposes of this article I am assuming that the bulk of the value in a technology start-up resides in its intellectual assets.  This should be self-evident – a new company typically has no tangible assets to speak of, and generally relies on what its founders bring to the table, namely their ideas, creativity, experience and skills in the relevant fields of technology and business.  The biggest problem with these initial intangible assets is not that you cannot ‘see’ them, it is that you cannot nail them down, buy them or sell them.  If a key founder bails, burns out, or suffers illness or accident, the start-up could be over before it has even begun.

Of course, investors and financiers know all this.  Up to a point, they will invest in people despite the inherent risks.  Indeed, the people are critical because the only way the risk can be mitigated at all is by trying to ensure that the right team is in place.  But ultimately people are not possessions to be owned, bought and sold.  They are free to come and go as they please, and they are subject to the whims of fate.

Patents provide one mechanism by which ‘free’ knowledge and ideas can be captured and owned by a business, in order to increase competitive advantage and add value.  In this series of two articles I will look at how this happens, and discuss some of the main issues to be considered when deciding whether or not to apply for patents.  Later in this first article, I will run through some of the reasons why a start-up might decide not to file patent applications.  The second article will focus on the key considerations on the other side, i.e. when and why start-ups should file patent applications.

Capturing Intangible Assets

A technology business needs to have some mechanism to capture and take control of the intangible assets its people bring in, and those they create while working on behalf of the venture.  One goal of an effective intellectual property strategy is the conversion of key intellectual assets from elusive ‘human capital’ to manageable intellectual property.  The key characteristic of ‘property’ in this context is that it is something – whether tangible or intangible – that can be owned, and can therefore be bought, sold and/or rented (i.e. licensed) by its owner.

Not everybody is a fan of the term ‘intellectual property’.  Free software advocate Richard Stallman is a strong opponent, and he is, in fact, quite right to point out that the rights commonly lumped together under the ‘IP’ umbrella – principally patents, trade marks and copyright – all have very different characteristics, and not a great deal in common with most forms of conventional ‘physical’ property.  For Stallman, the analogy is a ‘seductive mirage’ constructed by the evil corporate overlords of capitalism to limit the ability of critics and reformers to engage with the real issues raised by different types of proprietary rights.

However, for those of us engaged in the commercial world, the ‘property’ analogy is immensely useful.  Property is something that can be controlled.  It can be catalogued.  It can be audited.  It can be valued.  It can therefore contribute to the overall valuation of a business.  In short, intellectual property can take something that is virtually unbackable – the ideas, knowledge and thoughts in somebody’s head – and turn it into an investible proposition.

To Patent or Not to Patent?

Inventions are the ephemeral products of the inspiration and perspiration of inventors.  Once they are let loose, they are free for everybody to use, and thus provide nobody with a competitive advantage.  Patents create exclusive rights to inventions that can be owned and deployed to give companies a competitive edge in their markets.

Nonetheless, there are a few reasons that a start-up might not apply for patents.

1. Unpatentable Technology

First, the venture may not possess any patentable technology.  It has become apparent, through legal rulings such as that of the US Supreme Court in Alice Corporation v CLS Bank International, Mayo Collaborative Services v Prometheus Laboratories Inc and Association for Molecular Pathology Inc v Myriad Genetics Inc that some commercially valuable innovations (e.g. certain automated processes for use in business and commerce, some diagnostic methods and a range of biotechnologies) are simply not eligible for patent protection in the United States.  The eligibility rules differ from country to country, but exclusions from patentability exist in every jurisdiction.

Alternatively, patents may be unavailable because the technology does not meet the requirements of being new and inventive.  This might occur when someone has identified a new market opportunity for a known – and perhaps previously unsuccessful – technology.

A business that cannot obtain patents for its processes and technology must develop a business plan based upon alternative strategies, such as trade secrecy or strong brand recognition.

2. Better Things To Do

A second reason why some start-ups do not file patent applications is because the process is complex and time-consuming, and is not a high priority for the business.  This is not a terrible reason for ignoring patents.  Most ventures fail for mundane reasons, such as failure to finance properly (i.e. running out of money), the lack of a market for the product/service, mismanagement, or plain old bad luck.  A web search for ‘why start-ups fail’ yields dozens of articles (e.g. The Unlucky 13 Reasons Startups Fail at forbes.com), and I have yet to see one that identifies ‘did not obtain patents’ as a key reason for failure!

So there is actually something to be said for not letting patents distract the team from getting the basics right, at least at the very early stages of a new venture.  But this really addresses ‘when’ rather than ‘whether’ to apply for patents.  There are, equally, good reasons to file as early as possible, and certainly before the start-up comes out of ‘stealth mode’ and reveals its technology to the world.  Once this happens, the ability to obtain valid patent rights is lost in all countries of the world where there is no general ‘grace period’.  Therefore, timing can be of the essence.

3. Patents Not the Right Option

Another reason for not applying for a patent is that this might not be the best option for protecting a particular innovation.  A patent involves a quid pro quo with the public at large – a government-granted exclusive right for up to 20 years is given in exchange for a full disclosure of an invention and how to work it.  This disclosure is published early in the patent’s life (typically 18 months after the initial filing), for all the world to see.  Once the patent has expired – or, indeed, if no patent is ever granted – the invention is available for use by everyone.

The canonical examples of businesses in which trade secrecy has provided a longer-term and more effective competitive advantage than patents are Coca-Cola and KFC, whose recipes have (allegedly) remained secret for many decades beyond the theoretical expiry of any patents they might have obtained instead.  (Personally, I doubt very much that either of these recipes is still truly a secret from their competitors, but that is actually beside the point at this stage.)

However, businesses often underestimate the difficulties and costs involved in maintaining trade secrecy.  Information almost always leaks, unless access is strictly and consistently controlled.  The decision to keep something as a trade secret should not be taken lightly, or on the basis that it is a ‘cheaper’ option than the alternatives.

4. Too Expensive

The most common – and worst – reason for not applying for patents is the expense.  Yes, it is relatively expensive to obtain a patent.  If an applicant is reasonably lucky, has an invention with fairly clear differentiating features, and does not encounter any significant unexpected roadblocks during examination, they might be able to obtain a US patent for around $20,000-$30,000, start to finish.

But the key word here is ‘relatively’.  What matters is not how much the patent costs, but how much it costs relative to the value it adds to the business.  If a $30,000 patent can add $100,000 to the value of your company, then obviously you should apply for the patent.  It is no different from spending $30,000 renovating a house in order to sell it for $100,000 more than you paid for it.

If you do not know how much value a patent will add to the company, then you had better figure it out!  It will be difficult to write a business plan, or pitch to prospective investors, unless you can put a value on the company at various stages of its development.  An article entitled 10 Rules of Thumb for Startup Investment Valuation at the ‘Startup Professionals Musings’ blog states that ‘a “rule of thumb” often used by investors is that each patent filed can justify $1M increase in valuation’.  Even if that is a generous estimate in the case of many patent filings, it is not a bad starting point for discussion!

So, ‘patents are too expensive’ is a terrible reason for not applying.  However, ‘I have worked through our proposed business plan and determined that applying for a patent on this invention will not add sufficient value to justify the cost to the business’ could be a very good and valid reason.

Conclusion – Why Not to Patent

To sum up this first part, patents are not the be-all and end-all of valuation and success for every start-up.  As I have discussed, applying for patents may not be appropriate if:

1. the start-up’s technology is not eligible for patenting;
2. the timing is not yet right, and the business has higher priorities;
3. a patent is not the best option for protecting the company’s IP; or
4. the value that a patent will add to the business does not justify the cost.

In the second article in this series, I look at the reasons why, and when, a start-up might decide to go down the path of applying for patents.  To keep reading, click here for part 2.

Tags: Intellectual Asset Management, Strategy, Valuation