Should I Apply for Patents in My Tech Start-Up? (Part 2)

In my previous article (which you can find here, if you have not already read it) I wrote about the strategic role of patents, and other forms of intellectual property, in capturing the intangible assets of a business in a form that can be owned and managed.

I also outlined some of the reasons why a start-up venture might choose not to pursue patent protection for some, or all, of its innovative technology namely:

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 this second part I will discuss some of the benefits that patents may bring to technology start-ups, including: assisting in obtaining funding; setting a business up for success; providing additional revenue streams; protecting market share; establishing technology leadership; and strengthening the company’s position in business negotiations.

The Link Between Patents, Investment and Success

In June 2014 a report was published, based on a study commissioned by France Brevets and conducted by MINES ParisTech, entitled Can Patent Data Predict the Success of Start-ups? [PDF 288kB].  The researchers addressed two questions:

1. Are patents a good signal for venture capital (VC) investors?
2. Is there a link between patent positions and the probability of success?

The first question was answered by looking at outcomes for start-ups based on their patent positions before VC investment. 

To answer the second question, the researchers looked at the predictive power of various parameters of companies’ patent positions (e.g. existence, international coverage, size and quality of the patent portfolio) after receiving VC backing.  As the authors noted, ‘a positive impact of patent positions on subsequent success would … highlight the importance for VC funds of promoting good IP management and the building of strong patent portfolios within their portfolio companies.”

The results of the study were stark.  In response to the first question the researchers  concluded that a start-up with at least one patent before VC funding has a 50% chance of experiencing a successful exit within 10 years of receiving backing, while those without patents have a 30% chance.

However, this ‘average’ outcome does not properly account for differences between industry sectors.  The study found that patent ownership has a particularly large correlation with success in the software and biotechnology sectors, in which start-ups that owned patents before the VC investment were found, respectively, to be 2.89 and 2.99 times more likely to succeed afterwards.

After VC investment, the study found patent ownership to be associated with a 30% likelihood of success in the six following years, against 8% without patents, i.e. patent ownership was correlated with a 2.75 times multiplier of the chances of success by.  In this aspect of the study, industry sector was found to have a relatively small impact, although the effect was ‘probably’ stronger in the software and biotechnology sectors.

Having a larger patent portfolio and/or a portfolio of higher-quality patents was also found to have a significant correlation with the prospects of success.

The research therefore bears out the received wisdom that patent ownership makes a start-up into a more attractive investment target for VCs.  Furthermore, once a venture has received VC funding, investing some of that money in IP management and patent portfolio development is significantly correlated with a successful exit.

Of course, correlation is not causation, and just applying for patents will not make a start-up successful.  But there seems to be no doubt that start-ups with patents are more successful overall than start-ups without patents.

‘Offensive’ and ‘Defensive’ Value of Patents

Patents can be used offensively, i.e. by way of enforcement or threats to enforce, in order to increase revenues.  Offensive uses of patents include licensing strategies, and exclusion of competitors from the market.

Of course a patent provides its owner with an ‘exclusive right’ to exploit the patented invention, and can therefore be used to enforce a form of monopoly over the associated products, services or technologies.  If competition is limited, market share is increased, and revenues are therefore higher.  It may be possible to charge a premium price for products with unique and highly-valued features that are protected by patents.

Licensing of patents – or, indeed, entire entire products or technologies wholly or partially protected by patents – is another way in which they may be used to raise revenues.  While it might seem counter-intuitive that an operating company would license its rights to potential competitors, this may be desirable if the company chooses not to, or cannot, supply the entire market.  It may have patents in countries where it lacks market access, in which case market reach can be increased by licensing manufacturers, agents or distributors in those countries.  Modern business relationships can involve complex networks, and a competitor in one respect may be a customer or supplier in other respects – indeed, this is famously the position as between Apple and Samsung.

Patents can also have a passive, defensive value, even if they are never enforced.  For example, a strong patent portfolio may deter potential competitors from either copying or imitating a product, and may discourage them from asserting their own patents, for fear of reprisal – again, Apple’s decision to assert patents against Samsung on multiple fronts is a fine illustration of the dangers of underestimating a competitor’s patent position.

…But We Can’t Afford to Litigate!

It is often said by operators of start-ups and small businesses that there is no point in obtaining patents for offensive purposes because they could not, in any case, afford to enforce their patent rights.

This is actually totally irrelevant.  Hopefully it is becoming clear that the value of patents to an early-stage venture has nothing to do with enforcement.  It may have something to do with potential enforcement, but that is in the future, and there are many more important things to be worrying about in the meantime.

For the record, here are a few other things that start-up ventures usually cannot afford to do: acquire their competitors; establish their own semiconductor fabrication facilities; hire all of the leading designers, engineers, and business managers in their field; set up a dedicated and well-funded R&D department; and basically anything else that does not involve the founders wearing multiple hats and spreading themselves thinly across all areas of the business.

Yet there are many companies – Apple (again) and Hewlett-Packard spring immediately to mind – that have grown to do some or all of these things (and, of course, to assert their patents) after starting out literally or figuratively in somebody’s garage.

Strategic Business Value of Patents

Patents rights have value, and can therefore be traded or used as bargaining chips in negotiations with competitors, suppliers, customers, and other third-parties.

For example, it may be necessary to partner with a technology supplier, or even with a potential competitor, in order to access technology that is not owned by the company.  Having your own patent portfolio demonstrates credibility, technology leadership and ownership, and can place you in a stronger negotiating position and/or enable you to obtain more favourable terms in contracts, in-licences, cross-licences, and strategic collaborations.  As in any negotiation, the more you bring to the table, the more you are likely to take away.

Then, of course, there is the ability of patents to open doors to funding opportunities, as I have already discussed above.

Conclusion – Why to Patent

To sum up this second part, while patents may not be the be-all and end-all of valuation and success for every start-up, there are plenty of reasons why applying for patents may be the right option, including:

1. sending a positive signal to investors;
2. after investment, as part of a strategy to maximise prospects of a successful exit;
3. as a source of additional revenue, via licensing and enforcement;
4. as a means to increase market reach and/or protect market share;
5. to enhance negotiating power by demonstrating credibility and technology leadership;
6. as a bargaining chip to gain access to technology owned by other parties; and
7. to obtain intellectual property assets that contribute to the overall valuation of the business.

I realise that I have not actually answered the question, should I apply for patents in my tech start-up?  Ultimately every company, and every situation, is different.  While most technology-based start-ups can probably benefit from patent ownership, obtaining patents is not the only path to success.

In these two articles I have tried to cover a good selection of the factors and issues involved in making the decisions about whether, when and what to patent.  Answering the question in the title is then a matter of applying these ideas to the particular circumstances and business strategy of each individual venture.

Tags: Intellectual Asset Management, Strategy, Valuation