Patents: Asset or Liability

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This article was first published in the 43 Biz Journal city publications across the US .

4:00 on a Friday afternoon. You have an urgent call from a customer who has been a big booster. You are the CEO of a technology company with initial success introducing a product that materially improves the transmission speed of data over fiber optic networks. Your Beta clients love the product. You secured equity financing to bring the product to market. You and your team have worked hard to solve a real customer need and launch your company.

Returning the call, you learn that the customer was presented with a product almost identical to that offered by your company and at a lower price. You ask about the performance specs and are told that they are basically the same. As you thank the caller for the heads up, you ask yourself whether he did not fully understand the differences between the competing product and that of your company. Your technology has patents in place. This competitor must be violating your company’s patents if they are producing the same product with the same performance. And who is this competitor?

Patents – An Asset

Sustainable competitive advantage is the goal of every entrepreneur, CEO and investor. Among the first questions to a startup team, to a corporate R&D proposal or to the company seeking a new round of funding is: “Do you have patented IP?” Patents are believed to be a barrier to competition, creating a pricing and profit advantage over competitors.

We know the stories of Apple paying a small tech company $530 million for infringement of patents relating to their iTunes product. Samsung had to pay Apple $550 million for another patent violation.

Patents can establish a barrier to competition for a period of time. But patents only have value if they are carefully prepared and the owner of the patent has significant funding and time to defend the patents. Simply having a patent issue may or may not have much value. And a patent issued in the US does not provide any protection against copycat products in other countries. The large emerging markets in China have limited regard for Intellectual Property (IP) rights.

A Case Study

Consider the hypothetical case of Big Idea Technology (BIT). The founders have a novel idea for improving the resolution of CT Scan readings in hospitals. They raised funds from Friends & Family, built a prototype and filed for two patents. The $6,000 cost per patent was a big expense for them at the time. BIT pitched investors for a new funding round to expand production and develop sales with the assertion that their patents are a primary asset. BIT can compete against Siemens, GE and Here First Technology (HFT) shielded by their patents – patents pending.

Patents - Asset or Liability (2)- Rick Williams

BIT successfully raises $10 million and starts manufacturing and selling their CT Scan product. Some customers are buying, but the company is not profitable. Cash is scarce. Every dollar must go into gaining market share.  But they spend another $10,000 per patent to get them issued.

Reports come in that HFT is introducing a product very similar to the BIT technology. Patent infringement is a real possibility. The BIT CEO directs their lawyer to file a notice of patent infringement against HFT. The response from the HFT legal team is: “We are not infringing. If we are, your patents are not worth the paper they are written on. Sue if you want. We are Here First Technology. Who are you?”

The Big Idea Technology board of directors now includes the founders, an investor representative and outside directors. Time for a new look at the patents – the $16,000 patents. A new IP attorney advises the board that the patent filings were thin and did not adequately cover the prior art. The claims were not carefully drawn. BIT could file suit against HFT, but if BIT loses the case, they might be responsible for HFT’s legal fees. BIT’s cost for bringing an infringement suit could be $2 – $4 million – win or lose. Here First Technology can challenge the validity of the BIT patents with the US patent office or file for Declaratory Judgement against the patents. Defending those challenges could cost BIT $400,000.

What should the BIT CEO do at this point? If you are a member of the BIT board or a major investor in the company, what is your advice to the CEO? Are these patents an asset or are they a liability? As an investor, are you prepared to put another $5 to $6 million in the company to defend the patents which many not have been well crafted? Was the investment of time and funds into the BIT enterprise based on a false understanding of the value of these patents as an asset of the company?

Patents – Risks and Liabilities

A patent filing eventually becomes a public document. The patent filer is publicly disclosing the invention in exchange for protection from competitors for a period of time. This social and legal contract is intended to encourage innovation. The inventors get a premium on sales and profits as compensation for the risks and front end expenses when developing the new technology. Inventors incur risks and front-end development expenses in the hope of receiving a premium on sales and profits for a limited period of time.)

The dilemma for all smaller companies and particularly startup and growth phase companies is that creating patents with actual value is expensive. These companies usually do not have the funds or cannot justify the expense necessary for comprehensive patent filings without first establishing that their technology has a large market. A well-founded competitor can take the publically disclosed information and duplicate it or work around it. The originator of the invention is then challenged to contest the patent infringement in court. Who has more funding and staying power can become the deciding factor.The deciding factor can become who has more funding and staying power,

The process of crafting the patent filing, including the claims and prior art, is very technical. If not done properly, the resulting patent may issue, but can be attacked by a competitor. The patent protection and its value to the owner can be quite limited. If there is real value to the patent, competitors will look for its vulnerabilities.

Consider the case of the company whose product increased the speed of fiber optic networks. A company in their circumstances will probably not want to build manufacturing capacity in the US, at least initially, and may look for a manufacturing partner in China. In order to reduce their production costs as much as possible, the company might have the components built and the assembly work done in China. In cases like this, the same Chinese companies or related companies may duplicate the product and sell it in the Chinese market and even in the US market regardless of patent filings.

US companies are counseled to keep core technology out of China to limit the ability of the Chinese companies to fully duplicate their products. Yet US companies are doing deals with Chinese companies knowing that some of their technology will be stolen. Chinese companies have money and want access to technology. If funding for clinical trials for drug development and other long term investments is not available in the US, doing the development in China with Chinese funding may be the only way to get the work done. The hope is that while Chinese companies may take over the Chinese market using the US technology these companies will not aggressively go after the US and European markets.

Improve Your Chances for Success

For some companies, patents and other forms of protected Intellectual Property are important if not essential. But each company must design a strategy for developing and managing IP that is appropriate for its business and the industry in which it competes. Following these steps will improve your chances for success as a technology innovator.

1. Think of Intellectual Property (IP) more broadly – patents, trade secrets, copyrights, trademarks, contracts, confidentiality agreements, internal secrecy practices and cyber defenses. Be clear who owns new IP in employment contracts and in joint corporate development partnerships. Develop an IP strategy from the beginning that is appropriate for the circumstances of your company and your technology.

2. Don’t pretend that you can play the big well-funded company patent game unless you are a big well-funded company.

3. Carefully consider the tradeoff between filing for patents – disclosing your invention – and keeping your invention a trade secret. A patent is of little to no value in blocking competition unless you are able to defend it – which can be very costly.

4. If you go the patent route, play for time. Minimize your costs by inexpensive provisional filings including provisional international filings or PCT until you demonstrate that there is a significant market value in the technology that will be worth the high cost of securing and defending the patents.

5. Be realistic with yourself and your investors about the current and longer term cost to create patents that could limit your competitors. In some sectors like pharma, patents are essential. In much of the software and app world, patents and copyrights are under attack. Make the necessary investment in fully researched and carefully drawn filings. Include litigation costs as part of your budget.

6. Some early stage companies, will not Consider not playing the patent game. They Some early stage companies make an effort to keep their innovations confidential and primarily compete on the basis of being “faster, better, cheaper.” Sometimes they will attack a competitor’s patents. The big disadvantage of this approach is that investors believe – whether valid or not – that the patents are the value in the company. Fund raising is difficult without the patents.

Patents - Asset or Liability (1)- Rick Williams7. Make limited investments in patents even when you cannot defend them against well funded competitors. Patents can also be valuable for documenting who “owns what” between collaborators, time stamping the creation of an idea, cross licensing, and asserting a claim to ownership. Even when the early stage company does not have the funds to defend its patents, a perspective VC or JV partner will see the value of the patents when their funds are put on the table. But the company needs to keep the costs in proportion to the value of these benefits at each phase of the company’s development.

8. If you create a manufacturing process – think Coke – that will not leave your facility and decide to protect some or all of your IP as trade secrets, your entire organization must be part of the fortress keeping the secrets inside the company. The trade secret only has value if it is kept a secret. In addition to confidentiality agreements signed by each employee, you need to build a culture of protecting the IP and, to the extent possible, limiting and dividing access to the core IP.

Innovation creates value. Smart protection and commercialization of innovation captures the value.