Many early-stage technology companies struggle with developing a patent strategy. The founders usually understand their technology is an important part of the company’s value, but opinions in the business community about the best patent strategy are wildly divergent.
In recent years, vocal critics have argued that the patent system is too slow, too expensive and too rigid to accommodate the inevitable pivots that companies make as they find their space in the market. Others, just as vocal, make seemingly incredible claims about the positive impact of patents on company valuations.
On top of that, it is difficult to evaluate whether key elements of the company’s technology can be effectively protected as trade secrets, or if patents are the only viable option. It is no surprise that companies have difficulty deciding what to do.
Advice from legal counsel is sometimes of limited value. Attorneys who understand the company’s business usually turn to patent attorneys to advise on this aspect of the company’s overall business strategy. Patent attorneys often practice in boutiques or discrete practice groups in large firms where they develop a very narrow practice focus. As a result, they are better equipped to address what a company can patent than what a company should seek to patent, or whether the company needs patents at all. The resulting decisions about whether to file patent applications, how many, on what technology and where can feel more like an educated guess than a carefully designed plan.
For many companies, an important but often neglected consideration is a value-based analysis focused on the company’s specific industry. To be sure, there are many ways that patents or even pending patent applications can have value and the company’s specific situation needs to be considered. For some companies, patents can drive acquisitions, hold competitors at bay or document who owns what in the context of joint ventures and collaborations. Moreover, the nature of the company’s technology and the aggressiveness of established competitors may be important considerations. All of these should be considered. But few companies can afford to neglect considering the impact that patents and pending patent applications may have on valuations by potential buyers or investors.
The goal of a value-based analysis is to determine how patents are valued in the company’s specific vertical by the potential investors or buyers that matter. It bears emphasis that patents are valued differently in different industries. For example, patents are not valued the same in life sciences as in consumer products. Moreover, service and software-oriented industries such as SaaS and FinTech have specific legal and political considerations related to patents that are reflected in investor sentiments. Therefore, platitudes and even statistics about patents are of limited value if not tied to a specific market context.
Fortunately, tools are available to provide meaningful, industry-specific insights. The first step is to identify the company’s vertical. Many resources are available to define market verticals, including lists and resources published by investors and investor organizations, and the definitions are not consistent. There is a bit of an elephant problem in this regard and what the market looks like to different potential investors and buyers depends on which parts of it they touch. Accordingly, it is best to match a company to the verticals as defined in the relevant industries. Nonetheless, once applicable definitions are identified, it is simple for most companies to identify one or two relevant verticals.
Once a company has identified its verticals, various software tools are available to identify the significant investors and buyers in that vertical. For many early-stage technology companies, venture capital and private equity groups are a useful target for the analysis.
The portfolios of such groups can be readily accessed to identify a number of peers, or aspirational peers, of the company. Potential merger partners may also be considered. For law firms with an active corporate finance practice, these tools will be readily available.
Armed with these tools, a patent attorney can quickly obtain a snapshot of the patent portfolios of the company’s peers. Ideally, this analysis involves more than a “count” of the patents. It is generally useful to understand how many families of patents the peers have, whether the patents are “rifle shots” directed to specific product features or complex families attempting to carve out meaningful zones of exclusion, and what geographies are covered. Though patent positions are only one aspect of valuation considered by investors, there is wisdom and comfort in understanding what peer companies’ patent strategies looked like and whether they caught investors’ eyes.
If nothing else, the company will have a well-considered answer when asked, down the road, about its patent strategy and will be able to defend its level of spending.
Such an analysis need not be cost prohibitive. Potential investors and buyers can be identified, and a snapshot of their investment/acquisition portfolios can be obtained quickly. Then, an experienced patent attorney can get a good understanding of the general contours of the patent strategies of peer companies without requiring a deep dive.
It should be made clear that the patents are not being considered in relation to freedom to practice issues. The results of this analysis can provide immediate insights into what successful peer companies have done. In some cases, companies may realize that investors expect a significant and complex international patent position. In other cases, the analysis may indicate that patents are not viewed with great importance in the relevant verticals, and resources can be devoted accordingly.
Many early-stage technology companies develop or stumble upon a patent strategy without effective guidance. Decisions may be made in an ad hoc fashion, driven by deadlines, without a larger understanding of the objectives, long-term costs, and consequences of early decisions. For some companies, a specific competitive landscape or strategic relationship may influence the patent strategy and such factors should not be overlooked. However, for companies who are simply uncertain about how to approach patents or confused by conflicting advice, a value-based approach focused on relevant verticals can provide clarity. Considering the potential costs of developing, or failing to develop, a significant patent portfolio, this should be an aspect of diligence considered by early-stage technology companies.
— Kent Fischmann and Paul Prendergast are partners in the finance and acquisitions department of Davis Graham & Stubbs.