In this era of technology and innovation, businesses are becoming increasingly dependent on intangible property (aka: intellectual property) to run their operations and produce profit. That being said, investors need be confident that the intellectual property assets of a company (patents, copyrights, trademarks, licensing agreements, etc.) are legally and fiscally sound prior to tendering agreements. The intellectual property protection of a startup plays a significant role in determining its value. In fact, for some startups, intellectual property protection is the sole metric for valuation.
IP assets are incentivizing for venture capitalists because they have multiple aspects of value and have the potential for creating “excess profits”. These multi-revenue, generating aspects include defensive use, internal use, sale, licensing, and others.
Examples of IP assets are: patents, software, domain names, trademarks, and trade secrets. To ensure maximized profits and to promote growth, it is imperative that startups identify and protect these assets. Proper intellectual property protection can mitigate revenue swallowing litigation and demonstrate to investors that your business is a sound investment.
Probably the most well-known IP protection is through a patent. US Patents are granted by the United States Patent and Trademark Office (USPTO), within the Department of Commerce. When a US patent is granted, it essential gives the inventor(s) or assignee(s) the authority to exclude other parties from using, selling, or making their product or design in the United States. Given its power to create a temporary micro-monopoly, patents are generally highly sought after since they grant the patent owner exclusive rights to the product, which can translate to a significant competitive advantage. However, it is important that investors and innovators be aware of the nuances that accompany this IP protection method and how it affects potential investments.
While a patent may have significant advantages, the path to obtaining one is not easy and is time-consuming. Angel investors should take into serious consideration the current stage of patent prosecution the investment seeking startup is in. The average cost to prosecute a patent through its completion varies based upon the nature of invention and other variables, but can range from $5,000 - $20,000. This includes the cost of filing fees as well as the acquisition of patent practitioners (patent attorneys or patent agents). As of 2014, the USPTO takes, on average, 3 years to render a final decision on a patent application. The price and time necessary to obtain a patent are serious factors that should be considered by investors and business owners alike.
It is also important for investors to be well versed in the patent application process. A common misconception is that inventions or designs obtain patent protection once a patent application is filed. That is not the case. A patent application may be granted, rejected, or suspended until corrections are made or information is provided (in the form of office actions). A patent application renders no protection until the patent is approved and issued by the USPTO.
Similarly, the filing of a provisional patent application (patent pending status) provide only temporary protection and does not extend to the power of an issued patent. Investors beware: there is no such thing as a provisional patent. One may file a provisional patent application, but there is no patent protection until a non-provisional patent application is filed and a patent is issued by the USPTO.
Absence of filing for a non-provisional patent application or lack of an issued patent are serious red flags on the sustainability of a company’s competitive edge and orientation of its future growth. Furthermore, given the complexity and significant amounts of time required to obtain a patent, inquiry into the skills of the acquired patent practitioner should be made. While the USPTO permits the inventor to file for his or her own patent applications, signs of a well-drafted patent application come from acquisition of experienced patent attorneys or patent agents. This is more true for potential investments that overlap into international markets. Provisional patent applications, international placeholders, and self-draft patent applications are not strong signs of sustainable intellectual property protection.
Ownership of the patent is also necessary information for potential investors. With patent applications, the inventor(s) or assignee(s) have the power to enforce patent protection. Investors should ensure that their intellectual property is licensed to the startup, not the founders. Otherwise, single ownership of the patent may lead to the patent owner leaving and crippling your investment.
Investors should also demand the founder’s pre-prosecution research, known as a “prior art search”. This may be conducted by the founders or via a patent practitioner. This is important because patents are granted to innovations that are unique. Failure to conduct adequate research and to distinguish one’s product or design from existing ones creates a risk of a rejected patent application and potential patent infringement litigation. Furthermore, if a startup has marketed its product or design beyond the grace period (typically twelve months), their own product may be considered prior art and eliminate them from obtaining a patent.
Patent litigation can become a serious drain to a company's capital and resources. Averaging $3-$10 million per claim, not only can the court fees and time required to fight patent infringement claims reduce profits, it may potentially cripple the organization’s productivity through injunctions and court orders. Hence, avoiding IP litigation can result in superior returns. All the more reason for investors to get serious about their IP inquiries in the due diligence phase.
Trademarks also have considerable effects on the valuation of a company. While startups with filed patent applications or issued patents are likely to receive funding from venture capitalists, it is imperative that investors consider trademark protection during their due diligence process. Trademarks are strategic means to protect one’s marketing assets. Because branding and advertising depend upon visual imagery, venture capitalists should view ownership of trademarks as a sign of a startup’s potential growth, ambition, and interest in protecting its future marketing value.
Like patents, trademarks are granted via registry through the United States Patent and Trademark Office, however, they operate in a different manner and grant different authority. Trademarks grant the owner the ability to exclude others from using protected symbols or signs. Logos, sounds, smells, or phrases are also trademark eligible and can help distinguish the product or design of the startup you are considering from others within the same market.
Lack of trademark protection should trigger a red flag to potential investors that the leadership has failed to mitigate risks to their marketing value and lack the legal basis from future branding. Just like with patents, investors should be skeptical of trademarks in the review stage that have yet to be granted. A rejected trademark is not a myth. Just ask the Las Vegas Golden Knights.
Only acquiring a patent or trademark for your product or company is no longer a sufficient means of protection or profit maximization. Rather, a well-rounded IP protection strategy is necessary. There are other tools and methods startups can explore and implement to ensure that their ideas are protected from litigation and potential theft by competitors. Of these, IP licensing is probably most significant. Not only does proper IP licensing ensure only those permitted to access your product can, but also maximizes the full utility of the assets. Owning a patent or trademark is an excellent asset, because you can exclude others from using your design or product. However, oriented growth can be achieved by relaxing exclusivity authority through licensing agreements. Through licensing, IP assets can be tapped for their excess profit potential where a startup can leverage their ideas into profit making partnerships. It would behoove investors to take into account the various IP assets in a startup and analyze them for maximum return to their investment. Leave no stone unturned.
The thing about intellectual property issues is that they are avoidable. Typically, the red zone for startups to begin their intellectual property strategy is within the first twelve months of operation. Investors should seriously consider the risk they take by failing to conduct a thorough intellectual property investigation. Litigation, loss of IP rights, and mis-valuation of an investment can lead to no return for negligent investors. But for those that would take heed, you will reap the rewards, because intellectual property is the cornerstone of sound investments.
ABOUT THE AUTHOR
Caleb Green is pursuing a Juris Doctorate at the William S. Boyd School of Law, and holds a Bachelor’s in Computer Science He is working on a smartphone app in his free time, and has interests in intellectual property and cybersecurity law. Outside of RVF, he is actively engaged in the UNLV and the Las Community.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of RVF or UNLV. In addition, thoughts and opinions are subject to change and this article is intended to provide an opinion of the author at the time of writing this article. All data and information is for informational purposes only.