How Getting A Patent Can Actually Be Detrimental To A Startup's Long Term Success

Patents

from the thinking-twice... dept

There’s a standard refrain we hear all the time from startups in Silicon Valley, which is some form of “I hate patents and think they’re anti-innovation… but I still have to register a bunch, just for defensive purposes.” One variation on this is “just to show investors I’m serious.” These entrepreneurs insist that their patents will never be used offensively, but they can’t really promise that. In fact, such patents can actually harm the very company that got them. One way is pretty obvious: just getting patents takes (precious) time, money and resources that could be put to much better use elsewhere. However, that’s perhaps a smaller issue than the fact that patents can make a company throw in the towel earlier than it should.

To explain why, let me pull from a few recent news articles that, together, hopefully explain the issue. Tim Carmody at Wired highlights how, when startups fail, investors sometimes recoup some of their money by selling patents. He gets that from a PEHub interview with Silicon Valley tech startup liquidator extraordinaire, Marty Pitchinson, whose reputation, as the dot com cleanup guy, we’ve chronicled for nearly a decade (when his business is good, the rest of Silicon Valley’s business isn’t).

There are two key points that he makes. The first is that ten years ago, patents weren’t a big part of his business. Today, they’re a massive part of his business:

Things have definitely changed. I remember in 1999, 2000, I would sell a used server for $35,000 and I had a line of people wanting it. Today, a server is $5,000 and you can get an okay server for less than $2,000. [In the meantime], we?ve probably become one of the largest sellers of [intellectual property] in the country. We sell tons of IP, and as you know, the IP wars have started, so we play with the big guys, the little guys, and the in-between guys. During the last bubble, there weren?t as many patents. It was more ideas and URLs. So the business has matured.

Back in the Wired article, Carmody points to a case study on Pitchinson’s website, in which it notes that it helped sell off the patents of a company that had raised $65 million in venture capital. In that case, the board (meaning, mostly the investors in the company) decided that “they would be better off selling off their IP than seeking an additional round of funding.”

Now, combine that with the story we had discussed recently by law professor Colleen Chien about patent trolls, where she makes a point that many have raised before: the system actually encourages the formation of non-practicing entities (trolls) to hold patents, rather than companies who actually do stuff:

Successful trolls have found ways to remove these traditional obstacles to suit. Most obviously, not making anything immunizes them against counter accusations of infringement. A liability in every other context, having nothing to sell is an asset for trolls. This is why patents are often worth more when a company is dead and has nothing to lose from patent counter suits, than when it is alive and does.

Now, pull all of this together and you have a situation where patents can actually be a ticking time bomb for startups. With patents in hand, even if they were obtained solely for defensive purposes, a board could decide (as happened in the case above) that a better way to get some return on their investment is just to shut down the company and sell off the patents — again noting that the patents are more valuable when there’s no practicing entity to deal with.

Thus, startups with patents risk having those patents represent a greater value than the business itself, making it too easy a target for a board (of mostly investors) to simply liquidate the company in order to seek the immediate cash of patents for use by trolling operations. It’s the worst of all world’s. Companies get shut down too early because the cost/benefit tilts too strongly towards selling the patents. The patent that was originally acquired solely for defensive purposes then ends up in the hands of an NPE who plans to sue lots of companies.

While this certainly does not apply in every case, it should be a real concern with some companies, in that they will have a shorter timeline to build a business and succeed before the VCs decide it’s best to just sell off the patents and see what they can get.

Filed Under: innovation, patents, startups