Patent Pitfalls for Early Stage Investors –

Patent issues often loom large for the early stage investor. A young company may only have its patent portfolio to attract investors-no approved products and no revenue. In the high-stakes world of venture capital, patent-based risks become more critical, because young companies may not bring much to the table besides their business plans and their patents. Watching out for patent pitfalls will minimize risk for the investor.

Companies generally are eager to show off their IP assets, laying open their patent portfolios to potential investors. “We have over 50 patents,” the company asserts. But quantity may be deceiving. The company may be counting patent applications, which have no presently enforceable legal rights, along with patents. Furthermore, the company may not actually own what it considers to be “its” patents. Being aware of these pitfalls lets the investor avoid them.

What “counts” as a patent? Strictly speaking, the only thing that should be called a patent is a document issued by a national governmental agency that grants enforceable rights within that country. To obtain a patent, an applicant first submits a patent application to the appropriate agency in a particular country, which is then examined by that agency. Following a successful examination, a patent issues that provides the patentee exclusive rights to the invention it covers. Because not all applications will result in the enforceable legal protections of a patent, counting applications as if they were issued patents can unintentionally inflate their value. The investor should distinguish patents from patent applications, identifying the issued patents and determining the likelihood of patent applications issuing as patents with commercially meaningful coverage.

Imbedded in a company’s presentation of its patent portfolio is the presumption that the company actually owns those patents and applications. This may not be the case. The company may be using patents it thinks it owns but does not. Before asking how good the company’s patents are, the investor should find out which patents really belong to the company.

United States patent law begins with the premise that the inventors themselves own their patents, unless they assign their interest in a patent to another. Because companies do not themselves invent anything, companies will not own any patents unless the actual inventors assign their ownership. Ideally, agreements should be in place requiring an employee or consultant to assign his inventions to the company. Beyond these agreements, the company should direct the inventor to execute an assignment document when a patent application is filed, and then should record that assignment with the appropriate governmental agency-such as the U.S. Patent and Trademark Office (“Patent Office”)-to provide general notice of the assignment to the public.

Why does this matter? If the inventor, not the company, owns the patent, he may license it to competitors or use it as he pleases. If there are multiple inventors on a patent, each inventor has full rights in the patent, including the right to assign his interest to another entity and the right to offer any and all comers non-exclusive licenses to the patent. For a company to have exclusive control of a patent’s rights, each inventor must assign his rights to the company. As a first step, then, the investor should be sure that all the company’s patents are properly assigned. As a second step, the investor should inquire about whether the inventors are bound by pre-existing obligations to assign their interests. University faculty members and consultants are particularly likely to have conflicting obligations. Title problems, pre-existing obligations and other issues affecting patent “inventorship,” or ownership, are best resolved early-before the company’s valuation, and the patents’ value, increases.

Barriers To Entry

Patents impair a competitor’s ability to enter a company’s commercial space. To be effective barriers to entry, patents must be broad (so that a competitor cannot easily design around them), strong (so that they will withstand court challenges) and commercially relevant. An investor should look at the company’s patent portfolio with these parameters in mind.

Broad patent coverage is hard to obtain, because patents are only awarded for inventions that are novel and non-obvious when compared to everything else in the field. Fields that are fairly mature are crowded with all sorts of ongoing research. The more crowded the field, the less likely that any new technology described broadly will survive Patent Office examination intact. During examination, an applicant will likely need to narrow the definition of the invention by calling out certain features that the pre-existing technologies do not possess. The more features added to the definition of an invention, the narrower the patent covering it and the easier it is for competitors to design around it by eliminating or modifying one of its features.

A patent’s strength cannot be definitively known until it is challenged in court: A patent is strong if it survives a validity or enforceability attack during litigation. In the patentee’s-and, thus, the investor’s-favor, a challenger must meet a high standard to prove that an issued patent is invalid or is unenforceable. Although no one will know for sure how strong a patent is until it is attacked, an investor can obtain clues about its strength. As one clue, a patent that was thoroughly examined in the Patent Office is likely to be “stronger” than one where there was little back-and-forth with the Patent Office, because the thoroughly examined patent has already withstood a series of challenges. Another clue for an investor is the amount of research already existing in the field. A crowded field with many technical references suggests that other research preceding the inventor’s innovation may exist that could invalidate the patent.

Finally, broad and strong patents do not help a company if they do not relate to its business plan. A young company’s technology and business plan may change over time, so that the initial patents no longer cover what the company now intends to commercialize. The mere presence of good patents is not enough. The patents must map onto the technology that the company is trying to protect so that they keep competitors away from the company’s commercial endeavors.

Having a good patent position does not ensure that the company will be able to commercialize its technology. Other patent-holders can have their own patents, called “blocking patents,” that can prevent another company from doing what it wants. In other words, a company can have its own patents, but still can be blocked by patents that a competitor holds. How can this be? This outcome stems from the very nature of patent protection. A patent grants the patentee the right to exclude others from practicing what the patent covers. It does not grant the patentee an affirmative right to practice what the patent covers. A patent is simply a right to exclude.

Road Blocks

Broad blocking patents may issue early in a technology’s life cycle, dominating any future developments in the field as long as they are in force. Other inventors may obtain patents to innovations and modifications in the field, but they cannot practice what they have patented without obtaining a license from the pioneer. Blocking patents need not be broad, though. A narrow patent will block a commercial product if it covers a key component of that product. The company will then have to design around the patented component or obtain a license from the patent-holder to use the component in its product.

No matter what patents the company owns, the investor needs to look out for third-party blocking patents to be sure that the company can commercialize its products. If third-party blockers are identified, the investor should investigate the company’s strategies for dealing with them. The risk of patent litigation-especially the risk of triple damages when a company knows about blocking patents and does not plan properly to avoid them-can make an attractive deal lose its luster.

Even when the issues above have been addressed, any number of miscellaneous patent skeletons could lurk in the company’s closet that would affect the early stage investor’s decision-and he or she may not find out about them unless he or she asks.

For example, an investor should ask whether there are critical technologies that the company licenses in from third parties. If so, the investor should have someone review the license agreements to ensure that the terms are not too restrictive. As another example, an investor should gauge the risk of offensive or defensive patent litigation involving the company. Has the company received any notifications of potential patent disputes? Does the company do business in a litigation-prone industry? Is the company aware of potential infringers against which it will need to assert its patents to protect its commercial space? Litigation is time-consuming and expensive, distracting the company’s attention from its business. Have any of the company’s patents been challenged in the Patent Office, as part of an interference or reexamination process? Defending one’s patents, whether in administrative proceedings or in court, can have an impact on the company like an infringement suit.

None of the patent pitfalls described above may in themselves be sufficient to scuttle an otherwise promising deal. The early stage investor is in a position of heightened risk, though. Identifying patent problems will help her manage this risk. For example, an inquiry could alert the investor to additional potential problems, such as a disgruntled inventor who has not assigned his rights to the company, a license to important technology with restrictive terms, or third-party patents that are close to the company’s technology. The better informed the investor can be about the company’s patents and those of its competitors, the more sure-footed he or she will be in avoiding patent pitfalls and thus investing unwisely.

M. Sharon Webb is a patent attorney in the Life Sciences practice at Goodwin Procter and a former surgeon. Webb specializes in advising investors and companies about patent issues. She can be reached at swebb@goodwinprocter.com.