Intellectual property used to be something talked about mostly in a university classroom. Not anymore. These days, intellectual property represents an increasing share of the value of many portfolio companies. Yes, VC investors still look closely at the core business strengths of emerging companies, but they are also doing more and more due diligence when it comes to the value of a company’s intellectual property holdings, including untapped potential. Once the patenting process begins, to safeguard their inventions, these companies are looking for VC funding to attract the required investment capital needed to complete the marketing and funding of the technology.
One of the best reasons to invest in a company with a robust and significant patent portfolio is that it reduces unknown risks associated with pioneering technology. After all, investments in emerging technology companies are often risky propositions, because there are no established benchmarks.
But patent protection, at the very least, signifies some amount of novelty and future capital potential to insure against the risks associated with innovative technology. The procurement of a patent, for instance, provides a government-authorized monopoly for a period of time for the patented technology. United States patent laws generally provide three incentives: to invent; to disclose; and to risk capital in their procurement.
The Tricky Criteria
To obtain a patent, inventors must demonstrate a known usefulness for the invention; this quality is also known as “utility.” Also, inventors must demonstrate the novelty of their invention. Finally, for a patent to be granted, the inventor must show that it was non-obvious at the time of the invention.
It’s this last criterion that presents the greatest challenges today. Non-obviousness is perhaps the most difficult of the obstacles that a company faces in seeking patent protection. The non-obvious requirement considers all of the known information and discoveries in the field of invention and requires that the invention not be “obvious” to a person of ordinary skill in the field of the invention.
Patents consist of three parts: a drawing, a specification and a claim. Drawings, obviously self-explanatory, are an illustration of the invention. A patent’s specification is a written description of the invention, and it often includes a detailed description of certain embodiments of a claimed invention. The claims of a patent are numbered paragraphs at the end of patent that set forth the scope of the invention. More importantly, the claims of a patent are the metes and bounds of the patent property right, much like a deed to a piece of real property.
The U.S Patent Office grants patents in a variety of fields, such as computer software, hardware and biotechnology. Obtaining a patent in a particular field can confer substantial competitive advantages in an increasingly competitive marketplace.
Patents should be viewed as a tangible company asset, since the funds used to procure them result in the disclosure of emerging technologies. Recently, the U.S. Congress amended the patent laws to give patent owners an exclusive right for 20 years from the date of their original patent application. It is this limited “monopoly” granted under the U.S. Constitution that enables companies to exploit their invention through license agreements and litigation.
And patent protection is on the rise. Large companies can receive thousands of issued patents each year. The creation of a large patent portfolio typically does well with investors who look to patents as the future building blocks of a technology company.
Advantages of a License
A patent confers a bundle of rights upon the patent owner, namely, the exclusive rights to make, use, sell, offer for sale or import the invention. Patent holders may elect to retain these exclusively, or they may license their patents to others.
A license grants the right to operate under the patent without the threat of being sued for patent infringement. In exchange for this right, the licensee ordinarily pays royalties to the patent holder. Some license agreements call for a payment when it is signed; others require an annual payment; and still others require the ongoing payment of royalties.
A company can choose to license a portion or all of its patent rights to a licensee. Therefore, a patent holder can license different rights, such as the right to make or the right to sell the invention, to different licensees. In this way, license agreements can be very lucrative for companies. Creative licensing arrangements are one way to maximize revenue.
Licensing arrangements can vary, and agreements can be exclusive or non-exclusive. In an exclusive license, the company that owns the patent agrees not to license the patent to anyone other than the exclusive licensee.
In a non-exclusive license agreement the patent holder will license similar rights to multiple parties. Thus, an exclusive license will generally cost a licensee much more. However, with thoughtful, strategic planning of non-exclusive license agreements, a patent holder can maximize the revenue stream of its intangible assets.
Another interesting aspect of patent licenses in terms of their value as a revenue stream generator is how the bundle of rights can be divided into geographic territories. Licenses can also be restricted to a particular geographical region. For example, a licensee may have the right to sell the patented invention in a particular area of the United States, while another licensee may have a similar right in a different region.
Another aspect of licensing that is gaining some popularity is the ability to license patents on a claim-by-claim basis, as opposed to granting a license to the entire patent. These arrangements sometimes allow for different market segments of similar technology to be licensed separately. For example, a company’s patent may cover a novel way of designing a microprocessor. The patent may also contain claims to the use of the novel processor in a computer system.
By licensing only certain claims to certain companies in particular market segments, a patent holder can potentially maximize its licensing revenue.
An attractive patent portfolio is critical to attracting VC funding. A company that has already invested capital in acquiring patent rights should always examine whether its assets can be mined for revenue.
Moreover, the sales that are derived from intellectual property can fund additional research and development, which in turn creates a larger technology portfolio to leverage with future investors. Since the emerging company typically has the established knowledge base, revenue from intellectual property can quickly be diverted to additional projects with decreased start up costs.
Increasingly, patent litigation serves to increase licensing revenue. Because of the significant costs and risks associated with patent litigation, potential licensees may choose to reduce unknown risks by taking a license.
Alternatively, past patent litigation success serves as a possible predictor of the possible outcome against other infringers and also increases the bargaining position of patent holders. Every VC should at least consider how a company can transform research and development costs into revenue streams – known as “monetizing intellectual property.” While patent litigation is an expensive endeavor, it can reap significant rewards.
Obtaining patent protection – and asserting patent rights, either through licensing or litigation – is a critical step toward an overall plan for an emerging company. A successful patent strategy is key to assisting VCs in creating, analyzing and monetizing intellectual property assets.
Stephen J. Akerley and Bijal V. Vakil are partners in the Intellectual Property Department of McDermott Will & Emery LLP in the firm’s Silicon Valley office. Steve and Bijal focus their practices on high-profile patent and trade secret cases.