Startups and Patents..Really?

As an expansion stage venture capital fund, we are often asked by our expansion stage portfolio companies about the importance of patents. Needless to say, this is a highly debated topic within the venture capital community and one that I continue to monitor closely. Given my 15+ year tenure at Microsoft, I’m a staunch supporter of anti-piracy and patents, however, I’m open to listening to opposing positions.

For example, refer to a blog written by Jason Mendelson of Foundry Group entitled “Should Startups Invest in Patents?”. In his blog, Jason cites his friend Rob Shurtleff (also a VC) as saying:

1. Software patents have in our experience not added significant value to early stage companies when they are acquired;
2. Early stage companies can’t afford to use granted patents as an offensive weapon (this is equivalent to the rules of Mutually Assured Destruction), a few nukes isn’t going to cut it when fighting a super power;
3. It costs a huge amount of time and money to do a high quality patent filing, there are a lot better things to spend your time and money on; and
4. The rules are changing and making this whole area less predictable.

While I don’t entirely agree with Rob, I believe Jason’s comment is valid in that “there are some business plans that absolutely require patents: anything in the biotech / medical space, new hardware technologies, semi-conductor, new computing or interfacing languages, etc.”. Case in point, while trolling the web, the only examples I could find correlating patent portfolios to healthy exits were mainly life science and medical device companies.

Recently, IP Vision, a patent landscaping and data company originally out of MIT, conducted an extensive study of 9,000 venture backed firms to answer the question “can an evidence based approach to intellectual property analysis provide insights into the business and competitive context of a company’s intellectual property position as well as its importance and legal quality?” Understanding these insights will improve one’s ability to assess the business and investment value of a company’s IP and its prospects for business and investment success.

Refer to the article appearing in the March/April 2010 edition of IAm magazine entitled “IP in early-stage commercial and investment success” by Joseph Hadzima, Bruce Bockmann and Alexander Butler. The article explains the survey analysis, methodology and key findings summarized below.

Note that the research was not an attempt to identify a specific dollar value or to provide a legal opinion on any set of intellectual property rights. Rather, the objective was to develop a basis and systematic method for venture capital investment to triage opportunities and identify where traditional, more expensive deeper research and due diligence approaches would be warranted.

The assessments support answers to three important questions:

1. Does the company have intellectual property and, if so, how strong is it?
2. What is the intellectual property landscape position?
3. Are the intellectual property rights being managed well?

According to the article, a central challenge was to develop simple and understandable guidance and initial answers to those questions even though the analytics behind the answers might be highly complex. The design resulted in a rating system using metrics derived from first principles and employing publicly available data and complementary analytics. The ratings are based on more than a dozen vectors and related calibration data that represent views of the three important questions: IP portfolio strength, IP landscape position and IP investment (family strategy).

Following are the research’s major findings.

1. Intellectual property is an important component of value. – Analysis shows that across all sectors, a significantly higher percentage of venture capital-backed winners (companies that have been acquired or have gone public) have patent portfolios as opposed to losers (companies that are out of business). In certain sectors, such as healthcare, data demonstrates the value of higher-quality portfolios. In other sectors, such as telecommunications or information technology, the effect is less prominent – although still clearly and demonstrably present.
2. Winners score higher across all three rating factors
3. Focus on IP as a component of business strategy
4. Receive the positive returns from investments in quality – When offered the opportunity to increase one’s potential for success by 10% or more at an incremental cost, few investors, or even gamblers, would pass on the opportunity.
5. Understand and communicate the business implications of your IP investments

In conclusion, the research suggests that assessments of early-stage firms and their intellectual property (patent) holdings support the position that good intellectual property provides competitive advantage and a greater likelihood of success. I’m willing to take the 10%.