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

from the thinking-twice... dept

Mon, Aug 15th 2011 12:54pm — Mike Masnick

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.

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Filed Under: innovation, patents, startups

32 Comments

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ChurchHatesTucker (profile), 15 Aug 2011 @ 1:01pm

Vicious Cycle?
I suspect that you're going to hear more "just to show investors I'm serious" since the VCs will likely insist on patents so they have something to sell off.
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Anonymous Coward, 15 Aug 2011 @ 1:16pm

Sort of backwards logic here. The company selling the IP was effectively was going to be a non-functioning entity (because they were not going to get any more funding), and instead they sold off the IP to repay investors.

The buyers of those patents could be anyone, from a compatible existing business to, yes, a "patent troll". However, there is no encouragement for non-practicing entities, A sale is a sale no different from selling a classic car to someone who sticks it in a barn to pull out 20 years later to sell. Some people drive the cars, some people collect them, some people hide them.

There is no encouragement one way or the other.

However, these is encouragement to invest. See, the company that sold the patents were able to pay off their investors, who put money on the table up front. That is the value of the patent, right there, as in the end, when they decided to wind down the company, there were assets - patents - to sell.

If anything, you have proven the value of patents for investors. Congrats on making my points for me!
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dfed (profile), 15 Aug 2011 @ 1:33pm

I'm waiting for someone to patent the business process of shutting down a start up and selling their patents to recoup losses. That might provide some protections.
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6, 15 Aug 2011 @ 1:35pm

"again noting that the patents are more valuable when there's no practicing entity to deal with. "

Not necessarily. Some patents are more valuable while the company is alive so as to obtain an injunction or threaten one under the ebay standard.
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ChurchHatesTucker (profile), 15 Aug 2011 @ 1:36pm

Re:
That is the value of slavery, right there, as in the end, when they decide to wind down the company, there would be assets - slaves - to sell.

It makes perfect economic sense.
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Mike42 (profile), 15 Aug 2011 @ 1:41pm

Re:
Yes, you have echoed the backwards-ass logic of the original article. "Patents are great, because the investors have more assets if we fail."
But did you start your business to fail? Of course not. Then why be so excited about an asset that is only useful after you have failed?
If the startup had the next round of funding, maybe it would have succeeded. We'll never know, because their patents were too valuable.
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Richard (profile), 15 Aug 2011 @ 1:42pm

Re:
That is the value of the patent, right there, as in the end, when they decided to wind down the company, there were assets - patents - to sell.

However the odds are that at that stage the value of the patents is probably less than what it cost to obtain them in the first place.
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Anonymous Coward, 15 Aug 2011 @ 1:44pm

Re: Re:
I think you missed the part about its precarious (i.e., untenable) financial position that led to the decision to liquidate.
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Anonymous Coward, 15 Aug 2011 @ 1:46pm

Re:
because they were not going to get any more funding

Incorrect. Because they had the patents that were worth $$, they decided not to seek additional funding. The decision to give up was reached because of the existence of the patents. That's Mike's whole point here.
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Anonymous Coward, 15 Aug 2011 @ 1:58pm

Re: Re:
Uh...not quite, but then one should never pass on an opportunity to craft an argument, no matter how farfetched, to slam patents.

Frankly, it seems to me this company more likely failed because Jupiter did not align with Mars, and peace did not guide the planet. Hence, Aquarius never dawned.
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Anonymous Coward, 15 Aug 2011 @ 2:05pm

Re: Re:
So what you are trying to say is that the IP they created was worth more than the company was going forward, and that selling the patents to third parties to exploit them (perhaps in their current or future businesses) is somehow bad?

I am trying to figure out the point where making a profit by developing IP is bad.

All I am seeing is that what they intended to use the patents for was worth less than the value of the patents themselves. Not having a patent would have likely cost them their entire investment. Seems like getting the patents was a very, very good thing.
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out_of_the_blue, 15 Aug 2011 @ 2:50pm

Money is all that lawyers and Vulture Capitalists care about.
Direct connection to the patent mess.
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Richard (profile), 15 Aug 2011 @ 3:08pm

Re: Re: Re:
All I am seeing is that what they intended to use the patents for was worth less than the value of the patents themselves. Not having a patent would have likely cost them their entire investment. Seems like getting the patents was a very, very good thing.
Not if the expense involved in getting the patents (not doing the real work - just the drafting and filing costs) exceeded their realised value.

Clearly the existence of rhe patents gave the investors an excuse to panic.
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ChurchHatesTucker (profile), 15 Aug 2011 @ 3:09pm

Re: Re: Re:
Precarious != Untenable
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Chosen Reject (profile), 15 Aug 2011 @ 3:22pm

Re: Re: Re:
So what you are trying to say is that the IP they created was worth more than the company was going forward
No, what he is trying to say is that the current value of the patents is greater than the current value of the company, not necessarily the future value of said company. That might be because the company couldn't possibly be worth anything ever, it might be because the likelihood of success is low, or it might be the usual short term current valuation alone.

As an example, say Larry Page and Sergey Brin had patented the Pagerank algorithm. There was a time where that patent would have been worth more than Google. However, Google is now worth way more than the pagerank patent would have been.
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Josh in CharlotteNC (profile), 15 Aug 2011 @ 3:24pm

Re: Re: Re:
and that selling the patents to third parties to exploit them (perhaps in their current or future businesses) is somehow bad?

Absolutely yes.

Patents are supposed to be about progressing "science and the useful arts" - not just some piece of paper lawyers can wave around to get people to give them money.

I am trying to figure out the point where making a profit by developing IP is bad.

Nothing at all wrong with making a profit - unless you're doing it by stopping or slowing someone else from doing something useful.
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iptrolltracker, 15 Aug 2011 @ 3:25pm

The first question the sharks ask on Shark Tank is "Do you own the patent?" This is why.

I think it's reaching to say that having patents HURTS start ups though. It can hurt them, I suppose, if the owners of said start up are not happy with a buy-out price. If they are, I don't see the harm? You either get another round of funding to continue the business (greenbacks) or you get the proceeds from the sale of your patents (greenbacks).

Not sure the startup guys care...
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Anonymous Coward, 15 Aug 2011 @ 4:09pm

Poison pill?
How about if the startup makes a binding promise that the patent would only ever be used for defensive purposes?
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Beta (profile), 15 Aug 2011 @ 4:11pm

I'm missing something here...
I don't quite see the logic.

If the company bought the patents as a defensive measure, then it's as if the company's office must be be wallpapered with sheets of gold, which can be salvaged if and when the company folds: starting the company requires extra capital for this, capital which can be recovered in liquidation.

If the company created the patents, then why can't the board sell them without closing the company? If they cover inventions which the company is actually using, the company could require a full license as part of the sale agreement-- this shouldn't diminish the market value of the patents at all, since they couldn't be used against a defunct company anyway, and they can still be used against everyone else in the market (unless the company stands to corner the market in a valuable product, in which case the board would be insane to consider liquidation).

What am I missing?
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Beta (profile), 15 Aug 2011 @ 4:18pm

Re: Poison pill?
Even if such a promise were possible, why would the board allow it?
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Anonymous Coward, 15 Aug 2011 @ 5:38pm

Re: Re: Re:
"Frankly, it seems to me this company more likely failed because Jupiter did not align with Mars, and peace did not guide the planet."

Seems to me that you have your head so far up Uranus that everything you see has been flipped back upside down.
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Anonymous Coward, 15 Aug 2011 @ 7:29pm

What I see with patents is a consolidation of patents into mega pools of patents that cost billions to maintain and can effectively leave out everybody else who is not part of a patent pool.

So the only chance to produce anything is to be part of a mega patent pool and pray that patent trolls don't come knocking on the door. Maybe this will force people to go to other countries to produce things and find new markets because the one inside the US is becoming a wasteland.
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Anonymous Coward, 15 Aug 2011 @ 8:06pm

Anybody has the rate of approval of patents in the PCT(Patent Cooperation Treaty) scheme?

The USPTO removed the page there, for some reason they apparently don't want people going that route, maybe because it does have a high rate of refusal then their cavalier approach to patents.
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Anonymous Coward, 15 Aug 2011 @ 8:18pm

http://www.ip-watch.org/weblog/2011/07/12/trans-pacific-partnership-agreement-did-us-move-threaten-p ublic-health/

Granting patents that could harm people's health.
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Anonymous Coward, 15 Aug 2011 @ 8:29pm

Re: Re: Re: Re:
Which means that Mike is making the assumption that every sale of IP leads to patent trolling, which is just not right. It's misleading as heck to hold this company up as some sort of example of "feeding the trolls", isn't it?
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Anonymous Coward, 15 Aug 2011 @ 11:27pm

No matter which way you play it, the end result is the same:

The company saved it's investors millions by obtaining patents rather than just letting things go. They converted their ideas and concepts into valid, valuable assets. Those concepts are valuable enough that they can make more selling them than trying to exploit them, and in process, make their investors money.

Damn capitalist system!
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Mike Masnick (profile), 16 Aug 2011 @ 1:52am

Re:
Damn capitalist system!

Building a market based on gov't granted monopolies is not capitalism.
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Anonymous Coward, 16 Aug 2011 @ 10:17am

Re: Re:
Building a market based on gov't granted monopolies is not capitalism.

Sure it is, if those monopolies are the result of investing in lobbying the government or buying patents. That's what capitalism is, using money (investments) to make more money (as opposed to exchanging labor for it). Patent trolls are pure capitalism in action.
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Josh in CharlotteNC (profile), 16 Aug 2011 @ 10:20am

Re: Re: Re: Re: Re:
Which means that Mike is making the assumption that every sale of IP leads to patent trolling, which is just not right.

Please quote specifically what made you think that Mike is making that assumption.

Even I wouldn't say that all patent sales definitely lead to patent trolling, and I'm as anti-patent as they come. I will say however, that ever penny spent on patents and lawyers, whether filing your own patents, acquiring someone else's, or defending yourself from trolls, is money that could be better spent to make your products better, lower costs to your customers, or share profits with your investors.

It's misleading as heck to hold this company up as some sort of example of "feeding the trolls", isn't it?

It's not misleading at all. Not when the guy comes out and says both that he's likely one of the largest sellers of IP and that patent wars have started. I'll quote: "We sell tons of IP, and as you know, the IP wars have started" - he's admitting that he's feeding trolls himself.
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Vic Kley, 16 Aug 2011 @ 11:05am

Thanks for Truthfully SHowing Why Patents are a Great Resource for Start-ups
This silly argument professing to show why patents are a problem instead shows that when all else fails patents provide value to investors (and in most cases in which the funds raised exceed the funds in) put some money in the entrepreneurs pockets. No one should lose sight of the fact that the investor controls the company until they recover their investment and make a profit.
Thanks for confirming what most of us already knew!
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Chris Noble, 24 Aug 2011 @ 1:37pm

Are patents a liability?
I don't see the logic of the author's premises. (1) Companies should not spend money on patents unless they get an expert opinion that the patent is likely to be valuable, obtainable and defensible. Otherwise they should criticize their own expertise, not the patent system. (2) The "worth more dead than alive" argument is like saying people should not buy life insurance because it will tempt them to commit suicide.
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Mike Masnick (profile), 25 Aug 2011 @ 1:44am

Re: Are patents a liability?
The "worth more dead than alive" argument is like saying people should not buy life insurance because it will tempt them to commit suicide

Not at all. If you're going to use that analogy, it's much more like saying that people should not buy life insurance if the beneficiary of the policy is only focused on getting the most money possible out of the person and has a history of murdering 9 out of 10 others in the same situation.

Then the analogy works.

Patents do not help startups. Sorry.
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