The Relationship Between Intellectual Property And Venture Capital

The Context

It is no longer a secret that, in today’s world, intellectual property has become the chief source of the wealth of companies. IP, and other intangible assets, now account for more than 80 percent of the market capitalization of all public companies in the world — with protectable intellectual assets now comprising the lion’s share of these intangibles. Venture capital firms and the investment community as a whole have come to some understanding of the importance of intellectual property to a company’s success — but only at the level of theory. They can regurgitate the rhetoric, saying, “…all our ventures have patents,” or, “…we make sure our ventures align IP with business strategies,” yet according to a study commissioned by Accenture, 95 percent of those ventures’ executives said their companies have failed to manage IP assets effectively Forbes magazine once put it this way,

“A lot of CEOs talk about patent strategy, but nothing happens because they and their internal organisation simply don’t know how to do it.”

Can you imagine the treasury office of any country not knowing how the commanding general of its military deploys 80 percent of the military budget, and, even worse, that same commanding general not knowing how to implement 80 percent of the available military assets?

Since IP serves as the backbone of most firms, its importance can not be left to theoretical understanding, or a tick box exercise by a deal-appointed lawyer. As mentioned earlier, most VC’s are already fond of industries where companies have active research and development, as well as brands and technology, because they generate substantial levels of valuable intellectual property. However many still lack the mechanisms of how intellectual property is created and managed. Intellectual property is a valuable and versatile commodity, which, among its many values, can help to drive the creation of value, make the difference between an organisation and its competitors, pull in more customers, and motivate M&A activity.

Venture capital, or VC, firms are usually interested in deals with higher rates of profitability — their motivation being inspired by the desire to acquire or make an investment in, valuable intellectual property assets. The largest sectors that have been dealing with VC’s in recent years include consumer electronics, life science, and communications. In these sectors, the rate of which technology has improved is quite impressive, and this has prompted VC’s to go all in. Back in 2014, deals in mobile services/software and e-commerce accounted for over half of the top twenty-five VC deals. According to a 2014 report made by Statista, the funding from VC, in the US, reached its highest level since 2001.

Why the VC disconnect?

Several factors may account for this rather striking disconnect between the value of intellectual property and the almost non-existent involvement of venture firms in the total asset utilisation. Consider, first of all, that most of today’s VC leaders (the guys that actually put up the money) came of age and formed their investment behavior in the 1980’s and 1990’s, when tangible assets like physical infrastructure, plant, and equipment, still comprised roughly 80 percent of the market value of public companies. If their educators, bosses, and mentors ever spoke about IP at all — it was perhaps just to caution about the need for a good legal department to manage the risk associated with IP. As the economy shifted from an industrial to a knowledge base, IP has been transformed from a legal framework to a strategic business asset. It follows, then, that most of these guys were unprepared and uninformed. When you consider that IP has only been recognised as a business asset in the past 15 to 20 years, it is hardly a surprise that intellectual property is still excluded from the strategy processes of most venture capital firms.

Another possible reason for VC disconnection, when it comes to intellectual property, is the fact that IP assets, despite being the primary source of corporate wealth, actually never show on the balance sheet. Thanks to a centuries-old accounting system that was designed for a world in which physical assets were the only assets worth valuing.

The Opportunities

Venture capital industry is majorly concerned with making returns, and this serves as the major drive of their investment strategies. First, a VC will drive more value for its shareholders if it can coordinate the efforts of how it venture-manages intellectual capital. Second; it looks to help companies liberate IP value creation from the tyranny of balance sheet accounting. Third, it will seek to find other meanings for what profit might mean to them — it does not have to be seen as the gain in cutting costs and maximising profit alone. Instead, they should see profit in the additional concept of, “useful consequences,” and, “valuable results.” Venture Capitalists are always looking to make investments in opportunities that yield not only huge ROI but also huge in absolute amounts. Most of them are usually not interested in highly profitable openings that have a small market size. Again these could be opportunities missed as some of those little markets have profit to be gained from IP.

The long way

Despite the fact that a lot of VC’s were previously reluctant to prioritise IP, times have changed. The completion of deals is not enough for VC’s. They, and their target companies, need to come together to develop a solid understanding of the benefits that can be derived from IP assets, and the management of assets within their space. VC’s also need to understand that some IP is essential to a particular industry or firm.

In certain industries and sectors, intellectual property may be the chief asset of a company; for example, patents in the technology and life sciences sectors. In a much more competitive market, such as smartphone technology, intellectual property assets are acutely valuable, acting as a shield as well as a sword. Having a better understanding of intellectual property and its management can generate significant value.

Conclusion

Intellectual property is a vital component of any modern company. It can generate significant value for a lot of organisations, and help catch the attention of VC’s. Businesses can also establish and maintain their competitive edge, within a specific field, with the help of IP. And, as such, every VC-backed company must protect their IP at every point and turn. But for venture firms to fully maximise their potential, especially startups and companies in their early stages, it is important they attract businesses that are not content with conventional balance-sheet strategies. They should focus on companies that strive to develop their intangibles — the value creating channels that are often invisible to traditional bottom-line thinking, and that don’t show up on the balance sheet. Commentary: My focus is on intellectual property, and I am convinced that the management of IP is how added-value is going to be created at Fractional IP.