Startup Patents — You Have Nothing Better To Do?
You have too much on your plate already, not looking to add another thing. But filing patents is one of these things an entrepreneur has to do. When exactly and why? When you lack leverage over strategic partners, when things aren’t working out with your cofounder, and before fundraising or an exit event. 3 minutes read to focus on the right patent priorities.
Table of contents
1. Bootstrapping: retain ownership
2. Prototyping: avoid commingling
3. Manufacturing at scale: assert exclusivity
4. Co-founder parting ways: clean-up a mess
5. In an early stage: earning credibility with investors
6. In a growth stage: building a moat
7. In an exit stage: increase value
1. Bootstrapping: retain ownership
Bootstrapping is a way to start a business without external funding, relying on personal debts, subsidies, grants, a day job, a side hustle, or paid proof of concepts (POC). A paid POC brings revenues without distracting the startup. This is also an opportunity to test or demonstrate a new prototype or new product.
Isn’t magical? Well… not so fast. The client may be getting more out of the POC than you think. A typical POC agreement includes an Intellectual Property clause such as:
Client shall have exclusive ownership in all Materials including Intellectual Property Rights in the Materials that are made, prepared, developed, generated, produced or acquired under or in relation to this Contract by Startup Personnel when they are developed, delivered or paid for by Client, whichever occurs first.
Did you just sell off your new product ideas to your client? “Intellectual Property Rights” includes ideas, designs, inventions, copyrights, patents, trade secrets. All new ideas integrated into a “Material” such as POC prototype may fall into the Client’s exclusive ownership. They pretty much own you.
Here are two solutions to retain ownership of new product ideas. The first solution is to negotiate better intellectual property terms. This is easier said than done. The second (and recommended) solution is to file patents prior to starting the work on the POC or receiving any payment. The startup doesn’t need to wait for a completely functional prototype. It is possible to file a patent application as soon as the main ideas are clear enough to be described, even if there are multiple technical alternatives to test down the road and some design choices are still open. And if there is no money to pay for an attorney, a self-prepared provisional patent will go a long way to establish an official proof of ownership and date.
2. Prototyping: avoid commingling
Some startups turn to open innovation — a collaborative model for new product development. They incorporate both internal and external contributions as a source of product ideas, such as potential customer feedbacks. They test the feasibility of their prototypes with suppliers and contract manufacturers. Such collaborations allow changes to a product design while it is still inexpensive.
Absent any formal assignment agreement, intellectual property rights belong to the creators. It is impractical to record all the feedback or contributions from all external partners, let alone identify the origin of ideas after multiple iterations. Here are three simple steps to allow a free flow of communication, spontaneous exchange of ideas, and promote innovations:
- sign contracts with intellectual property clauses protecting the startup (e.g., a feedback clause providing full ownership or at a minimum a royalty-free license to the startup),
- sign a confidentiality agreement with each external partner privy to the product innovation details, and,
- file patent applications before the product demo or launch, so that inventions are protected from disclosure and fully owned by the startup — don’t forget to list external inventors who will assign their invention to your startup.
3. Manufacturing at scale: assert exclusivity
For hardware startups, going from a duct-taped Adruino prototype to a production-ready design takes some work: finding a competent manufacturing partner, simplifying manufacturing processes with design changes, and testing and validating the product based on small production runs.
The manufacturer is making a leap of faith, trusting a thinly capitalized startup with no proven market. The hope of the manufacturer is to recoup the initial investment in the long run. At this stage, the startup is not in a position to negotiate exclusive terms preventing the contract manufacturer from working with others on similar products. The manufacturer is already charitable to allow time for the startup on a pilot production line. The manufacturer may impose minimum volume commitments because of its leverage.
Patents provide an easier path to exclusivity than bilateral negotiations. By filing patents, the startup doesn’t need to negotiate an exclusive supply agreement. Once granted, each patent provides an exclusive statuary right. This right can be asserted by the startup against anyone: to prevent the manufacturer from enabling copycats, or against competitors directly.
4. Co-founder parting ways: clean-up a mess
When a technical co-founder leaves a startup, sorting out the invention ownership issues can be messy. The notorious case of the Winklevoss twin brothers is an illustration. The twins claimed Mark Zuckerberg stole their social network idea when he created Facebook. The lawsuit, brought by ConnectU Inc., ultimately settled after many years of legal battles¹.
Anyone working for a startup should sign an agreement assigning all inventions to the startup. But a blanket assignment is not enough. When someone leaves, undocumented ideas are hard to track after the fact. With emotions running high, invention ownership issues will most likely get resolved in courts: what was part of the general knowledge, skills, and experience of the departing person (allowed to use)? or part of the intellectual property of the company (not allowed to use)?
Patents create a clear and official record of the ownership of the company’s inventions. When a co-founder shows signs of disengagement, it is time to start a targeted patent process. Prepare a list of all the ideas she or he is working on. When the intent to leave is official, request to formally document these ideas in patents as part of a negotiated exit package. These last-minute filed patents can clarify what was actually invented by the departing co-founder, avoiding future legal battles.
5. In an early stage: earning credibility with investors
A regression-based quantitative research² estimates technology startups receive $530,000 more on average per additional patent. Does this mean that technology startups who file patents early have the ability to raise more money? This is unlikely. Very few early-stage investors ask questions about patents, most don’t understand them, those who do understand won’t hold it against startups who don’t have any yet. Why would an early-stage startup spend time and money applying for a patent?
Filing patents shows the founding team is doing the right thing: formalizing what they invented and formally assigning their inventions to the company. Even self-prepared provisional patent applications (a few hundred dollars in USPTO filing fees) help gain credibility with investors by demonstrating the commitment to building a real business. Simply put, filing patents in an early stage sends a positive signal and can alleviate investor concerns during due diligence.
6. In a growth stage: building a moat
A competitive advantage is what helps a business become successful. The “defensibility” (or the “moat”) is what keeps it there. Both are important. The latter is the concern of growth-stage investors.
Defensible companies need barriers that protect them from new market entrants once their abnormally high profits become too hard to hide. They can create barriers to protect their business (e.g., a large network of loyal customers, a capital investment in large-scale manufacturing infrastructures, a technology platform), or build unique assets to overcome existing barriers (e.g., obtaining licenses or regulatory clearances).
Some of these barriers will not last forever: unique access to raw materials, favorable geographic location, government regulations, unique know-how, or network effect. Competitors can integrate vertically, open new locations, lobby regulators, poach talents, or merge to scale… In the end, there are very few problems money and time won’t solve.
Patents on the other hand provide a barrier lasting 20 years. This is a legal monopoly on each novel technology created by the company and patented timely — before any public release, sale, or presentation. There are not that many ways to legally achieve such a monopoly.
7. In an exit stage: increase value
To understand how patents impact an exit valuation of a technology startup, let’s take the perspective of a rational buyer in charge of valuing the technology startup.
Let’s consider two hypothetical scenarios. In the first scenario, a patent-poor technology startup cannot defend its market. In the second scenario, a patent-rich technology startup can defend its market. Both startups are equal in all other aspects. Both have innovative products. The acquirer is a tech giant (like Apple, Google, Amazon, or Tesla) interested in acquiring the startup to deploy its technology at a much larger scale.
For the patent-poor technology startup, the maximum purchase price should be less than the cost of replicating the technology. Said in economic terms: a “make or buy” reasoning underpins a cost-based valuation approach. The cost analysis of replicating the technology internally for a tech giant often leads to an “acquihire” offer — enough to keep the startup engineers happy, not life-changing.
For the patent-rich technology startup, replicating the technology is not an option due to unavoidable patent barriers. The “make” alternative is out. The valuation approach changes from cost-based to value-based — the value derived from integrating the startup’s technology into the tech giant. To be clear, the value-based approach is not intrinsic. The value is in the eye of the beholder: the tech giant. A discounted cash flow analysis (DCF) of the increased profits will lead to an outsized valuation considering the tech giant’s size.
Startups need to focus on the right priorities to be successful. There are situations when patents are worth the daunting effort and expense: to retain ownership of product ideas when selling proof of concept prototypes, to avoid commingling inventions with external partners, to obtain exclusivity when the startup has no leverage, to properly capture ideas of departing co-founders or employees, to demonstrate good business practices to early-stage investors, to build a moat once the business becomes successful and ultimately to protect the value created during the exit stage. In short, patents are valuable at each stage of a technology startup, even early-stage startups benefit from patents.
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[1] Facebook Inc et al v. ConnectU Inc et al, 9th U.S. Circuit Court of Appeals, №08–16745. cdn.ca9.uscourts.gov/datastore/opinions/2011/04/11/08–16745.pdf
[2] Lerman, Celia. “Patent Strategies of Technology Startups: An Empirical Study.” SSRN, May 2015. papers.ssrn.com/sol3/papers.cfm?abstract_id=2610433
Ivan Chaperot is a patent strategist and writer. He received an MS from Paris-Sud University, practiced patent law as a European Patent Attorney, and was named one of the World’s Leading IP Strategist (IAM-300). He is on LinkedIn and Twitter, and you can read more about his work on Medium.
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