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April 08, 2005

Patents Don't Matter

"And the best part of all," says the entrepreneur with a big smile, "is that our unique process is patent-pending, which will provide us with tremendous upside and great defensability".

Right.

The sad truth is that when it comes to the VC process, patents don't really matter.  There is simply so much more to the company-building process - management team, market dynamics, competition, just to name a few.  Maybe, if all else fails, you can recoup some of the investment by selling off your IP.  But patents are so tertiary to the VC decision process, that it's really a bit silly to spend more than a nanosecond on them when pitching VCs.

How could this be, earnest entrepreneurs will cry!  Aren't patents at the core of creating value through innovation and invention?  First of all, having a patent pending is like kissing your cousin - it simply doesn't count.  Anyone can file.  Getting a patent issued is what really matters.  But even when you have an issued patent, 95% of the time it is too narrow to be relevant as a blocker, and so typically a competitor can find a way to design around you or have other patents in the same field that will cause a standstill to occur.  That other 5% of the time, a start-up will simply not have the legal resources to properly prosecute a patent strategy that could yield the investors any return.

Let me give you a case study I've lived through.  At Open Market, the founding technical team came up with incredibly fundamental inventions in 1993-94 that were filed and then granted in the form of three seemingly powerful patents in 1998.  These patents essentially covered secure credit card transactions over the Internet and the use of shopping carts.  On the day of our announcement, we made A-1 of the Wall Street Journal and and our stock jumped 2x that day (we did our IPO in 1996).  But after 3 years and a fairly focused effort, the company failed to extract any tangible value from those patents and the stock went back to being valued on more important metrics, such as revenue, growth, etc.  When Open Market was acquired in 2001 and its acquirer later went bankrupt, the patents were purchased out of bankrupcy court by an entity that then sued Amazon.com (see article).  So far, nothing has come of it.  Thus, despite nearly 12 years since these fundamental e-commerce inventions were made and filed, investors have nothing to show for it.

Call me jaded.  But ask your other VC friends and they'll most likely agree.  Patents just don't matter.

Comments

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Jeff,

Boy, you are debunking all of the myths! Many times the lack of defensible IP can be used by a VC as a convenient way of saying "not interested".

I do think that if your business is selling technology or infrastructure that having a strong patent position can be an asset and may even be a requirement. This is especially true if you are a small company trying to sell to big companies. Even at Open Market, there must have been deals that you got when you were a startup that you may not have closed if you hadn't had the "patented or patent-pending technology" story. I've personally benefited from a good "patent story" many times in sales situations.

I agree completely with your main point which is that patents alone won't make a business viable if you don't have a clear path to customers, revenue and a team that can execute.

There are a number of patent speculators getting into the game of amassing IP like Intellectual Ventures http://www.intellectualventures.com. Still unclear if they are going to make their money from outlicensing or from enforcement but they have been aggressively picking up patents and pending applications from defunct venture-funded startups for pennies on the dollar.

Myron

Where is Chip's blog?

I guess I am positioning myself in between Jeff and Myron. When it comes to turning your invention into an innovation that users will love, patent rarely seems important.

However I don't agree with you Jeff, that VC friends of yours hold your position. Rather the contrary. Too many VCs will shut their ears for anything but the patented or patent-pending technology. I really think VC's are to blame for the perceived importance of patent among entrepreneurs.

Entrepreneurs listen to VCs because VCs are those with the bucks. Then you gotta give them what you think they want. Patents.

One aspect of patents' value in a startup that you touched on tangentially is the company's ability to wage a legal battle against open infringement. If the competition is large and well founded, they can just ram and sink your startup knowing that a small, pre-revenue company does not have the financial resources to survive a sustained legal fight. Once the startup is bankrupt, they can pick up the patent for a song.

As a patent lawyer, I’m sure you’d expect me to disagree with the notion that patents don’t matter … and I won’t disappoint you! Let’s put aside pharma and biotech companies, which live or die on their patent protection, and focus just on the IT side. True, plenty of tech companies have succeeded mightily without any significant patent protection -- eBay, for example, didn’t patent its crucial feedback system yet dominates the online auction space. And many others, such as the one you describe, fail or struggle despite heroic efforts to obtain patents. But these situations are the bookends; most situations fall somewhere between them on the shelf. The real strategic question isn’t whether patents matter, but when.

Certainly the scope of a patent can be a red herring, since it doesn’t necessarily indicate value. Big, broad patents are marketplace weaklings if no one needs what they cover, while the puniest claims can clear the field of competition if they cover what works best, or fastest, or works at all. Patent strength is a secondary consideration in any case; it’s important only if patents are important for a given situation.

So how does a VC know whether and to what extent patents will matter for a prospective investment? Look first at the business strategy. If it contemplates partnering or licensing to a big player, then patents are essential. Next consider the competition. Will you wake up one morning to find that killer app turned into a new Microsoft Windows feature? Is an industry behemoth likely to come knocking at the door, demanding tribute on its own patents? Anyone who has ever sat across the table from IBM knows how patents can translate into bargaining leverage. And while enforcing patents can be expensive, that’s true for the infringer, too. Even big companies generally prefer to deal rather than fight.

Finally, what’s the exit strategy? To a prospective buyer, a strong patent portofolio can make acquisition not only attractive, but sometimes strategically inevitable.

Patents are never *sufficient* for success; strong patents won’t make a weak product sell. But they’re *necessary* more often than not. While patents can’t make a winner out of a loser, they can keep winners from succumbing to well-heeled competition (think Netscape), from finding themselves unable to monetize their research, from facing patent-wielding rivals with nothing to trade … and from the ire of a skeptical VC wondering if anyone has thought these issues through.

BS! Patents--or patentability--DO matter. I have been a successful VC at a top firm, and a successful entrepreneur (in that order). I ALWAYS looked at patentability, and so did every other VC I knew. Patents don't matter? Ask RIM about that sometime.

Where is your RSS feed?

Patents are organizes theft - organized by lawyers on behalf of the rich elite CEOs and "owners" of companies. Why should a company be able to steal from someone who has an idea be able to prevent others from using it? The best defense for an inventor is to share their idea widely.

You could have made *a lot* more money as consultants being known as the authors of various web based e-commerce techniques than by trying to patent the ideas. In any case the novelty of the inventions is debatable. There's 50 years of prior art in databases and hundreds of years of prior art in mail order world that I very much doubt e-commerce techniques - base on very basic general ideas - have done anything to improve upon in a patentable way.

The whole idea of patents re: business processes is debatable. Historical experience and research demonstrates how damaging patents are for innovation and scientific research and discovery. As for pharmaceutical and biotech - well **where** are all the breakthroughs? In fact all the biggest advances in medicine (hear surgery etc) have been due to open public scientific research. On the patent side we have erection pills and pills that make you happy but very little of any real medical value.

I saw your Blog mentioned in PE Week today.
I think that it is fair to say that the importance of patents varies depending on the industry. In biopharma they can be hugely valuable since they grant the patent holder a monopoly on a product that the customers ofen have no choice but to buy. Pharma companies are patent holders with a sales force.

Patents can also be important in semiconductor and other infrastructure type industries like Qualcomm.

Patents are unimportant in most software companies. If they were, open source software companies couldn't exist.

This is why we find very few software opportunities in university developed technologies, but most biotech startups have a strong university or hospital heritage.

I agree with you, Jeff, from an "invest/don't invest" point of view, but not from a post-investment "patent or not patent?" point of view. If you have the opportunity to get some solid, broad patents and your product is in the middle of a patent thicket, its worth the price -- not because you'll ever assert them, but because (a) you can use them for defensive cross-licensing purposes if *you* get sued, and (b) they can add value when you sell the company -- sometimes the only real value -- to a company in the same thicket that wants to build up its portfolio for the same reason. Not very glamorous, but good business strategy.


Looks like the Open Market patents were worth something after all, with Amazon settling for $40mm today. Your points continue to be valid though. This is a rare victory and most certainly didn't cover the amount invested in building the technology.

A patent do not protect no ones ideas it dont even sell your ideas its a fool to wast your money one a patent why somone can patent your same idea over and it can be better or simple and cheaper if i patent a idea it will be because the investor are working with me on developing the idea to buy it and that they can do for me to sign patents cost and dont do nothing for protection its better ways to protect ideas and they are cheaper.

once somone seen your patent they can copy its parts and make your idea out of they own idea i seen it all a lawyer can still your idea by loooking at it the peoples in the PTO or whoever if you dont tell others to document it or know about it to take them to court websites can do that .

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