Point of View January 23, 2011
Why every company needs an IP Strategy
When I was at Microsoft, I had the opportunity to be involved in several M&A transactions where my role was to oversee the intellectual property and legal due diligence of the target companies. I was always amazed to how little attention had been paid to these matters by their business owners (and their investors) given that these companies were all technology ones. In many cases, IP related issues uncovered during due diligence ended up affecting the ultimate valuation of some companies, delaying the earn out and, in some cases, killing the deal. All these companies had one thing in common: great team, great product, but no sound IP strategy.
Let me ask you this: would you build your house or invest your money in a real estate project without knowing whether you actually own the land on which it will sit, or that you are in full compliance with the zoning regulations and won’t be asked to demolish the building the minute it is erected? Of course you wouldn’t! That’s just plain common sense.
Yet, when it comes to most technology based ventures, business owners and investors seem to overlook some basic principles related to the intangible nature of their company. They also often underestimate how IP matters can dictate the viability and valuation of their business over time. In other words, while most small and medium size companies have a business plan, very few have an IP strategy and they often end up pay a high price for this shortcoming if a dispute arise or when it is time to exit.
Consider this: 85%+ of the value of most businesses nowadays is in the form of intangibles. For small technology companies, this percentage runs close to 100%. If you own a business, just ask yourself how much you’d generate if you were to sell all the assets on the books (equipment, inventory, etc. ) Now compare this to how much you think your company is worth. 1M, 5M, 10M? The difference in value is essentially in the intangibles, i.e. the bundle of intellectual property rights the company has developed or acquired over time (copyrights, patents, trade secrets, trademarks, licenses, etc.). When accountants value a company based on its trailing revenues or other sales figures, they are simply translating into a formula the expectation that people will continue to pay for the IP (e.g. superior or unique technology, well liked brand, exclusive franchise, etc.) embodied in your products or services and that no one can offer the exact same thing without infringing those rights. Simply put: no enforceable IP = much lower value. That is why a legit copy of Windows costs around $100 and a pirated one can go for as low as $1. $99 goes to the IP.
What is an IP Strategy? Does it simply mean you should go gangbuster and file a patent every time you think you came up with something smart? Of course not! Just consider that it costs on average $15K to $20K to file and prosecute a utility patent in the US only (the price goes up exponentially if you file overseas as well). Yet, it takes close to 5 years for a US patent to issue and research shows that fewer than 10% of issued patents are actually practiced by their owner. Are you, like most people, filing the wrong patents? Could you even detect if someone else was infringing your patent(s)? If not, what exactly did you pay for? Is filing patents (which means teaching your competitors how you’ve built a better mouse trap) even the right approach for you, as opposed to relying on trade secrets protection?
Conversely, what do you know about other patent owners in your industry segment? The Licensing Executive Society recently published a study showing that the average costs of a patent litigation in the US is 3 million dollars for a trial on the merits (and 5M if one party appeals). And that’s just for defending the case! Yet, patent litigation keeps increasing. To make matters worse, patent trolls (aka NPEs) have amassed thousands of patents in the past decade and their business model is predicated essentially on licensing revenues on a large scale. This is called “retail licensing” and it doesn’t bode well for SMEs who had been largely immune so far from law suits by NPEs. So do you know whether you infringe or will soon be infringing someone else’ patents? Would you survive such a claim, especially if you can’t use your own patents as a counter lever?
Branding is also extremely important and some famous trademarks can be worth in the billions of dollars. Yet, just like patents, trademark rights are on a country by country basis. Can you imagine Coke having to use tens of different names around the world? It hasn’t happened because Coca-Cola was aggressive and proactive in securing trademarks before it even entered those countries. As a business owner, don’t you want to know beforehand whether you will need to change the name of your flagship product every time you enter a new market? And what about your domain names? Heard of domain hoarding?
If your product or service relies on software, do you know for sure you own the code outright? Was the development outsourced? Do you have the proper agreements to confirm ownership (remember that software is NOT one of the listed categories or works under the Copyrights Act where a mere “work for hire” provision in a contract will transfer title)? What if your developers lifted the code from a third party? Do you have the proper contractual safeguards and will they protect you enough to cover your own exposure? Also, have you considered the possible long term impact of using open source components? Have you gone through the cost/benefit analysis of short term savings vs. long term dependencies under some copyleft type of licenses? Have you considered the fact that potential acquirers might balk at the presence of open source in your product given their business model or internal development policies and that it may be a lot more expensive (or just impossible) to untangle and rewrite some of those components a few years from now?
How would you fare tomorrow if someone wanted to acquire (or invest in) your company and subject it to a thorough IP and legal due diligence? Would you pass muster? Would valuation go down as a result of some IP dependencies or weaknesses? In other words, why would someone want to buy you or pay the full amount you think your company is worth if they can replicate what you did without infringing any proprietary rights? Or if they are required to secure rights after the fact because you didn’t do it when it would have been a lot cheaper to do so? Or if they have to redesign part of the product to avoid a third party IP (generally patent) claim once your technology is no longer flying under everyone’s radar screen?
Those are just a few examples to show how important a sound IP strategy is for any company. Having a business plan that doesn’t include a well-articulated IP component leaves a huge percentage of the execution and future success of your company to improvisation and sheer luck. It can -and will likely- affect the competitive advantage, profitability, legal exposure and, ultimately, valuation of a business, if not its very existence. Napster died because of IP issues, RIM almost did and the venture cemetery is littered with companies that never made it because they didn’t have the right IP foundation to protect and/or exploit their products or services in the long run. That’s not the kind of company you want!
Fortunately, very much like with financial planning, a solid IP strategy –especially if done early- is very affordable (much less than the cost of filing just one US patent)* and will go a long way toward minimizing some of the most common risks and maximizing long term value for your company. As an owner or investor, you need to make sure that the house you are building rests on the right IP foundation.
*We have conducted several IP Audits and IP Strategies for our clients. Estimates and sample reports are available upon request.
Disclaimer: Please note that this newsletter is for educative purposes only and does not constitute legal advice. It should not be relied on to make business or legal decisions, since each state has different laws, each situation is fact specific, and it is impossible to evaluate a legal problem without a comprehensive consultation and review of all the facts and/or documents at issue.
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(c) 2011. The Point Law Group, PLLC. All rights reserved.
Founder & Principal
The Point Law Group
THE POINT LAW is a boutique law firm specializing in business and intellectual property counseling as well as various technology transactions and overall IP Strategies & Audits. We cater primarily to technology and e-commerce companies. We offer a full range of legal and business solutions to start-ups, small and medium-sized businesses and large multinational corporations.
You can contact Louis directly at:
(425) 868-9280 (o)
(425) 213-7252 (m)
In the next few weeks, Louis will be giving a series of keynotes on topics related to Business, IP and Innovation
February 2: CEIM Meeting, Montreal, Quebec
February 2: Innocentre Meeting, Montreal, Quebec
February 3: 4th International Forum of Intellectual Property, Montreal, Quebec
February 4: Tuck School of Business, 6th Annual Private Equity and Growth Ventures Conference, Hanover, NH.
February 4: North Country Angels Meeting, Hanover, NH
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