Brian Chau is a JD candidate at Osgoode Hall Law School.

Given the essential role that entrepreneurs play in driving the economy, there is no question that the creation of patent laws must take into account the protection of their interests. From a small business perspective, patents play a large role not only in helping protect their inventions from patent infringement, but also in creating assets that can be readily assigned a value in the market. This valuation can then be used to either obtain investors or to negotiate an attractive buy-out price.

However, patents are a relatively costly and time-consuming exercise for small businesses, with arguably uncertain results. It has proven difficult in practice to readily implement a set of laws that is able to satisfy the interests of all parties.

The following report seeks to understand, from a practical perspective, how entrepreneurs use and are affected by the patent system.

The report

This is the first comprehensive study conducted in the US, and it raises several notions that are well worth further investigation. The study covered 1332 startups across several high-growth industries, namely: biotech, medical devices, IT hardware, software, and internet technologies. In general, the respondents were the CEO, president or CTO of their respective companies.

The researchers primarily focused on the following questions:

• Why are startups applying for patents?
• How do these patents affect investment?
• How to startups avoid infringing patents held by third parties?
• How effective are their patent strategies?

Key findings

1. Venture-backed startups are significantly more inclined to hold patents / applications than the general population.

The Berkeley report noted that the inclination to hold patents is driven by a company’s business model, strategy, technology, or other factors, such as the cost of patenting and subsequent enforcement. The results show that there is a clear differentiation between venture-backed firms and non-venture backed firms. In terms of the total number of patents, venture-backed startups held anywhere from approximately 1.7 to 4 times more patents.

These results may be skewed as it is uncertain whether venture funds are also providing patents. However, there is non-definitive evidence that point towards a relationship between the parties: Firms that seek venture-funding appear to be patenting more actively prior to the funding event (and for the purpose of securing funding), and venture-capital investors appear much less willing to fund companies that hold no patents.

2. Industry is a strong influence on the incidence of startups holding patents

Not surprisingly, what industry a startup is in is a strong indicator of how many patents are obtained or applied for. In this study, the ‘medical related’ companies (biotechnology and medical devices) had on average a far larger number of patents compared to software / IT hardware / internet firms (an average of approximately 15 vs.2, respectively).

I would think that this is due to the nature and usage of the patents in these industries – it would appear that the ‘medical related’ companies are highly cognizant of the critical nature of securing patent rights. As such, these companies are much more likely to use, and to see utility in using the patent system in the early stages.

“When you go into life sciences—and in reality, with any [bio-related technology] that you’re creating or acquiring—if it doesn’t have a reasonably strong patent, and if you don’t have the capability to expand the patent estate covering your technology and products, you are going to have complicating issues. [As a young company], you need to secure patents, and with the broadest claims and specifications that you can get.” – Venture firm partner

3. Patents may offer only weak incentives to engage in innovation

It is a bit of a surprise that there is a view that patents are offering only weak incentives in terms of innovation, given that a patent grants a virtual monopoly. Based on feedback collected in the report, the view has changed over time, perhaps due to infringement in international markets.

“Fifteen years ago, patents were probably very useful and offered a lot of protection. But not today. In fact, today they are not very valuable at all, and, even if I were to get a patent on my [updated technology], odds are that I would still find a copy for sale on the side of the road in China.” – Sole proprietor of a medical device company

However, for the patents that the startups did acquire or apply for, the single most important driver was the “first mover advantage”. This was the only appropriability strategy (among others such as secrecy, reverse engineering, complimentary assets) that was ranked between moderately important and very important on average by all companies. It is also important to note that patents were twice as important for product than process innovators.

 

4. Patents play a key role in seeking investments

 

This report noted a clear quantitative difference in terms of patents held and applied for by firms either with or those seeking venture capital funding. Several competing theories exist on the role that patents play when seeking investments: The first theory is that patents are serving as credible “quality signals” for startup investors that are often associated with future profits. Alternatively, there is also the theory that given the limited information that is generally associated with startup valuation (generally, startups have few assets and little to no operating history), patents provide a good basis to measure profitability. Finally, the patent portfolio of companies may serve as differentiators that help investors pick and choose the companies that are best suited to compliment their acquisition goals. The report findings are also consistent with studies showing that patenting plays a positive role in valuation during fundraising and upon exit for venture-backed firms.

“When doing deals, sometimes we only show our stack [of patents], and sometimes the other party wants to do a lot of due diligence on our individual patents. But we never fail to give a presentation of about one hour on them—patents play a huge role in securing investment.” – CEO of a biotechnology company

5. Some technology companies have deliberately chosen not to pursue patents

As such, all respondents were asked whether the last major technology innovation they did not patent was a product or a process (or not), and what reasons motivated their company’s decision not to patent. The results that came up included the belief that the technology is not patentable; the high costs associated with prosecuting and enforcing the patent; the perception that, with reverse engineering, patents may afford relatively weak protection; the fear of disclosure and the availability of other forms of protection.

The cost of getting a patent is the most common reason cited for not patenting a major technology. 10% of respondents listed cost as the only barrier to filing for a patent. Another of the survey questions revealed that the average out-of-pocket cost for a respondent firm to acquire its most recent patent was over $38,000. This may prove to bolster the first finding regarding venture capital-backed firms, given their access to a bigger pool of resources and/or legal expertise.

An important difference that was noted was that biotechnology companies are much more interested in non-disclosure (59% vs. 25%), and software companies more about cost (43% vs 64%).

“Startups often pay significantly more than incumbents to their prosecuting attorneys, because startups (1) tend to file for patents on inventions that are more important to the company’s core business model than large firms, (2) usually use outside instead of in-house counsel for  patent prosecution; and (3) often have difficulty monitoring outside counsel to limit overall costs” - Executive at a venture-backed semiconductor firm

Further considerations

 

Given a market recovery and the expected influx of capital from the various stimulus plans, can we expect entrepreneurs to be more inclined to pursue patent protection? Will the existing patent regime serve as an accelerator or impediment to the promotion of innovation?