Given that 2011 is already behind us, I’d like to take a brief time-out from the usual legal and financial wonkery to wish you and your loved ones a Happy New Year. Many thanks to David Rose, Ilana Grossman, Justin Stanwix, and the whole Gust team for making the Gust Blog such a valuable platform and resource for entrepreneurs and angel investors. I’m proud to contribute to the effort and always enjoy reading what the other authors have to say.
Last month we covered the basics of intellectual property (IP) for startups, including a simple taxonomy, some common issues and related documents for entrepreneurs to use when forming a new startup. I’d like to take a step back and discuss the significance of IP as a component of the overall value that founders intend to create as they grow the company. The questions that arise most with respect to any category of IP at the earliest stages include:
- How will this affect our chances of getting funded on favorable terms?
- What kind of advantage will this create vs. our competitors? Barriers to entry?
- How much is it worth investing in cultivating and enforcing an IP portfolio?
- Are there any rights the company risks losing if it does nothing to preserve them now?
- What kind of risk do we run of being put out of business by others’ IP rights?
Later stage companies have some additional concerns:
- What favorable impact could IP have for PR, marketing and investor relations purposes, or as an attraction to potential acquirors?
- To what extent are we able and willing to assert proprietary IP (usually patents) as a weapon against competitors?
- To what extent are we vulnerable to attack from competitors or patent trolls? Is there anything we can do about it?
- How much is it worth investing in international IP protection, if at all?
- What is the risk-benefit calculus for developing and protecting proprietary technologies vs. buying or licensing them (“build vs. buy”)?
- How much risk do IP issues in the aggregate pose to our business?
- To what extent might proprietary IP rights be undermined by antitrust laws?
Nearly every point above is subjective, varies from company to company, and at its core is more of a business judgment than a pure legal question. For this reason, among others, tech startups are well served by engaging a good IP lawyer early in the game to help develop overall strategy and call the plays rather than just execute them.
Starting with the first point, in general, IP assets of demonstrable value that are relevant to the startup’s business can only help when pitching investors. This could include anything from a clever domain name in the coveted .com TLD to issued patents or patent applications that could serve as barriers to entry for potential competitors. The only exceptions that come to mind are if the IP seems likely to provoke costly litigation, costs too much to develop, or taints the startup with some kind of ties to other ventures or people that give it a checkered past. For these reasons, it’s helpful to do things right the first time and ensure that all relevant IP is properly disclosed and assigned to the corporation, as discussed last week.
Competitive advantage is an area in which many investors are justifiably skeptical. Patents are the only way to legally exclude others from doing something similar, and then only if the method or system used infringes the claims of the patent. (It’s often possible to “design around” a patent to operate a business that achieves similar results in different ways.) As we’ve discussed, obtaining a patent can be a slow, costly and difficult process.
Most investors will assume that if the business plan is solid and a large market opportunity exists, there will be vigorous competition from other players. In general, IP protection will do nothing to prevent others from independently developing something similar, copying the overall business model, targeting similar customers or end users, and perhaps even mimicking the product’s look and feel. The most effective response is to beat the pants off the competition through brilliant product design, superior technology, clever marketing, strategic partnerships, swift execution, and so forth. (Easier said than done!) This is not to suggest there is no legal recourse whatsoever, though. The quicker the startup establishes a strong brand identity that “sells itself” through word-of-mouth and social media, earning goodwill in its name, the sooner it can effectively chase away knockoffs that try to use confusingly similar names, logos, or domain names. If the startup develops a uniquely effective or efficient system to solve a business or technical problem, regardless of whether it ever seeks patent protection, that proprietary method can and should be treated as a trade secret.
The amount of investment in IP in any direct sense is generally small for early stage startups. Measured as a discrete line item in a budget, it might be near zero. But given the expansive definition of IP discussed previously, in fact almost everything done by most members of the founding team at a startup on a daily basis involves the creation of one kind of IP or another. Here are just a few examples:
- Creating and revising a business plan (copyright, trade secret)
- Creating product mock-ups, wireframes, etc. (trade secret)
- Writing, debugging, testing and deploying code and scripts of all kinds (copyright, trade secret)
- Developing Web content (both the design and underlying code) (copyright, trademark)
- Building and populating databases of user-supplied information and content (copyright)
- Designing and producing marketing and PR materials (copyright, trademark)
- Financial, technical and operational plans and forecasts of all kinds (trade secret)
- Sales and marketing plans, lists of prospects, supplier and subcontractor relationships, pricing data, media buying plans and strategies, etc. (trade secret)
- Internal org charts, job descriptions, titles, resumes, compensation details and direct contact information for individual employees (trade secret)
At the earliest stages, direct IP expenses might include beginning the process of registering the company’s primary brand and logo as trademarks; registering copyright in any exceptionally valuable works of authorship before they are distributed to the public; and filing provisional patent applications for any proprietary technology that seems to be unique, original, useful, and of future economic value.
This leads to the next point about “using or losing it,” which can be a concern for some types of IP in some countries. In the United States, a patent application must be filed no later than one year from the date the invention is first described in a publication, used publicly, or placed on sale; otherwise, any right to a patent will be lost. The rules are stricter in most foreign countries, where the inventor must file a patent application on the date of public use or disclosure in order to preserve patent rights. In practice, this leads many U.S. startups to ignore foreign patent protection in the early stages, only to learn that they’ve lost the opportunity altogether if they try to pursue foreign patents later when better funded. (By 2013, the U.S. will transition to a similar system as a result of the Leahy-Smith America Invents Act (AIA) of 2011.) Such a “first-to-file” system also applies for trademarks in most countries outside the United States, setting the stage for ugly disputes involving companies that invest heavily in building their brands domestically while deferring international trademark protection.
The possibility of being put out of business by a ruinous patent suit brought by a large corporation with deep pockets understandably creates anxiety among entrepreneurs. Nevertheless, experience has shown this to be primarily a later-stage company problem. Paul Graham explains:
We tell the startups we fund not to worry about infringing patents, because startups rarely get sued for patent infringement. There are only two reasons someone might sue you: for money, or to prevent you from competing with them. Startups are too poor to be worth suing for money. And . . . they don’t get sued by other startups because (a) patent suits are an expensive distraction, and (b) since the other startups are as young as they are, their patents probably haven’t issued yet. [Large companies] win by locking competitors out of their sales channels. If you do manage to threaten them, they’re more likely to buy you than sue you.
As in the notorious Blackberry case a few years ago, the more successful the business, the more the company has to lose, and the more it will pay to settle and obtain a license to the patented technology ($612 million in RIM’s case to avoid a shutdown of the entire Blackberry network).
We’ll explore these challenges in more detail in the coming weeks. In the mean time, best wishes for a safe, happy and healthy 2012.
This article is for general informational purposes only, not a substitute for professional legal advice. It does not result in the creation of an attorney-client relationship. All opinions expressed are those of the author, and do not necessarily represent those of Gust.