The Abstract Truth

Archive for November, 2010

Assessing the Value of Software Patents in Early Stage Companies

Posted by rbpasker on November 12, 2010

I see a lot of pitches a year. Hundreds of them.

Probably about 1 in 10 claim “patented” or “patent-pending” technology.

Since one component of venture capital is assessing the current and future worth of a company, how much value should an investor assign to a company’s patents, particularly in software or business processes, as opposed to hardware/networking, biotech/medical, or green?

I would say the value of each patent is about negative $50,000.00.

Before laying out my rational, let me say that I am not addressing the issue of whether patents are right or wrong, good or evil, ethical or unethical. There are plenty of people who have already written about that topic.

And I’m not addressing the issue of whether or not a startup should patent its technology: that’s up to the startup.

Lastly, I am not a lawyer, and this is not legal advice. If you have questions, you should probably call yours.

There are four issues at work here, one of which I have experienced personally, two are public knowledge, and the forth is so rare that I don’t even have a concrete example.

Reason one, I’ll call “the Kenamea patent” problem, which refers to a patent I coauthored as the CTO of Kenamea, and which was filed in 2001. The patent covers much of the stuff we take for granted today – real-time web, pub/sub into browsers, and Comet/AJAX. But we started just at the end of the Dot-com bubble, and even though we had a groundbreaking technology (as opposed to FedExing cat litter to Hawaii), the company did poorly (perhaps deserving of another blog post), and one of the assets that was sold off was the patent. I don’t know who bought the patent, and I can’t tell you how much it sold for, but I can tell you that it didn’t fetch anywhere near the amount of money I think it is worth (although I am biased). The reason is because it would take millions of dollars and many years to prosecute all the internet giants and lilliputians who are violating it. So perhaps a patent troll bought it to prosecute at some point in time, or an internet giant bought it to legitimize its use. The value of the patent at the time Kenamea was funded? Zero.

The second reason is what I call the “let them eat cake” problem, when big companies knowingly or unknowingly ignore patents by the little guys. If the big guys are unsuccessful in the market with the infringing product, there’s little or no legal damages. If they are successful with the infringing product, they can settle or go to court for damages 5 or 10 years down the road, after they have established market leadership and made billions of dollars. Two public examples of this are the wireless email patent and the 802.11 patent. [David Pollack, who read an early draft of this, reminded me that, “if a large company knowingly infringes on patents, there are nasty things that can happen. Most tech companies stay blind to patents so that they don’t knowingly infringe.”]

Issue number three is the “patent bully” problem: any successful startup in an interesting space has a good chance of being bullied by a big company. NewCo sues BigCo for patent infringement, BigCo turns around and sues NewCo for infringing 20 patents, and the result is a costless cross-licensing arrangement. Sun was accused of this by Azul Systems:

“Sun has repeatedly threatened the company with litigation unless Azul granted Sun part ownership of the company, and agreed to pay exorbitant up-front fees and continuing royalties on the sale of Azul products,” Azul said in a statement.

A settlement was eventually reached, but the terms were never disclosed.

Reason four is the “you can’t get blood from a stone problem”: there is very little benefit for one startup to sue another startup over a patent. Even if the patent holder could get the Board to agree to spend the time & money to litigate, the most likely outcome would be that the infringer would have to stop infringing or it would have to pay a royalty on probably non-existant revenue. This is just the the wrong way to launch a successful startup, and most people know this, which is why I can’t cite a concrete example. Better to beat the other company in the market than to sue, because you’ll have to build a strong enough product and company to beat all the other competitors out there anyway. This is not to say that a startup should not defend its intellectual property rights, but rather that there are better ways to go about winning than with knee jerk lawsuits.

Now lets look at where the negative $50,000 comes from: its an estimate of the actual legal cost to prepare the patent added to the opportunity cost of the inventor’s time, who would otherwise be writing software.

The overall lesson learned is that unless a company has the funds and resources to enforce a patent, an investor should probably value an early-stage startup’s patents at a negative $50,000 each.

Go ahead, patent away, or not. You can decide if its right or wrong, or useful or not.

I’m just saying that as an investor, they don’t add any monetary value for me, and can often drain time and money away from the company which should be out building a business.


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