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For Most Small Companies Patents Are Just About Worthless

This article is more than 10 years old.

Update (Oct 7, 2014): It looks like patents are often useless for big companies, too. See the linked article on the wasteful smart phone patent litigation.

A widespread meme in the tech community holds that patents are a path to riches: an entrepreneur who solves a key technical problem and receives a patent can build a business on the technology and ride to glory. Xerox and Polaroid are celebrated examples (both now nearly extinct). But, IMHO, for most small companies today, patents are just about worthless. Many entrepreneurs misunderstand the value patents create, and how difficult they are to enforce.

A patent is a sword, not a shield. It gives you the right to attack a competitor who makes commercial use of ("infringes") your patented technology. Contrary to common belief, it does not give you the right to practice your technology free of interference.

Patents are often quite narrow and hence can be circumvented: they might apply to a specific design element or combination of characteristics. They have effect only in the jurisdiction of the patent-granting authority: effective world coverage requires six to ten patents in different geographies.

The patented intellectual property is usually not sufficient to deliver the product. Lots of other intellectual property is needed, too, and others often have patents on some of that.

And, frequently two issued patents arguably describe the same thing. I once encountered two electronic circuit design patents that were identical except for the way in which the components are laid out (which does not affect function). Each design had received a patent (and the same person at the patent office had awarded both patents).

A murky situation often results. Let's say a new company ("TechCo) solves a key technical problem that enables new value for customers and launches a new business. But, TechCo will need to use a lot of other technology to build and deliver a complete product, e.g., the product design might be protected by a patent, but the manufacturing process might be subject to another company's "blocking" patent. And it won't always be clear how effective that blocking patent is: perhaps it's been issued, but arguably it’s vague or not original (grounds for invalidation), and until now the patent holder has not enforced it. Does TechCo have a problem? That’s a “definite maybe". The choice is to just go ahead and see, or seek a license, which could well be denied and will definitely get the patent holder's attention.

Enforcing your patent in the courts is a nightmare. Plan on 3-5 years and $3-$5 million to get to a judgment. And then there is the appeal ... Usually the stakes and time frame will be too much for a start-up. One of my portfolio companies sued a big company for infringement, and the judge has ruled that infringement occurred, but there are many legal maneuvers available, and the litigation clock and meter tick on in year four. We think the big company wants to make a statement: "let this be a lesson to small companies that have the temerity to sue us for infringement ..." Patent litigation is the true sport of kings.

It costs $20k-$30k to file a final (“utility”) patent. Some small companies make dozens of filings, spending a good fraction of a million dollars. When might this investment pay off?

There are situations where patents pay off. Drugs are a good example. Drugs are based on unique molecules that sell mainly on technical merits: efficacy, side effects, etc. Once this data is in, most successful drug start-ups are bought by a big drug company that has sales and manufacturing capability and lots of lawyers. The patent is indeed the lynchpin of value.

In the information technology world, patents have the most value in the hands of big companies, as part of patent “portfolios” so large that any competitor is bound to infringe some of them. They use this weapon to attack competitors (usually smaller ones) that lack patent portfolios: e.g., the lawsuits against Google ’s Android operating system. To defend itself, Google acquired Motorola, which owned a large relevant patent portfolio. Now Google can counter-sue. The usual result among the big companies is a stand-off, reciprocal licensing, or a patent pool wherein the major competitors share their patents, and new entrants are out in the cold. Five of the top global producers of light emitting diodes, for example, have established a formidable patent pool.

So it’s true that patents will be worth something when a company is acquired, but in my experience the value here is often not large. E.g., a company that had about 100 patents, some of them significant, was sold recently. The offers received indicate that the value of the patents alone was on the order of $10 million: under $100,000 per patent, which pays for the lawyers but very little of the R&D.

Ironically, patents can have more value to “patent trolls” than to small operating companies. Patent trolls buy up patents and use them to extract royalties from operating companies that have infringed them. They don’t sell any products, so they are not vulnerable to counter-suits. Patent trolls have had some notable successes, e.g., the $800m settlement RIM paid in its heyday.

My suggestions for a small technology companies*:

  • Don’t base your business strategy on patents. And don’t try to raise money primarily on the basis of patents; most likely this will fail and you will appear naïve.
  • It’s worthwhile to file patents for your key inventions in the U.S. (what patent-savvy universities do), but don’t go much beyond that.
  • Pay close attention to patents that others hold which might enable competitors to block you. In my experience “freedom to operate” is more important when evaluating a business plan than patent ownership.
  • It will rarely make sense for a small company to sue a big company for patent infringement. The lawyers will probably be the winners.
  • Non-patent intellectual property strategies can hold off copycats effectively. Trade secrets (parts of the product or production technology that are hard for competitors to replicate), knowledge of customers, and superior rate of innovation work best.
  • Build your business on real competitive advantages: product value-in-use, customer relationships, rapid innovation. Don’t count on patents to defend you from your competitors.

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*With some exceptions, such as drug companies.

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