The Tradeoffs And Considerations For Patents
This is a reproduction of Investing in Patents by Russ Krajec. For the complete book, get it on Amazon.
Patents are not free. There is the economic cost, but there are business costs as well. The business costs include opportunity costs, time and energy commitments, and the like, but the biggest business cost is the quid pro quo with the government.
There are times when a patent becomes a substantial negative liability, not just because of the cost, but because of the requirements to publically disclose the company’s trade secrets in exchange for the limited right of a patent.
Patent Costs
The average patent in the US costs $56,525.00. This is based on the American Intellectual Property Lawyers Association’s bi-annual survey. Appendix B lays out the costs in detail.
The costs come in tranches. After a meaningful search ($4000), writing the patent application ($12,000), and US filing fees ($800) the initial outlay is $16,800. There is an additional $4,000 ififf a PCT or international application is filed, another $4000 for a total of $20,800.
The patent examination process costs, on average, $24,175 and can stretch over 3 to 7 years. These costs dribble out at $4,000 intervals as rejections come from the examiner and the attorney writes responses. This cost includes probabilities for going up on appeal as well. This is the most variable part of the patent costs, as most of the other costs are relatively fixed.
The issue fees are $1,800 when the patent is granted, and there are maintenance fees paid at 3.5, 7.5, and 11.5 years. This brings the grand total to $56,525.
Note that this is the US average. Some patents will cost less, and some substantially more.
Most patents can take 3 to 7 years before they are allowed by the examiner.
However, programs such as the PCT-Patent Prosecution Highway can accelerate the process and the patent will often issue within 12 months. Note that this will compress the schedule so that the prosecution costs of $24,175 will be spent in 12 short months.
Cost Drivers For Patents
There are several factors that cause the patent costs to vary.
The most expensive (and variable) cost is getting through the patent examination process. There are cases that sail through and get allowed on the first look, but there are also cases that seem to take forever. Every attorney has some cases that are pending for 10+ years.
Almost always, patent costs can be reduced by good due diligence. Obviously, a patent search will avoid submitting a patent application for something that has already been disclosed.
The costs are also reduced by good drafting. A clearly written, easy to understand patent application is much easier for the examiner to review. The examiners tend to do a much better job when they search, so that they can focus on the point of novelty and get the case allowed.
These are the cost drivers for getting the patent through the examination process, but a patent’s cost does not reflect the commercial value.
Big, Expensive Firms Tend To Do A Worse Job On A Startup’s Patents Than Small Firms
Many people use price as a substitute metric for quality.
Startup CEOs, especially ones that had experience in large corporations, can get addicted to the status symbol of Big Law. These CEOs are easy to spot because they will tell everyone who their attorneys are.
The way the sausage gets made in Big Law is hideous. Big Law needs Big Clients to pay the bills, and consequently Big Clients get all of the attention. A startup CEO may meet with a Big Law partner, but rest assured that the work is being done by an inexperienced first year associate in a windowless back room.
The pure economics of the situation is that startups are a waste of Big Law resources, and startups will never get the attention they deserve, no matter how friendly the partner is. There is just no incentive for Big Law to waste their opportunity costs on small startups.
The matter becomes even worse when Big Law does work at cut rate prices. The pyramid scheme of law firm partnerships only work when they can bill full rate. Cut rate work by Big Law only ensures that the quality is also cut rate.
Small firms do not have the Big Clients, so they have more attention to devote to helping a startup company.
There is a big difference between just doing a job and doing a job well. When writing an investment-grade patent, the patent attorney needs to absorb, digest, and describe all of the technical and business aspects of an invention. This takes enormous amount of brain power to do well. It cannot be done effectively when hurried or rushed – or when there are more important clients to serve.
An investor should not be impressed by a startup company that has legal work done by the most expensive lawyers available. The work product should be questioned because the incentive to do good work has vanished, and the judgment of the CEO should be also questioned.
The Quid Pro Quo
New inventors are often unaware of the quid pro quo that is fundamental to the patent system.
The inventors must show the world their innermost secrets of how to make or use their invention. In exchange, the government grants a limited right in the form of a patent.
One of the options for the inventor is to not to file a patent, but simply to keep their invention secret. The most common examples are the formula for Coca Cola or Colonel Sander’s secret herbs and spices. Both of these examples could have been patented, but were not. From a business standpoint, these were the right decisions.
There are many examples of patents that had virtually no value because the claims were undetectable, unenforceable, or ridiculously narrow. In the process of getting a worthless patent, the company gave up their complete roadmap for how to manufacture and use their product.
These patents are not just a waste of money, but their competitive advantage is eviscerated by disclosing everything they know. The bottom line:
Some patent applications can be very damaging to a startup company.
Part of the analysis prior to filing a patent is to first estimate how broad or narrow the patent might be, then evaluate whether the patent – at that breadth – would be worth pursuing. This analysis starts with a patent search.
Many investors want to check the box of “is it patented?”. However, most investors are not aware that the patent will post all the company secrets online for all competitors – with virtually no benefit to the company. The decision to get a patent or not needs to be made carefully and thoughtfully, and many companies are better off with no patent protection.
How does this happen?
One very typical scenario is when a startup company thinks they need to get a patent and do so in a panic, often just before they do a presentation for the first time and publically disclose their invention to the world.
It is conventional – but a terrible practice – for patent attorneys to file provisional patent applications in this situation. The attorneys get called at the last minute and grab whatever information is available, slap a cover sheet on it, and file a provisional patent application.
Some companies put their pitch decks, pages of lab notebooks, internal decision making processes, internal financial projections, even source code for their software in the provisional patent application. This is done with the mistaken belief that the provisional application will not be made public.
This situation happens because the patent attorney figures they will sort it out later. Maybe something in one of the documents will support some patent claims that we want to file a year from now.
From the patent attorney’s perspective, the larger pile of information, however disorganized, the more likely it will be that they can find something patentable.
From the client’s perspective, they have given up their most valuable trade secrets, including all their internal documents, in exchange for their patent.
As will be explained below in Chapter 3, the first patent that a company does is often the least valuable patent. This makes sense because both the technology and business risks are the highest at this stage. Why give up the most to get the least?
What to do if this happens?
How should an investor respond when a startup files these types of “kitchen sink” provisional patent applications?
One option to consider is to abandon the provisional patent application and start all over.
This appears to be a very drastic measure on the surface, but not as drastic as it sounds. In many cases, these types of patent applications are very thin when it comes to describing the actual patent claims.
Consequently, this provisional application does not actually give the right of priority to the filing date, so the real right of priority would only start with the second, non-provisional application.
In this case, the company did not have decent protection to begin with, so abandoning the provisional application and writing a good non-provisional application has no downside. In fact, there is a big upside because the company’s trade secrets are not published.
Patent Must Be Filed Early And Cannot Be Changed
Another similarity to a stock option is that for a patent, the entire bet must be placed today, and it cannot be changed over the 20 year life of the patent.
While the US grants a one-year grace period to file a patent after a public disclosure or offer for sale, in Europe and most of the world the disclosure rules require that a patent must be filed before any public disclosure, with no grace period.
These requirements paint the patent applicant in a corner. The patent must contain all the information the inventor knows about the invention, but there is rarely any market data to see if the invention actually makes business sense.
This combination heightens the risk factors of a patent. If the initial assumptions about the viability of the invention are wrong, the patent is likely to have little or no value. The assumptions are two-fold: the technology assumption that the invention operates as intended, and the market assumption that people will buy it.
The technological risk can be mitigated by prototyping and testing, but the market risk is much more difficult given the disclosure restrictions.
There are ways to do limited market testing under Non-Disclosure Agreements, but these are not nearly as effective as a large scale marketing and sales effort, which will reveal the true value of the patent.
Risk Analysis
Like every business decision, the decision to file or not file a patent application hinges on whether the benefits will outweigh the costs on a risk-adjusted basis.
There were plenty of risks mentioned above, but a patent’s enormous economic leverage can outweigh the risks.
Many of the risks can be mitigated by due diligence prior to filing a patent.
Small companies do not have the budget to pursue hundreds or thousands of patents, so the best strategy is to curate individual patents to meet specific business needs. This will minimize waste in the portfolio and maximize value for each asset.
There is a cost to doing due diligence. Patent searches, competitive analyses, working on design around alternatives, and other due diligence items take time and effort, but the difference between an investment-grade patent and a worthless patent is just a little extra effort.
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