Building A Moat Around The Business
This is a reproduction of Investing in Patents by Russ Krajec. For the complete book, get it on Amazon.
When it comes to patents, CEOs often state that they want to defend their turf, but they rarely have a good picture of how that works. Often, the CEOs will follow on by saying that they would not have the ability to defend their patents anyway, and they quickly run out of reasons to have patents.
There is much more to defending a company’s turf than going to court to enforce a patent, but few startup CEOs know how it all works.
Patents can be asserted in two broad scenarios: thieves who flat out copy technology, and competitors who build something close but not exact. Most people understand how patents work in the first instance, but often not in the second.
The second mouse gets the cheese.
The second mover in a market gets the advantage of all of the startup’s hard work. The startup thrashes around figuring out what actually works, educates the consumer about the actual product, then begins to get traction. Once that ground is plowed, which is very slow going at first, a competitor can breeze right in with the advantage of everything the startup taught them.
The patent is one way to have that competitor either cease and desist or pay a license to use the technology. The patent gives the startup leverage to have a legitimate, legal business discussion with a competitor.
Enforcing Patents Against Direct Copiers
Patents are incredibly valuable when there are direct copies of a product. A very real scenario is when a startup hires an unscrupulous foreign manufacturer who runs two shifts a day making product that they send to the startups and a third shift of product that they sell out the back door.
A software company may have product that is downloaded and resold under another brand, or they may have a disgruntled employee that walks out the door with source code only to pop up at a competitor the next day.
Both of these scenarios can be handled by patent enforcement.
Patents can be enforced without going to court.
Enforcing a patent in these situations is not the multi-million dollar ordeals that we read about in the news.
At the Consumer Electronics Show in Las Vegas, startups routinely enforce their patents by shutting down exhibitors who have knock off products. The Consumer Electronics Association fully supports these actions, and startups have shown up at a competitor’s booth armed with a handful of patents (and an official from CES), and had exhibitors take down infringing products as they watched.
In another scenario, a relatively small patent holder sent a letter to a very small business who was manufacturing a competing product that may or may not have infringed. The patent holder was able to negotiate a cash payment and require that the small business change their product design. The patent holder allowed the small business to sell off their holiday inventory, but the small business ceased being a direct competitor.
The International Trade Commission is an agency of the federal government that has the power to stop inbound shipments as they enter the United States. The ITC is the best place to assert patents and stop competitors from importing infringing patents. The cost to assert patents in this forum is quite modest, and they act very quickly.
In all three of these examples, patent holders are able to make enormous impacts in protecting their business without large cash investments.
One of the biggest factors in the success or failure of these types of enforcement actions is the quality of the patent. A startup company will get much more favorable results when they are asserting very high quality patents.
Enforcing Patents By Going To Court
Conventionally, patents are enforced by going to court – or seriously threatening to do so. This is often a big monetary commitment, to the tune of $5 million.
When there are tens of millions of dollars at stake, there are many groups that will take these cases on a contingency fee. These include law firms but also include private companies. They will bring lawsuits against big companies, and they have the resources for seeing the lawsuits to the end.
Most lawsuits are a big game of chicken and never actually get to court. Each side postures and pushes the other side around, hoping that the other side will back down and negotiate first. Typically, both sides want to negotiate, but the lawsuit devolves into a huge process of wearing the other one down. If one side does not have the money to bring the case to completion, the other side will wear them down and will outspend them until they give up.
Because the cost of a lawsuit is so extraordinarily high, it only makes business sense in cases where there is $50 million at stake–or more.
Defending An Investment In Other Situations
Patents are business assets. In some situations, they are just like trading cards.
In a competitive technology field, it is highly likely that a startup will step on someone else’s technology and their patent. It may be directly, such as when the core product infringes, or it may be tangentially, where a product might use patented technology as an enabling technology.
In either situation, someone might send a letter implying that the startup infringes their patent. They could be forceful and demand that the startup cease and desist, or they could kindly suggest that the startup take a license to their patent. This is where cross-licensing can come into play.
A cross license is where a startup and the other patent owner agree to let each other use their patents. Often, one side might pay the other side a royalty, but it would be a much smaller royalty than if there were no patent rights going along with it.
Many companies have big patent portfolios purely for cross licensing. Lots of competing companies have formal cross license agreements in place. Microsoft and Apple had such a deal that was part of Microsoft’s cash investment in Apple in the 1980’s. This deal allowed Apple to avoid bankruptcy, but it also gave Microsoft access to Apple’s user interface technology.
Many giant companies have monumentally big portfolios that serve as a “silent cross license” with other companies. These companies are staring across No Man’s Land at each other from their foxholes, each with a huge pile of weapons waiting for the patent Armageddon. Microsoft and Google have been in this pose for over a decade, and it remains to be seen if that ever happens.
Getting Access To Someone Else’s Patented Technology By Writing A Patent
When a company wants to use someone else’s patented technology, one very good way is to file their own patent in the same space.
Of course, a patent cannot be granted on something that someone else has already disclosed, but there are always patents that can be written on a piece that may be missing from the existing patent or the next logical step for where the market will go.
The sequence will go like this:
Let’s say a competitor has a patent on an airplane. The claims require:
An engine
A propeller
A wing
A startup invents the biplane, which is novel (never been done before) and non-obvious (having two wings gives better performance and structural integrity). The patent office awards a patent with claims:
An engine
A propeller
At least two wings
The startup clearly infringes the competitor’s patent, because the biplane has every element of their patent. But now the startup can stop the first company from building biplanes. The startup now has something to trade or cross license with its competitor.
Rather than negotiating a license fee for the airplane patent from a competitor, the startup can cross license the biplane patent. Maybe the startup can even negotiate for the first company to pay when they build biplanes, if the biplanes become more popular than the regular airplanes.
The point of this scenario is that even though someone else holds a patent in a startup’s space, there is still room to invent improvements and sell or license them back to the original patent holder.
Patents And Open Source Software
Open source software is not often protected by patents, which is unfortunate. However, there are situations where patents are particularly valuable.
In a commercial open source software context, a company may release its code open source but may place restrictions on use. A company may, for example, allow educational and non-commercial use of its products but may charge for commercial use.
A patent portfolio can be used to enforce the commercial-use restrictions of the software while allowing the code to be freely available to the public.
Protecting A Razor Blade Business
Many businesses have the razor/razor blade model, where they sell one product at a lower cost (sometimes free) with the hope that they sell replacement parts or consumables.
Patents play a very big role in protecting this business model.
Patents are great for protecting interfaces, mechanical and otherwise. The interfaces may be an application programming interface (API) in the software area, or it may be an electrical communication protocol in an internet-of-things product, or it may be a mechanical connection for a razor blade.
In general, these patents have very little stand-alone value, but they will prevent anyone from building a product that connects to the interface. With patents on the interface, the patent owner can license the patents to other companies to make products that connect to the product.
This licensing scenario allows the company to certify and approve each vendor. Some companies can arrange a deal so that a third party pays for “certification” as well as paying a license fee per unit sold.
These patents are typically narrow and rather specific, so they do not have much value outside of the specific product’s ecosystem, but inside the ecosystem, they allow the owner to control how products will grow and still get a piece of the action.
Protecting Any As-A-Service Business
Many companies operate “as-a-service.” In the software space, there are companies that provide authentication services or payment services. In the physical products space, there are companies that provide manufacturing or fulfillment services. In the financial services space, companies will provide background checks or other services.
In each of these cases, the business model is to take previously known functions or services and specialize. The specialization allows a customer to build their business without having to build their own authentication platform or fulfillment center.
The “as-a-service” business can be protected by patents on the interfaces, because competitors will have to have the same or similar interfaces.
There are several interfaces for any “as-a-service” business. These include the normal customer interface as well as various administrative interfaces.
For example, an authentication-as-a-service business might have an API through which a website may direct a user to the service, and once authentication was completed, the API may transmit a token. This may be the interface to the customer. A second interface may be an administrative user interface or API that provides analytics for how often the service was used, its success or failure rate, and other data. A third interface may be a configuration interface that a customer uses to set up and install the service as well as perform maintenance or change services.
Patentable business advantages may be found on each of these interfaces, and these patents will give the company a distinct advantage in controlling the market, either by excluding other competitors or licensing their interface technology to other providers.
Dealing With Employment Issues
A company-wide strategy for patents can have ancillary benefits when dealing with employee issues.
For example, a company that operates in a highly competitive market for talent can use its patent portfolio to limit the damage when employees leave and work at a competitor.
Documenting and reviewing inventions is a best practice.
The company’s practices of periodically reviewing patentable aspects of the business set the tone that the company is aware of its trade secrets and their value. This has a benefit of putting employees on notice that there is value in the intellectual property.
Such a company may regularly document its progress by filing patents, which legally document the inventions owned by the company.
The employees know the technologies that are owned by the company because they were listed as inventors on a patent and are much less likely to repeat the same invention when they jump to a competitor. Further, the competitor does not want a patent fight to ensue, so that competitor may look less favorably at poaching talent from the company.
Filing a patent after an inventor leaves the company.
When a key employee leaves the company, the company might wish to file a patent on anything that the employee was working on at the end of their tenure. With some of the recent changes to the patent law, the company can easily file the patent in the name of the inventor who left the company, but only when there is an employee agreement that transfers any inventions to the company.
In a typical scenario, a patent might be written within a month or two of the employee’s termination. The former employee will be sent the paperwork to sign.
The former employee might refuse to sign, and the startup would then file the patent anyway and the employee is put on notice about what is owned by the company.
One big benefit of doing this is to eliminate inventorship problems down the road.
The former employee might refuse to sign the paperwork and state that they were not an inventor which prevents them from creating an improper inventorship problem later. This would invalidate the patent.
When the former employee does sign the agreement, they are agreeing that the assets are owned by their previous employer, thereby heading off another potential problem.
This can prevent their new employer from using the trade secrets from their new employee without potentially incurring liability.–
A side benefit of these practices is that other companies might be less inclined to poach talent from the startup.
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