Patents Age Like Fine Wine

Patents reach peak valuation around year 12. Why is that?

We like to think about patents as call options on technology. With a call option, you have the opportunity, but not the obligation, to cash in the option before it expires.

A patent operates in a similar way. You have the opportunity, but not the obligation, to license/enforce your patent during its lifetime. Once the patent expires, it is over.

Why year 12?

Despite the breathless trope that “technology moves so fast,” it really takes a long time for technology to become mainstream.

The fundamental problem with any new product is that customers must change their behavior. The term “comfort zone” exists because we, as humans, get comfortable with what we know and experience. It is only after we get bored with the everyday things that we slowly, cautiously explore new things.

A new product requires moving outside our “comfort zone.” As such, it takes a long time before those early adopters try the product, then, as the product becomes more acceptable, for other people to join in.

Why do patents peak at year 12? This is an artifact of the patent system.

The patent system sets the lifetime of a patent to be 20 years from invention (technically, it is based on the earliest filing date, and the US system will give you patent term extension to give you at least 17 years).

For valuation, there are two factors: historical and potential revenue.

The historical revenue is the revenue that patent generated in the past, and the potential revenue is the revenue yet to come. From my standpoint in valuing a patent, the revenue comes from either the patent owner producing the product, or an infringer copying and selling an infringing product.

At year 12, the historical or existing revenue should be growing pretty steadily, and there is still enough runway (in the remaining 8 years) to generate more revenue. As we approach the end of the life of the patent, there is only so much more revenue that can be generated, so the patent value begins decreasing. Hence, the 12 year mark is the typical peak.

If you have patents that are 10 years old and nobody infringes, something is wrong.

The lesson here is that if you have patents that have a bit of age to them, say 10 years or so, and nobody is infringing, this is a big problem.

The problem is simple: nobody wants your invention.

If you think about patents as call options, you are betting that the market will adapt your “vision” of an improved product or service. From the initial idea, that vision is not a foregone conclusion – it will take investment. The investment implies risk, and there are plenty of risks: the market may go in a different direction (a different solution came along), the market was not ready for the idea (you were too early), the market was not that enthusiastic (your solution did not address a big enough problem), or countless other ways that businesses do not succeed.

Imitation is the sincerest form of flatterly.

After 10 years in the market, if you have not convinced a competitor that your solution to your mutual customer’s problem, the idea just isn’t that valuable.

It is one thing to convince a customer to buy your product, but it is a whole other level of validation when a competitor is convinced that your solution is so good that they choose to copy it (although sometimes they come to the same conclusion as you do).