SMEs and Patents: How

to Get it Right?Ivan Chaperot, IP Law

Summit, March 28, 2017

Content first presented at the IP Law Summit (a Marcus Evans conference) on March 28, 2017, Red Rock Resort & Spa, Las Vegas, NV

Disclaimer

The views and opinions in this presentation are those of the author and do not necessarily reflect the official position of any entity other than the author, whether current or former employer or other agency, organization or company.

Since the author is a critically-thinking human being, these views and opinions are

subject to change, revisions, rethinking at any time. By the way, please do interrupt, challenge and otherwise participate in a discussion with the author to challenge his thinking.

The SME patent paradoxSMEs invest most of their resources in R&D to produce new technologies. They take higher risks than larger companies, who in contrast focus their R&D efforts on incremental innovations.

Yet, SMEs mostly fail to protect the value they create with patents. When they do, these patents have in general very poor quality and do not adequately protect their core markets. Lastly, SMEs are underserved in terms of legal representation and understandably so: outside law firms tend to find it difficult to work with SMEs, let alone getting paid for their services.

There is a mismatch between the patent value creation potential of SMEs on one hand, and what they actually produce.

Patent Obtention CostsTypical costs for a 40-page application with 15 claims and 5 pages of drawings, first filed in the US, and then extended overseas with a PCT application for 3 countries/regions (US, CA, EP) to 6 countries/regions (US, CA, EP, JP, KR, CN)

Activities Costs

Drafting and filing a US patent application $15k - $20k

Early extension costs (filing and examination fees) $15k - $30k

Late extension costs (prosecution, grant, maintenance) $40k - $90k

Total $70k - $140k

Source: Based on “Estimating the cost for filing, obtaining and maintaining patents across the

globe” by Anthony de Andrade & Venkatesh Viswanath (August 28, 2016), IPWatchdog

Patent Utilization CostsTypical patent enforcement/defense activities include a filing an IPR to defend against an assertion, the acquisition by the SME of a patent as leverage in counter-claim/negotiations and a ITC or District Court litigation (up to trial)

Activities Costs

Preparing, filing an Inter Partes Review $250k - $500k

Acquiring a “claim charted” US patent $500k - $2M

ITC or District Court action $2M - $6M

Total $2.7M - $8.5M

Why should SMEs spend money on obtaining patents

they cannot afford to use?

Why are patents important to SMEs?“Reasons for Patenting Your Inventions”

1. Exclusive rights allow your SME to use and exploit the invention for 20 years2. Strong market position prevent others from commercially using your patented

invention, thereby reducing competition3. Higher returns on investments under the umbrella of these exclusive rights4. Opportunity to license or sell the invention if you chose not to exploit the patent

yourself5. Increase in negotiating power in the process of acquiring the rights to use the

patents of another enterprise6. Positive image for your enterprise for raising funds, finding business partners and

raising your company's market value.Source: Extracts from http://www.wipo.int/sme/en/ip_business/importance/reasons.htm

Why are patents really important to SMEs?Reality-checked motivations for seeking patent protection for SMEs:

1. Clearly establishes who owns what (employees, contractors, partners)2. Enables flexibility to disclose publicly (demos, fund raising)3. Protects the value of stock and stock options (investors & employees)4. Creates a valuation premium for strategic buyers (value of control)

And to a lesser extent, as it most likely won’t benefit the SME’s current team or shareholders unless something goes terribly wrong and the SME magically survives:

5. Fortifies the SME’s balance sheet (assets pledged as loan collateral)6. Protects the SME’s margins (licensing, enforcement)

#1: Establishes Ownership

Parting ways with a co-founderOusted co-founder, Reggie Brown (on the left in the photo) filed a lawsuit against Snapchat claiming he came up with the idea for disappearing photos but was pushed out and not given equity. Snapchat settled in September 2014.

Disgruntled co-founders or early technology partners may make claims if a company proves to be successful. It is important to get ahead of it.

The founders of Snapchat celebrate its launch: Reggie Brown, Bobby Murphy and Evan Spiegel. LA County Superior Court

Key employees/contractors leavingEarly stage companies create most of their value is the form of technologies. They are vulnerable if departing employees use it for their new employer or to form a new company.

Trade secret violation claims against

departing employees are hard to prove unless there is an overwhelming evidence, such as former employee downloading 14,000 proprietary design files weeks before resigning.

“Waymo sues Uber and Otto for theft of trade secrets” by Darrell Etherington, TechCrunch (Feb 23, 2017 )

How far can trade secrets & copyrights go?Zenimax sued Oculus (Facebook) for stealing their VR technology.

Carmack (Oculus CTO) stated: "No work I have ever done has been patented. Zenimax owns the code that I wrote, but they don't own VR."

While deciding Oculus wasn't guilty of stealing trade secrets, the jury also decided to award Zenimax $500 million for violations of NDAs. “Facebook just lost a $500 million lawsuit — here's what's

going on” by Ben Gilbert, Business Insider (Feb 7, 2017 )

Challenges in establishing ownershipHard to establish clear boundaries

Employees

● Not possible to brainwash departing employees.

● Non-compete hard to enforce

Technology partners collaborate well until some other partner comes along (infidelities) or break-up

Benefits of filing patent applications:

Employees document (invention disclosure) what they are working on during their employment, whether or not a patent is ultimately filed.

Filing a patent application forces a discussion about IP ownership while relationships are (still) good with a technology partner. Filing a patent application before initiating a technology partnership is even better.

#2: Enables Disclosures

Investor Pitch Demo Product Launch

Startup disclosures

Build MVP Optimize product

R&D activities

Investor Pitch Demo Product Launch

Build MVP Optimize product

Typical VC-funding

Seed Round A Round B Round C

$250k $2M $10M

Build MVPOptimizeProduct

Scale Up,M&As

BusinessDevelopment

$50M

Startup patent filing strategies

BAD

● Rely only on trade secrets by signing NDAs (no patent)

● Open source everything to foster technology adoption (no patent)

● D.I.Y. provisional filing or patent drafting services (no attorney)

● Capped patent drafting fees result in thin applications

GOOD

● Deferred attorney fees, bridge financing (e.g. convertible loan)

● Preserve rights with patent filings and PCT extensions

● Document all inventions and make judicious filing decisions

● Develop rich first application that can be (later) a source of CIPs

“Cheap things are not good, good things are not cheap” - Chinese Proverb.

#3: Protects Stock Value

Stock of value of a company

Concept of Intellectual Capital by Adam and Oleksak

Stock Value

Financial Capital Intellectual Capital

RelationshipCapital

StructuralCapital

HumanCapital

● IP assets (patents, code...)● Processes

● Network● Customers

● Management● Employees

Seed Round

$250k$500k $750k

Pre-Money Valuation Post-Money ValuationThe Money

VC=33%Team=66%

Round A

$2M$3M $5M

Pre-Money Valuation Post-Money ValuationThe Money

VC=60%Team=40%

New hires

Seed stage value creation

$500k$3M

MostlyIP assetscreation

$2.5M

New relationships

Value created in Seed stage by the team using the money

IP assets contribute to stock value increase

Patents

CopyrightsTrade Secrets

Industrial DesignTrademarks

● Computer programs● 3d objects● Panoramic images

● Technologies (e.g. VR)

● Brand names

● Structure

Enforceable trade secrets:● Generally secret● Economic value● Reasonable protection to

maintain secret (NDAs)

Exemplary Net Payoffs for VCs

IP asset value attributable to patentsReal-Option Value

An early-stage technology startup is a growth option.

The payoffs are derived from the expected the value of exploiting

the patented technology.

The patents provide legal exclusive rights (ownership) to this “real option”.

More information on real-option value: “Real Options: Fact and Fantasy”, Aswath Damodaran, NYU Stern School of Business (2013)

Fail

Round A

Seed

Round B

Fail

Round C

Exit

Fail

Exit

-$250k

-$2.25M

-$12.2M

$6.75M

$26M

$94M

-$250k

-$2M

-$10M

-$50M

“doubling of a start-up’s patent application stock is associated with a 45% increase in valuation”

“Small Firms, Big Patents? Estimating Patent Value Using. Data on Israeli Start-Up Firms’ Financing Rounds”, Gili Greenberg (2010)

#4: Valuation Premium

Who cares about patent quality?

Most high tech VCs don’t value patents because they don’t know anything about it. If they do, they don’t care about patent quality because they are out before it matters. Patents are at best a “check the box and move on” consideration.

Why should patent quality matter for VCs? Because buyers care.

Corporate buyers generally pay more than financial buyers and care about patents (which their IP team assess).

Patent

Strategic motivations for acquiring SMEs

Brand

Talent

Technology

Products

CostSynergies

GeographicExpansion

For Corporate Buyers, intellectual property and R&D is deal driver, which is protected by the SMEs patents.

What is the “value of control”?

● In acquisitions, acquirers often pay a premium for control that can be substantial.

● The value of controlling a firm derives from the fact that you believe that you or someone else would operate the firm differently (and better) from the way it is operated currently.

Patents present incremental strategic value for corporate buyers, which they can evaluate. They will operate the SME patent portfolio differently.

Important considerations:

1. Claim coverage2. Geographic scope3. Encumbrances (lack thereof)

Source: “The Value of Control”, by Aswath Damodaran (Stern School of Business)

Accountability for patent quality?

1. Some VC investors have experience with patents. Choose a VC investor who can bring this experience to the board (e.g., Corporate VCs).

2. The CEO or a C-level executive (CFO, CTO) should be responsible for establishing a patent strategy.

3. The company should establish processes so that the outside counsel can work efficiently.

Board / Investor1

2

3

Conclusion

ConclusionCommunicate the value of patents in business terms tailored to the key stakeholders:

● Management team cares about doing the right thing (#1, #2)● Investors care about their share value (#3, #4)

For outside counsels: choose clients who get it. It can be very frustrating otherwise.

For SMEs: be a good client. Help your outside counsel (processes, attention, availability).

Connect with me

https://www.linkedin.com/in/ivanchaperot/