VALUE OF INTANGIBLES: WHY START-UPS SHOULD INVEST IN PATENTS

An entrepreneur’s most valuable asset is the idea he/she possesses and therefore, the first task for any entrepreneur should be to protect and safeguard that idea. Patents are important to start-ups because they provide a legally sanctioned monopoly that bars entry to competitors, thereby providing start-up owners with the time to work on their idea without the fear of a competitor infringing upon the same.

A patent does not only grant an exclusive right to use the said patented idea, but more importantly grants the holder of the patent a right to exclude others from using the said patented idea. A patent is a valuable intangible asset for any company and evaluation of a patent should be done from a long-term perspective.

Keeping in mind the increasing rate of technological development, securing patents at an earlier stage is highly recommended to reap maximum benefit from the invention.

Start-ups and Intellectual Property: Indian Context

In India, the start-up culture is a relatively new concept but has been increasingly booming. India is one of the fastest growing economies in the world and as a result, is one of the biggest markets as well as candidates of producing future technologies.

The Government of India realises the untapped potential of India as a market and thus, has taken up several initiatives to support and promote innovation and entrepreneurship; the Start-up India Scheme, IPR Awareness Creative India, Innovative India Scheme are just some examples of initiatives taken by the Government. The said schemes facilitate the setting up of incubation centres, allow tax exemption for start-ups, provide up to 80% rebate on patent application fees, allow faster exits for start-ups, provide relaxed costs for women inventors etc. All these initiatives, coupled with phenomenal research and innovation from institutions, industry, and society, are strengthening India’s position as an innovation and knowledge hub. This is further evidenced by the Global Innovation Index 2020 wherein for the first time India, ranked at the 48th position, has secured a place in the top 50 countries.

As per NASSCOM’s latest report ‘Emerging Technologies: Leading the next wave of IP Creation for India’, Indian start-ups have filed over 200 patents in 2017-2018. Further, over 50 per cent of the technology patents filed, came from emerging technology trends such as Artificial Intelligence, Cyber Security, IoT and Cloud Computing.

Importance of owning a patent

Some key aspects to be kept in mind while deciding to invest in a patent are:

i) Costs involved– is it cost effective?

For start-ups, it is important to keep in mind that patent costs must be evaluated relative to the potential commercial value that the end patent product/service will hold, such as potential product/service revenues, royalties received, licensing benefits reaped, etc. Thus, due consideration should be given to the prospective returns that the patent shall provide rather than the initial spending involved.

Further, as many start-ups may require third party funding, having a valid patent may add credibility to their innovations for seeking investments. One of the recent trends that have emerged is the patent-backed financing by banks. This enables start-ups to meet initial costs without burdening other corporate assets; which is the case with other types of debt financing.

ii) Adds value to the company

Once a patent is granted, the patent holder has several avenues to recover R&D costs as well as earn a Return on Investment. For example, a start-up may licence and/or sell its patent to a bigger company which is in a better technical and/or financial position to facilitate the ideas into reality.

In today’s time, technology is being replaced/upgraded at a very fast pace; and there is often a lot of overlap in terms of the level and kind of technology being provided. More often than not, the core of a product depends upon technology acquired from many sources, and in view of the same, having a patented technology shall allow start-ups to license their technology to be put in practical use across several sectors. The patented technology can also be licensed in exchange for royalties or a lump sum.

Additionally, a start-up may benefit from licensing its patented technology as it shall lead to an eventual increase in its market share. For example, Fractus S.A., a telecommunications technology company, invented a mobile phone antenna based on principles of fractal geometry, which allowed it to be much smaller. However, the said company did not have the means to manufacture enough units to meet the demand. Eventually, Fractus licensed its technology to 90% of the world’s smartphone makers and in turn increased its market share.

Further, it is well-known that the process of valuation of a company is done by taking into account the company’s intellectual property assets as well. From the perspective of investors including venture capitalists, angel investors etc., start-ups with valid patents are far more attractive options than the ones with no patents at all. A 2008 Berkeley study paper titled ‘Patenting by Entrepreneurs: An Empirical Study’, found that 67% of venture capital backed start-ups reported that having a patent had been vital for them in securing investment.

The reason for attracting funding is that a patent is viewed as a signal of quality as well as a guarantee of unique innovation. Since start-ups heavily rely on investments, having a valid patent can provide an edge, such as provide a stronger negotiation position or favourable terms for contracts, licensing-in, cross-licensing, collaborative activities etc.

iii) Helps in deterring competition

The exclusive right to use the patented technology involves the right to stop competitors from infringing upon the same. Further, grant of a patent secures the market position of the patent holder and in several cases, the same might lead to a monopolistic market share. For example, Amazon after obtaining a patent for its “one-click” online purchase system, filed a patent infringement suit against its competitor Barnes & Noble over the latter’s use of a similar system. The judge granted an injunction ordering Barnes & Noble to stop using Amazon’s one-click patented technology, giving Amazon the edge in online book retailing.

Further, in a fast-pace technology-oriented world, competition is to be understood in terms of development of new technologies and future market share and not prices and current market value. Thus, to maintain its position of power, a patent holder has to be aware and has to continuously monitor the new technologies for which patents are being granted. In case of a patent infringing upon the patent holder’s prior art is granted, it is essential for the patent holder to take action swiftly.

Conclusion:

It is pertinent to note that as per the 2019 Intangible Assets Financial Statement Impact Comparison Report, for S&P 500 companies, tangibles, like real estate and equipment, comprise just 16% of company value, while intangibles, such as IP rights and reputation, are 84%! Thus, it is clear that the valuation of unicorns and deca-unicorns today does not depend on their tangible infrastructure, inventory, or expensive machinery, but instead on their know-how, goodwill, intellectual property – patents, copyright, trademarks and network effect.

Investing in a patent is the best way to move forward, especially for start-ups in India. Even analysing the worst-case situation, i.e. failure of a company to achieve the full commercial value of its patent, and thereby leading to its dissolution, the patent(s) held by the company can be sold at a residual value. For example, Motorola Mobility business was purchased by Google for a whopping $12.5B which included the cost of Motorola’s 17,000 patents!

“The Bright Side of Patents,” a study published as part of the USPTO working paper series found that approved patents tend to provide or assist start-up companies with increased employment growth, growing sales, further innovation and additional patent approvals, and receipt of critical capital support. Therefore, in the long term, investment in a patent is equivalent to an investment in the start-up itself.

The article was originally published on www.lexology.com on September 15, 2020 and can be accessed here.