Germany: Good Patent Practice For A Venture Capital Financed High-Tech Start-Up

By Dr. Malte Köllner, Patent Attorney, Triangle Venture Capital Group

What should a venture capital financed high-tech start-up do on the patent field to become a strong company. Is it worth spending money on patents? (You might guess that the answer is yes, the author is a patent attorney, but wait!) Is it of strategic importance or is it more a marketing tool on the investment market? Do patents have any influence on turnover and profit?

One way of answering this question would be by trial and error: gather experience. However: how many years and millions do you need to find out with sufficient significance? Will the company still be alive until you finally found out? You could ask your patent attorney. He may not have a very convincing argument but he will be in favour of patents. Or you can ask experienced managers. Probably, they won't be of much help either, telling different stories.

Help might come from empirical research in business administration. And here are the answers:

A number of studies have shown a significant influence of patents on the success of a company. With success of a company we mean vague things like turnover or profit.

Is it enough to just file patents, to just file anything? You will guess the answer to this rhetorical question: Of course not.

High quality patent applications significantly increase the turnover of a company two to three years later. The effect increases with the quality of the patents [Ernst, H. (1999): Führen Patentanmeldungen zu einem nachfolgenden Anstieg des Unternehmenserfolges? Zeitschrift für betriebswirtschaftliche Forschung 51. Vol.(12), page 1146-1168].

One reason for this increase could be the fact, that good inventions covered by high quality patent applications are more often commercialized than others [Shane, S. (2001): Technological Opportunities and New Firm Creation, Management Science 47(2), page 205-220].

No wonder, therefore, that patents with a broad scope of protection increase the value of a company [Lerner, J. (1994): The importance of patent scope: an empirical analysis. RAND Journal of Economics Vol. 25(No. 2), page 319-333].

And, grouping the individual patents to a "portfolio", you find that a valuable, high quality patent portfolio increases the stock price and market capitalization of a publicly traded company [Deng, Z./Lev, B./Narin, F. (1999): Science & Technology as Predictors of Stock Performance. Financial Analysts Journal 55(5), page 20-32].

The implementation of a patent strategy in the R&D department together with corresponding patent management processes almost doubles the profit margin of a company, in particular if it is combined with a systematic use of patent information [Omland, N.: "Patentmanagement und Unternehmenserfolg – eine empirische Analyse", Mitteilungen der deutschen Patentanwälte (2005) 402].

One reason for this could be the fact that a well managed patent portfolio has a higher quality and thus increases the turnover of a company (see above). At the same time, systematic use of patent information can safe R&D expenditures by avoiding spending money for reinventing things already invented elsewhere [Omland, N.: "Patentmanagement und Unternehmenserfolg – eine empirische Analyse", Mitteilungen der Deutschen Patentanwälte (2005) 402] [Ernst, H. (2003): Patent information for strategic technology management. World Patent Information 25, page 233-242]. This looks quite plausible.

Meanwhile, we have become familiar with a number of principles and can almost guess what comes: companies with an actively pursued and systematic patent strategy have a higher growth rate of the turnover [Ernst, H. (1996): Patentinformationen für die strategische Planung von Forschung und Entwicklung, Deutscher Universitäts-Verlag. Wiesbaden]. Having read until these lines, we cannot say that this is really a surprise for us.

So, have these ideas become a common place for us within minutes? Are these results all of a sudden evident? They may be for those who have read these lines or the cited literature (or other relevant literature). Unfortunately, however, few have taken the time to read this or even had the chance of reading it, since most of these papers appeared in journals not read by patent professionals. Consequently, these ideas are anything but commonplace in industry. Although they should, shouldn't they?

Quantity does not matter. It only costs money for loads of patents. And low quality patent applications have, if at all, a negative influence on the company, because they consume money without producing anything helpful for the success of the company.

Build a high quality patent portfolio. Don't file just anything. Look for quality. And install patent management. Be systematic. Put brain into your patent work. Develop a strategy and actively pursue it. But what is this: "patent management" or "patent strategy"?

What could patent management involve? Management is the art of achieving a goal, some say. So when reflecting on the best way of achieving a goal, it seems to be a good idea to first spend some time thinking about the goal to be achieved. In other words: where do you want to go with your patents? What is your patent strategy and your strategic aims? What is a suitable patent strategy for a venture capital financed young high-tech startup company?

What does "patent strategy" at all mean? Is it just a buzz word, management talk? Some people call their way of choosing countries for applications abroad their "patent strategy". Others consider the ideal way of patent prosecution to be their "patent strategy". Again others do not differentiate much between patent portfolio management and "patent strategy".

Let me stick to a vague but simple differentiation: for me, strategy has something to do with the goals to be achieved and the big picture of the way to do so. Management, on the other hand, rather concerns every day routines of doing business, in particular finding processes for supporting the strategic goals.

In this perspective, patent strategy generally could aim at the following:

• Licencing out your patents. If you are lucky, your ideas will form the basis of a standard. Or you can claim damages (the so-called "stick licensing").
• Cross licencing your patents with the patents of your competitors.
• Building a monopoly position based on your patents around your products, protecting them.

Different of these strategies are best practice in different industry sectors. Mixtures also occur.

Do any of these strategies make sense for a young high-tech start-up company? Experience shows that patent strategies of young high-tech start-up companies in the big picture do not differ from those patent strategies pursued by industry leaders. Rather, a suitable patent strategy for a young high-tech start-up company looks like an imitation of the best practice for the respective industry sector, complemented by some additional measures to be taken, which I would like to illustrate a little in the next paragraphs.

• First of all, imitate what is best practice in your industry sector. For example, in the pharmaceutical area of biotechnology that would mean to try to monopolize a drug. In telecommunications this might mean to try to create intellectual property which may serve as the basis of a new standard.
• Secondly, patents are better than trade secrets. Do not forget that we are talking about young companies that are venture capital financed. Such companies often go from financing round to financing round. Financing rounds and the anxious months before they are closed (and sometimes not) may cause a fluctuation of the personnel. Also, the personnel might fluctuate with the ups and downs of business success. Even more so, the personnel might be subject to considerable changes in case of a sale of the company. Surely, fluctuating personnel takes trade secrets along and reveals trade secrets as what they are: a perpetual risk.
• Thirdly, rather make a few patents too many than one too few. As we have seen, it is important for a high-tech company to build a strong patent portfolio. This should contain - in the ideal case - only valuable, high-quality patents. The problem is, that you cannot always judge which patent has a high value and which one not. This is even more the case since this judgment can change over the years with changing business environment conditions. Therefore, in case of doubt: file a patent and uphold your old patents. Only abandon patents if you are more or less 100% sure that they are doomed to fail. (You may be forced to lower this threshold when you are short of money.)
• Make patents regularly, say one per month or quarter, at least one every six months, since it is one of the most prominent aims to be achieved by a young high-tech start-up to build a strong patent portfolio. You should not rely on the strength of only one patent. You might be wrong in your judgment about this patent. More than once, the most valuable patent of a patent portfolio was not the one which everybody would have thought it to be.
• Go for a quick grant of the patent applications. Accelerate the prosecution where possible. It might be wise to avoid the PCT route and go directly into different countries or regions. When choosing the PCT route for application, it generally takes four to five years and more until patents are granted. However, a patent application has a much lower value than a granted patent in case of a financing round. On the other hand, the preliminary report on patentability issued at the end of the international phase of a PCT application is achieved fairly quickly (after about two years) and is almost as good as a grant of the patent, if this report is positive. Clearly this implies that once you chose the PCT route, you have to take extra care to achieve a positive preliminary report on patentability.

In following these simple measures, a young high-tech start-up company can achieve a number of advantages:

• The company will be in possession of a respectable patent portfolio. This can always be used as marketing tool for the next financing round. Granted patents somehow prove the uniqueness of the technology. Also, a well-established patent portfolio has a crucial influence on the valuation of the company, in particular for a tradesale, i.e. when the start-up is taken over by an industry leader. The younger a company is, the more its potential will be judged based on the patent portfolio - and not on the vanishing turnover.
• A suitable patent portfolio can help a young company become visible even with low turnover. Competitors may not be awakened by the negligible sales a young company may have achieved. But they may be awakened by the threat that resides in a patent portfolio.
• Valuable patents might also allow you to trigger a merger or acquisition using your patents, e.g. by filing a patent infringement suit and settling it by being acquired.

Maybe we know now where we want to go in patent matters.

This obviously brings us to the question how we can achieve these strategic goals. In other words: what patent management should strive to pursue? Let me enumerate the essential steps of a good patent management for a young venture capital based high-tech start-up.

• Step one is the definition of a patent strategy and of goals to be achieved. Needless to say that this strategy must be deduced from the general business objectives. R&D, sales and IP must be interlocked. Also, the strategy you once drafted might not quite work the way you expected it to do. So keep it dynamic, update and fine tune your patent strategy regularly.
• Step two is very simple: have regular meetings discussing IP matters. The participants should come from the R&D department, from sales, from management and - of course - from the IP department. For a small start-up, the CEO and the patent attorney alone might populate such an IP meeting. Others might join when the company grows. The aim is as simple as thinking regularly about patents; this simple step seriously helps to improve the IP position of the company. Very simple and yet all too often not observed.
• What should be discussed during these IP meetings? There is one paramount point: Collect all ideas and inventions of your engineers that you can get hold of. You can only build a patent portfolio if you are aware of inventions. Now: what to do with these ideas? File them as patent applications? Wait. Don't hurry. Here come some of the key success factors for a good patent management.
• Do not file everything. Remember that only quality matters, not quantity. (And remember that money is short in young companies, even with venture capital on board.) It is your duty to select the potentially best inventions for patent application.
• Do not file event driven. A typical event driven filing is governed by the following script: An idea has been born within the R&D department of the company. The CEO will meet a customer next months and has the intention - among others - to present this idea to foster the sales process. In order not to destroy any IP, it is agreed to contact the patent attorney and make him file a patent application rapidly to protect this idea.
• However: concentrate. Step back. What do you want to achieve? A patent portfolio full of high quality, valuable patents. You are to pursue a strategy. Therefore, file in a strategic and systematic way. Does this invention support your strategy? Will it create a valuable patent? Is it really worth spending the money on it? Surely, you cannot judge for sure which invention will be of value later on. Nevertheless, try to analyse. Think twice. When in doubt: file. But stick to your strategy. I don't have to remember that we are not living in the best of all worlds. Money is a scarce resource. You probably have a limited IP budget. You are forced to optimise the allocation of these scarce resources. Where should you put the money on in order to best serve your company? You should invest on one hand in high-quality patents. On the other hand, investing according to your patent strategy is probably the wisest decision in terms of money allocation.
• Conduct searches. Make use of patent information. Remember that the systematic use of patent information is beneficial to your company. Analyse the patent landscape. Analyse the patent portfolio of your competitors. This will allow you to find landmines before they find you. Find ways to circumvent your competitors' patents. Be well informed and don't be taken by surprise.
• Monitor all patent publications in a certain field. Definitely monitor all patent publications of your mayor competitors. But also monitor the entire field of interest. Take care to narrow your field of view to a level that can be supported by those responsible for reading the material. These can be the engineers, if they received some basic IP training. The CEO may not have enough time for this. But those who read the results of the monitoring process should be part of the IP meeting team.
• Do not analyse too much what you find by monitoring patent publications. There doesn't seem to be a need to categorize all patent publications found. In any case, you will have to make a novelty search before filing an application. And again, what would be the criteria for categorizing the patent publications? The criteria relevant later on in a conflict might be entirely different from what you consider today. Patent monitoring is like reading a specialized newspaper tailored for your needs as well as a means for discovering imminent danger.
• Before filing an application conduct a novelty search or try to be familiar with the prior art by some other way, e.g. by knowing every patent document in your field. You risk wasting a lot of money in filing an application - and probably expensive foreign filings twelve months later - in case some patent office can confront you with highly relevant prior art killing your application. True, it is not easy to conduct prior art searches and the searches performed by the patent offices often have a higher quality than your own searches. The risk to be surprised by prior art found, e.g., by the European Patent Office cannot entirely be eliminated. However, a simple calculation shows that it is worth spending on the order of one, two or three thousand euros or dollars on a prior art search before filing an application. This money may prevent you from spending much more on a useless application in case you find highly relevant prior art. But there is another very important effect of a prior art search: if you are familiar with the relevant prior art for a patent application, you have a much better impression what the core of the new ideas is. What are the all important distinguishing features over the prior art? With this knowledge at hand the drafting of the application will result in a patent application of higher quality, stressing the important point with the necessary degree of detail. Such an improved quality of the application will have a beneficial influence on one hand on reduced prosecution costs. In the ideal case - which happens in real world every now and again - there will be no material office action at all during prosecution - in the entire world. The examination of the application will quickly result in grant of the patent in all countries with much reduced costs for the prosecution. On the other hand, a higher quality of the patent has a beneficial effect on your business. So the money spent for a prior art search before filing an application is money well invested.
• Before starting a product development make a freedom-to-operate analysis. This should be fairly evident to everybody. If you omit this, you might end up having spent quite a bit of money for product development without being able to sell your product and that way get any return on your investment, because unfortunately your mayor competitor is holding a patent on just what you developed and - well, well, well - you somehow didn't know. The money will simply be lost.
• After filing an application go for quick grant. Try to get an office action as early as possible in order to get an idea about the chances of success of this application. Also, you should try to get an idea about the form of the claims that might eventually be granted. What scope of protection might this patent end up with? Broad or narrow? This will allow you - among other factors - to get an idea about the qualitative value of this patent (application). Remember that patents with a broad scope of protection increase the value of a company (see above), while narrow patents don't.
• It has proven very helpful to take into account the above mentioned two factors:

• chances of success of the patent application and
• qualitative value of the patent application

• If licensing out your patents is part of your patent strategy, uncover licensing potential on a regular basis. This can be achieved, e.g., by monitoring all patent applications during the examination of which your patents are cited as prior art. Also, it is beneficial to discover what patents are dependent on your patents. (There exist automated tools for this on the internet, see www.ipcentury.com.)
• Prosecute any infringement consequently. This might cost money and bring in money. At the same time, it teaches your industry sector that you not only bark but also bite, if necessary. This will definitely increase the influence of the existence of your patent portfolio on decisions taken by your competitors. They are much more likely to respect your patents and your products will face less competition. This, of course, increases your turnover.

I think these simple rules have a beneficial effect also on other high-tech companies, beyond venture capital financed companies and beyond start-ups.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.