United States: Startups And Intellectual Property: A Pair Of Cautionary Tales

Tech startup companies often rely on patents and other types of intellectual property (IP) rights to help safeguard against competition, thereby protecting their investors and increasing the chance that they will succeed in executing on their business models. However, in many cases there are fundamental misunderstandings among the individuals and companies who invest in startups as to how best to use IP rights. Either the wrong attributes of the startup's products and services are protected, or IP is forgotten as a critical asset altogether. There is no better way to learn how best to protect and exploit IP than by examining the successes – and miscues – of others. That being said, below are two stories I'm happy to share, which are based on my real-life experiences while practicing IP law over the last 27 years.

Cautionary Tale 1

Asking the right questions about IP

About 10 years ago, I received a call from a friend who worked as a general partner at a well-known venture capital (VC) firm. The VC firm had recently made a large investment in a startup technology company, "Acme Corp.," which had a large patent portfolio. My friend wanted me to take a quick look at the Acme patent portfolio, and provide him with my general thoughts.

My first thought was, "Why is he calling me now, after the investment has closed, rather than calling me before the investment was finalized?" Nevertheless, I told him I'd take a look.

I received a listing of the patent portfolio and downloaded the patents. The patents looked interesting and appeared to cover a technology ("Technology A") fairly well. A few days later, I called my VC friend back. I walked him through Acme's various patents, including some of the patent claims ("patent claims" are the sentences embedded within all patents that specifically define the invention that is covered by the patent – similar to the metes and bounds of a property description).

"Are you sure that's what the patents cover?" he said.

The next hour was spent discussing the patents in further detail. My friend was completely surprised by the nature of the patent portfolio owned by the company in which the VC fund had just invested a large sum of money. "I thought the patent portfolio was directed to Technology B, not Technology A," he stated. Technology B was the technology at the heart of Acme's current business model.

"Do you know why Acme's patents would be directed to Technology A?" I asked.

He responded, "Well, Acme used to have some products that used Technology A, but they pivoted away from that business about three years ago into a new product line that employed newly developed Technology B. I guess they never filed new patent applications for the new products and technologies!"

"Didn't anybody take a look at their portfolio before the investment was finalized?" I asked.

"No," he responded. "We simply asked whether Acme had filed patent applications, and they answered in the affirmative. It was a line item on a checklist – 'patent applications filed, check!' Acme's management answered correctly – the company did indeed have patent applications filed. But not the proper patent applications directed to the relevant products and technologies. We didn't ask the right question!"

At this point, our conversation ended. Relations between the VC firm and the management of Acme subsequently were strained over this major oversight. Acme later tried to correct the misstep by filing additional patent applications for Technology B, but because it had waited too long and the technology had already been disclosed publicly and commercially, it was severely limited in what it could claim in its new patent applications. As a result, the firm's competitive advantage in the marketplace was significantly damaged.

Some important lessons from this true story:

  • Ask the right questions about IP. Don't just ask, "Have patent applications been filed?" Rather, ask, "Have the right patent applications been filed?" And then take a look at them, to be sure. Your patent attorneys can help in this regard.
  • IP should not just be a line item in a checklist. All too often, IP is oversimplified to a binary question, with one of two possible answers: "patent applications filed," or "patent applications not filed." Or, similarly "trade secrets protected" or "trade secrets not protected." The real answer is almost always much more nuanced and usually necessitates a closer look.
  • Management doesn't always know what they have and don't have with IP. Often without deceptive intent, management of a startup may not truly know what IP they own. They may throw around words like "proprietary," "protected" and "patent pending," but without looking more deeply, the true substance of what they own may be more complicated, and not what they think.
  • Take action early. Missteps with respect to protecting your IP may not be able to be corrected later. Whether it's waiting too long to file for patent protection, or inadvertently letting trade secrets become public, protecting your IP usually requires that proactive steps be taken early in the stage of technology development. Waiting too long can be a costly mistake.

Cautionary Tale 2

David v. Goliath: How an IP slingshot resulted in an acquisition

A number of our clients fall into the category of "serial entrepreneurs" – individuals or teams who have a knack for founding startups, building the companies into strong players in the market, selling their interests and then moving on to found new startups.

I represented one such serial entrepreneur who developed some pioneering financial services using Internet technology. I worked closely with the client to map out a suitable patent strategy, balancing a comprehensive patent protection approach with a limited budget. Over time, while starting with a small patent portfolio, we built the patent portfolio further to protect a large swath of the various inventions embedded within the client's products.

After operating in the marketplace for several years, it became clear that a much larger competitor was slowly but steadily encroaching into our client's space. The competitor took important features from our client's service offerings and incorporated them into its own. By the time our client fully realized what was happening, we fortunately had secured several key patents for our client, including its most valuable inventive features. While the competitor had also filed for patent protection, our client had superior patent claims given its head start in filing.

Our client was undoubtedly alarmed by the competitor's actions – both because the competitor was likely infringing the client's patents, and because the competitor was much larger in size, with more funding and resources at its disposal and greater visibility in the marketplace. After taking a closer look at the competitor's activities, we determined they were, indeed, likely infringing.

Our client's first inclination was to file a patent infringement lawsuit against the competitor and try to recover damages and/or force the competitor to cease infringement. However, as we explored options further with the client, we determined it was in our client's best interest to work with the competitor in some fashion, as opposed to trying to force them to stop infringing or take a license.

After developing an appropriate approach with the client, we carefully reached out to the competitor, set up meetings to discuss our client's patents in general terms, and negotiated a solution to the potential dispute. After thoughtful discussions and negotiations, it became clear to both sides it was in everyone's best interest for the competitor to acquire our client. Our client would contribute its valuable patent portfolio and related technical expertise to the deal, and the competitor would contribute its existing products and technologies and its position as a larger player in the field, with deeper pockets. And the competitor would pay our client a significant amount for the acquisition – truly a win-win.

We helped structure the deal, and the transaction was consummated. After the deal closed, the benefits that were anticipated played out well, and the combined company continues to be dominant in the field.

Some important lessons from this true story:

  • IP can be a sword, but also can be a means to a beneficial end for both sides of a dispute. It's important to be creative when considering potential solutions to an IP dispute, and a win-win outcome can often be achieved, eliminating or minimizing more expensive legal options, such as litigation.
  • IP can level the playing field between smaller and larger companies. In many cases, IP can help bring different types of companies together, leveraging the strengths of both – for example, the innovation and scrappiness of a startup company and the deeper pockets and market reach of a larger player.
  • A robust IP position can be created on a startup firm's limited budget. With help from patent/IP counsel, there are innovative techniques to protect the most important IP initially, and later expand and cement the IP position as the company grows.

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.

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