Venture capital investing in intellectual property

Venture capital investors are on the opposite side of the spectrum: they do not give patents any weight at all. Due diligence for IP and patents specifically is not that hard. It just takes a few rules of thumb and common sense. Patent Ownership Owning the IP is essential, and it is staggeringly often that a startup company does not own its patents. In the US, patents are granted to the inventor — a natural person. That person owns the IP until they assign the patents to another person or corporation.

If the patent is unassigned, the inventor owns the IP. Startup founders often file patents before raising money. The angel investors wind up owning the company but the founder owns the IP. This leads to huge problems. Sometimes, the clever founder puts the patents in a holding company and charges a license fee to their own startup.

This is a technique that all big companies use to avoid taxes. Big companies set up a patent holding company in a tax-advantaged location Bahamas, Isle of Man, Ireland, Jersey, etc. The license fees are expenses against operating income, which is moved to a lower tax jurisdiction. This is not a good situation if you are an angel investor in a startup because the founder is self-dealing.

A founder can siphon off revenue for themselves and the angel investor will be cut out. The angel investor is helpless. In the case of a bankruptcy or receivership, the IP can be one of the assets that are sold to return money to investors. Patent Ownership Checklist Patent ownership comes in two flavors: present ownership and future ownership. The things to check: Does the company own each and every patent asset? Are any of the patents encumbered? Does the company own inventions created by employees?

Does the company own inventions from founders? Every published patent application or issued patent should be checked to confirm that they are owned by the company. If there is no assignment at all, the patents are owned by the inventors. In this case, an investor must require the inventors — every one of them — to sign an assignment. Without the assignments, the investor should never invest. What if the Patents are Owned by Someone Else?

In many cases, patents are controlled by a startup but owned by someone else. This happens when startups license technologies from universities, for example, or when they finance their patents through a company like BlueIron. When there is a license agreement, it is essential that the investors read the license agreement. Does the company have the right to buy the IP?

Can the license be terminated by the patent holder? Does the company have the right to enforce the patents? Is there any patent enforcement insurance or assistance provided by the patent holder? Most importantly, ask whether the investors have an option to purchase the IP. An option to take over the license agreement might give angel investors downside protection. Such a right would allow an angel investor to take over the IP and sell it off, hopefully recouping some of their investment.

Rights to Future Inventions It is absolutely essential that everybody connected with the company be obligated to assign their inventions to the company. Every employee, consultant, and advisor must sign a Proprietary Information and Inventions Agreement with the company. This agreement automatically transfers their inventions to the company, even if they person refuses to sign an assignment. When the founder is working solo out of their garage, this is not a problem, but when they take on investors, it is essential.

Get an example Proprietary Information and Inventions Agreement here. Some founders view their IP as their biggest accomplishment and most valuable possession, and they are very reluctant to part with it. As an angel investor, you must require every founder to sign a Proprietary Information and Inventions Agreement before investing — without exception.

There are two types of patents: i utility and ii design. For example, a mobile application developer may use a utility patent to protect her unique way of operating an application. Utility patents can be further divided into two subsets: i products and ii processes.

CLS Bank International that claims about a computer-implemented, electronic escrow service for facilitating financial transactions are abstract ideas ineligible for patent protection. However, subsequent decisions by courts and the Patent Office have further clarified that software can still be patented in a limited manner.

Now, software-based inventions face more scrutiny, but nevertheless may still be patentable. For example, with respect to user interface UI patents under Alice, claims directed to graphing a curve on a user interface were found to be patent-eligible while a claim directed to building and displaying a user interface was not patent-eligible.

Therefore, in contrast to the understanding of many, software based startups should still consider patent protection for their business. When considering IP protection, a startup should consider whether to pursue utility patents, design patents, or both.

Traditionally, startups that pursue and obtain patent protection are often viewed more favorably by investors. A trademark is only effective in a class associated with a particular field of commerce in which the trademark is registered. Startups should factor the differences in protection provided by trademarks and patents when pursuing IP protection.

Particularly, a startup that serves the general public directly is more likely to benefit from trademark protection to protect the connection with consumers. This differs from startups that operate upstream and tend to sell technology to other businesses. These startups may benefit from patents that can exclude others from making or selling their patented technology.

Conclusion For a nascent startup, IP protection can serve as a powerful tool for protecting potential growth as well as helping to secure venture funding. Both patent and trademark protection are correlated with increased venture funding and likelihood of business success. Although obtaining IP has associated costs that may be off-putting to startups, the investment generally has a positive return when viewed against future fundraising and longevity.

Having a solid IP portfolio can also help promote a future sale of the startup. Forbes Aug. Audretscha et al.

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