CUSTOMatrix™ Insights Newsletter

Patents: Protecting Your Investment

By Harris Brotman

Before an entrepreneur asks an investor to plunk money into a venture based on patented technology, a strong patent position should be documented.

Otherwise, what will you tell your investor when you find out that the technology you just acquired with his or her money might infringe another patent, that your startup might not have the freedom to operate, that the barrier to enter your field has vanished?

The investor's point of view

A startup's credibility will rely on its due diligence to uncover and correct gaps in its patent protection. If an entrepreneur withholds knowledge of risk factors associated with an investment in the company, he may have to pay the investor later for breach of contract and the investor's losses.

For entrepreneurs, the day-to-day challenges of growing a company often obscure the investor's point of view. The potential investor, looking at a startup, will take every precaution against financial overcommitment, especially to avoid investing on the basis of unverified intellectual property (IP) assets.

Investors back companies that can move products to market faster. They must therefore ask if the technology has commercial potential for a large market, and if the invention is patented or patentable. If the entrepreneur knows in advance that the IP rights in the technology are not fully or even largely controllable, then why would he or she expect an investor to undertake the investment in the first place?

Controlling the patent, which covers the technology as it would be used in the business, means owning the power to stop imitators from copying the technology, and exclude others from making, using or selling that invention. With that power, the business can grant licenses to would-be imitators.

To be seriously considered by investors, you must prove ownership of the rights to the underlying technology. You must carefully establish the ownership, the scope, and status of those patent rights. Your success will depend, in part, on convincing an investor that you have obtained patents or patent licenses (from third parties) to protect your products or methods, and that you can operate without infringing the intellectual property rights of others.

Avoiding future IP disputes: The IP due diligence process

There are traps for the unwary buyer or licensee. The patent portfolio may not be sufficiently protected for the company to operate in its chosen field. The acquirer or investor should have a clear view of the transaction's risks before a merger, acquisition, joint venture, license transaction or investment (public offering or private placement) is completed.

The savvy investor always insists on thorough disclosure of the strengths and weaknesses of a company's IP. Securities law requires the disclosure of risk factors associated with an investment in the company, and significant liability can be incurred if the risk factors are not disclosed or properly characterized. Withholding knowledge of that weakness, an entrepreneur may have to pay the investor later for breach of contract and the investor's losses.

To determine whether clean title resides in the party offering it, the acquirer of one or a portfolio of patents should perform a due diligence investigation The patentability of the technology claimed in the patents needs to be revisited. All the legal rights bundled in the patents need to be confirmed: ownership/title, infringement, validity, scope of the claims, prior art and patents owned by others that could block your freedom to practice the technology claimed in your patent.

A company's business plan should state the risks learned from patent due diligence to assess whether it has, or can acquire, the IP to operate the business. The purchase price can always be adjusted if the due diligence finds vulnerability to claims of invalidity or infringement that could curtail the company's operations,

Before discussions with a potential investor or acquirer, the entrepreneur should have already established clear, documented ownership of the IP, or the risks anticipated in acquiring or practicing it.

If the deal is struck, the investor will insist that the company remains vigilant about protecting its IP property. A written IP audit submitted to the investor will serve that purpose.

Conclusions

The entrepreneur must put his patent rights in order before arranging an introduction to a potential investor. Anticipate the investor's need to have faith in the ownership of the core business asset – the patent. A comprehensive IP due diligence investigation will determine the patent portfolio's strengths and weaknesses and identify needed corrective steps. Why risk the confidence of future investors?

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