Tag: startups

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Economic Study Innovation

Creative Upstarts and Startups: How IP Creates Opportunities and Opens Doors

the word "inspiration" typed on a typewriterThis is the first in a series of posts summarizing CPIP’s 2016 Fall Conference, “Intellectual Property & Global Prosperity.“ The conference was held at Antonin Scalia Law School, George Mason University on October 6-7, 2016. Videos of the conference panels and keynote address, as well as other materials, are available on the conference website.

The opening panel of CPIP’s 2016 Fall Conference examined how intellectual property (IP) creates opportunities for startups and creative upstarts. Unfortunately, IP policy debates often refer to a misguided notion that intellectual property hinders innovation and creativity, especially among smaller businesses. The panelists, Prof. Deepak Hegde (NYU Stern School of Business), Brian Detwiler (Cobro Ventures, Inc.), Prof. Jerry Liu (University of San Francisco School of Law), and Antigone Peyton (Cloudigy Law, PLLC), illustrated how this notion ignores the fact that intellectual property provides incentives and security for startups and small businesses entering the market and enables returns on investments.

Prof. Deepak Hegde discussed a study he undertook to measure the extent that patents benefit startups. Patents provide incentives for innovation by affording the right to exclude others from making, selling, or otherwise using the patented invention. This incentive is ensured by increasing the cost of imitations, while facilitating licensing and access to venture capital by innovators. At the same time, there is a concern that patents are not as effective for smaller entrepreneurs because patents take too long to issue (three years on average), they are costly to obtain ($20,000 in patent application costs on average), and are expensive to enforce once infringed. The study, however, shows that timely patents do substantially benefit startups.

Hegde noted that measuring the causal effect of patent rights on startups is often an empirically challenging task due to the lack of complete data on issues like rejected patent applications, firm outcomes, and correlations between patenting and startup success. However, Hegde was able to show a positive causal relationship between approval of the first patent application and various measures of startup success such as persistent employment growth and higher sales.

For instance, Hegde found that approval of the first patent application by a medium-sized firm with eight employees leads to three more employees (on average) hired within the five years following approval. Likewise, a medium-sized firm with $4.3M in revenue has $2.3M higher sales over the five years following approval of its first patent. Moreover, approval of the first patent application leads to a 66.4% increase in the number of subsequent applications, a 48.4% growth in the number of approved patents, and a 68.5% increase in the number of total citations.

On the other hand, Hegde discovered that delays in the patent approval process reduce sales growth, with each year of delay reducing growth by 28.4% over the five years following approval. Delays also reduce the quality and quantity of subsequent innovations, with a 14% decrease in number of subsequent applications and a 8% reduction in number of total citations. Even more so, a five-year approval delay is comparable in effect to not granting a patent at all. Finally, Hegde showed that patent approvals causally increase the probability of venture capital funding by 57%, and thus, help to set startups on a growth path.

Brian Detwiler discussed the challenges startups face from a more practical point of view. Specifically, Detwiler focused on two startups that Cobro Ventures is currently managing. Measures of success differ among the two. For a health & fitness center, the issue is profitability, and for a tech startup, the concern is typically acquisition or an initial public offering. Because Cobro Ventures is a self-funded company, it does not encounter some of the funding challenges as other startups. It does, however, face the same intellectual property issues as others in the industry.

The critical issue for a startup in the fitness industry, Detwiler noted, is building a strong brand identity to distinguish itself from other companies in the crowded marketplace. CrossFit is one good example of how a strong brand makes a business successful: CrossFit generates its revenues solely from licensing its brand out to gyms and fitness centers, without operating any of its own.

Tech startups, continued Detwiler, are more invested in the value of their patents because patent due diligence is a major component of any tech acquisition. Bundles of patents and open continuations are what acquirers value the most. The former allows acquisition of all patents associated with a particular technology; the latter provides opportunities to expand claims to pending patents down the road. A patent by itself does not necessarily guarantee the merit of a particular technology, but it certainly shows that at least the Patent Office believes that the particular technology was unique in the marketplace at the time of issuance. Patents can also be used as weapons in protecting a company’s interests and as a bargaining chip in negotiations.

Detwiler stated that trademark registration is equally accessible to startups and big corporations because it is inexpensive (the filing fee is about $300 per class of goods/services), easy to file (only 10 minutes), and fast (around 3-4 months). With patents, the biggest challenge is getting a notice of allowance. There is a common misconception that all patent applications have the same value. This may be true for big corporations that file thousands of patent applications each year. But for startups, which usually have only two or three applications that they depend on, each such application is incredibly important, and if rejected, causes a lot of frustration.

Even though startups have more executive involvement in the patent approval process and are more willing to accept reasonably narrow claims at the outset, Detwiler said the patent examination process is still too lengthy. To get the best of it, he suggested that applicants explain in plain terms what they want to protect, examiners explain in plain terms what they found in their prior art searches, and both sides explore how to capture the claimed invention.

Prof. Jerry Liu talked about the study he undertook on market incentives and intrinsic motivations in the creative industries, particularly in the Chinese music industry. He focused his study on how online piracy affects the music industry and how real-world artists respond to copyright incentives. According to Liu, the Chinese music industry is significantly underdeveloped as compared to the United States. While the overall Chinese economy is fast approaching the size of the U.S. economy, the Chinese music industry represents only 1.5 % of the U.S. music industry.

Liu found that this outcome has little to do with the overall economic environment in China. Even though the music industry experienced a substantial decline since 2005, the economy as a whole enjoyed about 10% of annual growth. Nor is this a consequence of the infamous censorship system in China. Unlike the music industry, the book industry in China has demonstrated growth by 129% for the last decade. The likely reason for this difference is that the piracy rate in the music market is much higher than it is in the book market.

Empirical data collected by Liu establishes the correlation between online piracy and the Chinese music industry downturn. Online piracy surged in 2005, the very same year when music production started to decline significantly. As a result of such widespread piracy, music products have become undervalued among consumers. Only 25.4% of Chinese consumers are willing to pay for music, and only 5.9% actually pay for music. Online piracy has also caused a significant imbalance in the development of the digital music market. Notably, the Chinese government itself recently recognized that uncontrolled piracy has devastated the digital music marketplace.

In China, Liu said that online music services, including downloads and streaming, account only for 1% of the total digital market, while mobile sales (e.g., ringtones) hold 99% market share. But only 32.6% of music consumers are accessing music on their mobile devices, while 96.8% of users access music online. This shows that Chinese consumers pay the least for the most popular channel of music consumption. Additionally, online piracy affects business models in the music industry. For instance, record labels have moved away from their traditional role as investors. They are now working with new artists either on a self-funded basis (labels only provide services and artists bear all the risks of investment) or under so-called “360-degree deals” (labels sign artists for long-term contracts and retain more control over their careers and even their personal lives).

Finally, Liu highlighted the paradox of intrinsic motivations: 92% of the surveyed artists named emotional benefits as their incentive to create, and 97% of those artists also recognized the importance of economic benefits for creation. Importantly, many artists started their career in music not because of the money, but many of them also gave it up because of the money. In this way, copyright protection may provide a powerful incentive for artists to create in that it preserves their artistic freedom while ensuring a decent level of living and a fair return of production costs.

Antigone Peyton talked about strategies for tech companies to protect their assets. In this regard, she noted the importance of contracts at the early stages of the product development cycle. From the copyright prospective, contracts help to establish whether hired developers are employees or independent contractors and to ensure that their rights are assigned to the company. Without a written, explicit assignment of a copyright, a company may get in trouble down the road. For instance, when registering its work with the Copyright Office, enforcing its rights, or selling its assets to a third party.

Peyton stressed that companies working with the government need to understand what intellectual property rights they are giving away and to avoid assigning away all of their rights. Government contracts often include IP provisions that provide the government with a fully-paid license and allow it to bring in another contractor to continue the job. Another important aspect involves privacy policies, especially in the cyber security area. Companies that innovate in this sector usually bring people and know-how to the table, but not necessarily anything that is patentable. To protect its know-how, such a company should consider signing non-compete agreements with the people working with the company.

The barriers to entry for starting up a company in the software industry are small, said Peyton. But that means there are a lot of such companies out there trying to compete with each other for market space. To this end, companies need to think carefully about brand development and brand recognition, as well as how to protect their markets from competitors.

Peyton noted that if a company believes it has patentable subject matter, it should consider filing a patent application early on. However, patenting is the most expensive IP regime and usually requires the help of a patent professional (even with provisional applications). Patents are particularly critical in the biotech, chemical, and pharma industries that are money-intensive endeavors, which largely depend on attracting venture capital investment as early as possible. Generally, tech companies do not need to choose between copyrights and patents, and they may pursue both options to protect their software. But investing in copyrights and brand development is a relatively inexpensive way to start out and build an IP portfolio. Depending on the technology used, trade secret protection may also be an option for tech startups.

Together, the four panelists highlighted how intellectual property has a critical value for startups and small companies in the creative and innovative industries. Not only does IP ignite their businesses, but it also brings opportunities for future growth through sales, licensing, or acquisition. A strong IP portfolio is an invaluable asset, and building it early allows companies to open more doors.

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Economic Study Innovation Inventors Legislation Patent Law Uncategorized

How Patents Help Startups Grow, Innovate, and Succeed

Many academic studies of the patent system focus on the negative, extrapolating from anecdotes about a few bad actors to make the case that our patent system is broken and to bolster cries for legislation weakening patent rights. Precious few studies focus on the countless honest and hardworking patent owners whose inventive labors benefit us all. But understanding how patents support inventive enterprises is a crucial part of the equation, especially at a time when Congress is considering legislation that would make it extremely difficult for startups and individual inventors to enforce their patent rights.

In a newly-published working paper, The Bright Side of Patents, CPIP Edison Fellow Deepak Hegde, along with co-authors Joan Farre-Mensa and Alexander Ljungqvist, take a look how patents help startups grow. They show that, contrary to the claims made by several academics and activists, startups are not victims of the patent system. On the contrary, patents help startups become more successful and innovative.

The study finds that “patent approvals help startups create jobs, grow their sales, innovate, and eventually succeed.” When a startup’s first patent application is approved, its employment growth increases by 36% and its sales growth increases by 51% on average over the next five years. First-patent approval also has a strong causal effect on a startup’s continued ability to innovate, increasing the number of subsequent patent grants by 49% and increasing the quality of those patents by 27%. In fact, a startup with first-patent approval is twice as likely to end up listed on a stock exchange—a common indication of success for a startup.

Negatively affecting startups are delays in the patent application process and ultimate application rejections. For every year an ultimately-approved patent application is delayed, the startup’s employment growth decreases by 21% and its sales growth decreases by 28% on average over the following five years. Furthermore, each year a patent application is delayed, the average number of subsequent patents granted decreases by 14% while the quality of those patents decreases by 7%. And for each year of delay, the probability that a startup will go public is cut in half.

One big reason why patents help startups is that they make it easier to access capital from external investors. The authors find that patents serve to mitigate frictions in information between potential investors and startups. Patents play an important role by alleviating startups’ concerns about having their inventions misappropriated by investors and by alleviating investors’ concerns about the credibility, quality, and monetary future of the startups. Having access to capital in turn sets startups on a path of growth where they can turn ideas into products and services, generate jobs, increase revenue, and undertake further innovation.

What makes this study unique is its unprecedented access to the USPTO’s internal databases, which allowed the authors to evaluate detailed review histories of both approved and rejected patent applications. Prior studies only focused on approved applications, thus making it impossible to accurately separate out the economic and innovative effects. The authors here are able to demonstrate the direct benefits of patent protection with causal evidence from a large-sized sample—45,819 first-time patent applications filed by startups.

There is a surprising amount of criticism of the patent system today. Some claim that patents are a waste of time and resources for startups, useful only for defensive purposes. Others claim that patents actually harm startups. The authors here show that startups that secure patent protection are in fact more likely to succeed. As Congress considers yet another round of large-scale patent legislation, lawmakers need to understand the role that enforceable patent rights play in enabling startups to grow and succeed. This study is a great step in adding some much needed clarity to the ongoing patent policy debates.

Categories
Commercialization Innovation Inventors Patent Licensing Uncategorized

Google’s Patent Starter Program: What it Really Means for Startups

The following guest post comes from Brad Sheafe, Chief Intellectual Property Officer at Dominion Harbor Group, LLC.

By Brad Sheafe

Recalling its rags-to-riches story of two guys with nothing but a great idea, a garage, and a hope of making the world a better place, Google recently announced its new Patent Starter Program. As part of its commitment to the culture from which it came, Google claims that it simply wants to help startups navigate the patent landscape by assigning them certain patents while it receives a license back. It describes the situation as follows:

The world of patents can be very confusing, cumbersome and often distracting for startups. All too often these days, the first time a startup has to deal with a patent issue is when a patent troll attacks them. Or when a prospective investor may ask them how they are protecting their ideas (“You don’t have any patents???”). These problems are the impetus behind the Patent Starter Program[.]

There are of course many tendentious assertions here – from the well-established definitional problems with the use of the pejorative term “patent troll,” which is often used to attack startups, to the untrue statement that patents are “distracting” for startups (which is false, as any person who watches Shark Tank knows). But we will not go over this well-tread territory here. For our purposes, this statement is notable because it is couched entirely in terms of a desire to help other tech startups. But when one looks at the specific details of the Patent Starter Program (PSP), it’s quite clear that it is designed to benefit Google as well – perhaps even most of all.

On its face, the PSP is advertised as an opportunity for the first 50 eligible participants (“startups or developers having 2014 Revenues between US $500,000 and US $20,000,000”) to select 2 families from Google’s patent portfolio out of an offering of between 3-5 families of Google’s choosing. These families are intended to be broadly relevant to the participant’s business, but Google makes no guarantee that they will be, and there is no “re-do” if the participant doesn’t like what Google offers the first time.

In exchange for access to these patents, many are not paying attention to the fine print that creates some significant contractual restrictions on anyone who uses the PSP. First and foremost, the patents cannot be used to initiate a lawsuit for infringement. They can be used only “defensively,” that is, if the participant is sued for infringement first. In fact, if a participant does choose to assert the supposedly-owned patent rights outside of Google’s terms, the Patent Purchase Agreement punishes the startup by requiring “additional payments” to be made to Google.

The boilerplate text of the Agreement states that this additional payment will be $1 million or more! Although specific payments may end up varying from this based on the negotiating tactics of the startups who make use of the PSP, the punitive nature of this payment is clear. For an undercapitalized startup that is just starting out in the marketplace and perhaps still living on the life support provided by venture capitalists, a $1+ million payment is a monumental charge to write down. This is especially the case if the startup is simply exercising a valid legal right that is integral to all property ownership – the right to keep others from trespassing on one’s property.

Additionally, participants in the PSP must also join the LOT Network (LOT stands for “License on Transfer”), which presents itself as a cross-licensing network committed to reducing the alleged “PAE problem.” Members of the LOT Network must “grant a portfolio-wide license to the other participants” in the LOT Network, but “the license becomes effective ONLY when the participant transfers one or more patents to an entity other than another LOT Network participant, and ONLY for the patent(s) actually transferred.”

On its face, this might still seem a reasonable concession for the “free” acquisition of some of Google’s patents. But the fine print makes it clear that there are additional burdens agreed to by the startup. First, the LOT Network agreement includes all of the participant’s patents, and not just those it acquires from Google. Second, even if one decides later to withdraw from the LOT Network, the agreement explicitly states that all of the patents owned by the participant at the time of withdrawal will continue to remain subject to the terms of the LOT agreement. The LOT Network thus operates in much the same way Don Corleone viewed membership in the “family” – people are welcome in on certain non-negotiable terms, and good luck ever getting out.

These all add up to be incredibly onerous and surprising restrictions on startups, which often need flexibility in the marketplace to adopt their business models. But as the old, late-night television commercials used to say, “But wait, there’s more!” If the terms and conditions of the LOT Network seem highly limiting on the rights associated with patent ownership and overly broad in terms of who gets a license to the applicant’s patents, there’s an even greater surprise in the license-back provisions of Google’s Patent Purchase Agreement. Once one wades through the legalese, it becomes clear that while a participant in the PSP and LOT Network nominally owns the patents granted by Google, these patents are effectively licensed to everyone doing anything.

There is substantial legalese here that is clearly “very confusing, cumbersome and . . . distracting for startups,” the very charge leveled by Google against the patent system as the justification for the PSP and LOT Network. We’ll break it all down in a moment, but here’s the contractual language that creates this veritable universal license. The agreement gives Google, its “Affiliates” (defined to include any “future Affiliates, successors and assigns”), and its “Partners” (defined as “all agents, advisors, attorneys, representatives, suppliers, distributors, customers, advertisers, and users of [Google] and/or [Google] Affiliates”) a license to the patents Google grants to the participant if the participant were ever to allege infringement by any of these partners through their use of any of Google’s “Products” (defined as “…all former, current and future products, including but not limited to services, components, hardware, software, websites, processes, machines, manufactures, and any combinations and components thereof, of [Google] or any [Google] Affiliates that are designed, developed, sold, licensed, or made, in whole or substantial part, by or on behalf of that entity”).

So let’s review: A startup can acquire some patents from Google, but only from the handful of patents that Google itself picks out (which may or may not relate to the participant’s business). The startup must agree to an incredibly broad license-back provisions and promise not to assert any ownership rights (unless the participant gets sued first) on penalty of $1+ million payment to Google. And the startup is bound to join the LOT Network, where Google execs are on the Board of Directors, which further reduces the rights not only in the patents granted by Google, but in the startup’s entire portfolio of patents, including most importantly patents not acquired from Google.

To be fair, Google is far from the only large corporation to take advantage of its size and financial strength to mold public perception, markets, and even government policy to its liking. Some might even turn a blind eye, calling it “good business” and accepting such behavior as the price we all must pay for the products and services that established corporations like Google offer. To some extent, there is some truth in this – most of us use Google’s services every day and many of us working in the innovation industries continue to be impressed with its innovative approach to those services and its products.

When it comes to the underpinnings of the innovation economy – the startups that drive economic growth and the patent system that provides startups with legal and financial security against established market incumbents (again, as any episode of Shark Tanks makes clear) – the restrictive contractual conditions in the PSP and LOT Network give one pause. After all, Google began as a startup relying on fully-licensable IP, despite the fact that Google apparently wants us all to forget about its founding page-rank patent (Patent No. 6,285,999, filed on January 9, 1998). One will search in vain in Google’s corporate history website, for instance, for evidence of Larry Page’s patent. Yet it’s well-established that Google touted this “patent-pending” search technology in its announcement in 1999 that it had received critical venture-capital funding.

The next Google is out there, counting on the same patent rights to be in place for it to rely upon just as Google did in the late 1990s. Instead of making every effort to collapse the very structure on which its success was built, shouldn’t Google be the first to defend it? Competition will always be the greatest motivator for those who have what it takes to compete – and with its balance sheet and world-renowned collection of bright, inventive minds, Google should not be afraid of competition. Or worse, give the appearance of promoting competition and then use that appearance to dupe potentially competitive startups into emasculating the intellectual property those startups need to actually compete.

So, if Google and its far-flung business partners in the high-tech sector want to support startups on terms that are reasonable for both the startup and Google given their relative positions, there is certainly nothing wrong with this. But, Google shouldn’t hide behind the bugaboos of “patent trolls” and the supposed “complexity” of a patent system designed to benefit small innovators in order to drive a largely one-sided partnership while hiding behind confounding legalese that certainly does not match its feel-good rhetoric to startups, to Congress, or to the public.

If an established company wants to support innovation by providing worthy startups with the stepping stones they need for success, then go for it! Everyone should be 100% behind that concept – but that is not what Google’s PSP or the LOT Network represent. These aren’t stepping stones to successful innovation, but rather they are deliberately fashioned and enticingly placed paving stones that lead to the shackling of startups with terms and covenants that give the appearance of ownership but strip away the very rights that make that ownership meaningful – and all the while Google benefits both from the relationship and the public perception of munificence. When one is using someone else’s idea, one should compensate them for it, and the nature of the license and the compensation should certainly match what one is saying publicly about this agreement.

All we can ask, Google, is that you treat others as you were treated in the past as a startup, and now approximately fifteen years later as a market incumbent just, well, Don’t Be Evil.