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Blog | Return prospects for investors are too often untapped | EP&C

Return prospects for investors are too often untapped

Questions which you as an investor should ask to uncover the strengths and weaknesses of a tech startup's intellectual property.

Even with a revolutionary and ground-breaking idea, a tech startup will only succeed with a motivated team that makes it happen. Is the team able to successfully develop the technology and match market demand? The first important step for a tech startup is to build a strong team and create a business model. On top of that intellectual property (IP) is generally a crucial business asset for any tech startup. Good IP protection can provide a long-term competitive advantage, limit financial risks and attract external funding. A good assessment of the IP portfolio is therefore crucial for investors and potential partners. It is also important to investigate at an early stage whether there are any third party IP rights that could prevent the startup from entering the market.

Investors are aware of the importance of IP, but it is not easy to recognise the value of an IP portfolio. Moreover, if it is incorrectly valued this could mean that there is insufficient basis for a decision as to whether or not to invest and opportunities to strengthen the IP portfolio could be missed. Especially in the crucial early phase (Angel, "A Series"), startups are not asked enough questions: how broad is the patent, in which countries is there protection, what is the term of the patent, are there any alternatives in the market, have third party rights been looked into? As a result of misreading the IP situation investors may end up doing business with companies whose IP is not in order and the technology may, for example, be copied by Chinese companies or multinationals with better distribution and marketing channels. These companies will then run off with the loot and the startup will be sidelined. There is also a risk that when you invest money in a startup that does not have a good IP strategy you will keep missing opportunities. You will end up at a dead end and will be unsuccessful.

In order to make a well-thought out investment, information about the IP strategy and the quality of the existing IP portfolio is crucial. This is how you bring (hidden) opportunities and threats to light.

Criteria for IP assessment

As an investor you need to understand the role of IP in the industry in question and the importance of IP within the context of the transaction. Investors naturally like to see unique innovations that are protected with IP and that can be monetised via a solid and preferably proven business plan. In our experience the IP situation of a tech startup can best be assessed at an early stage based on the following criteria.

1. A solid IP strategy

A solid IP strategy is aligned with the business strategy and includes a forward-looking plan for securing valuable IP in the relevant industry. The startup must be able to explain how the existing IP fits into the business strategy and how it can generate competitive advantage and revenue. Can copy-cats be thwarted? Is the IP being licensed to other companies? And if the technology is internationally relevant - which is generally the case - it is important to plan ahead. After all there is a limited timeline for obtaining international patent protection. In addition potentially relevant third-party IP rights must have been taken into consideration.

It is of course highly recommended to engage a reputable patent agency. A professionally drafted patent application offers a much better chance of success in a granting procedure and in any legal infringement proceedings.

Determining the strength of the IP strategy can be started by asking the tech startup the following questions:

  • Which technology is currently protected and how does that fit into the business strategy?
  • Which technology might be developed and protected in the future?
  • Has a reputable patent agency been engaged?/li>

2. Strong proprietary IP

As an investor you are naturally focused on the strength and value of a tech startup's proprietary IP. To determine whether the IP portfolio offers meaningful protection it is necessary to examine the patent (applications) in more detail.

Are there any striking issues with the patent applications that have been filed? For example, if the patent claims are too broad, the application may be vulnerable to irrelevant prior art. But if the patent claims are too narrow, competitors can easily work around the patent.

Sometimes investors have their own patent agency conduct an independent review of the IP portfolio. This can be a brief and preliminary review but for a large funding round a detailed "IP due diligence" is recommended.

In the case of a patent, determining the strength and value of the proprietary IP can start with evaluating the claims of the patent. Questions to ask:

  • How narrow or broad is the realistically obtainable scope of protection?
  • Does this scope of protection cover the tech startup's commercial products and services?
  • In which countries or regions have the patents been filed and what geographic coverage is still possible?

In addition, it is important that the IP ownership has been properly investigated. This should not (partly) lie with previous employers, estranged founders or other third parties. It is also important that solid agreements with regard to IP are made with the founders and employees.

3. Competition has been identified

As an investor, you also want to know where the tech startup stands in the marketplace relative to existing and potential competitors. Pursuing IP protection shows that the tech startup has thought about how their product stands out from the competition.

Even if they do not know it themselves, an IP portfolio can work for a startup because IP can reduce or deter competition in the industry: potential competitors will have to make an expensive and difficult decision about whether they want to risk infringing IP by entering the market. Conversely, if a competitor accuses the startup of infringement, the startup can use its IP as leverage to solve the problem. Instead of engaging in costly litigation, it is sometimes possible to reach agreement on a cross-license for each other's technology.

As an investor you want to know if the startup has considered these scenarios and how they plan to use the IP in the face of competition. A startup should also have looked into third party patents and patent applications, in other words conducted a Freedom-to-Operate (FTO) analysis. Even in the early startup phase it is important to explore whether there are any major roadblocks that could prevent the startup from entering the market.

Determining the position with respect to competitors’ (patent) rights can be started by asking the following questions:

  • Has a (preliminary) Freedom-to-Operate analysis been conducted?
  • Are there any third-party patent rights that are relevant to the tech startup’s technology?
  • If so, how does the startup plan to deal with these third-party patent rights?

When you question tech startups about their IP strategy, proprietary IP and the (preliminary) findings regarding third-party IP in an early phase (Angel, “A Series”), you as a potential investor get a good idea as to whether the tech startup has a well-thought through approach and whether there are areas of concern that need to be addressed in a later phase. You can pass these tips on to the tech startup during its preparations.