November 4, 2010
For the last few days I have been staring at the title for the last topic in my “Spin-Off vs Start-Up” mini-series. Unlike the topics of focus, budget and customer development, it seemed really hard to write about intellectual property without a long explanation of the patent system. Thankfully, a panel presentation on Intellectual Property at BDO last night reminded me again how fundamental the differences between spin-offs and start-ups are.
Mark McLeod, a seasoned software start-up CFO and fresh partner at RealVentures, presented a practical guide to intellectual property. His message was that patents are useless because start-ups don’t have the financial resources to actually make use of the protection afforded by patents. Moreover, trade secrets also don’t work because investors don’t sign non-disclosure agreements during their due diligence process. Mark’s conclusion is absolutely right for traditional start-up and absolutely wrong for university spin-offs (or comparable technology ventures)!
The two business types use intellectual property very differently. Traditional start-ups use intellectual property to protect their business and Mark’s problem is spot on. It takes millions of dollars to fund effective patent litigation and start-ups don’t have that kind of money. University spin-offs on the other hand don’t just protect their business with patents, patents are their business.
Building a technology manufacturing company has become almost impossible in North America and Europe. Outsourced manufacturing, fabless design and patent licensing have become the dominant business model for Western technology companies. These models have in common that intellectual property is the value carrier between the innovation and productisation groups. As such, intellectual patents are effectively the output of the technology business. Bluntly put, if a technology spin-off doesn’t have patent coverage it doesn’t have a product.
Once patents and other intellectual property make the transition from protecting your product to becoming your product, your view on intellectual property needs to shift accordingly. Patent protection doesn’t become a safety mechanism that can be assessed on the basis of cost and risk, but rather a product investment essential to the success of your business.
The shift is similar for Mark’s secrecy concerns in the investment process. Trade secrets are usually impossible to maintain during investment due diligence in start-ups and spin-offs alike. But the implications of this are radically different. Most start-ups can blissfully ignore the loss of secrecy because the value of their secret idea is marginal anyhow. The real value of conventional start-ups doesn’t come from the initial business idea but rather the follow-on implementation (e.g. leadership, corporate processes, marketing and market adoption, etc.). The potential damage of exposing your secret is therefore marginal and relying on the ethics of you potential investors is probably just fine.
Not so for technology spin-offs! Non-confidential exposure of your idea will destroy or at least substantially limit your ability to obtain patent protection which in turn removes the foundation for your entire venture. That’s true even if your investor is the most ethical person on the planet. It is absolutely essential that you file at least a provisional patent application before you make the rounds in the investor community. Mark is right in that investors hate non-disclosure agreements, so early patent filings are really the only way to protect the future of your business. Fortunately, university spin-offs usually have the financial resources to obtain this protection. Just don’t forget to do it!