Do Early-Stage Companies Need a Patent Defense Strategy?

Start-up companies often spend years in relative obscurity developing and perfecting technology-based products and services. During those early years of angel financing or Series A venture funding, these companies rarely need protection against NPE assertions. Not only are they too small to attract notice, but few have the financial resources to generate sufficient damages from a successful legal action.

For those companies that hit the inflection point where product potential becomes realizable market opportunity, NPEs are a near certainty. Before a company reaches this stage – when venture and/or strategic partners begin to pour in new growth capital, the product or service begins to generate real revenues, and the company begins to get noticed by customers, competitors, and NPEs – management should establish patent defense as a critical part of its core operating strategy.

Having a well-considered patent defense program is important for several reasons. First, any kind of legal encumbrance is a serious obstacle for a company planning to close a round of financing. But even if potential investors are satisfied that the company’s legal position is strong, consider the heightened financial risks for such a company. On average, B-round product-launch financing for a venture-backed company during 2008 raised $11.1 million – capital earmarked for establishing quality assurance and fulfillment processes, preparing marketing strategies, and building a sales organization. The monthly burn rate for such an emerging company – for example, a software developer with 40 to 50 employees – in the run up to product launch would be approximately $500,000, and possibly twice that for a hardware or device manufacturer with production infrastructure. If such a company suddenly had to carry legal costs of $50,000 per month to defend against an assertion, the burn rate would jump and the path to profitability would be slowed – especially problematic in the current tight financing environment. Management attention would also be distracted from key pre-commercialization activities just when it is needed most.

To mitigate this risk, start-up companies have several choices. They can do nothing, which is a common approach, but one that can have severe long-term consequences. More active strategies include adding in-house legal expertise, either through bolstering their management – a high fixed cost when capital efficiency is critical – or by relying on their boards, though IP legal skill is not often a core competence of venture capital partners. Finally, emerging tech companies can pursue preemptive defensive strategies, such as purchasing patent rights in the open market or joining a defensive aggregator.

The cost/benefit impact of each approach will vary from company to company and industry to industry, but CEOs and their boards should explicitly address which strategy makes the most sense. With NPE activity growing wider, start-ups are not immune to patent assertion and their business plans should evolve to reflect this potential threat to their near-term survival and long-term success.