Patent monetisation in the 21st century
March 2018 | PROFESSIONAL INSIGHT | INTELLECTUAL PROPERTY
Financier Worldwide Magazine
March 2018 Issue
The great US innovators of the 19th century pioneered the use of intellectual property as a business tool. They fought notorious ‘patent wars’ and created a secondary market in invention by licensing, trading, swapping, pooling and litigating their patents.
Recently, headline battles between smart phone manufactures, including Google, Samsung and Apple, echo those patent wars. Dramatic growth in patent filings over the last few decades, combined with economic globalisation, has made the value of intangible assets and the role of intellectual property in competitive strategy, higher than ever. This has resulted in a resurgence of a secondary market for patents.
The benefits of a liquid secondary market in any asset class are well established. A secondary market provides valuation comfort. Re-sellable assets sell better in the first instance, and assets that hold their price in the secondary market command a premium in the primary market.
Patents, however, are not liquid assets because their value is too hard to predict. The value of a patent is situation-specific and may be tied to volatile variables, such as the performance of counterparties. Only patents with predictable licensing value – those patents where infringement, damages and invalidity risks could be determined and managed – are good candidates for the secondary patent market. Patents without any predictable licensing value are often untradeable.
One strategy is to bundle a number of good candidate patents with poor candidates. By bundling patents into portfolios, the incremental value of all of the patents can be increased, chiefly because worthless patents can be attributed some value.
Only a tiny fraction of patents, however, have significant value. And it is expensive to find the high-value patents. The companies that have the most opportunities to buy, sell and licence patents have developed know-how and proprietary data sets for locating high-value patents. Foremost among such firms are non-practicing entities (NPE) that derive the majority of their revenue from patent licensing and enforcement.
The most successful NPEs became experts in identifying and acquiring patents whose licensing value far exceeded the accounting value. As a result, NPEs could generate significant profits in the open market through licensing or sale to strategic counterparties. Moreover, NPEs found that the valuations of many of their patents had a floor based on both the relative costs of litigation defence versus settlement, and the risks facing a defendant in a patent infringement lawsuit. So many NPEs took advantage of this ‘cost-of-litigation’ floor, which often exceeded the cost of an offered licence, and so, they became known, pejoratively, as ‘patent trolls’.
NPEs could generate attractive returns on their investment by monetising the value of a patent to an entire industry. The more licensing that NPEs did, the greater their insight into real pricing became. Opportunity scale proved invaluable in more accurately pricing settlements and managing large portfolios on a probabilistic basis.
NPEs have had a dramatic effect on the secondary market. Third-party know-how has sprung up to meet the demand for patent research. Many companies now exist, predominantly in India, that provide affordable patent research services. Technology, such as artificial intelligence and machine learning, has been developed to help reduce the unit cost of patent analysis. Expert networks and crowdsourcing are abundant for helping companies perform their due diligence.
It is now commonplace to find vendors that can provide in-depth analysis to determine the value of a patent throughout its remaining years of enforceability, or valuations of pending patent applications, which can be useful for those looking to secure funding from venture capitalists and angels or for venture capitalists and angels who want to ensure the product they are funding has or will have market value. Sophisticated systems use multiple data inputs – sometimes hundreds of factors, such as patent indexes, forward and back citations, claim scope, possible licensing opportunities and the current technology in a patent’s sector – for algorithms and software that estimate patent value.
While the NPE phenomenon helped spur development of a modern secondary market for patents, it has also led to significant reform. Legislative and judicial reforms have reduced patent values and made valuations more unpredictable. For example, the America Invents Act created the US patent office litigation which has made it easier to challenge patents and, importantly, is able to delay the monetisation of patents by around 12 to 18 months. Judicial reforms have reduced damages and made it harder to obtain injunctions. The US Supreme Court restricted what subject-matter is eligible for patenting, for example abstract ideas are not patent-eligible, which resulted in nearly every software related invention being challenged, both at the patent office and in court.
These and other changes have reduced the number of patents that can realistically be monetised. They have also raised the investment required to run screening and valuation processes, and the time frame required to deliver an economic return to investors. The secondary market’s largest players have gradually scaled down their operations and with it the secondary market itself.
Although patent monetisation opportunities are less abundant than in the prior decade, they still exist. Liquidity opportunities tend to originate at the point of greatest utility, which is likely to be in earlier-stage or new patents. Utility and value have migrated toward innovation, financing, technology transfer and job creation. Companies should target investment in these. Useful patent value focus not only on the current addressable market of deployed intellectual property, but also probabilistic technology path adoption and future value.
Moreover, it is important to understand that patents are only a part of the value proposition and are not the value proposition. Where a patent fits in to the value chain is a key input to any patent value analysis.
Certain patents are trading and will continue to trade in markets that are characterised by a great deal of liquidity. The estimated size of the brokered patent market was $165m in 2016, down from $233m in 2015. It was estimated that of all the brokered patent packages brought to market, only 21 percent of them sell, with an average asking price per patent asset of $197,000 in 2016.
Patent owners, intermediaries and service providers all have a role to play in bringing liquidity to the secondary market and need to take a realistic approach to valuations and deal structures. By adopting new valuation approaches, market participants can increase the relevance of their valuations and this will directly drive liquidity. For the active participants in the secondary patent market, only the truly skilled will do so successfully. The best companies will adopt advanced valuation techniques and strategies that go beyond market data models and patent claim charts.
Brian A. Tollefson and Matthew Vella are partners at Prince Lobel Tye LLP. Mr Tollefson can be contacted on +1 (617) 456 8099 or by email: firstname.lastname@example.org. Mr Vella can be contacted on +1 (617) 456 8191 or by email: email@example.com. The authors would like to thank Chris Donegan of Invention Capital Associates for his contribution to this article.
© Financier Worldwide
Brian A. Tollefson and Matthew Vella
Prince Lobel Tye LLP