Patent Encumbrances Can Reduce Market Value up to 100 Percent

By: Steve Brachmann & Gene Quinn

Patents can help business startups in a number of important ways. Filing a patent application can aid a startup’s first mover advantage as a patent grant gives them the right to exclude others from a market sector, which could prove to be very valuable for a variety of reasons — not the least of which is to attract investors keen to invest in companies with some strategic advantage in the marketplace. 

Patents can also help minimize the risk of facing an infringement suit because it gives a startup an asset to assert defensively if and when an aggressive competitor might come knocking. But even if a defensive position does not ultimately prevent litigation from initiating having patents can open the possibility for counterclaims and cross-licensing settlements, which sometimes are the primary strategic reason patent lawsuits are filed in the first place.

These are well known examples of the advantages of patents to start ups and the venture capital firms (VCs) that often fund them. However, patents also help startups and the VCs that fund them because the patents can be sold. If the startup changes course from its initial designs – a not uncommon occurrence – then the sale of irrelevant patents can help recoup earlier sunk costs and the revenue used to fund more promising lines of research, development and commerce. If a startup fails, which ends up happening to the overwhelming number of startups, the sale of the patents can give investors a chance to recoup some of their funds.

The sale of a patent becomes more complicated and less valuable if the patent rights have been compromised. Not surprisingly, an encumbrance upon a patent negatively impacts the market value of the patent because it reduces the ability of others to monetize that patent by removing at least some avenues of opportunity.

Encumbrances can take several of different forms. A patent licensing agreement is an encumbrance because it prevents a company buying a patent asset from obtaining royalties from a company that has already licensed the patent. Companies can also sign covenants not to sue each other that can run with the patents. If those patents are sold while those covenants are still in force, the patent’s market value is similarly limited.

Patent broker Brad Close notes that encumbrances can have the effect of reducing a patent’s value by up to 100 percent, practically rendering a patent valueless on the market. “If the only companies which are potential targets for a license are already licensed, then the intellectual property is essentially worthless,” Close said. Close has worked as a patent broker for 12 years and has spent parts of the last decade working on brokering patent sales for startups while working with such firms as TIPS Group, Transpacific IP and Blackstone IP.

“If a startup is considering entering into an agreement that would place an encumbrance upon a patent, I would advise them to be very sure that what they’re receiving in return offers adequate value and to take into consideration both their investors and the future of the business,” Close said.

Certain organizations and consortiums in the patent sector require their members to enter into agreements which place encumbrances on patent assets. One such organization is LOT Network which requires members to sign an agreement that offers a conditional license in the event that a patent is sold to a patent assertion entity (PAE) or non-practicing entities (NPEs), effectively protecting members from PAE suits of LOT originated patents. While the potential of avoiding litigation from PAEs and NPEs may seem attractive to startups, Close notes that startups don’t face the same litigation risks of much larger entities. “True NPEs don’t target startups because they don’t have the market share to make litigation worthwhile,” Close said. “NPEs are typically going to go after companies who hold a significant share of the market.”