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Intellectual Property Venture Capital


There have been numerous articles and blog posts on the death of the venture capital model.[1] Only six companies that were venture capital backed went public in 2008, the lowest number since 1970.  There were also very few acquisitions of venture backed companies.[2] As a result, many venture capital firms are likely to disappear in the next couple of years.

Historically, venture capital funds have invested in a limited number of companies and taken an active part in the oversight of the companies.  Sarbanes Oxley and the likelihood of more financial regulation threaten the ability of start-up companies to go public.  Without a robust IPO market, it is unlikely that M&A activity will result in strong valuations.  Additionally, many IT start-up companies have low capital requirements and can forego traditional venture capital investments.

In order for venture capital to survive it needs new models.  The VC community has generally considered intellectual property an important part of good management, but has generally not considered it key to a company’s value proposition.  Generally, the attitude of VCs has been that first mover advantage is more important than the company’s patent portfolio – the most important part of a start-ups intellectual property.  One of the most startling examples illustrating the fallacy of the first mover advantage is Xerox.  Xerox spent millions of dollars and over a decade to perfect the plain paper copier.  They held numerous patents on the technology that made plain paper copiers possible.  In 1975 when Xerox agreed to the FTC antitrust consent decree to license their patents to all comers for a pittance, they had almost a 100% market share in plain paper copiers – a huge first mover advantage.  Just four years later, their market share was down to 14%.

The “so-called” patent trolls were built on the patent portfolios of failed venture capital companies.  NTP (New Technologies Products) is a patent holding company that was built on the patent portfolio of Telefind.  Telefind was paging company founded in 1986 and held a number of patents on transmitting wireless messages.  NTP continued developing patents and technology related to wireless messages and in 2006 received $600 million award from RIM for violating its patents.

Then there is the case of Mostek.  Mostek was founded in 1969 by former Texas Instruments engineers and had 85% of the Dynamic Random Access memory market in the late 1980’s.  SGS-Thompson bought out a struggling Mostek in 1985 for $71 Million. By 1992, Thompson had received over $450 million in licensing royalties from Mostek’s patent portfolio.

These examples vividly illustrate the value of intellectual property that has not generally been recognized by the venture capital industry.  This neglect has included not placing enough resources and emphasis on developing client companies’ patent portfolios.  Based on this it is likely that there is substantially more value to be gleaned from the patent portfolios of start-up companies.

A venture capital fund or IP merchant bank focused exclusively on funding and creating patent portfolios for seed stage companies could obtain superior returns.  In order to spread out the risk this IPVC fund would invest in as many as 100 companies.  The fund would focus on a narrow range of technologies in order to build up a portfolio of patents.

An investment would include the funding to analyze the patent market space the company competes in and helping the company develop a superior patent portfolio.  For more information on the specifics of this service see IP Strategy That Amazes Investors. (http://hallingblog.com/2009/10/05/ip-strategy-document-that-amazes-investors/)  Companies funded by an IPVC would significantly increase their chances of receiving follow on funding.

The IPVC fund would receive a security interest in the patents, certain licensing rights in the patents and convertible debt.  The secured interest would ensure that the IPVC could exploit the patent portfolio of any company that failed.  The licensing rights would allow the IPVC to license any issued patents to non-competing entities.  The IPVC would receive a potion of the licensing revenue.  The convertible debt would be convertible upon an IPO or merger and would extinguish the security interest in the patents of the company.

An IPVC firm as outlined above would need expertise in licensing in order to fulfill its promise.  It is my estimate that 70% of the returns for such a fund would be based on licensing revenue and 30% of the returns would be the result of normal exit strategies.  By investing in a narrow range of technologies the firm can increase the size and quality of it portfolio.

A variation of the present idea is to allow limited cross licensing among portfolio companies.  The client companies must pay fair market value for the licenses, but outright blocking of another client company would not be allowed.  This would increase the value of being a client company for both the technology creator and the technology leasing companies.

This model would be a particularly good fit for Universities.  An IPVC firm associated with several Universities would increase technology transfer and increase licensing revenue.

Finally, an investment firm along the lines outlined above is consistent with modern economic theory.  Schumpter, Solow, Romer and other economists have shown that innovation is the only way in which per capita income growth is possible.  Having legal title to innovation is the only method to capitalize or collateralize  innovation.  The hunter gather age was followed by agricultural age, which was followed by the manufacturing age.  The future is the information age.  An IPVC (merchant bank, private equity fund, etc) is on the side of economics and history.


[1] http://fiveyearstoolate.wordpress.com/2009/01/08/the-death-of-venture-capital-again/[2] http://www.ft.com/cms/s/0/c78a2fc0-da8b-11dd-8c28-000077b07658.html?nclick_check=1




2 Comments

  1. [...] patents could be used to support further university research.  Another potential group would be an intellectual property venture capital group.  Other groups could include NPE (Non-Practice Entities) invention firms, similar to Intellectual [...]

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