Your Patents: What Will The Investors Think?

Tuesday, February 1, 2005 - 01:00

You've got a lot to be proud of. You've built a company with promising technology and a patent portfolio to protect it. You've agreed on a term sheet for your first round of financing. With all your company has accomplished, you are expecting applause, or at least a pat on the back. Instead, you receive a sheaf of due diligence requests from investors, including a number of queries about your patents. Your responses to the investors' due diligence inquiries are critical for this round of financing, and are therefore critical for your company's future prosperity.

Before the due diligence requests arrive, before you even begin to seek institutional funding, you should be sure your patent portfolio is in order so it will withstand the investors' scrutiny. Investors are concerned with how your patents will protect the company's commercial endeavors and how patents held by other entities may interfere with the company's business plan. Investors also want to avoid, or at least manage, risk, so they will be looking for unexpected patent problems that could compromise the value of the deal. Their due diligence questions, then, will fall into five general categories:

  • What IP exists?

  • Who owns the relevant IP?

  • Does the IP protect the company's business?

  • Does anyone else hold patents that will interfere with the company's business?

  • Are there any other IP problems that face the company?

1. What IP Exists?

This is an inventory issue: you will need to catalog your patents and patent applications in a user-friendly way so that the investor can survey the entire universe of your intellectual property. It is important for the investor to be able to distinguish between issued U.S. or foreign patents and patent applications. The issued patent grants enforceable rights in its jurisdiction, while the patent application does not. Furthermore, the patent application is by definition a work in progress: the scope of rights it will grant will need to be negotiated with the governmental examining authority, for example, the United States Patent and Trademark Office (the "PTO"). This examination process is generally termed "patent prosecution." Prosecution has a built-in timeframe and cost schedule, so the investor will want to know how far along each pending application is in this process. Additional complexities accompany foreign applications and their examination procedures, so you should organize information about foreign patents and applications so the investor can appreciate how much longer the foreign prosecution could take, and how much it could cost.

2. Who Owns the IP?

U.S. patent law states that an inventor owns her own patents, unless she assigns her interest in the patent to someone else. Your company, then, does not own any patents unless the actual inventors have assigned their ownership. Investors will want to see evidence that assignments have been carried out properly, so that the company owns its IP. There also should be agreements in place requiring employees or consultants to assign their inventions to the company. Having policies where the inventors execute assignment documents quickly after a patent application is filed helps to ensure that no assignments fall by the wayside. An inventor initially willing to assign the invention to the company may decide to charge a higher price for cooperation if a financing is on the horizon.

Why would investors care about properly assigned IP? Because if the inventor, and not the company, owns the IP, he may license it to competitors or use it as he pleases. If there are multiple inventors on a patent, each has full rights in the patent, including the right to assign interest to another entity and the right to offer non-exclusive licenses to it. For your company to have exclusive control of its IP, each inventor must assign his rights to the company.

3. Does the IP Protect the Company's Business?

In an ideal world, your company's patent position should be broad, strong and commercially relevant. Of these three, commercial relevance is the most important. Broad and strong patents will not help a company if they do not relate to its business plan. The mere presence of good patents is not enough: they must map onto the technology your company is trying to protect.

Beyond commercial relevance, investors will also look at the breadth and strength of the patents. Broad patent coverage is hard to obtain, because patent applications are examined by comparing them with everything else in the field. In mature technologies, a wealth of ongoing research exists, making it difficult for an inventor to stake out a claim that does not read on what others have already done. The narrower the inventor's claim, the more likely it will get through the PTO. The narrower the claim, though, the less protection it offers against competitors whose technologies are close to what your company wishes to commercialize. A patent's strength cannot be definitively determined until it is challenged in court. A patent that has been vigorously examined in the PTO, with a good deal of back-and-forth between the patent examiner and the inventor, is likely to be stronger than a patent that faces little PTO scrutiny. You enhance your patent's strength by being aware of research in the field that relates to your invention, and - crucially - by submitting to the PTO references that are material to your patent appliction.1

4. What Third-Party Patents Can Block the Business?

Having patents that cover your technology does not ensure that you can actually make, use, sell, or offer for sale that technology. Other patentholders can have patents, called "blocking patents," that can prevent you from doing what you want. How can this be? A patent is simply a right to exclude. It only grants you the right to exclude others from practicing what the patent covers; it does not give you an affirmative right to practice what the patent claims.

Investors will generally carry out their own investigations into the existence of blocking patents. You should be keeping on top of your industry, too. You may decide, as you consider commercializing a product, to search for patents that relate to your product. You may even commission a formal study to look at the competitive landscape. If a potential blocking patent is identified, you will need to deal with it in some way: you may attempt to design around it, you may seek a business arrangement with the patentholder, or you may decide that it does not affect you significantly. In any case, as you encounter patents close to your projected products, you should consider seeking legal advice about their relevance and about the further steps you should take regarding the third-party patents.

5. Other IP Problems?

Are there other skeletons in your IP closet? The investors will go looking there, so you should know in advance what they may find. Have you received any notices about patents held by third parties? Have you encountered any potential infringers? Have any of your patents been challenged, either in court or in a PTO proceeding? These are major issues that investors are unlikely to miss. There are more subtle problems, too, that are worth ferreting out before IP due diligence begins. Are there potential disputes among the inventors on your patents about who invented what? Are certain assignments missing? Are there outstanding licenses whose terms need to be reviewed and perhaps renegotiated before the upcoming financing? Looking for IP problems and solving them puts your company in a better position when investors begin to get involved.

Concluding Remarks

Investors carry out IP due diligence to identify risks and determine their overall relevance for the deal. It's always best for the company to identify potential IP problems first, if possible, so that these problems can be addressed. The best time to prepare for IP due diligence is before you need to. If you know what the investors will be asking, you will be able to strengthen your IP position as you prepare for answering their questions.

1 In fact, if you are the inventor or are substantively involved in preparing or prosecuting a patent application, you have a "duty of candor and good faith in dealing with the [PTO], which includes a duty to disclose to the Office all information known to [you] to be material to patentability." 37 C.F.R. 1.56. You do not have a duty to search for material information, however.

M. Sharon Webb, a Patent Attorney in Goodwin Procter LLP's Life Sciences Practice Area and a former practicing surgeon, focuses on advising companies and investors about patents and technologies. Her practice includes due diligence, patent evaluation and risk assessment, opinion drafting, and IP transactions.

Please email the author at swebb@goodwinprocter.com with questions about this article.