The Weird World of Software Startups: Where Everything’s Made Up and the Patents Don’t Matter

By Evan Jensen

Today’s high tech industry is characterized by the extremes of modern business. Massive tech giants like Google and Microsoft sit atop the industry, with a menagerie of startups popping up all over the place trying to break into the market.

For large companies patents are akin to nuclear weapons. For a large company like Apple or Samsung the strategic usefulness of the patent tremendously outweighs the cost of the application, and the large company can file for thousands of patents. A large patent portfolio opens up a world of business and litigation options because of the large scale of the company’s operations and the long time scale that the large company operates within.

But for fledgling startups, like insects living in their own microcosm while giants stride by, patents don’t necessarily serve the same purposes. In the world of tech startups patents behave very differently.

Anatomy of a Tech Startup

The idea of the startup is ingrained in the American spirit- of building something great from nothing, of starting in the garage and creating a multibillion-dollar corporation. In today’s economy startups are responsible for much of the innovation. Today’s high tech landscape is littered with startups ranging from wildly successful new companies to ignominious failures.

Like winning the lottery, the potential gains of a successful startup are enormous. Legendary “killer apps” have the potential to be worth billions of dollars. Startups can even become huge corporations in their own right. Big names like Facebook and Twitter began as tiny startups and developed into web empires. But for every big-name success, there are many failures and piddling successes. About 75% of venture-backed companies do not return investors’ capital, in other words they fail.[1] But these failures are relatively silent compared to the big splash of the few successes, both due to the successful companies’ newsworthiness, and the fact that venture capitalists “bury their dead very quietly.”[2]

A startup can also succeed by being purchased. Large companies frequently acquire tech startups in order to build out their technology. Microsoft and Google have acquired over 150 companies each.[3][4] For big companies, obtaining the building blocks of the next generation of technology is integral to staying competitive, and the array of innovative startups are like a menu of new ideas for companies to choose between. For many startups, the intended successful endgame of the startup is to sell to a large company.

Many tech startups are focused on building software. Software is great for startups because a few people with an idea can build their idea using inexpensive and readily-available tools. Software can also be brought to market worldwide cheaply and quickly using the internet. Small companies can make money selling iOS or Android apps, and the capital requirements to make such an app are extremely low. Because of the wide reach of the internet popular apps can rapidly spread to millions of users. An app costing one dollar with 100 million users will still yield $100 million, even if it was made by one person working out of their basement.

For hot technologies the price tags for these acquisitions can be mind-boggling. A recent example of a successful tech startup is the software company WhatsApp; an online message platform which Facebook purchased in February of 2014. Facebook paid a whopping $19 billion for WhatsApp, constituting the fourth-largest tech acquisition in the last decade.[5] At the time the company had only existed for five years, and had only 50 employees.[6] But the influence of WhatsApp was indisputable. At the time WhatsApp had 450 million users worldwide, and was adding 1 million new users a day.[7] Despite the company’s tiny size and its product’s nominal price of $1 per year (with the first year free), WhatsApp was still bringing in millions of dollars due to the sheer size of its user base. Because its app was popular worldwide, Facebook was prepared to pay an astronomical sum to own the company’s software, and to gain access to WhatsApp’s user base.

To Patent or Not to Patent?

For a fledgling startup whether to file a patent application is a difficult strategic decision.

Obtaining patent protection has big advantages. For a tech startup, the startup’s ideas and intellectual property are probably the most valuable assets the company owns. Patents give broad protections over a company’s inventions, and allow the company to go after anyone who uses those inventions without permission. Venture capitalists might decide your startup is a good investment based on its patent portfolio. And if your startup does become successful, the patent opens up the option of pursuing competitors and stopping them from using your technology.

Patents are also valuable assets, and represent concrete and valuable technology that the startup has exclusive control over. If necessary, patents can be sold for a chunk of capital which can be put towards more growth and development. And adding patents to the startup’s patent portfolio will increase the startup’s valuation, and make the startup more appealing for an acquisition.

Opting to forgo patent protection carries some huge risks because it is entirely possible that another company will straight up steal your ideas. For a startup that depends on the exclusivity of certain key features of its product, a competitor’s theft of those ideas could make it impossible for the startup to be competitive.

 

Damn the Torpedoes, Full Speed Ahead!

Depending on the startup, it may be advantageous to deliberately forgo patent protection and instead focus on making startup’s core product as big as possible as quickly as possible.

Patents are expensive, and cost can be a serious hurdle for a capital-hungry fledgling startup. Strategically valuable patents that give expansive powers over key market technologies will probably be especially expensive, but those are the most important patents that are worthwhile to own.

Owning a patent enables you to stop others from using the invention by asserting the patent, but asserting the patent is very expensive and may be infeasible for a startup. Large institutions who try to copy your startup’s ideas will have enough resources to stonewall your startup in court and strangle you with legal costs while your competition keeps building. And myriad little copycats will be extremely difficult to track down, might be unreachable in court, and if you try to stop them it may devolve into a game of whack-a-mole. Even if you stop one copycat, two more will spring up in its place. A small startup needs to be realistic about its abilities to enforce its patents.

Patent applications are also very slow. It will be years before the decision to file a patent application manifests as a usable patent, and it is entirely possible that the game will have changed by then. Your startup’s technology may have changed, or it have already been acquired, or failed. Worse, it would be a tragedy for the startup to fail because it wasted money on patent protection, causing it to barely get beaten to market by some other technology, or fall just short of enough user base to start to gain real traction. The time delay between a patent application and the actual granting of the patent is an eternity for a startup.

However, a startup does not necessarily need patents to be successful. Depending on the startup, it may make sense to prioritize the startup’s core product and user base over patent protection. Small, innovative startups have very limited resources, and it may make more sense to spend that time and energy building the product and its user base rather than protecting the company’s technology using patents.

Other techniques can protect a company’s intellectual property, particularly just continuing to innovate so that a copycat will always be left with the previous generation of technology. Being nimble, hard to catch, and hard to copy is a reasonable strategy for a small, innovative tech startup with limited resources. This approach also shifts the value of the company’s ideas from a static invention that can be copied to the dynamic innovation of the company and its employees, which will drive the startup to success in the market, and drive its value in an acquisition. Copycats will always be a step behind, and that fact will draw users to your product. By pushing the edge of the envelope the startup can ensure that its product stays on top even in the face of a myriad of copycats.

The realpolitik of tech startups is simply that nobody cares until your product is a thing. The patent will protect your technology, but if nobody cares about your technology anyway, then spending valuable and scarce resources protecting it is pointless. And once your product is a thing, it could be that patent protections will not be helpful in any practical way. You might be unable to effectively enforce your patents against a horde of copycats or risk being bled dry in litigation against a giant.

Under the strategy of focusing on the core product and user base, the guiding principle is that once the startup’s product is confirmed to be viable then it might make sense to pursue patent protection from the vantage of a larger and growing business. In other words, succeed first. When limited resources make patents ineffective, a blitz of innovation and growth can protect your company’s ideas without a government-granted patent. Having a large and loyal user base that springs out of building a stellar product is inherently hard to copy even without patent protection.

WhatsApp is a great example of a startup which put all its energy into developing its product, and did not pursue patent protection. Facebook acquired no patents when it bought WhatsApp.[8] Nonetheless Facebook evaluated the WhatsApp software and user base together as being worth $19 billion, regardless of the lack of patents.[9] Arguably, patents would not have helped WhatsApp because it created value through rapid growth of a low-cost service to connect users together. Even a competitor who tried to copy WhatsApp would have no traction with users to work with. In WhatsApp’s particular circumstances the strategy of building the best possible product to attract a large user base was superior, and that strategy was extremely successful for WhatsApp.

 

The Strategic Decision

For a startup the selection of a patent strategy is particularly complex because of the heightened levels of uncertainty inherent in startups, and the difficulty of predicting future changes and developments in the startup’s technology and business.

Focusing on developing the product and user base is most effective in situations where the chances of another company infringing are minimal. Factors that reduce the likelihood of another company stealing your startup’s ideas tend to encourage forgoing patent protection. If your startup’s ideas are little-known, secret, rapidly changing, or otherwise difficult to steal or do not appear worth stealing to an outsider then it may make more sense to push ahead with the business as quickly as possible instead of filing. An established base of users and a decisive first-mover advantage can make your ideas difficult to copy for long enough that your startup can develop further and patent its new developments, get acquired, or otherwise advance its strategic goals.

A realistic assessment of your startup’s vulnerability to copycats is vital. Any factors that make it more likely a competitor will copy your ideas will tend to encourage obtaining a patent. Products that depend heavily on research and development, which can be reverse-engineered, or which have readily apparent commercial value are particularly vulnerable. Pharmaceuticals are the canonical example of being research-intensive to discover, and inexpensive to actually make. Hardware products frequently have large development costs, long development cycles, and their designs can be easily copied, which makes them vulnerable to copying and makes patent protection far more desirable.

Another option is to use provisional applications. However, provisional applications do not actually confer any usable patent protections. A provisional application provides a 12-month period which enables you to file a non-provisional application that will have an effective filing date of when the provisional application was filed. A provisional application delays when the startup must pay for the non-provisional application, and preserves the filing date of the provisional application on the non-provisional application. Provisional applications are less expensive and provide a potentially invaluable option to delay the choice to get the full patent, for some extra cost.

In order to obtain effective patent protection it is critical to file quickly. Waiting can result in a loss of rights, losing the option obtain patent protection, which can be disastrous if it results in the loss of a critical patent. Particularly under the new America Invents Act, patents are given to the first to file, making delayed filing particularly dangerous. Filing a provisional application gives a startup breathing room to decide whether or not to pursue a non-provisional patent application. But in any case the startup must select its intellectual property strategy very early on because of the new first-to-file rules under the America Invents Act.

 

Opinion

A carefully engineered intellectual property strategy is essential for a tech startup. The startup’s ideas are the lifeblood of the company, and the source of almost all of its value. Consultation with an intellectual property attorney early in the process is essential for innovative startups.

However, in my opinion, startups should think hard before applying for patents. The patent system serves large institutional corporations well, but is too slow and too expensive to serve fledgling startups due to their limited resources, high speed, and uncertain future. Spending tens of thousands of dollars on a patent that the startup probably won’t assert against anyone is most likely a waste. Building the best product as quickly as possible is much more likely to build a solid business foundation than relying on patent protection, which ultimately depends on expensive litigation if push comes to shove.

Some startups will need patents, whether for strategic reasons or due to peculiarities of their business. Patent protection can be imperative to meeting the strategic goals of the startup.

While most startups are unlikely to be in a position to use their patents aggressively against competitors, any startup that anticipates doing so should file. Startups that have no desire to use patents aggressively might still want a patent for other reasons, but a patent is absolutely necessary in order to go after a competitor for patent infringement.

Second, if the startup wants the ability to sell or license its technology then it may make sense to file. Obtaining a patent will enable a startup to sell the patent, and if selling the patent is a strategic goal of the startup then the startup must file.

Third, a patent portfolio is likely to increase the startup’s value in an acquisition. If the startup’s successful endgame is to be acquired by a large company then obtaining a patent is probably a good idea. However, other factors are also important for acquiring companies, particularly user base. Patent protection may not be essential for this purpose, but a patent is another valuable asset to bring along in an acquisition. But the startup must make a cost-benefit analysis about the cost and acquisition value of other possible choices before determining to file for a patent to increase acquisition value. It could be that spending the same money to increase the startup’s user base will add more acquisition value than obtaining a patent.

 

[1] Deborah Gage, The Venture Capital Secret: 3 Out of 4 Startups Fail, Wall Street Journal, Sept. 20, 2012, http://online.wsj.com/news/articles/SB10000872396390443720204578004980476429190

[2] Id.

[3] List of Mergers and Acquisitions by Microsoft, Wikipedia, http://en.wikipedia.org/wiki/List_of_mergers_and_acquisitions_by_Microsoft

[4] List of Mergers and Acquisitions by Google, Wikipedia, http://en.wikipedia.org/wiki/List_of_mergers_and_acquisitions_by_Google

[5] Facebook acquires no new patents in WhatsApp takeover, World Intellectual Property Review, Feb. 20, 2014, http://www.worldipreview.com/news/facebook-acquires-no-new-patents-in-whatsapp-takeover-6263

[6] 400 Million Stories, WhatsApp Blog, Dec. 19, 2013, http://blog.whatsapp.com/472/400-Million-Stories

[7] Facebook acquires no new patents in WhatsApp takeover, World Intellectual Property Review, Feb. 20, 2014, http://www.worldipreview.com/news/facebook-acquires-no-new-patents-in-whatsapp-takeover-6263

[8] Id.

[9] Id.

Opinions expressed in this article are those of the author and do not necessarily represent the views of Stein IP.

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