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Opinion and commentary on financing and nurturing the growth of entrepreneurial enterprises in the innovation economy.

Richard Meyer

The Venture Capital Fascination for Patents©

by Richard T. Meyer, Ph.D.
President, CIC Photonics, Inc.
President, Orion Technical Associates
Founding Board Member, National Association of Seed and Venture Funds

Albuquerque, NM


VCs are always asking new enterprises about how many patents the company has in its name!

Have you ever wondered about that fascination for patents; and why the number of patents held by your enterprise tends to enhance their interest in your company as a VC investment prospect; and why trade secrets hold considerably less value as intellectual property in the minds of the VCs?

The answer lies in part within the formal training, industry experience, and investment successes and failures of the VC.  While the collective knowledge of a set of VC partners can be extensive, the innovations to which they are exposed when they evaluate a new enterprise can challenge their capabilities and judgements extensively.  The challenge can be as great as one might experience from being trained to use canaries to detect methane in a coal mine and next being expected to operate a FTIR gas analyzer for CH4, C2H6, C3H8, etc. without any knowledge of spectroscopy and without an instruction manual.  The potential value of a patent on the gas analyzer in that case is that it would outline the principles of its operation and would cite applications of the analyzer likely with illustrations of spectral records and and absorption intensities as indicators of the presence or absence of species like CH4 (methane) as well as its concentration.

Put yourself in the place of the VC; would you not be better informed and more comfortable having the patent available on the FTIR gas analyzer!  The patent not only defines the technical components of the device but also provides the assurances of the U.S. Patent & Trademark Office that it is unique in certain respects and is differentiated substantively from other devices known to the patent office.

For the VC, that translates to a technology advantage and a potential market opportunity.  In many respects the patent confirms two key elements of the enterprise’s business plan and relieves the VC of some percentage of its due diligence obligation, that due diligence having been provided by the USPTO.

By contrast, trade secrets held by an enterprise are subject to employees walking away with them and/or reverse engineering by a competitor.  As a result, trade secrets are a risk factor for VCs; they are uneasy with them and are not scored high on the investment checklist.  The VC has no one, like the USPTO, to evaluate them for their value as investment security.  Their investment value is best verified by end-user testimonials of an entire product, not specifically the trade secret that is embedded in the product.

Trade secrets are difficult to quantify.  Yet trade secrets are the foundation of most manufacturing companies around the world!

One might conclude from this discussion that the real value of patents is that patents “add value” to the VC firms!  They increase the knowledge-base of the VC partners, they certify the uniqueness or novelty of the innovation, they indicate the possible existence of a market opportunity, and they reduce the risks that accompany the VC investment.  It is no wonder there are so may VC firms and so many MBAs that migrate to the VC industry; much of the investment analysis is being done for them by the combination of the new enterprise, its patents, and the USPTO!


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Replies and rejoinders:
Dan Loague

Well thought out and informative!

R. Dan Loague
Capital Formation Institute
Amherst , NY 14228

BIO
http://www.cfi-institute.org


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