Innovation Summit: IP mistakes drive down valuations

BROOMFIELD — Mistakes made in protection of intellectual property can drive down business valuations — and even kill some investment or sale deals prior to closing, according to experts speaking at the inaugural Rocky Mountain Innovation Summit in Broomfield.

The event took place Thursday at the Omni Interlocken Hotel and was presented by Berg, Hill, Greenleaf & Ruscitti LLP, a Boulder law firm.

Speaking on a panel titled “Issues Impacting Innovation,” Adams Price, president of EKS&H Capital Advisors LLC, a Denver-based investment-banking firm, said company leadership should ensure that they can answer some basic questions in order to maximize valuations.

“There’s some fundamental things you look for,” Price said. “Do you have relationships with your employees, contractual agreements with your employees who are developing this IP, such that it’s assigned to you? Do you own that IP, or do they have some claim to it that might be a problem when talking to investors or talking to buyers?”

Similarly, Price said, business owners should know whether their IP incorporates “artifacts or pieces into your IP to create, for instance, a software product that is owned by someone else, and to what degree does your software rely on that specific IP that might get you in trouble?”

Even a company’s business model itself must be carefully examined, he said, including whether the company’s IP relies on product roadmaps of other products in the marketplace. If so — and if that other company changes its product roadmap substantially — risk is increased.

“The challenge of that is if the product roadmap changes direction, then there’s significant risk to revenue stream coming from that IP,” he said. “That constitutes risk to the investors, and they’ll ding the value of the business and the IP as a result of that.”

Scott Friar, managing partner with Peak 5 Capital, a Denver-based private-equity firm, said investors or buyers must ensure that they’re protected if there is any question about intellectual-property rights.

Investors must “make sure the patents are defendable and really protecting the revenue and profit streams associated with it,” Friar said. “But in the private equity world, a lot of times, on a smaller spectrum, people want to move very fast and tend to trip over the legalities that exist.

“The reality is, we need to make sure that that intellectual property exists, or, if it doesn’t that proper protections are in place,” he added. “A lot of times, where we’ve seen large revenue streams driving significant profitability for the business without adequate protection, we’ve oftentimes set up large escrows or side agreements that would protect that revenue and profitability stream to ensure that the investment that we’re making is truly protected in the long haul.”

Patrick Perrin, a partner with Berg, Hill, Greenleaf & Ruscitti and the panel’s moderator, asked whether investors and buyers are concerned about use of open-source software in a proprietary software product.

“Investors have gotten used to that, as long as it’s ring-fenced,” Price said, adding that companies must “draw boundaries between what is open source and what is your proprietary software.”

Another danger, Price said, is when developers borrow code that might be from developers at other companies and incorporate that code into their own software. Invariably, he said, investors and buyers in due diligence will use a product such as Black Duck software that examines code for violations of IP rights.

“You’ve got to have a very clear story about how that tracks back to your IP, where yours starts and where that other IP ends,” Price said

Steven Joanis, CEO of Golden-based PlanetIQ Inc., said companies must maintain a competitive advantage to drive valuation.

“Valuation and sustaining a competitive advantage go hand in hand,” said Joanis, whose company functions in the Internet-of-Things arena, providing data for weather forecasting and climate monitoring.

Joanis said that hardware typically includes patentable technology, but that hasn’t been a major focus for PlanetIQ, whose hardware resides in space.

“In our case, the secret sauce, or trade secrets, are more important to us than patent protection for hardware,” he said, “because if we patent our hardware, people can get a better idea of how it is we’re solving this very unique problem that we’re solving.”

That approach takes some explaining to potential investors, he said, including as the company is about to close a $12 million Series B funding round.

“All the investors … the first question that they ask is, ‘tell me about your IP,’” he said.

“In our case, we aren’t patenting this particular technology because, again, it cannot be reverse-engineered very easily because it resides in space and secondarily, if we did patent it, people would get a better idea of how our technology works,” he said.

He said that in PlanetIQ’s case, this approach does not carry with it a ding in valuation because the company protects its trade secrets.

“That’s a very unique scenario,” Joanis said. “In the vast majority of cases, it makes a lot of sense to seek some sort of patent protection.”

Companies can also protect trade secrets by having different people working on different things, essentially compartmentalizing development of intellectual property.

“Nobody has the entire trade secrets in one place,” Joanis said.

Joanis said companies that are licensing technology from another party should ensure that those rights carry over if the company is sold. If such agreements have to be renegotiated for a third-party transfer, it can cost sellers a lot of money, he noted.

Dave Harris, managing director of the Rockies Venture Fund and director of operations for the Rockies Venture Club, said his group focuses on investing in early-stage companies seeking $500,000 to $2 million.

“The background of the company plays a big role in valuation,” Harris said, noting that early-stage companies typically won’t have patents, though some might have provisional patents.

“The way we approach IP strategy is really with that strategy piece in mind, he said, adding that his group prefers companies with a blend of trade secrets with patents.

Harris related a story of a company making a pitch for investment at a Rockies Venture Club event, with the entrepreneur including a patent number in their slide deck. An investor at the event looked up that number, only to discover that the patent didn’t exist.

“That was a mistake [by the presenter],” Harris said, with the lesson being, “Don’t lie.”