Startups, investors and intellectual property

Getting a startup off the ground is daunting. For most, success rides not on an inspiring business model, impressive pedigrees or even jaw-dropping technology, but rather a startup’s ability to raise capital.

There are many factors that weigh heavily in determining whether a startup will walk out of a meeting with funding, but two stand out: a world-class management team and the existence of a competitive advantage.

By any measure there are vast resources ready to be invested in new, innovative companies, but access to that wealth is as difficult as ever. Investors have rediscovered that carefully thought out due diligence is not only wise, but also necessary if they are to maintain credibility and success. Undeniably the composition and capability of the startup’s management team is a critical step in gaining investors’ confidence. But once the team is in place, the startup’s next hurdle is to demonstrate a sustainable competitive advantage, which translates into value for investors.

One way for startups to accomplish this is by securing intellectual property that covers the underlying technology. While patents offer some level of assurance that a startup has developed a unique and protected position in the market, a competitive advantage can take many forms. These include being first in an industry, having a strategic alliance, and having access to a significant and necessary capital infrastructure. If properly managed and developed, a company’s competitive advantage can be increased by IP.

Many companies understand that IP is important for ensuring long-term success, and many startups are quick in the early stages to try to capture as much as they can. Few, however, take the time to carefully structure an IP strategy that will create value.

How should investors determine whether or not to invest in IP? One way is to consider how IP will be viewed if the startup is acquired by a large company or assessed in the public capital markets.

Protecting technology is not limited to any one form of IP, and no one form of IP is better than the other. In fact, relying on a single form of IP is almost always an insufficient means by which to protect a company’s intellectual assets. A better approach is to seek protection commensurate with an overall IP strategy.

Software, for example, can best be protected by a combination of patents, copyrights and trade secrets that form a formidable competitive advantage.

Investors want to see a reasonable and thoughtful IP strategy aligned with a startup’s business strategy, business model and target market in order to maximize competitive advantage and value.

For instance, the pharmaceutical and biotechnology industries strongly rely on patent protection because many of their products require a significant capital expenditure and can be readily reverse engineered once released into the market. Investors also want to know that the startup has done its homework by scouring the patent and trademark databases to understand and appreciate the prior art landscape.

Even though obtaining IP may appear to bring little value to a startup, to a larger firm interested in a potential acquisition its value may be tremendous. Large companies are hesitant to acquire a company that has not sought industry-specific IP protection. There are two reasons why this is so. First, the approval of the applicable governing body provides some comfort that the ideas expressed do not explicitly infringe another company’s rights. Second, a startup’s IP may be viewed by a larger company as a subset or compliment of a larger solution. Investors recognize IP’s appeal to larger companies and thus are keen to ensure that the return on their investment is maximized.

Time and money are in short supply for any startup and it’s no surprise that the cost of gaining IP protection is a significant concern. But the focus should be on the IP’s value or potential return on investment. Budgets and milestones for IP investments can be used to help a startup determine how to best craft an IP approach that yields the highest return.

Just as it takes careful thought to pull together the right group of individuals who can take an idea and turn it into a successful venture, it also takes thought to develop a company’s competitive advantage. A startup that has successfully built a great management team and identified its sustainable competitive advantage including the appropriate use of IP is likely to gain the attention of many investors.

Michael Martensen of Gregorgy & Martensen LLP in Colorado Springs specializes in intellectual property matters. He can be reached at 719-358-2182 or michael.martensen@comcast.net.

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