• Mathias Karlhuber

IP Risks for Investors

Intellectual property is a prime asset for investors in tech ventures, but few realize how vulnerable it is to attack as growth starts to happen. So explore these five questions first with potential targets, says Mathias Karlhuber at Cohausz & Florack in a book IP and the next wave of growth

Many investors in technology companies are well aware that their returns largely depend on a potential target’s portfolio of intellectual property, so realize it is worth making a close analysis of it. However, they sometimes fail to appreciate that it may not necessarily protect the company against IP-related attacks by competitors in the market, let alone by so called non-practising entities (NPEs) or trolls, ie, companies or research institutions that hold patents and other IP rights, but do not offer any products or services.

It comes as a surprise to them because of the special protective function of IP rights, such as patents. They merely grant a negative prohibitive right, ie, the owner may prohibit others from using the protected creation, such as a patented invention. However, a patent does not provide its owner with a positive right of use for a product. If this product infringes someone else’s patents, its marketing can be prohibited, irrespective of whether the seller owns a patent covering that product or not, so jeopardizing an entire investment. Such a scenario is worth keeping in mind when assessing a target’s risks, especially as when growth happens, hopefully boosted by the investment, visibility in the market rises and, hence, the risk of IP- related attacks.

So even if the target company has built up a more or less sizeable patent portfolio, it does not mean that it is protected against patent- based attacks to its products and services. If a target’s patent portfolio is only mapped to its own products and services, it typically falls too short in properly assessing the IP-related risk to the investment.

Instead, it usually takes:

  • an analysis of the IP situation of immediate competitors, as well as other IP stakeholders in the respective field of technology;
  • an evaluation of the potential defensive value of the target’s IP portfolio;
  • and an assessment of the overall litigiousness in the competitive environment.
  • Such questions asked upfront greatly simplify and clarify the prospects for realizing the value in an investment.

Explore what IP is out there

Irrespective of what kind of attack scenario a target company might be facing, an obvious prerequisite to a sensible IP risk assessment strategy is to obtain comprehensive knowledge about the IP rights which exist and could potentially represent a risk for the target’s commercial activities. In the field of patents this knowledge is typically obtained by running a suitable patent database search which provides information about existing patent applications and granted patents. The hits provided according to the search profile chosen then have to be assessed for their relevance to the target’s current or future products and services.

The major challenge clearly is to define the right search profile which produces a digestible number of hits which can still be processed within the typically limited amount of time and within a budget that is reasonable in view of the potential investment, yet provides a sound overview of potentially critical patents. Patent database searches generally provide a multitude of arbitrarily combinable options to restrict the scope of the search. Typically, the search profile is technology based using classification schemes, such as the International Patent Classification (IPC). One could, for example, further reduce the number of hits by combining this technology-based search with the names of relevant competitors in the target company’s markets or by exclusively focusing on known competitors. The latter however possibly creates risky blind spots for NPEs or yet unknown competitors which might hold or obtain patents in the target’s field of technology.

A target with a seasoned IP strategy will already have set up such a search process and profile, typically as a continuous monitoring and risk assessment process where new hits are identified and assessed for their relevance to the target’s business. Hence, if possible, the target should be asked for their monitoring profile and existing risk assessment, as a starting point for the investor’s own analysis.

It should in any case be noted that such a database search is, of course, only a snapshot of the situation at the time of the search and has a blind spot of about 18 months due to the delayed publication of patent applications after filing. Hence, depending on how long the risk assessment process takes, running the search again towards the end of the process is recommended to catch more recently published patents and patent applications.

It should be further kept in mind that any existing risk assessment made in the context of a third-party patent is only a snapshot based on the target’s current commercial activities. As these may change fairly quickly, not least due to the investment, the risk assessment may rapidly become outdated. Hence, such risk assessments should be continuously updated along with the target company’s development.

Explore the defensive value of the target’s IP portfolio

A further element in assessing the IP-related risk is evaluating the target’s resilience against attacks by competitors. This can be done by evaluating whether or not the target’s IP portfolio covers aspects of the technology which are attractive to competitors in the market. If such a position has been achieved by the target, any competitor who risks infringing a target’s patents will think twice before attacking it. A prerequisite to this preventive effect is that a competitor holding critical patents is itself interested in using the technology covered by the target’s patents and therefore willing to enter negotiations. Hence, under this defensive aspect, the relevance of the target’s patents to their own products is less important. Rather, the primary value of the target’s IP portfolio lies in its relevance to the products of the competition.

A target with a seasoned IP strategy will already have set up a filing and prosecution strategy which does not only focus on its own products but keeps the defensive value of patents in mind. Optimally, the target already has a corresponding charting process in place which analyzes competitor products against the target’s patents. Hence, if possible, the target should be asked for their filing and prosecution strategy, as well as their competitor-analysis process.

Explore the target’s active IP risk mitigation strategy

Certain targets may even have implemented a more active approach to mitigate IP risks associated with competitor patents in that they try to prevent potentially critical competitor patents from being granted or to attack such patents on grant.

In essence, most of the existing national or regional patent systems provide two ways of attacking patent applications and patents. Depending on the respective national or regional provisions, an attempt to prevent a patent from being granted can be made by submitting third-party observations or, where applicable, by filing a pre-grant opposition with the examining patent office. Challenging a granted patent can either be achieved by a post-grant opposition filed with the competent patent office or by other invalidation attacks, eg, nullity actions, before the competent patent office or national court.

In certain fields of technology or markets, it is a more or less customary preventive practice to file such attacks against competitor patents using typically fairly inexpensive opposition procedures even without an immediate commercial threat.

Furthermore, it should be noted that NPEs are not susceptible to infringement counter-claims. The only possibility to mitigate the risk are attacks to their patents. However, for a certain type of NPE, rather than developing its own patents, it successively acquires interesting patent applications or patents from practising entities to enforce. This is often the case where competitors of the target pull out of certain fields of technology and monetize their related IP by selling it or spinning it off into a licensing entity. Hence, what may once have been the patent of a competitor perceived as less aggressive in the market may well end up in the hands of a considerably more aggressive NPE, the business model of which is to license and, if need be, enforce their patents.

Hence, investors should ask the target for its strategy towards these types of NPE. It will indicate the level of sophistication of its IP strategy and its IP awareness in the market. The target should also be asked if they are aware of any noticeable patent sales by competitors as the latter may be a signal for upcoming licensing activities by the buyer.

Explore the target’s licensing strategy

Certain targets may also have mitigated IP risks by entering licence agreements with IP holders. While a target will have to reveal existing license agreements to the investor, it is worth exploring whether the target entered that licence agreement at will or whether it was forced to do so in order to avoid or terminate patent litigation. The latter gives an immediate idea about the litigiousness of the market and the risk of further infringement claims, especially if the market share or commercial success of the target increases.

A special licensing scenario may arise with patent pools, where patent holders pool their patents for a certain technology in order to license them to third parties. Such a scenario is often encountered in the context of standard essential patents (SEPs) which are inevitably infringed if a certain industry standard is to be met. Such SEPs cannot be freely enforced by their owners but are subject to a licensing offer under fair, reasonable and non-discriminatory (FRAND) conditions. Enforcement is only available if the potential licensee refuses to take a licence under these FRAND terms.

While the options for attacking these patents are available in this scenario, the sheer number of patents involved typically does not lend itself to such an approach. As it is typically advisable to assess one’s exposure to this scenario and to seek early clarity by obtaining the necessary licences, a target having agreed licences for such patent pools shows a reasonable level of sophistication in their IP strategy.

Explore the litigiousness of the market

A final aspect to be explored when assessing IP-related risks is the overall litigiousness of the market. Certain markets or fields of technology are far more prone to IP litigation than others. Even if the target operates in such an environment, it does not necessarily have to have been involved in such litigation. This may, for example, be due to the current low visibility or market share of the target which makes it an unattractive object for IP litigation. However, that situation may of course quickly change, not least due to the investment.

Hence, investors should ask the target if they have been involved in IP litigation in the past or if they are aware of such disputes in the market as this gives a good indication
about the litigiousness of the market and the related IP risks. It should be noted that commercial providers are available to provide statistics and further insight in litigation activities in certain fields of technology.

In any case, investors should not forget that what puts a target on the radar of competitors or NPEs most likely is their commercial success. The main difference between
a competitor and an NPE is that the former is more likely to take early action in order to protect its market share, while the latter has good reason to wait until the target has
established itself and reached a sizeable market share which makes it an attractive object of licensing activities.

In summary, assessing the IP-related risks of the investment in a technology company is a comprehensive task for the investor which should be based on a thorough understanding to the patent situation in the market. The target should be asked a series of questions which provide the investor with a good initial idea of these IP-related
risks, as well as if and how these have been approached by the target in the past. Asking these questions may greatly simplify the IP risk assessment process which is crucial, as successful IP litigation against the target may jeopardize the entire investment.

This article first appeared in: Managing Intellectual Property Today - Opening up new parts to growth by Novaro Publishing

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