Investing in Patents: A Four-Point Checklist

In some cases, a business model is based on the assumption that a patent portfolio will ensure exclusive access to customers wishing to buy a particular product or service. This assumed exclusivity can be a critical component in the forecasts a business owner makes for market share, pricing, marketing costs, revenues, margins, etc. Whether or not these forecasts materialize hinges on the actions of competitors. For example, if competitors are not impeded by the legal barriers expected by the holder of the patent portfolio, then market share and margins may fall dramatically short of predictions. Too much of a disparity between the expectations of the patent owner and the actual legal protection available may place the entire business venture in jeopardy. Entities who are investing in such a business model should carefully evaluate target patent portfolios to determine whether the portfolio has the strength to support business development and growth.

The process of critically analyzing patents is often referred to as “due diligence.” The fine points of due diligence can vary depending on the industry. However, there are usually four common lines of inquiry that are used by intellectual property professionals when investigating the strength of a patent.

First, does the patent cover the current product? Patent applications are sometimes filed early in the development stages of an innovative offering. Invariably, the technical features of a product may change during testing or in response to feedback from a supplier or consumer. However, one of the “hard and fast” rules at the Patent Office is that the contents of an application cannot be supplemented after filing. If a concept evolves in a direction not contemplated by the original patent filing, then the commercialized version of that concept might be left unprotected. Therefore, it is always prudent to compare the valuable features of the existing product with the contents of its corresponding patent.

Second, is the patent relevant to competitors? A patent does not necessarily protect everything that it discloses. For example, the fact that a commercialized product is shown in exacting detail in the figures of a patent does not translate into robust protection for that product. Take a scenario of an innovative “infant friendly” handle that a parent may purchase to add to an existing baby bottle. It could happen that the patent describes the handle but only “claims” the handle in combination with the baby bottle. The gap in protection is that a competitor may avoid infringing this patent by copying and selling the new handle without the baby bottle. As unfair as it may appear, if the competitor isn’t selling what the patent claims, there is a risk that the patent cannot be successfully asserted against that competitor. Quite simply, the name of the game is the claims. Thus, it is best to scrutinize the claims of a patent to ensure that there is a “one to one” correspondence with what competitors are likely to sell.

Third, does the patent have the right geographical scope? Some companies elect to maintain only a domestic patent portfolio, while others choose to supplement their domestic protection with patent rights in other nations. Depending on the market, either approach may be the appropriate course of action. For example, because the European Union (EU) wields as much economic power as the United States, the rationale for introducing a product into the U.S. market may apply with equal force for markets in the EU. If so, the relatively high costs of obtaining patent protection in the EU may be justifiable. On the other hand, cultural differences or governmental regulations may make it unprofitable for entry into non-U.S. markets. In such instances, it may be best to concentrate financial resources for patent protection in only domestic opportunities. From an investor viewpoint, a concern might be whether the business has relinquished potential foreign revenue streams due to inadequate patent coverage in those foreign states. On the other hand, a consideration might be whether the business is saddled with burdensome overhead costs (e.g. maintenance fees) from having acquired unnecessary extra-territorial patent rights.

Fourth, is the “history” of the patent pristine? Securing patent rights involves filing numerous legal documents within prescribed deadlines. Further, errors or deficiencies in the contents of these papers can taint the validity of the patent or raise doubts as to ownership. For instance, the U.S. Patent Office requires inventors to disclose prior publications that may be material to patentability. Under some circumstances, failing to submit these publications can result in a patent being held unenforceable. With respect to ownership, neglecting to properly document the transfer of ownership rights from an inventor to another party, such as the inventor’s employer, could render a patent impossible to enforce. So no “due diligence” is complete without first scouring the documents associated with a patent to locate potential “landmines.”

In the end, a prospective buyer of intellectual property should have the same mindset of one considering the purchase of a house or commercial property. A prudent real estate investor would never be satisfied with “drive by” inspections or “breezing through” a deed or loan papers. Nor would such an investor rely on the verbal assurances of the presumed owner. Instead, the investor would walk the property with a critical eye and have legal professionals scrutinize every contract, deed, or loan. The investor would have a certified inspector determine the safety and physical state of the property. In a like manner, investors in patents should implement similar measures to determine whether a patent will live up to their expectations.