Not every company is dependent on their own proprietary technology,
but many are, and often the most valuable companies have proprietary technology
as their raison d'être; that is, their technology is the principal
justification for their existence and belief that they can control key markets.
For new ventures, technology is developed to provide a
strong differentiator from existing competitors. Technology characteristically
underpins the creation of inventions, innovations, new useful devices, and
services. As entrepreneurs know, new
technology is appropriately and legally preserved though the securitization of
patents, trade secrets, etc. Technology
also serves as a principal basis for valuing early-stage companies for purposes
of investment.
Early in the development of a new venture it is important
that entrepreneurs/founders conduct their own self-evaluation (e.g., due
diligence) of their technology in relation to the impact of technology on the
value of their nascent startup.
The Technology Must
Be Able of Being Legally Secured
Legal rights to technology property ownership are evidenced
in the form of granted nonprovisional patent(s), which is the preferred position;
patent application(s), which offer the potential of
being granted early in the life of the developing new venture; or provisional
patent application(s), which offer merely hope for the future.
The availability of a granted
patent, perhaps as the result of the work of one or more founders, is a
preferred position because it is a confirmation from a third party (the United
States Patent and Trademark Office, or USPTO) that the invention has met its
requirements for novelty and nonobviousness as well as other criteria. Patents can also be secured by other means, including
especially license agreements. Granted patents are highly recommended for
companies that anticipate seeking professional investment in their futures.
Patents in process,
while not yet having the official approval of the USPTO, are valuable because
the company’s patent attorney has provided and documented the
evidence needed by the USPTO to assess patentability. This same information will
be useful to prospective investors, who will be tasked with judging on their
own or with the help of their technical due diligence assistants whether the
new invention can be patented. Therefore, the entrepreneurs and their patent
attorney should develop the patent application with an eye toward its future
review by potential investors. Ideally, the patent application both validates the invention to
the USPTO and provides key data on potential products, markets, and uses that
are persuasive to early-stage investors. This process can be challenging, so
entrepreneurs should expect to provide significant amounts of background
technology, competitor, and patent research to the patent attorney. That
information will eventually be discovered by potential investors. At this early
stage, however, the entrepreneur only needs to do that amount of research that
is satisfactory to the founding team members.
The availability of one, or more than one, provisional patent application presents
challenging problems for the new venture. Provisional patent applications often
lack the detail (e.g., background, related patent searches, market information,
etc.) and specificity (including especially claims) that are found in patents
or patents in process. This lack of information detail leaves professional
investors with great uncertainty. While professional investment based only on
the existence of PPAs can occur, it will be very difficult and/or time
consuming to achieve and certainly will result in reduced valuations—outcomes
that are unsatisfactory to an entrepreneur.
Trade secrets can be very valuable in combination with
patents; however, trade secrets may be disclosed either inadvertently or
purposefully by employees (current and former) and thus, on their own, may be
insufficient as a technology foundation.
For the reasons outlined above, entrepreneurs and founders
should consider waiting until a granted patent is secured before seeking
professional investment, though other forms of investment (e.g., founders,
friends and family, etc.) can be considered. It may take two to three years to
work through USPTO office actions and secure a granted patent. This can seem like an untenable position for
many entrepreneurs/founders but the lack of granted patents simply means that
investors will value the new venture less because of the uncertainty of not
knowing how secure the technological basis for the new venture may be.
Aside from the actual status of patents in process, there
are actions the founding team can take to conduct early due diligence on the
technology under development. Fundamentally, entrepreneurs and founders need to
assure themselves that their technology and IP is unique; that is, it has not
been done before and no person, company, or university researcher[2]
has a granted patent in the space the future company would want to do business
in.
Some of this patent due diligence can be accomplished by visiting the USPTO
website[3]
and conducting searches to find patents that contain keywords and phrases that
apply to new venture technology. Patents identified should be carefully read
and key reference documents secured and reviewed further. The effort put into
patent research should be useful in revealing aspects of the new ventures
technology that may already be claimed in others’ patents or, ideally, show
that the new venture’s technology (and invention) has not already been identified
and claimed by others.
Discovered patents also reveal inventors (by name) and
ownership; for instance, the inventor may be an employee of a company, or the
patent may have been assigned to another party. These are useful pieces of
information that can help guide the founding team. If the new venture’s patent
attorney is onboard, he/she may conduct a freedom-to-operate (FTO) search that
can further refine those areas of the existing patent landscape that are not
owned by others
If a patent is discovered that effectively includes an
entrepreneur’s idea or patent intentions, then that discovered patent may be
used to guide new thinking and research, or perhaps the entrepreneur can strive
to secure the patent or license the technology from the patent owner. In any event, there is no excuse for not
knowing about prior patents and their impact on the new venture.
Patents in process (including provisional patent
applications) by others are not discoverable, as the patent applications are
not disclosed until a patent is granted. Thus, a certain amount of risk
exposure can’t be avoided.
The Technology Must
Be Able to Defend the Company’s Chosen Markets
The entrepreneur must determine the likelihood that current
or eventual patent positions will be able to protect or defend a valuable
market or market niche in which the new venture desires to serve its customers
and users with new products and services. It is also understood that value
creation is based on the ability of the new venture to generate profit (by
selling products and services), from which investors can eventually be repaid
in the form of dividends and substantial increases in the value of company
stock.
With respect to the ability of the technology to defend the
company’s intended target markets from competitors, initial due diligence can be
conducted using the Internet. The Internet can be searched using appropriate
keywords to discover companies and people who may be working in areas similar
to that of the new venture. Discovering what other companies are doing is one
aspect of competitor research that is important to future
marketing-and-sales plans. It would be quite normal to discover a myriad of
companies (e.g., competitors) that offer products secured by various kinds of
technology or possessing different technical specifications and features. This
is also useful information, as it further defines those attributes of the new
venture’s expected products that can offer important advantages in the marketplace.
Even at this early stage of technology due diligence, the information can lead
back to granted patents or perhaps tidbits of information that may be useful in
the research process. The research should also help guide the development of
both broad and narrow claims for the new venture’s patents in process.
The actions described above are properly referenced as
“secondary” research, as they rely upon sources that were, in turn, developed
from the original or “primary” sources of the data or information. Secondary
research is based on public disclosures, and this type of research constitutes
the minimum necessary, though it may not be sufficient.
Primary research is conducted through contact with people
and organizations directly. Once done, that information, which may still be
public, becomes part of the database owned by the future company. Primary
research can consist of discussions with others at conferences, interviews with
others on the telephone, e-mail exchanges from knowledgeable sources, etc. This
primary research may occur incidentally between a competitor’s employee and an
entrepreneur, and even seemingly insignificant pieces of information, when
combined with others sources of data, can illuminate an important piece of
information.
This type of intelligence sourcing is often called G2 in the
military.[4]
All companies, especially those technologically oriented, should advise their
technical employees to be watchful for information about competitors’ actions,
products, specifications, etc.
Government agencies and their technology area managers can
be good sources of information (not confidential or secret, of course), as they
are very knowledgeable of military requirements and technical approaches that
they prefer based upon their continuous scanning of available technology and
discussions within the military agencies with compatible interests. Discussions
with technical experts and consultants can occur either informally or formally
via a consulting contract of short duration. These technical experts are often
well informed of happenings within markets and with applicable technology.
The research and activities of others (individuals and
companies) that have not been made public constitute a risk of investing in
technology that can’t be resolved (until a long time, as measured in years, has
transpired) because the information is largely unknowable by any reasonable
means.
As the period of time for founders to conduct their own
initial due diligence is limited, the goal of technology due diligence at the earliest
stage is not just to conduct a thorough analysis of the markets, but rather to
simply establish that the new venture’s technology, inventions, and IP have a
good chance of providing a basis for products and services that can be made and
sold for a profit and at large enough volumes to make professional investors
interested.
Summary
If the answer to the question of whether the technology is
unique and innovative and capable of supporting the development of new products
and markets is yes, then the goals of the founders’ technology initial
due diligence have been achieved and the founders can continue with their due
diligence on other matters.
***
Rocky Richard Arnold provides
strategic corporate and capital acquisition advice to early-stage companies
founded by entrepreneurs wishing to successfully commercialize
high-value-creation opportunities, ideas, and/or technologies. More information
about Rocky can be found at www.rockyrichardarnold.com. His book, The Smart
Entrepreneur: The book investors don’t want you to read, is available as
paperback or Kindle ebook for purchase on Amazon at http://tinyurl.com/pv248qq.
Financial software for use by startups can be purchased on Amazon at http://www.amazon.com/gp/product/B00K2KPSI2.
He posts articles about entrepreneurship on his blog at http://thesmartentrepreneur.blogspot.com.
Connect with Rocky on Twitter @Rocky_R_Arnold; Facebook at www.facebook.com/rocky.r.arnold;
Google+ at www.google.com/+RockyArnold01.
[1]
As a reminder, at this nascent stage of new venture development, founders are
also busy evaluating themselves and potential products and markets, and they
are beginning to think about the business model and strategies.
[2]
Researching and discovering prior work, inventions, and patents in process
within the university environment can be challenging. It is best to start with
selected universities working in areas in common with the entrepreneur and
research departmental websites and tactfully ask questions of the professorial
and student researchers.
[4]
G2 is a term used in the military that refers to information and data secured
from external sources (e.g., adversaries and cooperative entities, for
instance) and used to guide the development of offensive and defensive
strategies and tactics.
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