Patent Encumbrances Can Reduce Market Value up to 100 Percent

By Steve Brachmann & Gene Quinn
September 13, 2018

https://depositphotos.com/4013287/stock-photo-man-burnning-the-money.htmlPatents can help business startups in a number of important ways. Filing a patent application can aid a startup’s first mover advantage as a patent grant gives them the right to exclude others from a market sector, which could prove to be very valuable for a variety of reasons — not the least of which is to attract investors keen to invest in companies with some strategic advantage in the marketplace.  

Patents can also help minimize the risk of facing an infringement suit because it gives a startup an asset to assert defensively if and when an aggressive competitor might come knocking. But even if a defensive position does not ultimately prevent litigation from initiating having patents can open the possibility for counterclaims and cross-licensing settlements, which sometimes are the primary strategic reason patent lawsuits are filed in the first place.

These are well known examples of the advantages of patents to start ups and the venture capital firms (VCs) that often fund them. However, patents also help startups and the VCs that fund them because the patents can be sold. If the startup changes course from its initial designs – a not uncommon occurrence – then the sale of irrelevant patents can help recoup earlier sunk costs and the revenue used to fund more promising lines of research, development and commerce. If a startup fails, which ends up happening to the overwhelming number of startups, the sale of the patents can give investors a chance to recoup some of their funds.

The sale of a patent becomes more complicated and less valuable if the patent rights have been compromised. Not surprisingly, an encumbrance upon a patent negatively impacts the market value of the patent because it reduces the ability of others to monetize that patent by removing at least some avenues of opportunity.

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Encumbrances can take several of different forms. A patent licensing agreement is an encumbrance because it prevents a company buying a patent asset from obtaining royalties from a company that has already licensed the patent. Companies can also sign covenants not to sue each other that can run with the patents. If those patents are sold while those covenants are still in force, the patent’s market value is similarly limited.

Patent broker Brad Close notes that encumbrances can have the effect of reducing a patent’s value by up to 100 percent, practically rendering a patent valueless on the market. “If the only companies which are potential targets for a license are already licensed, then the intellectual property is essentially worthless,” Close said. Close has worked as a patent broker for 12 years and has spent parts of the last decade working on brokering patent sales for startups while working with such firms as TIPS Group, Transpacific IP and Blackstone IP.

“If a startup is considering entering into an agreement that would place an encumbrance upon a patent, I would advise them to be very sure that what they’re receiving in return offers adequate value and to take into consideration both their investors and the future of the business,” Close said.

Certain organizations and consortiums in the patent sector require their members to enter into agreements which place encumbrances on patent assets. One such organization is LOT Network which requires members to sign an agreement that offers a conditional license in the event that a patent is sold to a patent assertion entity (PAE) or non-practicing entities (NPEs), effectively protecting members from PAE suits of LOT originated patents. While the potential of avoiding litigation from PAEs and NPEs may seem attractive to startups, Close notes that startups don’t face the same litigation risks of much larger entities. “True NPEs don’t target startups because they don’t have the market share to make litigation worthwhile,” Close said. “NPEs are typically going to go after companies who hold a significant share of the market.”

LOT Network poses the question of whether membership in the consortium is appropriate for a startup as a simple one: If the firm is optimistic about its future and expects to remain in business, then it should consider joining to mitigate its litigation risk. “[I]t comes down to whether you’re optimistic about your future,” Ken Seddon, the CEO and president of LOT Network, told IPWatchdog in an interview in August 2018. 

Close doesn’t believe the question is quite as simple as Seddon makes it out to be, because a market exit might not be the only scenario under which a startup may want to sell patent assets. “A startup might create IP to protect, say, a widget product, but if the startup decides to go in a totally different direction, it might behoove the company to sell their widget-related IP if they become cash-strapped,” Close said. “To just say, ‘Hey, don’t you believe in your company?’ ignores the reality of the situation and substitutes pride for logic.”

Close noted that 90 percent of the patents he has brokered from startups have gone to patent aggregators and NPEs. A startup joining a consortium such as LOT Network would essentially foreclose those opportunities. “It really takes us back to the fact that encumbrances aren’t good for investors or rapidly changing startups,” Close said. “The benefit of not being sued by an NPE is really small for these startups. I don’t think that the claimed benefit they’re getting may be worth the price of trading value on their patents.”

 

Image Source: Deposit Photos.

The Author

Steve Brachmann

Steve Brachmann is a writer located in Buffalo, New York. He has worked professionally as a freelancer for more than a decade. He has become a regular contributor to IPWatchdog.com, writing about technology, innovation and is the primary author of the Companies We Follow series. His work has been published by The Buffalo News, The Hamburg Sun, USAToday.com, Chron.com, Motley Fool and OpenLettersMonthly.com. Steve also provides website copy and documents for various business clients.

Steve Brachmann

Gene Quinn is a Patent Attorney and Editor and founder of IPWatchdog.com. Gene is also a principal lecturer in the PLI Patent Bar Review Course and an attorney with Widerman Malek. Gene’s specialty is in the area of strategic patent consulting, patent application drafting and patent prosecution. He consults with attorneys facing peculiar procedural issues at the Patent Office, advises investors and executives on patent law changes and pending litigation matters, and works with start-up businesses throughout the United States and around the world, primarily dealing with software and computer related innovations. is admitted to practice law in New Hampshire, is a Registered Patent Attorney and is also admitted to practice before the United States Court of Appeals for the Federal Circuit. CLICK HERE to send Gene a message.

Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com. Read more.

Discuss this

There are currently 6 Comments comments. Join the discussion.

  1. Anon September 13, 2018 11:28 am

    Not discussed in this story (not a criticism), but an item related to the notion of “encumbrances” that may well overshadow the type of encumbrances that are discussed in this story are “in play” in the patent world today.

    Of course, I am referring to both the AIA and the particular case of Oil States which changed the fundamental nature of patent rights from Private personal property to Public Franchise property.

    That change undergirds the AIA-induced “encumbrance” that a patent grant really does not have a presumption at a clear and convincing level of validity. Even though that portion of the law was not changed (or discussed as to be changed through other changes in the law), what has effectively happened is that through the change to patents being nothing more than a Public Franchise right, the Franchisor can decide – at levels FAR BELOW the clear and convincing level – to remove the stick in the bundle of property rights of the clear and convincing level of presumed validity.

    It is important – nigh critical – to recognize that this taking occurs at the Institution Decision point of the AIA provided post grant review processes. As such, this taking is divorced from ANY consideration on the merits as to whether or not a granted patent is vindicated or withdrawn due to the rest of the respective post grant processing.

    It is important – nigh critical – to ALSO remember that this taking occurs solely at the discretion of the (political) executive agency control, that (largely) such an institution decision has no recourse as to appeal (OF the decision), and that NO remuneration of the stick taken is ever provided.

    One of the “excuses” given in the dialogue following the Oil States decision was that since the patent right is “really” merely a Public Franchise property right, that the government is FREE to put any type of encumbrance it wants to put as a condition of grant. Current “arguments” then seek to differentiate on this point by attempting to follow the (in my view, weak to the point of being evanescent) dicta offered by Justice Thomas in Oil States (dicta mind you, as I have pointed out contradicts the result that the Court ordained).

    Drawing to the point being offered in THIS story, would not the very type of “encumbrance” being offered post-Oil States as a “necessary” caveat to a post-AIA grant of a patent directly conflict with BOTH what occurs at the Institution Decision point as well as other Constitutional protections of property? Does not THIS type of encumbrance effectively nullify the Constitutional imperative underlying patent law (by securing… the exclusive right)? Does this not rise to the point of making “grant” itself have a radically changed meaning?

  2. Night Writer September 13, 2018 12:50 pm

    OT, but Anon the R. Stern on the other patent site is the one that wrote the Benson brief for the DOJ. Basically, the progenitor of Benson. He posts on that site occasionally.

  3. Anon September 13, 2018 2:26 pm

    Night Writer,

    Understood. As you may well be aware, I am not an advocate for providing “borrowed authority” for posts made by people with their real names.

    I would rather take the content of the post as provided. I noted that the content “on that other blog” was to the effect of attempting to distinguish “per se” anti-trust violations with the offered “these just invite investigation” into violations.

    As such, it was a little “light” and really did not seem to make a big difference to the topic, so I was not compelled one way or another to join the conversation.

    But along the lines of your comment, I would also note that it was the same R. Stern with whom the late Ed (Ned) Heller was associated with, and from whom, many of a wayward legal view was undoubtedly influenced.

    R. Stern indeed appears to have made a “career” with subverting patent law to exclude certain forms of innovation. He may have his philosophical drivers for doing so, and assuredly, his long applied advocacy is blameworthy, but I still place more blame on the Supreme Court for adopting and spreading that anti-innovation muck.

    Much like I blame them for the Oil States decision more than the attorneys involved in the case (from both sides of that case).

  4. Night Writer September 13, 2018 5:35 pm

    @3 Anon

    Fair enough. It was just an FYI.

  5. angry dude September 14, 2018 1:48 pm

    US patents are already worthless to anyone but the largest players.

    Period.

  6. David Cohen September 14, 2018 2:08 pm

    ” … Can Reduce Market Value up to 100 Percent” is a peculiar construction. Instead, one might say ” … can reduce market value to zero”.

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