Winning the Future: How States Can Promote Innovation

By David S. Nay
February 4, 2011

“The first step in winning the future is encouraging American innovation.”

– President Obama, January 25, 2011

The political climate across the nation is ripe with encouragement and support for entrepreneurship.  At the national level, we are being told that to “win the future” Americans must out-innovate, out-educate, and out-build the rest of the world.  For many states that have fallen on difficult times, this message has become much more than political rhetoric.

In Michigan, for example, a former venture capitalist and Gateway Computer co-founder was elected Governor primarily on a platform of jobs and reinvention.  During his inauguration speech, Gov. Rick Snyder re-affirmed his focus on innovation and reinvention, and has since outlined many aggressive plans to foster entrepreneurship.  For entrepreneurship movements, such as this, to truly take root and develop into viable, job-producing industries, however, States/regions must better focus on protecting the intellectual capital created by their motivated entrepreneurs.

Across the nation, incubators, mentorship networks, and business accelerators have been working at the grass-roots level to promote a climate of reinvention.  These incubators have been providing low cost work space, access to funding, and extensive mentorship opportunities for both fledgling and early stage companies.  These are invaluable resources that many companies use to develop and refine their entrepreneurial ideas.

It is often overlooked, however, that the vast majority of startup companies either do not produce a product, or are still many years from profitability.  Until they achieve such a position, their most valuable asset is entirely intangible — it is the intellectual property (IP) that they create through long working hours, personal sacrifice, and the financial generosity of friends, family, and other angel investors.

Unfortunately, too many entrepreneurs view protection of this most prized asset as merely an afterthought.  Whether this mentality is due to lack of education or a lack of financial resources, a reactionary approach to IP protection can be fatal to both a company’s access to financing, and its chances for ultimate success.

Studies have shown that IP is essential in attracting Venture Capital (VC) investment.  A 2010 study performed in association with the MIT Sloan School of Management demonstrated that companies with high-quality IP positions are over six times more likely to be acquired or go public than to go out of business.  See Show Me the IP! Venture Capital Success Based on Patents. This probability for success is a significant driver in VC investment decisions, yet it appears to be underappreciated by entrepreneurs that are often focused solely on product development.

Similar to the MIT study, a 2008 U.C. Berkeley survey found that 97% of all venture-backed biotech/medical device companies hold patents, and 70-90% of all venture-backed IT firms hold patents.  The Berkeley survey found evidence that patents are often the differentiator between two similarly situated companies, and that “venture-capital investors appear much less willing to fund companies that hold no patents.”

This correlation between IP protection and VC investment is significant because in 2010, venture capitalists invested roughly $7 billion in Seed and Early Stage companies (according to the National Venture Capital Association).  This is 10.6% greater than in 2009, and in line with 2008, pre-crash levels.  Furthermore, according to a December 2010 NVCA/Dow Jones VentureSource survey, 87% of venture capitalists expect this figure to increase or stay the same in 2011.  See NVCA 2011 Industry Stats and News – Dec. 21. In a time when sources of public funding may yield to fiscal conservatism and deficit reductions, this large private investment pool is becoming even more attractive.

Unfortunately, all states do not share this multi-billion dollar VC pie equally.  For example, in 2010, Michigan represented 0.7% of the reported national investment pool, while Pennsylvania had a 2.3% share, Texas was at 4.1%, Massachusetts was at 10.9%, and as an extreme outlier, California was around 50%.  States and/or regional incubators that are truly concerned with promoting successful entrepreneurship and attracting more investment dollars may be best served by embracing the value that IP protection can provide.  By carefully structuring entrepreneurial funding in a way that incentivizes IP protection, States and/or incubators may give their startups a collective leg-up in attracting available VC money and guidance.

One approach to promoting IP protection at the State/regional level would be for the State/incubators to create targeted “IP Protection Funds.”  These Funds could be used to both educate the entrepreneurial community about IP protection and to finance protection for qualifying local startup companies.  For example, the fund may directly pay IP legal fees, either as grants or convertible loans, on behalf of a startup, thereby ensuring that IP protection is an integral focus of the company.  Administration of the Funds, along with company qualification, may be handled through the grass-roots incubator networks that are already actively counseling the startup community.  Such a Fund may also serve to bridge the gap between the under-funded start-ups that desperately need IP protection (yet do not always value it), and the patent practitioner community that is sometimes reluctant to accept under-funded ventures as clients.

By investing a modest amount in early-stage IP protection, States truly focused on promoting “successful” entrepreneurship may both increase their likelihood of entrepreneurial success and may position themselves to better leverage the existing investment community.

The Author

David S. Nay

David S. Nay

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