March 8, 2021
In "Angel Investing Tips"
Everyone knows the importance of IP and hears that IP is one of a company’s most important assets, and for many companies in today’s technological landscape, a crucial one. The World Intellectual Property Organization says that “complementary research-based market valuations of firms in Standard & Poor’s 500 Index indicate that intangible assets account for around 80 percent of the average firm’s value.1”
At Propel(x) we stress the importance of knowing how to evaluate companies and be able to determine which opportunities are best for you. This can especially be the case when considering science and technology startups. Investor Brian Cohen, a part of the New York Angels and author of What Every Angel Investors Wants You to Know outlines eight questions when looking at potential companies to invest in. One of those questions focuses on IP: “How solid is the IP? Provisional patents or lawsuits pending don’t add up to a strong sustainable competitive advantage.2
For an explanation of importance of IP and 4 Types of IP protection, check out Intellectual Property Protection by Upcounsel. While most people may think of patents, copyrights, and trademarks when examining the topic of IP, another possibly beneficial type is in the form of trade secrets. Trade secrets “can be used to protect ideas that may be difficult to patent but which still have economic value.” They are also useful for patenting ineligible technology, avoiding patent expenses, and for technologies that are difficult to reverse engineer.2 For many innovative technology startups, trade secrets may be the proper way to protect IP in some cases.
So why is IP so important and why should it matter to investors?
Three reasons that IP can be considered an important asset is that it gives a startup competitive advantages, can increase its valuation and profit potential, and can render it an appealing acquisition target.
It’s incredibly important for a company to manage its IP wisely from a competitive advantage standpoint. Startups strive to stand out in a market so in order to stay ahead, protecting and managing their IP is crucial. We’ve seen some exciting technologies that are frankly not something many have seen before, or could even fathom. Managing IP diligently may take effort and investment, but it can be well worth it. Tim Harris, a partner at international law firm Bird & Bird noted in the article Intellectual Property: The Most Valuable Asset of a Technology Startup notes that “A startup that proactively identifies, protects and manages its IP is likely to be in a much stronger position to attract investment capital than one that takes short-cuts…” A specific example of this is a Freedom to Operate Opinion (FTO) which may protect a startup’s ability to offer its product in the marketplace and “the knowledge gained from such an exercise can help mitigate risk, provide assurance to potential investors, and facilitate the development process by informing design changes necessary to avoid identified patent barriers.” Even though obtaining an FTO can be costly and timely, in the long run it can be a huge benefit to your competitive advantage.
When a company has a strong competitive advantage, they not only demonstrate promise of building strong market value but can be poised for being a potential favorable investment. When a company has strong IP, such as patents, in the market and has gone to correct lengths to protect it, it can make your investments potentially much less risky. When discussing the importance of IP for technology startups, Harris adds “a venture capitalist is likely to invest in and give a higher valuation to a company that has given thought to and take appropriate steps to protect its IP.” It is indicative of a company that is truly innovating, is mindful with their IP management and has a competitive culture.
A startup that creates, provisions and maintains IP is not only protecting its technology but grooms itself as a potentially attractive target when it comes to being viewed as a prospective acquisition. The very nature and point of acquisition means that companies don’t acquire enterprises with underwhelming potential. It’s completely tied to what kind of expected returns the target can provide, which is based on several factors including the IP. Educational website ip.education say “High quality, investment-grade patents can have spectacular impact on a startup’s valuation. In the early stages of a company, especially when technology risks and market risks abound, the patents may be the most valuable asset the company has.” (Startup Company Valuation Goes Up With Patents).
Increased competitive advantage, higher valuation and profit potential, and posture as an appealing acquisition target can be three ways that hugely impacts the importance of IP for startups. Investing in startups, even with strong IPs, is very risky and can result in the loss of capital. When looking at companies to invest in, their IP and how it’s managed is a good thing to add to an evaluation checklist.
For more detail on what to look for in a company when investing, check out Part 3 of our 5-Part Guide to Angel investing, How to Evaluate a Science and Tech Startup.