The US Patent and Trademark Office (USPTO) Chief Economist has released a report, “The Bright Side of Patents,” that counters a lot of myths about patents and startups.
Given the amount of very poor data out there – see “More Bogus Patent Litigation Statistics” for examples – it’s nice to have some reliable data from reputable scholars (Harvard, NYU) that highlights the importance of patents.
A lot of people in tech, especially in software, have an “anti-patent” mentality. The herd thinking is “open source is the way to go.” Even Google has jumped on that bandwagon, famously giving away some 150 patents to the public with its “Open Patent Non-Assertion Pledge.” Just try infringing one of the company’s 20,000+ other patents though and see what happens.
A crazy blog post Arguments you can make as a startup CTO against filing for software patents claims “Most software engineers believe that software patents are bad for innovation, and shouldn’t exist.” The author goes on to list a bunch of reasons NOT to file for patents including they are expensive, take a long time to get, are expensive to enforce, force you to disclose your ideas to your competitors, etc.
The authors of “The Bright Side of Patents,” Harvard Business School’s Joan Farre-Mensa, and Deepak Hegde and Alexander Ljungqvist of NYU, have a much better argument in favor of startups filing patents: you’ll make more money.
They took an interesting approach to their research. They studied over 20,000 companies that applied for patents, and compared the ones that were granted patents with the ones that were denied patents. Almost no one has bothered looking at companies that were denied patents before. The comparison between the two sets of companies is striking.
The authors say
Our analysis shows that patent approvals help startups create jobs, grow their sales, innovate, and eventually succeed.
Companies that received patents enjoyed:
- 36% higher employment growth
- 51% higher sales five years out
- Much likelier to keep innovating with more, better patents
- Twice as likely to go public
What is it about patents that helps startups succeed?
The authors believe it’s because patents help startups get past “financing friction.” Large, established companies that are doing well usually have a pretty easy time raising money. They have a track record, profits, predictable cash flows. Startups are nothing but a pile of question marks.
Startups not only have no revenue, potential investors don’t know if the technology will actually work, if there will be demand for the new product, or whether the technology could easily be copied by competitors.
The authors claim that patents help reduce “financing friction” for startups in four key ways:
- Patents can facilitate transactions and give investors greater confidence that the company will be able to monetize the invention.
- Investors often are not eager to sign non-disclosure agreements before committing to a company. It can cause headaches if they have other portfolio companies in similar technologies. Patents allow companies to disclose their technology without needing NDAs.
- Patents give a credible way to communicate the technical details of the product.
- Patent are an indicator of quality to investors.
Patents are especially important to early stage startups:
Beyond the second round, the effect of patent approval on access to VC funding all but disappears.
The reason is pretty easy to understand – by the time a company is going into its third round of financing, investors on the board of the company have a lot of information about the company and the founders, and the company usually has some results. There are other things on which to base investment decisions.
It’s also interesting that patents are especially important for inexperienced founders:
Patent approval increases a startup’s likelihood of raising VC funding in the next three years by 44.5 percentage points for inexperienced founders; for experienced founder teams, the effect is virtually zero.
If a founder has a track record as a successful entrepreneur, the investors are putting their money behind the entrepreneur more than behind the idea. Lacking an experienced founder, the investors are placing a heavier bet on the company’s IP, and a patent serves as a form of government backed due diligence for the IP. Prospective investors know that at a minimum there is something novel that can’t be immediately copied by the competition.
Patents also seem to be more important in certain fields than in others. Totally contrary to the blogger arguing against “software patents,” patents are especially important in the IT space.
Evidence from interviews at semiconductor firms suggests that the primary function of a patent in that industry is “securing capital from private investors [for firms] in the startup phase” (Hall and Ziedonis 2001). In addition, recent evidence by Galasso and Schankerman (2015) indicates that patents are particularly effective in blocking downstream innovation and imitation in the IT sector.
Patents substantially increase an IT startup’s chances of raising money, but don’t seem to have much effect on biochemistry startups. The authors speculate that this could be because biochemistry startups are usually founded by scientists with a lot of experience and a scientific track record.
The authors also found that delays in getting patents harm startups. Each year of delay in the first patent being granted results in:
- 19% lower sales and employment growth
- 14% decline in number of future patents and 19% decline in citations (an indicator of patent quality)
- Reduction in the chances of the company going public or being acquired
Given the importance of patents to startups, the authors urge caution on patent reform:
We find that patents offer a substantial bright side to entrepreneurs and small inventors, especially if processed in a timely manner. In particular, patents appear to play an important role in reducing uncertainty and alleviating information asymmetries in the market for entrepreneurial capital. Reforms of the patent system that do not take this role of patents into account run the risk of negatively impacting the availability of capital for innovative startups.
The patent system is doing one of its jobs – helping small companies and startups use their innovative ideas to compete against much larger and more powerful competitors, benefiting the entrepreneurs and society at large.