Some thoughts on investing in start-up companies
I have come across investors who have been successful entrepreneurs in the past but many of them have lost a lot of their hard-earned money investing in businesses they know very little about. In doing so, they have failed to take advantage of their many years of hard work, knowledge and expertise that created their first success. In other words, they didn’t stick to their knitting.
Other mistakes often made by investors include: a general lack of ‘process’ in evaluating opportunities before investing; undue reliance on the fact that someone else has invested; and giving too much weight to such things as ‘gut feel’, the CEO (past failures and ability to deal with them), the team, R&D expenditure, the issue of patents per se, accolades given by industry bodies, and peer-reviewed papers.
On the other hand, it makes more sense to invest in the business idea of someone who has done the hard work over many years to become an expert in his chosen field, someone who has spent 10,000 hours of “deep practice” (a term used by Daniel Coyle in his excellent book, The Talent Code).
Another essential pre-requisite to a successful technology investment is a well-understood and clear intellectual property position. This does not necessarily mean having a patent or registered trade mark, even though these can be useful in giving the start-up company an advantage over its competitors. What is more important is a strong assessment of the novelty and competitiveness of the start-up’s business idea. Without this assessment the start-up cannot be confident of being able to fight patent infringement claims or persuading potential investors that its business is worth investing in.
Therefore a comprehensive “competitive landscape” search is essential. While a Freedom to Operate search is useful, it does not always go far enough. A standard FTO search looks at existing (and some expired) patents recorded on the databases used by the FTO search engine. The search will also be limited by the search criteria input by the person making the search.
Furthermore, standard FTO searches tend not to look outside the field of registered patents. A lot of competitive and market information can be found through standard Internet searches, as well as searches of expired patents, university publications, research organisation reports and magazines.
If information uncovered by the search predates known patents held by third parties, that information can constitute “prior art” and, as such, can be both a strong weapon and shield. For example, if a patent holder threatens an infringement claim, the defendant’s disclosure of the prior art will more than likely send the patent holder running for fear that the defendant may seek to overturn the patent or tell others about the prior art, thereby weakening the patent holder’s position.
A comprehensive search of the competitive landscape can provide other benefits as well. It can identify other players in the same market, who is buying what patents, who has succeeded with the technology and who has failed.
Looking at previous failures is also a good way of helping a start-up decide whether to continue with its idea, give up altogether or modify its approach in order to avoid the same failures. For example, if someone has previously failed with an idea, what has changed to justify continuing with the same idea? If nobody wanted the product in the past, what has changed to make the product more desirable now? If these questions cannot be answered easily, there may well be no point in carrying on with the product or idea.
Good money spent early on a comprehensive landscape search will save an investor wasting more money on a business whose chances of success cannot be proven. Conversely, if the search results show that the business idea is truly novel and does not infringe anyone else’s rights, the chances of success could well improve beyond the investment community’s standard expectation of only one or two successes out of 10 investments.
The start-up will also be better positioned to negotiate a good investment agreement, reducing the risk of his product or idea being devalued by the investor. A higher valuation based on a unique proposition is also possible.
A comprehensive report can also save the start-up spending too much time and effort on unproductive R&D and IP protection before going to market. For example, if the report shows that the same technology or other technology achieving the same outcome has been or is being developed by someone else, the start-up can change its R&D and commercialisation strategy accordingly.
On the other hand, if the other players are not identified until after the market launch, the start-up’s business could very quickly become uncompetitive and it will be difficult, if not impossible, for the start-up to recover its R&D investment.
Another risk for a start-up that hasn’t done its homework is that of being sued. There have been a number of recent stories of “trolls” timing their patent infringement attacks deliberately to coincide with a start-up’s market launch or completion of a capital-raising. For some interesting commentary on this phenomenon see The Giants Among Us by Tom Ewing and Robin Feldman and Patent Assertion and Startup Innovation by Colleen V. Chien.
In summary both investors and start-ups need a good level of comfort with the novelty, intellectual property position and competitiveness of the business idea. This level of comfort can be increased by conducting a full novelty and competitive assessment. It also helps if the start-up’s founder has spent a lot of time deeply practising his skills, and acquiring leading knowledge and expertise.