Startups & Funding: Where do IP and Licensing Fit In?
30 April 2022
Startups need to pay attention to their intellectual property assets. But, they also have limited funds. That is why they aim for much-needed funding, either from angel investors or venture capital (VC) firms.
These angel investors and VC firms prefer to put their money in startups with a strong IP portfolio. However, obtaining IP protection can be expensive.
So, what’s a startup to do?
IP does matter
“Most seasoned and institutional investors will not, or in fact cannot, invest in a startup without any IP, as the presence of a sound and robust IP portfolio would be a standard item on their risk management checklist,” said Coral Toh, principal and managing director at Spruson & Ferguson in Hong Kong.
IP protection, therefore, provides a competitive edge.
“IP is no longer about just raising funds,” said Raja Pannir Selvam, managing attorney at Selvam & Selvam in Chennai, “but rather a tool to keep competitors in check. When an investor looks at a startup, they look at how their IP can be used to prevent others from imitating the products or services offered by the startup they are investing in.”
“In our experience, startups that have a strong IP portfolio enjoy greater investor confidence and sometimes are able to claim higher company valuations based on their IP portfolio. More specifically, early stage and pre-revenue startups are able to show strong innovation culture and uniqueness of products and services through a strong IP portfolio,” said Nishant Kewalramani, senior partner at Ediplis Counsels in Bengaluru.
“A robust IP portfolio is one such cornerstone that proves to investors that a startup has the capacity to back up its promises of rapid growth or market disruption,” added Ren Jun Lim, a principal at Baker McKenzie Wong & Leow in Singapore. “Without an IP portfolio, the true value of the startup cannot be unlocked and determined.”
Startups, therefore, should think about developing their P portfolio at the earliest opportunity, specifically before seeking funding.
The problem is, building an IP portfolio can be expensive especially when filing to register patents, trademarks, designs and other IP assets in different jurisdictions prior to getting funding.
What startups should do at the bare minimum before approaching potential investors, said Toh, is to conduct freedom-to-operate or availability searches in their primary market. This will ensure that their products and services can be sold freely without infringing other parties’ IP.
“Thereafter, while the ‘space’ is still available, the startup should file for its own core technology and main brand in their primary market, and if resources permit, in their place of manufacture to protect the security of their back-end operations,” Toh said.
“More often than not, you will require a combination of different IP rights to properly protect your assets. Say for instance, you are trying to sell an invention – such as an innovative medicine or a novel device,” Lim said. “You’d first need to seek an IPR that gives you a monopoly over its production, which in this case would be a patent. You will separately have to protect your brand or designs from being ripped off, which would in turn require the use of registered trademarks or registered designs. You might also need to take steps to prevent individuals who helped develop the invention from sharing the know-how with a competitor. This is where trade secrets come into play.”
Some startups may view IP as a luxury. But they must think of their IP assets not as a luxury that they
will have to spend on heavily. Instead, startups should see it as a basic requirement – something they need to invest in to get ahead business-wise, and to acquire funding to make this possible.
“Basics can be cleaning their brand names before launch, ensuring that employees assign their rights in IP to the company, ensuring that the content or creatives in their website do not infringe the rights of others, etc.,” said Selvam. “These basic checks give a strong message to the investors about the way the startup is run.”
Lim added that startups should also ask questions like, “Are there third-party IPRs that protect a component of the product that the startup is trying to sell?” and “Are there potential competitors who might object to the registration of their trademark?” “Left unchecked,” said Lim, “these areas can be deal-breakers.”
Describing a scenario where a startup is in the midst of negotiations for possible funding but without the necessary protective mechanisms for its IP, Toh said: “Without IP protection, every additional meeting with potential investors presents an additional risk that the startup’s ideas, brands, technology and knowhow would be compromised. This puts the startup in a bind. On the one hand, the startup should be setting up as many meetings as possible to canvass as much support as possible. But, on the other hand, the startup will be trying to keep its IP secret and not share too much with potential investors and competitors.”
She added that to mitigate this risk, most startups ask their potential investors to sign a non-disclosure agreement (NDA) before they start discussing. However, with the lack of resources needed to draft a customized NDA and enforce this via litigation or arbitration, what they have is a template NDA from the internet. Often, these startups will eventually realize that this NDA does not offer much protection after all.
Licensing: A plus factor
IP with licensing potential is a plus. Not only can licensing become a significant revenue stream for the startup; it also proves to angel investors and VC firms that the startup has thought of ways of leveraging its IP.
“Certain steps like filing Patent Cooperation Treaty (PCT) applications to keep international filing options open, studying competitor portfolios and creating patent fence around competitor IP and
others may open doors for licensing in the future,” said Kewalramani. “Such licensing strategy may be used to command better valuations in private equity transactions.”
For Toh, however, this would all depend on certain factors.
“Of course it would be good to have that extra source of income from licensing. However, it is generally not easy to get licensees before having some kind of a performance track record. Also, it is hard to manage licensees without any experience in operations, whether in terms of expectations, problem anticipation and resolution, quality control, brand management, and others,” she explained.
Also, if the license being offered is not exclusive in nature, the potential licensee may not find the exclusive, that means there can be no other licensees for the brand. This may then stunt or limit the startup’s business growth opportunities. In the mind of a potential investor, this may be less than ideal.
“Overall, startups should be cautious about committing to an exclusive license over a long time period,” Toh advised.
It all begins with IP
To develop a solid licensing strategy that will help win the investors over, startups should go back to IP. They must first pay attention to their IP assets and build a robust portfolio covering all their bases.
“Start small, but start,” added Selvam. “Get basic IP protection on all sides, be it trademarks, copyrights, designs, domain names or a patent. Document everything and educate the team about the importance of IP and how their small mistake can cost the company in terms of protecting the IP they create. This will lead to building IP portfolios that can then be leveraged to generate revenue.”
But then again, that takes us back to the fact that startups usually have limited funds. Kewalramani says a balance should be struck to solve this problem. He explained: “While it is quintessential for a startup to build a robust IP portfolio, it should be a balanced approach as any startup has limited funds. The idea is to build an effective IP portfolio and keep future licensing options open at a cost that does not jeopardize the active current business of the startup. Many times we deploy strategies like cost reduction, postponement of bigger expenses like international filings and others to ensure that a startup doesn’t have to choose between running their business and developing an IP portfolio.”
Considering that developing an IP portfolio requires business and legal know-how, it is also important to seek the help of law firms with a regional or global presence. By hiring their services, startups will be better able to identify gaps in their IP portfolios and remain adequately covered as they penetrate foreign markets. This is critical because IP rights are territorial in nature.
“Startups should recognize the value of their own IP and not let the lack of resources stop them from building an IP portfolio,” said Toh, citing the many ways by which startups can acquire funding for their IP filings such as through government grants and industry awards.
There was a time when a startup company’s IP portfolio did not matter much to VC firms. Instead, venture capitalists were on the lookout for its management team. Eventually, they would decide to put their money in a startup with a strong and seasoned management team whose members boast of solid track records in their industry.
That was the priority.
Now, the landscape of venture capital funding has changed in terms of the factors that drive VC transactions. Venture capitalists are now looking at a startup’s IP assets through a different lens.
Startup companies aiming to acquire funding should suit up and “showcase” themselves in front of this lens if they want to grow, deliver better products and services and solidify their foothold in the industry. They can do this by building a strong IP portfolio and licensing strategy – before facing angel investors and VC firms.
Espie Angelica E. de Leon