For all of the glamor and allure surrounding the Venture Capital industry, one would expect the investment returns from VC funds to be considerably higher relative to other investment vehicles that are more widely obtainable. However, industry research indicates that over time, venture capital returns have been approximately equal to the stock market in general. Indeed, over half of all venture capital-backed companies fail and approximately the same 50% of all money invested in venture capital funds is lost. This article discusses how a comprehensive IP management strategy could help VC firms lower their risk and increase the return in their respective funds.
According to some conversations I’ve had with people in the VC industry, the statistics above don’t tell the complete picture. In addition to half of the venture funded companies that fail, there are those that are described as the “walking dead” – companies that neither go out of business, nor ever provide the substantial returns needed to satisfy typical VC models. One panelist I saw at a venture conference last year suggested that for their financial form to make sense, they needed at the minimum 1 out of 10 companies to provide a 20x return on their investment. This could be especially troubling for the industry, given the emerging trend towards fewer and lower valued liquidity events.
But what if a venture fund could extract incremental investment returns from their portfolio companies, including the failed companies and from the so-called walking-dead companies? I believe a comprehensive cross-portfolio IP management strategy could provide increased returns to venture investors.
IP Due Diligence to Lower Business Risk
VC’s typically invest in companies at the earliest stages of their respective life cycles. At the point of making the investment decision, the venture capitalist is placing his or her bet on the business idea, the management team; and whether they know it or not, they are also placing a bet on the IP which underpins the business.
It is basic that VC firms perform proper and adequate due diligence in sustain of their investment decisions. Sorry, but simply having a list of patents and applications is not enough. Investors need to understand whether or not the patents are strong patents, with adequate coverage for the business and the technology in question. The following quote sums it up better than I can:
“In particular, before you invest in a new business idea for a new venture, why wouldn’t you want to know whether you can own the business idea in the long term or whether you have minimal opportunity to original freely in relation to that business idea? Or, why wouldn’t you want to know whether another firm has invested $100K or more in patent rights alone in the new business idea that you are investigating?” – from IP Assets Maximizer.
These all-important questions should be answered during the investor’s due diligence. Be warned however, that topographical patent scenery maps or other recondite visualizations do not represent a sufficient level of examination. They may be an improvement over a simple list (although some might argue that point), but a proper examination must include a detailed examination of patent claims in the context of the business and of the technology in question.
IP Portfolio Management to Lower Costs & Increase Margins
Although most of the portfolio companies financed by a given venture fund will be comparatively small, and have a comparatively small portfolio of patents, it may be worth it for the VC to look across the complete IP portfolio in aggregate.
I did a quick examination of a associate regional VC firms – with comparatively small portfolio’s of companies, these firms had an invested interest in over 300 and 600 patents. By corporate standards, these are large portfolios. I would expect to find already larger portfolios with larger venture firms.
In businesses with portfolios of this extent, it is important to understand the portfolio in multiple dimensions. For example, IP professionals, marketers and business leaders want to know what IP assets sustain which products. Knowledge of these relationships can allow a company to block competitors, lower costs, raise margins and ultimately increase returns to investors. In addition, they will want to categorize their patents by the markets and technology areas they serve, as it helps them understand if their patents align with the business focus.
Bringing this discipline to IP Portfolio management has the additional assistance of revealing patents that are not chief to the business of the company. With this knowledge in hand, a typical company will seek to lower costs by letting patents expire, or they may seek to sell or out-license their non-chief patents, consequently creating a new source of revenue.
IP Licensing to Increase Returns
Patents that are not chief to the business of the owning company may nevertheless be valuable to other companies and other industries. There are some well-known examples of companies who have been able to generate meaningful revenues from their non-chief patents by active licensing programs — Companies like IBM and Qualcomm come to mind. However there are a number of other companies that have generated meaningful returns by monetizing their non-chief IP assets.
In the case of a VC portfolio of companies, each company may only have a small number of non-chief patents. But across the portfolio of companies, the venture firm may have rights to a meaningful number of patents that may be valuable to other companies/industries.
We can extend the concept of monetizing non-chief assets of the top companies in the venture portfolio to the “walking-dead” and already the defunct portfolio companies (although with these latter two groups, we may worry less about the distinction between chief and non-chief patents). In many situations, the business form and the due diligence supporting the original investment in these were probably sound, but the business failed due to execution or market timing issues. In many situations the inner IP assets may nevertheless be fully valid, valuable and obtainable for entry into a focused licensing and monetization program.
A multi-million dollar licensing revenue stream would nicely compliment the regular liquidity events in today’s VC market.