Despite all the glamor and glamor that surrounds the venture capital industry, one would expect investment returns from venture capital funds to be significantly higher relative to other investment vehicles that are more widely available. However, industry research indicates that, over time, venture capital returns have roughly equaled those of the broader stock market. In fact, more than half of all venture capital-backed companies go bankrupt and roughly the same 50% of all money invested in venture capital funds is lost. This article looks at how a comprehensive IP management strategy could help venture capital firms reduce their risk and increase the return on their respective funds.
Based on some conversations I’ve had with people in the VC industry, the above stats don’t tell the whole story. In addition to the half of venture capital firms that fail, there are those that are described as “living dead”: firms that neither close nor provide the substantial returns necessary to satisfy typical venture capital models. A panelist I saw at a venture firm conference last year suggested that for their financial model to make sense, they needed at least 1 in 10 companies to provide a 20x return on their investment. This could be of particular concern to the industry given the emerging trend towards less liquidity and lower value events.
But what if a hedge fund could extract incremental investment returns from the companies in its portfolio, including failed companies and so-called walking dead companies? I believe that a comprehensive cross-portfolio IP management strategy could provide higher returns to venture capitalists.
IP due diligence to reduce business risk
Venture capitalists typically invest in companies in the early stages of their respective life cycles. At the time of making the investment decision, the venture capitalist is betting on the business idea, the management team; And, whether they know it or not, they are also betting on the intellectual property that underpins the business.
It is critical that venture capital firms perform appropriate and adequate due diligence to support their investment decisions. We’re sorry, but simply having a list of patents and applications is not enough. Investors need to understand whether or not patents are strong, with adequate coverage for the business and technology in question. The following quote sums it up better than I do:
“In particular, before investing in a new business idea for a new company, why wouldn’t you want to know if you can own the business idea for the long term or if you have a minimal opportunity to innovate freely in relation to that business? Or Why wouldn’t you want to know if another company has invested $100,000 or more just in patent royalties on the new business idea you’re researching?” – from IP Assets Maximizer.
These all-important questions must be answered during investor due diligence. Note, however, that overt landscape topographic maps or other abstract visualizations do not represent a sufficient level of analysis. They may be an improvement over a simple list (although some might argue that point), but a proper analysis must involve a detailed examination of the patent claims in the context of the business and technology in question.
IP portfolio management to reduce costs and increase margins
Although most portfolio companies funded by a given venture fund will be relatively small and have a relatively small patent portfolio, it may be worthwhile for the VC to look at the entire IP portfolio together.
I did a quick scan of a couple of regional venture capital firms: With a relatively small portfolio of companies, these companies had an vested interest in over 300-600 patents. By corporate standards, these are sizable portfolios. I would expect to find even larger portfolios with larger venture firms.
In businesses with portfolios of this magnitude, it is important to understand the portfolio in multiple dimensions. For example, IP professionals, vendors, and business leaders want to know which IP assets support which products. Knowledge of these relationships can allow a company to lock out competitors, reduce costs, increase margins, and ultimately increase returns for investors. Additionally, 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 business focus.
Bringing this discipline to IP portfolio management has the added benefit of revealing patents that are not core to the company’s business. With this knowledge in hand, a typical business will look to cut costs by letting patents expire, or may try to sell or license their secondary patents, thus creating a new source of revenue.
Intellectual Property Licensing to Increase Yields
Patents that are not core to the business of the owning company may still be valuable to other companies and other industries. There are some well-known examples of companies that have been able to generate significant revenue from their secondary patents through active licensing programs: companies like IBM and Qualcomm come to mind. However, there are a number of other companies that have generated significant profits by monetizing their non-core IP assets.
In the case of a portfolio of venture capital firms, each firm may have only a small number of secondary patents. But across the entire portfolio of companies, the venture company may have rights to a significant number of patents that may be valuable to other companies/industries.
We can extend the concept of monetizing the non-core assets of major venture portfolio companies to the “walking dead” and even defunct portfolio companies (although with these last two groups, we may be less concerned with the distinction between companies central and secondary patents). In many cases, the business model and due diligence supporting the original investment in these was likely sound, but the business failed due to market timing or execution issues. In many cases, the underlying IP assets may still be fully valid, valuable, and available for entry into a focused licensing and monetization program.
A multi-million dollar licensing revenue stream would nicely complement the periodic liquidity events in today’s venture capital market.