Question the conventional wisdom on patenting and finance for start-ups

Novice entrepreneurs typically believe they must secure intellectual property rights in order to commercialise an invention and raise equity investment in order to launch a company. University technology transfer units generally work according to these same principles.

There are, however, plenty of examples of entrepreneurs who do neither of these things, as well as examples of those who have attempted to follow these principles unnecessarily. So when are intellectual property rights and equity essential, and when not?

In my experience at Imperial College - where I began by overseeing a (later discontinued) College-wide business plan competition - I frequently saw winners and runners-up rush out to spend their prize money on filing patents. And that was often the last I heard of the business.

Competition judges would return the following year and ask, ‘what happened to... ?’ In one case, I had to report last year’s winners were bogged down in patent filing and consultancy work, whereupon the enquirer – a seasoned investor who would normally expect solid IP for most investment propositions – replied, “With that kind of product, why did they bother with IP? Why didn’t they just go straight to market?”

Specialists such as Imperial Innovations, the quoted technology transfer and commercialisation arm of Imperial College, generally place great importance on IP rights. Their first task, when assessing an invention disclosure from an academic, is to decide whether a patent can and should be filed, depending both on eligibility and commercial criteria. The second task is to decide whether the technology should be licensed or spun out into a free-standing company, with the latter option implying the need for financial equity investment.

Patent/no patent? Equity/no equity?

Given this, how should entrepreneurs approach to the question of whether or not to patent and/or raise equity investment?

Recent research by Professor Bart Clarysse et al., that appears in a chapter of our new book, The Smart Entrepreneur, draws on a sample of technology companies which achieved substantial growth - in either profits or intellectual capital - in their first five years of operation to answer this question.

Technology entrepreneurs must generally decide whether they want to enter a market for new products, in which we include standardised services, or for new technology. In the first case, their primary task will be to tailor a technological product or service to the intended market segment; in the second, to develop the performance capabilities of a platform technology to make it fit for its most likely early applications, and consequently attractive to a trade buyer.

The market decision is largely based on environmental conditions – clear commercial opportunities or gaps in potential markets, the invention’s eligibility for registered IP rights, the (im)penetrability of the industry value chain, and the relative speed and complexity of the sales process dictated by potential customers.

The research uncovered a pattern in the relationship between successful growth, initial environmental conditions, and different resources with respect to IP, finance, and management.

Start-ups which successfully enter the market for products frequently do not waste time with patent filing, but focus instead on addressing an attractive, underserved market segment, using customer insight to create the most suitable products and to build strong customer relationships in that chosen market.

Understanding customer needs

With the founders and/or members of the management team usually hailing from the same industry as customers, speed to market is achieved through shared understanding and astute attendance to customer needs, allowing the start-up to become a supplier of reference. Frequently, the company is financed through the founders’ own financial resources and money from family and friends for early development, supplemented by bank loans once revenues begin to flow.

Founders and managers can thus keep customers, rather than investors, at the centre of their attention, to build profitable growth. When outside investment is needed, founders have sometimes been known to file a patent just to appease investors, and then allow it to lapse once the company gets off the ground.

Criteria for choosing to enter the product market thus include a clear market opportunity and a relatively easy value chain and sales process, allowing for easy access to customers. Patentability is less of an issue; in fact, companies designing and creating novel market-specific products frequently employ underlying technologies which are already established and widely used in other commercial applications.

Perhaps a claim could be filed for a new application or combination of technical features, but this may not be worth its long-term additional cost if a strong customer-brand relationship can be built.

Start-ups which decide to enter the market for new technology on the other hand, are usually contemplating longer and less predictable development times, higher starting costs, lack of legitimacy for a not-fully-proven technology concept, and possibly some uncertainty about future market applications.

Strong brands and speedy marketing

Access to end markets is also likely to be complicated by an environment populated with incumbents which have established relations with prospective customers, who in turn may have long, arduous processes for making new procurement decisions. While the long-term financial potential of a new technology could be huge, these starting conditions are hardly the stuff of strong brands and speedy market entry.

Under such conditions, the subsequent choice to play on the market for technology requires strong registered patents and substantial investment from specialist venture capital to give the venture competitive and financial staying power, while it ramps up its technical capabilities, develops its core proposition and identifies the most promising early application.

Experienced venture capital backing also lends legitimacy to the technology, as do the proven (and expensive) top managers recruited from relevant industries. These firms grow rapidly in technical staff and intellectual capital, but generally don’t reach the end market or the point of making revenue – the ultimate ‘profit’ comes from the firm’s trade sale to an incumbent.

The research also summarises a third, hybrid market entry strategy under other combinations of starting conditions. In these cases, there may be a very attractive target product market on the one hand, but market entry is difficult due to the existence of incumbents and slow sales processes. The target market may also perceive the invention’s usefulness but not yet an urgent need for it, making likely take-up slow.

In addition, the core invention may not be eligible for a patent, as is frequently the case with algorithms or new software. The research shows that start-ups facing similar initial conditions can still achieve growth and create routes to the end market by entering commercial partnerships with existing firms or, more aggressively, by acquiring outright other small companies with established customers in the target market, leveraging those existing customer relationships and managers to introduce the novel product proposition.

In doing so, they may also acquire additional intellectual property from other firms to create a more integrated product offering. This approach is, of course, highly capital-intensive, requiring large amounts of venture capital in successive investment rounds, from investors with experience of several relevant industries and markets. These firms tend to grow in both headcount – as they acquire other firms with their own management and sales teams – and profits.

Decisions on how to protect a product or business from imitation and how to finance it are thus related to a number of environmental factors which imply different risks and needs. The above is not a one-size fits-all categorisation but, as spelled out in greater detail in our book, may provide entrepreneurs with a starting framework for choosing an appropriate path to commercialisation. Interestingly, many of the case studies presented in other chapters of The Smart Entrepreneur, which were selected for other reasons and not part of this original academic research, also fit the framework.

University technology transfer units tend to focus on patenting and finance, understandably, since they usually aim to commercialise nascent technology with high risks and start-up costs, and see themselves more in the business of creating valuable technology than of building extensive marketing and distribution operations.

However, some of the research findings may also suggest a wider range of internal and external relationships and routes to market which could be pursued in order to commercialise more of an institution’s intellectual capital – including the creation of software or of services, drawn from accumulated and tacit knowledge.

Sabrina Kiefer, Venture Coach and Business Plan Manager in the Innovation & Entrepreneurship Group at Imperial College London,  is co-author, with Bart Clarysse, of The Smart Entrepreneur, published May 2011, Elliot & Thompson, London. The book is based on the approach used in Imperial College Business School’s Innovation, Entrepreneurship & Design Programme.