Five killer intellectual property issues when pitching to investors
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Learn about five intellectual property issues that are important to investors when you pitch. Presented by Simon Rowell, founder of Innovation Liberation Front, a business consultancy fighting for good ideas to prosper. We help entrepreneurs understand and protect their IP, and assist them create and execute commercialisation plans.
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Five killer intellectual property issues when pitching to investors
- 1. FIVE KILLER IP ISSUES WHEN PITCHING TO INVESTORS MARCH 25, 2015 SIMON ROWELL, FOUNDER
- 2. ASKING INVESTOR TO SIGN AN NDA • Mistake • Risk is limited • Don’t focus on how it works • Patent novelty? • Acceptable pre due diligence
- 3. YOU DON’T KNOW ABOUT FREEDOM TO OPERATE • Can you execute plan without infringing third party rights? • Patent and design searches • Trade mark searches • Update so current for due diligence
- 4. NO BARRIERS TO PROTECT YOUR POSITION • Why can’t someone replicate your USP? • Formal IP is important but not only mechanism • First to market is not a sufficient barrier • Trade secrets – are they really secret, how well documented? • Exclusive supply agreements • Long term customer agreements • Regulatory hurdles
- 5. YOU DON’T OWN THE IP • Loose founder documentation • Use of holding company structures • Use of family trusts • Loose agreements with third party collaborators • Right to file invention • Copyright • Foreign complications • University student complications • Get your house in order • Tax implications of transfers
- 6. UNREALISTIC IP VALUATION • Valuation of IP is inherently difficult • Most founders have wildly over-inflated values • If we get only 1% of huge market X, THEN … • Failing to isolate addressable market • Understand the bigger picture, what investor brings with the money, subsequent rounds, etc • Consider options such as convertible notes that postpone early stage valuation • Related issue – do not ask to be paid out your shareholder loans incurred in developing the IP
- 7. CONCLUSION • First win, then seek battle! • Internal due diligence prior to pitching • Fix issues ahead of time to avoid surprises and delays which negate investor trust • Check IM and business plan carefully • Ensure full cost of IP protection strategy is reflected in plans • ILF is happy to help reviewing IM’s, pitch decks or business plans, and getting your house in order for DD
Editor's Notes
- In this session we want to take a look at five issues that could either improve or ruin your chances of getting investment. It’s about painting your business in the best possible light from the investor’s perspective, whether you have your own formal IP protection or not. You need to gain an understanding of where issues lie in your business and trying to resolve those prior to seeking investment. We believe in tabling any issues that cannot be immediately resolved, so there are no surprises, and spelling out how those issues might be later addressed or minimised.
- Asking professional investors to sign an N.D.A may well put them off from the get go – it’s a rookie mistake that could paint you in a bad light. They might see 300 business plans per year, across many industries. If they signed N.D.A.s with every entrepreneur who pitched to them, it would be nearly impossible to avoid conflicts of interest. They are interested in investing, not in setting up competitive businesses using your ideas. Because capital raising is such a close knit and relatively small industry, the reputational damage to someone ripping off someone’s idea would be devastating. The practical risk of it happening is just so low, it’s not worth worrying about. The difficulty for someone who is seeking capital before they’ve filed for patents is that in order for the invention to be patentable, it must not be known, used or published prior to the filing date. Disclosing the technical details of your invention to an investor may count as public disclosure. If you cannot file your patent application before you seek investment, then you need to be careful about exactly what you disclose – but only so that you preserve the novelty of the invention. The reality is that investors do not usually want to know about the internal workings of your invention, or how it technically achieves the particular advantages you claim. There is no real need to tell them that, at least in the first pitch. There may come a time when the investor decides they are potentially interested in your business, and in which case they may wish to conduct a technical due diligence. At that point it may well be acceptable to ask for an N.D.A to be signed.
- Investors will expect you to have established freedom to operate. This means you’ve taken steps to ensure that executing your business plan does not infringe the intellectual property rights of third parties. These steps might include: commissioning professional patent or design searches in the target markets; and commissioning professional trade mark searches for any brands you will use in foreign markets. Initial freedom to operate patent searching might cost around 3 to 5 thousand dollars depending on complexity and how many relevant hits you get. For trade marks, expect costs of around $1000 per country. Investors are likely to require you to update your freedom to operate searching as part of their due diligence, or they may have their own attorneys conduct searching.
- You only have to watch Dragon’s Den or The Shark Tank to understand the importance most investors place on carving out a protectable patch. Without some form of barrier to entry, they are not willing to put their money at risk. That is not to say that formal I.P. protection is the only way to establish barriers to entry. But to pitch on the basis that you will be first to market without any other barrier, will certainly drastically reduce your chances. You may be first to market, but if it’s a great idea and an existing market player comes along with a bigger and smarter marketing budget, then you will be in trouble in the long term. If you have patents or designs to protect the functionality or look of the product, then great – that will certainly give you a good foot in the door. If you have got trade secret elements to what you do, then that is a viable barrier to entry. However, expect in due diligence to have the protocols you use for keeping that secret tested. What physical security measures do you have; do you keep access logs; what are employment and your confidentiality agreements like and such like. Furthermore, how well documented are these trade secrets – if they all reside in someone’s head then that is a huge risk for an investor. If your brand character is important, then that should be protected using trade marks. This can be done at any time, but note in some countries there is a first to file rule – which means even if you were first to use in that country, you could get held to ransom by someone who registers your brand before you do. China is a good example. Contracts are another way of creating barriers to entry. Signing up critical suppliers with exclusivity deals, or binding customers into long term relationships is another way of creating barriers to entry for competitors.
- You don’t actually own the I.P. There are two potential issues under this heading. If you have not been careful with your agreements with third parties, it could be the case that you do not actually own the I.P. you think you do. Just because you pay someone to develop or design a product for you does not mean that you will own all the I.P. rights associated with it. For example, if you engage a third party consultant to work on some aspect of your business, and they invent a new product as a result of working on that, you will not own the right to file a patent for that invention unless it is expressly set out in the contract. If you engage a third party to develop software for you, and they write both code and a user manual, you will likely own copyright in the code, but not the manual – unless you expressly put that in the agreement. Even if you have a contract with a University for certain work, if they involve students in the work and the students come up with I.P., unless you’ve got an assignment from the students, they will own it. Before you seek investment, ensure any loose ends around ownership are tidied up. The other part of this issue is where the entity seeking funding is not the entity that owns the I.P. This could arise is the I.P. is held by a holding company, or in a trust, or just as a result of history and not tidying up loose ends, the I.P. is actually owned by a founder. My experience is that most investors will want to their ownership stake reflected in the IP entity as well as the operating entity. Be aware that trying to achieve that when you are seeking investment can slow things down and have adverse tax consequences. For example, if patents are held in a family trust, you cannot just make the investor part of that trust – you have to transfer the asset out of the trust – and usually this will need to be done at a market value. There is then income tax payable by the trust on the sale proceeds pertaining to any patents in the sale.
- In early stage investing, the business may have little more than it’s I.P. Valuing such businesses is very difficult, and entrepreneurs often get it very wrong, which can really put off an investor. The more risk you can remove from the equation, the better your valuation is likely to be. If you have only proof of concept in the lab, then you’ve got technological risk. If you have a working protoype, then you may have proof of concept, but you’ve still got risk that it can be scaled up to commercial manufacture at an economic price point. You may have proved you can manufacture it at an appropriate price, but there remains risk that consumers will actually buy it. Mistakes entrepreneurs commonly make in their valuation methodologies: they base estimates on total market figures, rather than the addressable market – the market you are targeting and can actually serve they say market X is so big, if we can achieve just 1% of that, then the business is worth Y - without showing any understanding or justification of how they can secure that 1% market share in the business plan A further related issue is that some founders want the investors to pay them out for the time and cost that they have put into developing the I.P. No investor wants a founder to take skin off the table. Consider those as sunk costs, or at least a very long term loan. The investor will want all of the investment money to go towards growing the business as fast as possible.
- One of the I.L.F core vlues is first win, then seek battle. In the case of investment, this means get your house in order first: do an internal due diligence and tackle any issues early, check your I.M. and business plans to ensure there are no red flags, and prepare your pitch carefully. We can assist you with conducting an internal I.P. due diligence, or reviewing the I.P. sections of your information memorandum.