Originally Published MX January/February 2005
FINANCE
IP Strategy and the Quest for CapitalClearly connecting a company's intellectual property strategy with its business plan can secure a vital link to venture capital funding.
Steven C. Furlong
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| Patents on medical devices don't last forever. Trademarks and other forms of IP protection (distinctive shapes and colors, for example) can help protect a medical technology market space. |
An idea for an artificial liver could lead to a breakthrough invention benefiting millions of people in critical need. But without adequate funding to bring such an invention to fruition, the potentially life-saving device may never get to market, remaining simply someone's dream. Companies that do bring to market useful medical technology innovations tend to succeed in this by crafting a business plan that includes a well-conceived intellectual property (IP) strategy that protects all facets of the medical device. Such an IP strategy can also win investor interest.
Capitalization—whether the money source is venture capitalists, angel investors, or a wealthy friend of the family—can be the difference between a breakthrough entry in the medtech market and just another good idea that went nowhere. And the difference between those who do and do not get capitalized can boil down to how well an innovator understands the critical importance of IP and uses IP protections to make a business strategy effective.
Most medtech companies seeking funding know that a solid strategic plan is vital, but many do not appreciate the important, and sometimes pivotal, role that the development of a comprehensive and defensible IP position plays in that plan. Most realize that they need protections for their IP, but many don't understand that all protections are not equally important or necessary. In fact, appropriate choices regarding how and what to protect can be a valuable asset that enables a company's market strategy to play out successfully. Conversely, a poor strategy can be fatal to the chances of attracting capital, thus dashing hopes of building a successful business.
The Business Plan
In any business, a proven management team is the basis for executing a great idea. Developing a comprehensive business plan is a critical early step. Its comprehensiveness is important. The IP strategy should be woven into the business strategy to such an extent that the IP does not just serve the business strategy, but enables it. The business plan should include four key elements, to be worked out in this order:
- Market assessment.
- Competitive assessment.
- Market entry strategy.
- Business exit strategy.
An assessment of the competitive market space that is the target of the business plan should come first. The plan defines potential customers and characterizes what they want, what they are willing to pay, how their needs are met now, how much they currently pay, and what barriers to market entry exist. The market assessment aims to answer the question of whether, if a market space can be claimed, it is going to be worth it.
An assessment of the competition and the strength of competing companies' market positions is also important. This competitive assessment involves looking at both current and likely future competitors and determining their value proposition. Product differentiation is crucial. Understanding the importance a competitor places on its market space and how well it protects it will help determine whether the products will clash, and, if so, what the respective strengths and weaknesses will be when it comes to the duel. The new company performs this assessment in order to find out who will care if it grabs a particular market space, and how much, and what they can do about it.
A strategy and execution plan for market entry and development generally includes R&D, IP portfolio building, manufacturing, distribution, demand creation, order fulfillment, and other components. The plan takes account of how a product gets into a market space and how it stakes its claim once there. A strategy and execution plan for market consolidation should also be devised. Elements of this plan would be IP portfolio expansion and diversification, and the development of an IP enforcement strategy and licensing strategy.
These strategies need to be considered and assessed, and the IP strategy should be developed, so as to support staking a claim in the market. Competitors have to be kept away; otherwise, going into the market may not be worth the effort. Recognizing how it can consolidate and hold its position will prove very helpful to the company over the long haul.
Finally, having a strategy and execution plan that includes the endgame—an exit strategy for reaping business rewards—tells potential funding sources what they're getting, how much it's worth, and how soon the return will be realized. However, the promise of a good exit will not be credible unless the planning and execution that precede it are solid.
The Venture Capital Acid Test
The innovating medtech company should begin the execution of its plan with the critical foundational elements. Without funding, the job won't get finished. The company needs to show planning, commitment, and the ability to pull it off.
Usually, one of the first executional steps is getting the initial IP protections in place. Until these are secured, the essential element of the medical device business plan—that on which all else depends—is simply not proven. Understanding the IP portfolios of competitors plays a pivotal role in the first two assessments contributing to the comprehensive business plan, and crafting the company's own IP portfolio is central to the entry and exit strategies.
So, in each step leading up to and enabling the endgame, IP is crucial. Nevertheless, companies often view the formulation and deployment of an IP strategy as a necessary evil, giving this function only minimal attention and resources. This ignores the reality that companies get to reap their rewards only if they have managed IP right. Investors know this, so they pay particular attention to it. It remains a valuable cornerstone of the funding proposal.
The remainder of this article discusses the challenge of crafting a medical device business plan and IP strategy that take into consideration the concerns of potential investors. Call this the venture capital acid test. The focus of the examination will be a hypothetical medtech company, Newco, that aspires to introduce an innovative technology into the market.
Developing a Market Space
From the beginning, Newco must be clear about the market space it is after. Fuzzy thinking is costly. Once the company has come to perceive the characteristics of the target market exactly, it will do well to tailor its IP strategy to the critical drivers of that market. For example, a potential investor will not react well if asked to fund a patent on a locking mechanism for a diagnostic tool when the context for use of the invention doesn't require security. Newco may want to protect that inventive feature of the device, but not for this strategy, and not with this investor's money. And if the innovative device has to be delivered to a treatment site refrigerated, then the company should not overlook patenting a differentiated method of refrigerated transport.
To get into its desired space and keep the competition out, Newco has to play both offense and defense. If the desired market space is already occupied, then an offensive strategy is necessary. That means carefully studying the competitive technology and patent portfolio and crafting a technology and patent strategy specifically to get around them. The company ideally would also create barriers to any further portfolio development by its competitor.
If it's a new space that Newco is after, then it must design an IP portfolio such that it will be as difficult as possible for a competitor to get close to, let alone into, the company's territory. The best strategy here is to identify the salient features that would allow success to be achieved cost effectively, and to protect those. It is always better to take the high ground, and besides, defense is often easier than offense.
Venture investors will always look for the strategy behind the IP portfolio and the choices that are implied in the strategic plan. They'll want to see what IP protections are being deployed (trademarks, utility patents, business method patents, copyrights, and so on) and what they cover. They'll also need to know whether the inventions covered are the right ones to protect. Perhaps some aren't worth protecting. Patents may properly be used offensively, defensively, or both ways. The company should determine up front if they are constructed to accomplish the right mission. When the correct approach is established, the patents should be deployed accordingly.
A patent used offensively may directly bar competitors from entering a market space, or it may block further product development by them and limit their effectiveness in a jointly occupied space. A patent may be used defensively to support a counterclaim in a dispute or to supply leverage in order to achieve a licensing or cross-licensing agreement, or even a buyout. It may also be used to discourage competitors from attempting to block future product enhancement with their own offensive patents.
Perhaps it is possible to obtain five patents on a single invention. But if the optimal strategy requires only three, then there is no point in spending money on the other two. A trade secret may serve the strategy better than a patent. If so, then why patent? Likewise, if trademarks or trade dress are not important to the strategy, then a family of marks need not be developed.
No company wants to cede market space to a competitor. Established players will have devised market strategies—often complete with solid IP portfolios—to make it as difficult as possible for Newco to create a new market space, or to invade a space it covets. How well Newco can succeed in spite of a competitor's efforts depends on what the competitor is doing.
The competitor might not have done a good job in building its IP portfolio. Determining the strengths and weaknesses of that portfolio is probably going to require hiring a skilled patent attorney to study and analyze the competitor's patents and prior art. Investors will want to know, in great detail, how Newco is designing around the prior art, or why this invention or these patent claims steer clear of competitors' claims. They will want to know where the risks—that is, unrecoverable costs—lie, where their money is to be applied, and how it can be used most effectively.
IP Protection
Newco has a variety of options for developing an IP strategy that will best serve its larger marketplace strategy. If the company needs a patent to secure its innovation, it can apply for a broad core patent, a series of narrower, so-called picket fence patents, or both. The picket fence option can take the form of a construction around Newco's core invention designed to maximize market protection of its own technology. Or, the fence can be built around the competitor's invention to prevent any further development of that invention. If the marketplace strategy involves trademarks, Newco might opt for a weak but useful mark in a family of marks, or for a single, strong, fanciful mark.
Any of these tactics, or another one, could be the optimal approach for Newco to take. Individually, they have different strategic implications. Each can be used offensively or defensively. And each carries a different price tag for Newco and its investors.
Patents. A broad patent, one that covers the widest possible range of uses for the invention and that encompasses the greatest amount of technical nuance, is very often a good opening gambit. Whether the company stops there or piles onto the initial patent very specific patents targeted to each conceivable deployment of the invention is a matter to be determined by the strategic evaluation.
The strategic evaluation looks at how close the competitors are and considers how best to create and defend a market space. It will reveal whether a properly constructed picket fence will make it more costly for any competitor to open a new space or to penetrate an occupied market space. That evaluation might also reveal an opportunity to pioneer a new market space that no one else has yet envisioned.
Of course, the strategic evaluation must also consider affordability. If cost is a constraint, some of the strategic execution will have to wait. The evaluation can help determine which part of product development can wait and which is most important for including in the initial strategic play. An IP strategy can sometimes be suboptimal yet still able to achieve an acceptable business outcome.
Trademarks and Trade Dress. Patents usually do most of the heavy lifting when it comes to developing and holding a medical technology market space, but they don't last forever. When patents can't completely protect a market space, trademarks and other forms of IP protection can often help fill in the gaps. That's why Astra-Zeneca has registered the color purple for its purple-colored Nexium. That's also why Pfizer has a trademark on the diamond shape of Viagra. And it's the reason that a number of medical device companies have trademarks on their products.
In one case, for instance, a medical device company effectively protected its product for many years by means of utility patents on the most important aspects of its invention. During these years of patent protection, the medical community grew to prefer the company's product because of its effectiveness in addressing some of the perceived deficiencies of competitive devices. As all patents will, however, the company's utility patents eventually ran out.
Because the product was still commercially very valuable, the company didn't want to simply cede the market to competitors. And, as it happened, it didn't have to. Searching for ways to protect its device from would-be competitors, the company realized that doctors had come to recognize the product by the unique way it looked and felt. Quite apart from the product's superior functional characteristics, the company's device was readily identified by incidental design elements unrelated to its intended use.
This look and feel aspect of a product, known as trade dress, is not subject to the limitations of patents—particularly their propensity to expire—and it can be trademarked. However, effectively using such a trademark requires an advanced strategy to ensure that customers associate the trade dress with the product itself. That is why Nexium is so heavily advertised as "the purple pill." In the example just described, the company and its attorneys effected continuing protection for the intellectual property by undertaking an IP strategy extension that protected the distinctive design elements of the company's product with a trademark.
Deploying such a strategy is best accomplished when coordinated with a company's business planning. According to Michael Lasky, a founder of Altera Law Group (Minneapolis), "The one-two punch of limited-life patent protection followed by perpetual trademark protection requires careful advanced strategic IP planning from the very start. If claims of the patent cover the trade dress feature, for example, that potential trademark option is lost forever. Thus, at the time the patent is drafted, it is critical that trade dress features be considered and kept out of the patent."
The Objective. The IP strategy outlined in the business plan, developed under the best guidance of an IP attorney, will speak volumes to potential investors. They'll follow the money, knowing that these protections are expensive and that defending them or challenging them is also costly. The stakes are high. Any company should get used to that fact early on. At the end of the day, Newco must decide, as the investor will, whether the likely reward is great enough to justify both the initial cost of a solid IP portfolio and the potential cost of defending against or challenging a competitor's portfolio.
Whether a family of trademarks is developed, whether patents are broad or narrow, or whether either type of patent is employed defensively or offensively—each of these questions of approach is a matter of strategic choice. The decision doesn't fundamentally change the equation involving risk and reward. To be a successful company, and therefore a successful suitor of investment capital, requires making the choices that will most likely guarantee a good business outcome.
It is not really the invention that patents seek to protect. Rather, it is the ability to operate freely in a market space that is the point. All eyes should be focused on that strategic objective.
An Optimal Outcome. Right out of the gate, Newco needs an IP attorney, preferably one who will take the time to learn the business concept and contribute to the development of a plan to achieve it. If the patent attorney isn't going to get to know the business and isn't needed to provide advice on how the IP can be deployed strategically, then go for cheap. Just remember, the old adage that you get what you pay for usually applies to IP strategy.
In addition, Newco should make deliberate choices regarding the use of IP to implement the business strategy, including what to patent, trademark, or copyright, and how to craft each type of protection. Broad patents are valuable and often necessary, but narrowly framed patents might also be required. Neither is better than the other; they just serve different ends. All patents create obstacles for competitors to overcome. The main thing is that each patent in a portfolio should be an essential element in a comprehensive plan to enter and defend a market space.
A really well-designed IP portfolio can look so daunting and costly to challenge that competitors never do. Instead, they try elsewhere in the market. Or, they may instead cooperate to share a market space. Newco might set up licensing or cross-licensing arrangements with its might-have-been rival. Whichever way the competition is neutralized, the IP protections will have served the business objective and protected the market space.
Patent Costs and Timing
A patent issued in the United States for a typical medical device will generally cost in the range of $10,000 to $20,000. Some simple patents will cost less, and some complex ones will cost several times the average amount. Whatever the cost, all patents are not created equal. To be effective, patents in the medical arts rarely stand singly; rather they are usually part of a portfolio of IP protections. The quality and cost of this portfolio will depend a lot on the quality of the patent attorney and on the strategy that the inventor (the innovating company) and the patent attorney together craft.
The cost just cited accounts for only one patent in one country. Depending on the extent of the variations, subsequent picket fence patents may be cheaper individually. Or not. If the company plans to approach the usual lineup of foreign markets, costs for a patent may run $150,000–$200,000 to get comparable protection overseas.
Also, it may take two or three years for the U.S. patent to issue. In the meantime, Newco can launch its technology. However, its competitors are free to do the same—with the same idea. Patents will not directly help secure a market space through enforcement until they issue. But, considering that they are often published 18 months after application, long before the issue date, pending patents may serve to discourage other companies, who will have to anticipate a costly fight, and to provide provisional rights against bolder competitors.
Courts will not enforce the original patent rights until the patent is issued, of course. Without a final patent issue, the court has no way of determining exactly what is actually patented.
The time and cost involved in securing patent coverage will vary widely depending on individual circumstances. The point to take is that obtaining the most strategically effective IP protection is not a trivial exercise. The best advice is to plan carefully and spend money where it counts.
The Cost of Contending for Space
If a particular market space is attractive to Newco, it will also be attractive to the other guy. So Newco had better anticipate either defending the space or trying to knock the other guy out of the box. Even if Newco has done its homework and created a brilliant IP portfolio, the company may still face challenges, or have to challenge the competition. That is a normal and foreseeable aspect of high-stakes business that relies on intellectual property.
Litigating. Markets are generally orderly. They are kept orderly by agreements that recognize boundaries, agreements that may be formal or informal, acknowledged or not, and imposed by fear of sanction or simply a desire for peace. In the end, orderly markets serve business well. However, parties occasionally can't, or won't, agree on what is acceptable, especially when the stakes are high. That is when the courts step in to bring order by decree. The process by which market spaces are recognized and protected by the courts is a substitute for voluntary agreements, and it is often based on IP. Patent law works, but it's not cheap.
In Minneapolis, the average cost of a high-stakes dispute that is headed to litigation (which most medical technology disputes are) ranges from $1 million to $2 million—just through the discovery process. In Texas, the cost runs $2 million to $6 million; in Boston, $1.5 million to $3 million; and in California, $2 million to $4 million. If an out-of-court settlement is to be reached, it normally happens once that much money has been spent. The costs jump, of course, if settlement does not occur and the dispute goes through trial. They would be generally $2 million to $3.5 million in Minneapolis, $4 million to $8 million in Texas, between $2.5 million and $5.5 million in Boston, and $3.5 million to $6 million in California. And these figures do not include the appeals process or the damage awards.1
Given the high price of dispute resolution, it is clearly best to avoid a dispute in the first place. A well-reasoned and well-executed IP strategy goes a long way toward that end. Nevertheless, some friction is inevitable in an attractive market. When it arises, litigation may not be the best or only option. Litigation can have a winner-take-all outcome, and is attractive to some for that reason. However, the door swings both ways. There is no guarantee that Newco would prevail in a legal contest, regardless of how well it had crafted its IP portfolio.
Licensing. From a practical business perspective, a good enough outcome may be that two or more competitors share a market space in a way that minimizes the cost of friction. Licensing and cross-licensing agreements are usually designed with this outcome in mind. Here again, IP strength is key. The value of a licensing agreement is directly related to how well the participating company's IP portfolio was conceived and executed.
IP as Armor and Armory. In terms of litigation, and of dispute resolution in general, the design of Newco's IP portfolio will be an important determinant of the strength of its bargaining position. When Newco goes into battle against an opponent, it wants to deploy as many independent weapons systems as it can. A military force will have an easier time defeating an infantry ground attack than it will repelling a simultaneous attack of infantry, artillery, tanks, attack planes, missiles, and infantry air units. Analogously for Newco, its opponent will have an easier time prevailing over a patent with one claim than over a patent with numerous independent and distinctive claims—and can more easily overcome one patent than many.
If Newco is on the wrong side of the invalidation of a one-claim patent, or a court ruling of noninfringement of that single claim, Newco stands to lose all. But if the vanquished claim is only one of many, the basic patent may still hold up, albeit dented. And even if several of its patents are invalidated, but Newco has a slurry of others that are upheld, the company is still in the game. Survival is the important thing.
It will cost Newco's opponent a lot of money to dent the Newco portfolio. And if Newco is still going to be standing at the end of the day, there might be little point. Both sides may conclude that it is economically better to settle with a deal that lets both share the market.
IP and the Investor Pitch
The inventor who founded Newco may intend to run the business until retirement. In all likelihood, potential investors will not want to stick with it that long; they'll want to cash out as soon as possible. Since Newco wants to play with their money, it has to play by their rules. That means that the investors are going to look for an opportunity at some point to bail out with a handsome profit, typically via a public offering or a buyout. Consequently, when Newco presents its plan to investors, the latter will be interested in seeing who is likely to want to buy the business, why, and for how much.
Early-stage businesses usually don't have a track record characterized by sustainable annual profits. What they do have, if they've done their work properly, is an IP portfolio that either has proven, or is credibly going to prove, itself capable of creating and defending a market space. At this juncture, IP portfolio strength helps determine the level of interest in, and the value of, the business. Assuming that the market space is desirable, then the more of that space the company can hold, and the better it is protected by the IP portfolio, the higher the capital investment that can be expected.
By the end of the presentation, Newco should have convinced the potential investor that it has carefully planned a medical device business strategy based on, and able to capitalize on, an equally well planned IP strategy. Moreover, it should have made a convincing case that that IP strategy has been devised to suit the nature of the desired market space and anticipates the competitors to be confronted in a three-dimensional chess game playing out on a moving board. The final requirement for an effective presentation speaks directly to the venture capitalist's interest: Newco must show that its IP strategy is deployed in such a way as to produce the highest possible value at the endgame stage.
A Case in Point
A real-world example can illustrate how important the reasoning behind an IP plan can be. In this example, the business plan could have been compromised by a poorly conceived approach to developing the IP strategy. Furthermore, the well-thought-out approach ultimately taken expanded the concept of the business and made possible additional opportunities for profits. It created more-attractive endgame options as well.
In developing the business plan to market his new invention, an inventor learned several lessons, among them the potential value of good IP counsel.
His initial thought was to protect his invention, a handheld communications device and computer envisioned for use by the medical community, with a single, omnibus patent generally describing a multitude of market applications and derivative designs. This approach is easy and relatively inexpensive in market-by-market terms. It can hold significant advantages for some inventors. In addition, the singleness of focus signaled by such a decision might be initially attractive to investors. However, after working with an attorney who gave much more than passing thought to his business plan, the inventor found that, by avoiding the single-patent approach, he could develop a much expanded business strategy supported by a more rigorous and effective IP strategy.
Aided by strategic and technical insights from his law firm, the entrepreneur discovered several additional, and very viable, ancillary markets for his device. He gained a better understanding of the scope and depth of the previously identified market, too. Mindful of these new and evolved markets, he came to realize that an omnibus patent could undermine his ability to pursue them. A single patent could make it very difficult to deploy the invention through exclusive license or sales agreements in very different markets. Additionally, it would introduce unnecessary risk to the patent if any one of the competitors were to successfully challenge this patent in any of the ancillary markets.
The inventor's initial approach to IP in this case could have jeopardized his business by not being the best overall strategy. Only by hiring a law firm that was able to speak the languages of both medical technology and business, and by involving the firm in the development of his business strategy, did he avoid committing to this risky approach. He learned, with the help of his patent attorney, that the IP portfolio can shape key aspects of the business plan—in his case, the applicability of the core invention to unforeseen markets—and that the requirements of the business plan should in turn shape the nature of the IP protections.
This inventor settled on an omnibus-plus-picket-fence approach, to be defensively deployed in multiple markets with multiple competitors while shielding the core market, and to be offensively deployed to capitalize on opportunities in ancillary markets. While he was implementing his full IP strategy prior to getting funding, the inventor did execute foundational elements, in the form of several initial patents, in order to strengthen his pitch to the investor audience.
The structure of this entrepreneur's IP portfolio, allowing for easy deployment to ancillary markets, also provided an attractive exit strategy. It enabled the company to envision several sales or licensing agreements in ancillary markets while preserving still other markets for further development. Not surprisingly, the inventor could deliver a much stronger pitch when he had a more comprehensive IP strategy serving a more comprehensive business plan.
Winning the Investor
Attracting a venture capitalist is mainly a matter of instilling confidence that the start-up will fulfill its promise in four key areas. First, the investor must be confident that Newco's management team competently plans its business, assesses realities, and makes choices. Competence is judged by how well the business plan holds together. In addition, the investor wants to see that Newco understands its markets, has designed its IP portfolio to help carve out a space in each market, protect that space, and enhance an endgame strategy, and has demonstrated that it can execute.
Second, the investor has to have confidence that Newco has a great invention that will succeed in an attractive market. The target market has to be appropriate for the invention. The IP portfolio must be seen as able to move competitors out of the way when used offensively and, when used defensively, to protect the claimed market space from incursion.
Third, of prime importance to the investor is confidence that Newco will get its invention to market effectively and efficiently. IP protections should be sufficient to ensure that the invention enters the market without undue and costly dispute over who owns the space it claims.
Fourth, and as critical as any of these concerns, the investor has to be confident that what is now Newco's will stay Newco's; that is, that Newco's invention, which makes the whole enterprise possible, is adequately protected, and that the nature of the protection serves the company's business strategies.
Conclusion
Newco's IP strategy has to serve its business plan and make its objectives achievable. There are many other determinants of success for a new venture or an old one, but the role that the careful design and execution of IP strategy plays in business success, and in successfully attracting capital, is central. Acquiring funding is often a make-or-break proposition dependent on the IP equation.
Today's investors are some of the savviest ever. If an innovating company wants their time and venture capital, it should be prepared to show them a thoroughly protected invention integrated into a solid business strategy. Investors may be risk takers, but they will always prefer to back the company they can see is a winner even before it has left the starting gate.
Reference
Steven C. Furlong, PhD, is chief business adviser of Altera Law Group (Minneapolis), a firm with a specialization in medical intellectual property strategy.
Photo by PUNCHSTOCK
Copyright ©2005 MX
