Government funding for startups: How IP strategy can enhance valuation and attract outside investors

Authors: Matthew Wahlrab and Craig Rochester

Many founders recognize that intellectual property (IP) assets such as patents are valuable in protecting technology investment, and that they can be the catalyst for huge windfalls when exploited successfully. Most of us have heard of the high-profile success of IBM, who boosted annual patent-licensing royalties a phenomenal 3,300% – from $30 million in 1990 to nearly $1billion today. However, it is often the case with some of the most innovative companies, startups, that few of them actually protect and grow IP assets in a comprehensive and strategic manner. In fact, many don’t realize even a fraction of the IP potential in the company, which includes not just patents and trademarks, but brand value, customer data, operational and human resource processes, and innovative business models.

Moreover, investors and funding agencies need to know how their money is being spent, whilst giving startups breathing space and ability to innovate and grow. Understandably, most startups are first and foremost concerned with product development so that they can launch a product and show that there is demand, and so IP and detailed R&D accounting are secondary considerations.

But we at Rapid Alpha believe that, with a little help, startups can build IP protection at the early stages that is critical to being the first inventor.  Further, a good IP strategy can be implemented at a reasonable cost and with a manageable time commitment from the company, while at the same time providing a framework and set of metrics for tracking business milestones to keep government funding agencies and other investors informed.

Shelf IP Vs Living IP: Looking good on paper vs. actual success

A common scenario that we see in startups is the accumulation of ‘shelf IP,’ for example, patents that are filed quickly for the purpose of checking a box with investors.  This means that the IP potential of the company is under-exploited, and that any IP rights such as patents that may issue are not integrated into the story of the company. In such a case, IP is isolated from the organizational functioning of the business and its expansion goals. As is widely recognized, investors favor startups with a patent, yet after the patent and funding is secured, the IP is often put in cold storage and mothballed. We see it time and again – the commercial and operational health of a startup is kept distinct from its IP assets. Patents may be kept like trophies in a cabinet, nice to look at but gathering dust.

The reality is that IP encompasses much more than technology patents.  IP can also relate to many tangible facets of the business, including logistics and operational models, trademarks and branding, sales and marketing innovations, innovative business models, and hard-won customer lists. As a business grows and develops its unique landscape of intangible and tangible functional capacity, the IP ‘wealth’ stretching over this landscape should increase too.

Moreover, when developed in the context of the market, a company’s IP can tell you a lot about the value of the business. IP is an indicator of the success a business can achieve in the market in which it competes. So shelf IP might look good on paper, but an IP strategy in sync with the market context is a far better indicator of business success, and a much better tool to help achieve it.

A well-planned, comprehensive IP strategy helps you communicate your competitive advantage, giving investors confidence that there is a symbiotic relationship between innovation and tangible, operational success.

Key growth stages of a start-up

  1. Pre-seed

The pre-seed stage is known as the phase of analysis, where the groundwork is laid to place the business in the correct market and to define the route for expansion. Critically, a real problem or pain point in a specific market needs to be detected and then an assessment must be made of the intensity – or severity – of the pain point to evaluate the potential upside of opportunity. This is also the phase in which competitors need to be analyzed, and the core founding team is solidified

2. Seed

This is the phase in which the business model and go-to-market product is validated. Over this phase the startup begins to take shape through developing and testing prototypes which can be rigorously assessed and tweaked with the help of friends, family, and volunteers. The objective is to validate the initial value hypothesis and pinpoint the first customer profiles. Notably, this does not have to be a functional or viable product. At this stage, through experimentation and evidence gathering, the founding team will make quick, low-risk decisions. Bootstrapping forms the core funding strategy at this stage, and pivoting from this, there is the potential for the participation of seed grant funds, incubators, angel investors, or government agency funding programs.

3. Early

This is the phase for the Minimal Viable Product (MVP), where the seed idea is launched. The first version of a product is often launched with many faults and represents the ‘bare bones’ of the idea. User testing is intensive and the business model and go-to-market strategy needs to be defined in detail. One or more basic patent applications may be filed at this stage (or earlier). This is also when funding ramps up in intensity, because with a product launch and patent application(s), Venture Capital (VC) can more easily be attracted, and startups can enter more intensive and specialized accelerator programs. 

4. Growth

As the product is refined and takes on greater complexity, customers, cash-flow, and brand identity takes shape. This is the phase requiring the most remarkable transformation for the founding team, and it is also the phase with the highest failure rate. Agility is key, as paying customers begin to shape the product. Competitors and market factors impact and harden the product viability. This is when the robustness of IP in the form of training and replicable company processes informs and bolsters successful employee recruitment, as well as attracting additional VC and private equity funding.

5. Expansion

The term associated with this phase is ‘scaleup.’ The go-to-market business model has been proven, and now the company needs to consider more ambitious goals; the horizon shifts rapidly at this stage, and IP management is crucial. This is when IP clusters and licensing strategies can be implemented, further expanding business valuation, and opening the business to new markets and revenue streams. Mergers and acquisitions are another common strategy in this phase to align the scaleup with larger companies and to rapidly access new markets. 

6. Exit

Not all scaleups end in an exit phase. Believe it or not, there are businesses whose plan is to develop into a high-value, long term operating company. Nevertheless, it is very common for a startup to seek an exit by selling the IP and business to a larger competitor. This can occur in a number of ways, but the most common are: sale of founders’ shares to another company, acquisition by another company, and Initial Public Offering (IPO).

The IP lens: What are the key metrics
for success across growth stages?

As a company transitions through capital raises of Seed, Series A, and Series B, Rapid Alpha typically advises that the percentage of equity being sold should be between 10% and 20%. This ensures that the founders and early employees can retain their shares and reap more of the rewards for the risk and effort that they have invested. A critical factor that enables this is IP protection – IP protection that is robust and comprehensive enough to stand up to the rigors of due diligence.

IP is a major factor in not just valuation, but also in business performance. A study by the USPTO Economic Working Paper Series, “The Bright Side of Patents” demonstrates that companies with patents raise an average of $7 million more than companies that do not. Moreover, this study shows that startups that file for patents are 35 times more likely to be successful than those which don’t. The immediate effect of patents is a 51% increase in sales growth.

Notably, issued patents are worth on average over $50,000, and often much more. By keeping total drafting and patent prosecution costs to between $25,000 and $34,000, this represents a 2x return on investment or more, with a host of other benefits. 

Rapid Alpha team members have managed patent portfolios of over 2000 patents and patent applications, raising hundreds of millions in capital and generating hundreds of millions in licensing revenue.  Rapid Alpha knows how to build strong portfolios, and how to justify the valuation to support founders.

IP strategy for longevity in the market

Although intellectual property rights may have a limited life span (commonly about 20 years), informed management of patents can provide business benefits in the long run, even as your business evolves. A strategic IP plan greatly enhances the value of a business and its attractiveness to investors in the present, but can also ensure longevity in the market. There are a couple of approaches that enable this to happen:

IP clusters to safeguard against competition

Each patent has a number of small variations that are linked to, but distinct from, the primary innovation. A skilled IP expert is able to map out these variations to create a plan for protecting interlinked IP clusters. Each variant may be a distinct IP entity or asset. This means that if you don’t obtain that patent yourself, a competitor may beat you to it. An IP cluster can be generated at different stages along a business growth trajectory, for example, it can be secured in advance of product roll-out or business growth milestones in a proactive manner. On the back of this, there is potential for licensing of patents to competitors for royalty income, or assertion to exclude competitors from the market altogether.

Use of IP to finance debt

IP rights can also serve as collateral for loans. Although this is a lesser-known strategy, it is increasingly being used and tested. For example, China operates government-led initiatives that promote the use of IP rights as collateral for subsidizing interest rates, specific bank funds, and valuation guidelines and tools to reduce lending risk. Reports by the World Intellectual Property Organization (WIPO) indicate that between 2018 and 2019, Guangdong province provided patent-collaterized loans worth more than $4 billion, benefitting thousands of companies.

IP as ‘innovation finance’

As discussed, IP can be used to raise capital and in debt financing, but it can also be used to leverage financing opportunities through exchanges and marketplaces in the same way firms use stock or bond exchanges. This is a more complex aspect of IP strategy, and it depends on the assumption that there is an unending potential for IP to be obtained, which in turn, translates to liquidity. One difficulty is that not all patent and IP licensing is the same. A recent study by WIPO makes the distinction between two different market segments: ‘stick licensing,’ where a company has been using a technology and the holder of the underlying IP rights (an external entity) wants that company to obtain a license under threat of legal action; and ‘carrot licensing,’ where parties cooperatively pursue a license for the knowledge or technology they are interested in as a partnership or other collaboration. WIPO adds that the distinction between these two market segments is important because “both types of licensing have different characteristics and potential public support needs – even if the boundaries between the two markets are, to an extent, fluid.”

Exit plans and IP

In many ways, entrepreneurs are also investors; they invest their precious time, skills, and sometimes money into building and growing their businesses. They need to create a good exit strategy from the beginning, actively considering which IP rights are relevant to their business, and when and to what extent to protect their IP assets. 

Jag Singh, Managing Director of Techstars Berlin and one of Europe’s most active angel investors, has discussed the people component of the exit strategy in relation to IP. Singh points out that this involves enhancing IP awareness internally, in conjunction with the acquisition of IP skills and expertise. It is important to put in place structured measures to ensure sensitive information is protected prior to the exit phase, as well as dealing with employment contracts that clarify how IP rights are assigned and who owns them. All of this greatly impacts how valuable (in real terms) your IP is in the present (even if you are well away from exit phase), and how attractive it is to investors.

Rapid Alpha founder Matthew Wahlrab advocates for all startups to be continuously ‘data room ready,’ meaning that your precious IP, and all other company data, is secured and organized at all times. This not only underpins an exit strategy in a practical way (what do you actually do as a founder when you sell and move on?), but it means that investors can effectively conduct due diligence. The ‘what,’ ‘how much,’ ‘where,’ and ‘when’ of your intellectual property rights can be secured in the data room for others to view under confidentiality agreements. An exit strategy is imperative from an investor point of view, and an IP strategy that complements a clear exit plan indicates for them robust market knowledge and heightened ROI potential.

Ready to devise the strategy your innovation needs?

Helping technical leaders win their markets, negotiate from positions of strength, and outperform their competition for investment are Rapid Alpha’s driving aims. To talk more about how we can support your team to map, leverage, and protect its IP, don’t hesitate to get in touch.

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