Improve VC Returns with Intellectual Property Portfolio Management

For all the glamor and allure 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, returns from venture capital have been roughly equal to those of the broader stock market. In fact, more than half of all VC-backed companies fail, and about the same 50% of all money invested in VC 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 of their respective funds.

Based on some conversations I’ve had with people in the VC industry, the above statistics don’t tell the whole picture. In addition to the half of venture capital firms that fail, there are those that are described as “walking dead”: firms that neither close nor provide the substantial returns needed 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 ventures to provide a 20x return on their investment. This could be of particular concern for the industry, given the emerging trend towards fewer 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 think a comprehensive cross-portfolio IP management strategy could provide higher returns for venture investors.

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’re also gambling 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. 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 you invest in a new business idea for a start-up, why wouldn’t you want to know if you can own the business idea long-term or if you have 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 rights on the new business idea you’re researching?” – from IP Assets Maximizer.

These very important questions must be answered during investor due diligence. Note, however, that patent 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 proper analysis must involve a close examination of patent claims in the context of the business and technology in question.

Intellectual property portfolio management to reduce costs and increase margins

Although most of the portfolio companies financed 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 analysis of a couple of regional VC firms: With a relatively small portfolio of companies, these firms had an invested interest in 300+ and 600+ patents. By corporate standards, these are sizeable portfolios. I would expect to find even bigger portfolios with bigger 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 the business focus.

Bringing this discipline to IP portfolio management has the added benefit of disclosing patents that are not core to the company’s business. With this knowledge in hand, a typical company will look to reduce costs by letting patents lapse, or may try to sell or license its secondary patents, thus creating a new revenue stream.

Intellectual property licenses to increase returns

Patents that are not essential to the business of the owning company may still be of value 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 hold only a small number of sub-patents. But across the entire portfolio of companies, the venture firm may have rights to a significant number of patents that may be of value to other companies/industries.

We can extend the concept of monetizing the secondary assets of major venture portfolio companies to the “living dead” and even defunct portfolio companies (although with the latter two groups, we may care less about the distinction between the main and secondary patents). In many cases, the business case and due diligence behind the original investment in these likely were sound, but the business failed due to execution or market timing issues. In many cases, the underlying IP assets may still be fully valid, valuable, and available for entry into a focused monetization and licensing program.

A multi-million dollar license revenue stream would nicely complement the periodic liquidity events in today’s VC market.