Not every company is dependent on their own proprietary technology, but many are, and often the most valuable companies have proprietary technology as their raison d’être; that is, their technology is the principal justification for their existence and belief that they can control key markets.
For new ventures, technology is developed to provide a strong differentiator from existing competitors. Technology characteristically underpins the creation of inventions, innovations, new useful devices, and services. As entrepreneurs know, new technology is appropriately and legally preserved though the securitization of patents, trade secrets, etc. Technology also serves as a principal basis for valuing early-stage companies for purposes of investment.
Early in the development of a new venture it is important that entrepreneurs/founders conduct their own self-evaluation (e.g., due diligence) of their technology in relation to the impact of technology on the value of their nascent startup.
Technology due diligence at the earliest stages consists of two major considerations:
Technology Must Be Able of Being Legally Secured
Legal rights to technology property ownership are evidenced in the form of granted nonprovisional patent(s), which is the preferred position; patent application(s), which offer the potential of being granted early in the life of the developing new venture; or provisional patent application(s), which offer merely hope for the future.
The availability of a granted patent, perhaps as the result of the work of one or more founders, is a preferred position because it is a confirmation from a third party (the United States Patent and Trademark Office, or USPTO) that the invention has met its requirements for novelty and nonobviousness as well as other criteria. Patents can also be secured by other means, including especially license agreements. Granted patents are highly recommended for companies that anticipate seeking professional investment in their futures.
Patents in process, while not yet having the official approval of the USPTO, are valuable because the company’s patent attorney has provided and documented the evidence needed by the USPTO to assess patentability. This same information will be useful to prospective investors, who will be tasked with judging on their own or with the help of their technical due diligence assistants whether the new invention can be patented. Therefore, the entrepreneurs and their patent attorney should develop the patent application with an eye toward its future review by potential investors. Ideally, the patent application both validates the invention to the USPTO and provides key data on potential products, markets, and uses that are persuasive to early-stage investors. This process can be challenging, so entrepreneurs should expect to provide significant amounts of background technology, competitor, and patent research to the patent attorney. That information will eventually be discovered by potential investors. At this early stage, however, the entrepreneur only needs to do that amount of research that is satisfactory to the founding team members.
The availability of one, or more than one, provisional patent application presents challenging problems for the new venture. Provisional patent applications often lack the detail (e.g., background, related patent searches, market information, etc.) and specificity (including especially claims) that are found in patents or patents in process. This lack of information detail leaves professional investors with great uncertainty. While professional investment based only on the existence of PPAs can occur, it will be very difficult and/or time consuming to achieve and certainly will result in reduced valuations—outcomes that are unsatisfactory to an entrepreneur.
Trade secrets can be very valuable in combination with patents; however, trade secrets may be disclosed either inadvertently or purposefully by employees (current and former) and thus, on their own, may be insufficient as a technology foundation.
For the reasons outlined above, entrepreneurs and founders should consider waiting until a granted patent is secured before seeking professional investment, though other forms of investment (e.g., founders, friends and family, etc.) can be considered. It may take two to three years to work through USPTO office actions and secure a granted patent. This can seem like an untenable position for many entrepreneurs/founders but the lack of granted patents simply means that investors will value the new venture less because of the uncertainty of not knowing how secure the technological basis for the new venture may be.
Aside from the actual status of patents in process, there are actions the founding team can take to conduct early due diligence on the technology under development. Fundamentally, entrepreneurs and founders need to assure themselves that their technology and IP is unique; that is, it has not been done before and no person, company, or university researcher has a granted patent in the space the future company would want to do business in.
Some of this patent due diligence can be accomplished by visiting the USPTO website and conducting searches to find patents that contain keywords and phrases that apply to new venture technology. Patents identified should be carefully read and key reference documents secured and reviewed further. The effort put into patent research should be useful in revealing aspects of the new ventures technology that may already be claimed in others’ patents or, ideally, show that the new venture’s technology (and invention) has not already been identified and claimed by others.
Discovered patents also reveal inventors (by name) and ownership; for instance, the inventor may be an employee of a company, or the patent may have been assigned to another party. These are useful pieces of information that can help guide the founding team. If the new venture’s patent attorney is onboard, he/she may conduct a freedom-to-operate (FTO) search that can further refine those areas of the existing patent landscape that are not owned by others
If a patent is discovered that effectively includes an entrepreneur’s idea or patent intentions, then that discovered patent may be used to guide new thinking and research, or perhaps the entrepreneur can strive to secure the patent or license the technology from the patent owner. In any event, there is no excuse for not knowing about prior patents and their impact on the new venture.
Patents in process (including provisional patent applications) by others are not discoverable, as the patent applications are not disclosed until a patent is granted. Thus, a certain amount of risk exposure can’t be avoided.
Technology Must Be Able to Defend the Company’s Chosen Markets
The entrepreneur must determine the likelihood that current or eventual patent positions will be able to protect or defend a valuable market or market niche in which the new venture desires to serve its customers and users with new products and services. It is also understood that value creation is based on the ability of the new venture to generate profit (by selling products and services), from which investors can eventually be repaid in the form of dividends and substantial increases in the value of company stock.
With respect to the ability of the technology to defend the company’s intended target markets from competitors, initial due diligence can be conducted using the Internet. The Internet can be searched using appropriate keywords to discover companies and people who may be working in areas similar to that of the new venture. Discovering what other companies are doing is one aspect of competitor research that is important to future marketing-and-sales plans. It would be quite normal to discover a myriad of companies (e.g., competitors) that offer products secured by various kinds of technology or possessing different technical specifications and features. This is also useful information, as it further defines those attributes of the new venture’s expected products that can offer important advantages in the marketplace. Even at this early stage of technology due diligence, the information can lead back to granted patents or perhaps tidbits of information that may be useful in the research process. The research should also help guide the development of both broad and narrow claims for the new venture’s patents in process.
The actions described above are properly referenced as “secondary” research, as they rely upon sources that were, in turn, developed from the original or “primary” sources of the data or information. Secondary research is based on public disclosures, and this type of research constitutes the minimum necessary, though it may not be sufficient.
Primary research is conducted through contact with people and organizations directly. Once done, that information, which may still be public, becomes part of the database owned by the future company. Primary research can consist of discussions with others at conferences, interviews with others on the telephone, e-mail exchanges from knowledgeable sources, etc. This primary research may occur incidentally between a competitor’s employee and an entrepreneur, and even seemingly insignificant pieces of information, when combined with others sources of data, can illuminate an important piece of information.
This type of intelligence sourcing is often called G2 in the military. All companies, especially those technologically oriented, should advise their technical employees to be watchful for information about competitors’ actions, products, specifications, etc.
Government agencies and their technology area managers can be good sources of information (not confidential or secret, of course), as they are very knowledgeable of military requirements and technical approaches that they prefer based upon their continuous scanning of available technology and discussions within the military agencies with compatible interests. Discussions with technical experts and consultants can occur either informally or formally via a consulting contract of short duration. These technical experts are often well informed of happenings within markets and with applicable technology.
The research and activities of others (individuals and companies) that have not been made public constitute a risk of investing in technology that can’t be resolved (until a long time, as measured in years, has transpired) because the information is largely unknowable by any reasonable means.
As the period of time for founders to conduct their own initial due diligence is limited, the goal of technology due diligence at the earliest stage is not just to conduct a thorough analysis of the markets, but rather to simply establish that the new venture’s technology, inventions, and IP have a good chance of providing a basis for products and services that can be made and sold for a profit and at large enough volumes to make professional investors interested.
If the answer to the question of whether the technology is unique and innovative and capable of supporting the development of new products and markets is yes, then the goals of the founders’ technology initial due diligence have been achieved and the founders can continue with their due diligence on other matters.
1. As a reminder, at this nascent stage of new venture development, founders are also busy evaluating themselves and potential products and markets, and they are beginning to think about the business model and strategies.
2. Researching and discovering prior work, inventions, and patents in process within the university environment can be challenging. It is best to start with selected universities working in areas in common with the entrepreneur and research departmental websites and tactfully ask questions of the professorial and student researchers.
4. G2 is a term used in the military that refers to information and data secured from external sources (e.g., adversaries and cooperative entities, for instance) and used to guide the development of offensive and defensive strategies and tactics.
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