Startups and Patent Trolls

While patent assertion entities ("PAEs" or patent “trolls”) have received a lot of attention, little of it has focused on the distributional impacts of their demands. The impact of PAEs on startups is crucial, because startups contribute to job creation and innovation, making them potential targets and sources of patents. To assess the impact of trolls on startups, I analyzed a comprehensive database of patent litigations from 2006 to the present, conducted a non-random survey of 223 tech company startups, 79 of which had received a demand, and interviewed nearly twenty entities with relevant knowledge of startup patent issues.I find that although large companies tend to dominate patent headlines, most unique defendants to troll suits are small. Companies with less than $100M annual revenue represent at least 66% of unique defendants to troll suits and at least 55% of unique defendants in troll suits make $10M per year or less. Suing small companies appears distinguish PAEs from operating companies, who sued companies with less than $10M per year of revenue only 16% of the time, based on unique defendants. Of survey responses that had received a demand (N=79), a large percentage reported a “significant operational impact”: delayed hiring or achievement of another milestone, change in the product, a pivot in business strategy, shutting down a business line or the entire business, and/or lost valuation. The smaller the company, the more likely it was to report one or more significant operational impacts. To the extent patent demands "tax" innovation, then, they appear to do so regressively, with small companies targeted more as unique defendants, and paying more in time, money and operational impact, relative to their size, than large firms. 40% of survey respondents stated that they were being targeted because of their use of another’s or a widely available technology.Yet an operational change was not the only response to a demand: 22% of responders reported that, to resolve the demand, their primary response was to “do nothing,” while 35% fought the demand, and 18% settled it. Based on available information, costs were highest when fighting in court was the primary response (with average expenditures of $857K (N=7)); settling cost an average of $340K (n=12) and fighting out of court cost $168K (N=18), on average (Table 1). Small companies can also benefit from a robust market in patents, both as sellers and buyers. An estimated 50% of NPE patents come from companies with less than $200M in revenue. Patent sales can support the ongoing business, and 4% of survey responders said they had monetized their patents, and another 20% said that they had considered it. Yet while the conditions of a majority of sales is unknown, they often take place when the company is in distress or transition, as growing young companies often lack the inclination, time, or extra patents to monetize their intellectual property. When patents are sold under firesale conditions, investors, creditors, and patent focused companies share in the profits, reducing the direct returns to the inventive entity. Growing companies can also benefit from the patent marketplace as buyers, buying patents from the marketplace "on-demand" and overcoming some of the advantages of incumbents. What can be done to decrease the harms of patent assertion and increase the benefits of a robust patent market to small companies and startups? Focusing exclusively on the first question, I present new data that suggest that a number of the reforms put in place over the last year, including by the America Invents Act, are having a positive impact. Fewer defendants are being named in patent suits. The new post-grant review provisions will reduce the leverage of patent plaintiffs in some cases. However, some of these reforms are out of the reach of startups. Prior user rights benefit older companies against younger patents, but don’t help new start-ups. Startup companies are cash-poor, but challenging issued patents is expensive and time-consuming. Reforms to reduce the cost of litigation defense are laudable, and likely deter some suits from being brought in the first place, but don’t reach small companies against whom litigation is threatened, but not brought. Increasing the cost of software patents would limit the number of patents but would also disadvantage startups that patent, relative to large companies and PAEs with large budgets. The distributional impacts of reforms need to be kept in mind, and I suggest some alternative reforms for the consideration of the courts, Congress, and the market.