December 30, 2024

It is heartbreaking to see bad behavior by 'inventors' and their startup companies, but it occurs over and over again. Let this lesson be an example of the things you need to check anytime you are doing due diligence on an early-stage company.

First Pass at Due Diligence

Inventors/CEOs call every week looking for a loan using their patents as collateral. As is often the case, I request a list of patents ahead of time or I look them up. Typically, I look up patents based on the assignee, where I take a quick look at the portfolio.

Here's what I can learn from the first glance:

• The earliest filing date tells me how long the technology has been under development (the longer, the better, generally).
• The number of patents tells me how much effort the company has put into their development.
• The current vs original assignee tells me if the company has changed hands since inception.
• The number of foreign applications - and where they are located - can tell me a lot about the CEO and management.

I will look at a couple of their actual patents and applications to learn:

• The number of references cited are a first pass indication that the patent attorney did not 'mail it in' and actually put some effort into the asset.
• The use of provisional patent applications is a sure indicator that their patent attorney was (1) incompetent, (2) running the standard provisional patent application scam or (3) that the company did not believe in the strength of their IP.

Figure 1: Pending Cases by Priority Count

Source: Krajec Patent Offices

From this graph – large entities (more sophisticated patent owners) do not file provisional applications, but, sadly, small entities (less than 500 people) follow this terrible strategy.

• Terminal disclaimers are indicated by the tiny star next to the date. This indicates that the examiner said that two of the company’s patents are not patentably distinct. In essence, the client paid double (and will continue to pay double) for a single patent. This is yet another indicator that the patent attorney was taking advantage.
• Very long patent applications are a sure indicator that the patent attorney was billing by the hour and was milking the client - or the client was writing their own patent applications (which is even worse).
• A long sequence of continuation-in-part applications indicates very poor patent strategy, and I always double check to see if there any patent term left.
• From their PCT applications (if they have any), I always look to see which country did the search. If it was the US, I immediately know that their patent attorney was incompetent. Good options are the European Patent Office (EPO), Korea, and Singapore, as well as certain other countries based on the technology.
• I skim through the patent application, looking for patent profanity (like the word "invention"), which also shows the incompetence of the patent attorney.

I often pull up the prosecution history of a patent from the USPTO website. 

I always look at the registration number of the patent attorney. A very high registration number means they have not been practicing for very long and have little experience. An extraordinarily low number means they came of age years ago and, in many cases, still practice in the same way they were taught.

Many big law firms train their first year associates on startup work. This means the company gets to pay obnoxious prices for next-to-incompetent work product. It may mean that the CEO may be more enamored with the law firm name than their work product.

I always look at the style of the patent attorney when they respond to an examiner. Part of this is intellectual curiosity, and if I find some language that is particularly well done, I might even copy and paste their language into my (50+ page) template for responding to Office actions.

I also look for huge red flags in the prosecution history:

• Use of Track One is always - always - a red flag.
• Micro entity is always - always - another red flag.
• Notices of allowance that come out in September - always an assumption of poor examination.

This was my normal diligence that I would do before I even talk to a candidate for a loan. It let’s me know the client’s sophistication and experience with the patent system, and what to expect about the quality of the IP assets in general.

Assignments are Key to Diligence

There is a new place that I need to look: patents on the side.

Although I have seen all sorts of unethical behavior on the part of inventors, patent attorneys, and even theft from an investor), I learned a new lesson recently.

I talked to an inventor who had some 'patents on the side.' He sent me a list of patents before our meeting, some of which were assigned to his company, but others were not. The filing dates were close together, and the technologies were pretty related.

I was curious why all the patents were not assigned to the company, and the inventor said that he was keeping one of them for himself. He said that if – and only if – the company was successful, he would assign to the company.

Think about what this says to me as an investor. The inventor who knows all the inside information about the company is unsure if the company will be successful - and he is asking if I will invest! These kinds of situations arise much more often than you would think.

My new lesson: do a patent search for every company officer, engineer, advisor, investor, board member, or anyone else I can think of.

If someone with inside information (or even tangential information) about the company is filing their own patents, this is a problem.

The patent owner can intentionally blackmail the company, but often it might not be blatant or nefarious. They just might want to "contribute to the company" by getting some patent protection on their own.

Whether the inventor is intentionally nefarious or not, this situation is rarely good for the company and needs to be addressed immediately.

What I really mean by "addressed immediately" is that you should always walk away from this kind of situation. People who file their own patents to "help" a company can become enormous problems later on, as they can hold the company at gunpoint to "get what they deserve." This is a no-win situation. Always walk away if you find this.

KEY TAKEAWAYS

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