Author - Advocate Ankush Bedi and Associate Rishima Rawat
Intellectual property (IP) plays an important role in a start-up's business, especially when the startup is involved in technology. However, often times, startups fail to recognize this. Protecting a company’s IP also plays a crucial role in attracting investments. While venture capitalists want to know where innovation or invention stands vis-à-vis competitors in the prevalent market, other potential investors also think about whether it is advantageous to build a business based on the innovation or invention. Protecting the company’s IP also avoids litigation costs arising out of infringement claims, which is not affordable for a new venture. Therefore, investors also look at the IP protection system in place before they advance funds to the startup.
Importance of IP for Startups
Before talking about IP protection for startups, it is imperative to talk about why it is significant and therefore necessary. The value of IP increases considerably as the company does well. For example, according to an estimate, the value of the Apple trademark is nearly 150 billion euros. The exclusive rights gained through IP act as an asset when used for commercial purposes. This also helps in attracting investment as investors look at the commercial value of a trademark, patent or domain name or any other IP associated with a startup. Having strong IP protection serves as an indicator for potential investors that the startup is more likely to sustain itself than its competitors.
Protecting IP also stabilizes the market and allows for growth and innovation. When investors see this growth, they put in more money to get returns, thereby setting in motion a cycle of investment, innovation and economic growth. On a micro level, as the individual startup receives commercial benefits from its IP, it tends to invest more in research and development. This leads to further innovation, a primary objective of IP rights, and helps the startup in attracting more funding.
Another significant point in having secure IP is that it allows for its licensing, which can fetch handsome royalties to the startup. For example, Rovio, the creator of Angry Birds, makes a significant amount of the company’s revenue through licensing.
Role of IP in Funding/Valuation
Investments in startups usually take the form of equity and sometimes debt. When investors hold equity, they take part in the growth of the company. As the company’s assets grow, so does the value of their shares in those assets. At this stage, the investors are more concerned about the potential of IP assets of the company to allow for increased growth and innovation. This includes current as well as future products. Therefore, IP protection should cover a broad range of ideas encompassing future product iterations. When financing takes the form of debt, startups have to pledge their IP as collateral.
With regard to an early stage business, its quality can often not be determined directly. In such a scenario, IP protection such as patent filings plays a vital role in creating a positive perception in the investors’ minds. It serves as evidence to venture capitalists and other investors that the company is at a certain stage of development and has succeeded in carving a niche for itself in the market. It also shows that the company owns the IP and is not under any obligation to any third party. This positive perception and sustained growth can lead to an increased number of funding rounds and a lower chance of bankruptcy. Even in the case of investors, nearly every investor asks questions about the startup’s IP protection. If the IP assets are adequately protected, it tells the investor that the startup knows that its product is viable in the market.
When it comes to valuation, determining a company’s value becomes easier if the value of its IP assets can be ascertained. While it is challenging for early-stage ventures to achieve valuation, it becomes easier as the risk in the company’s IP assets reduces and it starts attracting more funding. For many startups, IP is the sole basis for valuation and hence investors are extra cautious to check that the IP is real. It is essential to conduct a valuation of IP assets for a multitude of reasons. It helps in having informed negotiations of licensing terms and conditions. During a merger and acquisition transaction, the value of the IP of the target company helps shape the financial strategy to be adopted. This affects the value and share price of the resulting company.
As discussed, the role played by IP in the business of a startup cannot be underplayed. Yet, most startups fail to recognize their IP, let alone protect it. It is important for founders to realize, from day one, the impact that secured IP assets can have on the growth of their startup. From getting the early stage funding to getting subsequent high-value investments, IP has one of the most important roles to play. It is time that founders realize this and start working on building IP and protecting it to reap its numerous benefits.