Counter-Measures – How Startups Can Fight Pirates Without Burning Cash

By Michael A. Nicolas

It’s never been easier for innovative companies to raise the funding they need to spur growth, invest in research and development, and build a revenue pipeline. Typically, early funding rounds also include the relatively minor costs of protecting the company’s proprietary technology by securing patents.

But patents alone don’t stop pirates. Bad actors know that patents are worth little unless the patent owner is prepared to enforce them.

And that’s often a problem for growth companies trying to fund operations with finite cash. Litigation to prosecute patent violations is expensive and time consuming. It can take months or even years – during which sales are likely plummeting and margins compressing as a competitor seizes market share by selling knockoff products at cut-rate prices.

I’ve seen this scenario nearly break businesses – and not just startups. Even relatively established technology companies can be dragged under by piracy’s cross-currents.

I’ve worked with a number of growing companies that have had their intellectual property stolen at trade fairs, or by subcontractors during the manufacturing process.

In both scenarios, the costs associated with enforcing the company’s intellectual property rights could have been crippling to the company’s long-term growth strategy, draining funds necessary for critical operations and development initiatives.

Michael Phillips, a pioneer in voice recognition software, offers an instructive example. He thought his company was set to take off when his inventions were integrated into Apple’s voice-activated assistant Siri. Then another company contacted him and challenged his right to the patents. He won the lawsuit, but spent $3 million on the legal battle and ended up selling his company.

“We were on the brink of changing the world before we got stuck in this legal muck,” he told the New York Times.

The cost of IP litigation — often coming at the exact moment when startup funding is exhausted and before other revenue streams open — is almost never built into the startup business model, especially for growth-stage companies.

Entrepreneurs trying to pitch a lean investment opportunity can’t tack on a few million dollars for potential legal costs down the road. So they simply must plow ahead with development and, eventually, sales, knowing that pirates await.

When their intellectual property is stolen, traditional options are grim: they can sell assets to cover legal costs or gear up for a long legal fight and hope their product remains relevant when the dust settles.

This all may change after enough startups are stifled by patent litigation, but until investors agree to bake in these costs, there is another option. Litigation financing is often viewed as a narrow funding option used exclusively for lawsuits. But it can be applied more broadly.

If a company has a strong legal claim, and has armed itself with solid intellectual property protections, there is every incentive on the investor’s side to advance funds to pay for operations and propel the business forward while the legal process plays out.

While the primary focus of most litigation finance companies is to pay the attorneys’ fees and expenses associated with enforcing a company’s intellectual property rights, litigation finance can also provide a lifeline for startups to grow operations – hiring staff, expanding production or developing new products – as legal proceedings play out. It can act as bridge funding after startup capital runs out, but without many of the risks that come with typical startup investors. It is a non-recourse investment in the success of the company’s legal claims.

In most instances, the litigation finance company receives a percentage of the proceeds from a successful enforcement campaign.  However, if the campaign is unsuccessful, the company owes the financier nothing.  There is also flexibility to use financing for proceedings in the United States Patent and Trademark Office or the International Trade Commission, where perhaps injunctive, rather than monetary, relief is being pursued.  Indeed, the flexibility to take on patent thieves in various legal venues is immensely important in the global tech race.

Getting outflanked in Asia or Europe can cost a company millions in lost revenue and profit. Companies with sophisticated IP protection strategies will be prepared to wage a worldwide defense of their technology; obtaining global exclusion orders protecting their patents can be just as valuable as winning a multimillion dollar lawsuit in US courts. Savvy companies can now do both.

One of our clients employed precisely this strategy to block the importation of infringing products manufactured overseas, while at the same time obtaining valuable licenses from its foreign competitors.  We believe the strategy was extremely successful, and allowed our client to enforce its intellectual property rights while simultaneously scaling its business. Litigation that once looked like it might wipe them out turned into an opportunity to achieve the profitability they set out for in the first place.

Mike Nicolas

Michael A. Nicolas is a Co-Founder and Managing Director of Longford Capital, responsible for Longford’s portfolio management, including underwriting, investment selection, and overseeing the due diligence process. He has more than 15 years of experience representing a wide array of corporate clients involved in complex litigation throughout the United States.