Bsusiness Lawyers Toronto Barrie

Startup, Venture Capital and Patent Protection


Many startup and established companies are rushing to the U.S. Patent Office (USPTO) to register patents for the startup's main areas of business, especially startups that have software as their main product or that conduct business across the Internet. There are several reasons why there is a recent surge in filing for patents at the USPTO. The most significant reason is that recent changes in case law have removed the prohibition against business methods being patented. Another major reason is the modern process of creating a startup company and the corresponding demands to seek and obtain patents. A further reason is that many of the modern patents procured and patent-related litigation conducted receive significant publicity in media and savvy entrepreneurs are aware of these activities. Accordingly, because of this increasing prominence of patents in the business world, entrepreneurs must be aware of the potential issues affecting both their startup's own patent strategy and the probable strategy of the startup's major competitors.

Reasons for the Patent Office Rush

The increase in patent applications filed and issued is due in large part to a significant increase in patent applications being filed in the electronic and computer arts, and especially for inventions concerning the Internet. The shear weight of the number of issuing patents should alert an entrepreneur that it is likely that someone has obtained a patent that directly affects the business area in which the entrepreneur practices. And logically, the most probable affected area from the surge of patents will be in the software and Internet arena. Many of the reasons for the surge of patents in the software and Internet area are straightforward. One major reason is that a recent change in U.S. case law has allowed the business methodology underlying the software's function to be patented. Another significant reason comes from the shifting economy and the increasing dominance of e-commerce and its associated software and Internet applications. However, other less obvious factors are also motivating the increased patent filings. The venture capital arena is quite savvy to the importance of an intellectual property portfolio. Further, the increasing publicity of recent Internet and software patents and patent-related litigation has heightened awareness of the combative patent arena and has business management clamouring to obtain their patent swords and shields.

Changes in Software Patent Law

The USPTO was traditionally hostile to software being patentable subject matter because of the long-standing principle that software was simply an algorithmic mathematical expression. Thus, as software is simply a glorified mathematical formula, the prohibition against patenting a mathematical formula was used to reject patent applications on software. Moreover, the algorithm itself which the executing software follows is a series of steps in a process that often an individual can perform himself or herself without the use of a computer system. Many of the more recent financial software patents comprise algorithms executing steps for a specific business method which is a simple algorithm that can be practiced without the use of a computer system. There is another traditional prohibition at the USPTO against the patenting of business methods. When applications were previously filed claiming financial software, the USPTO rejected the application not only for being a mathematical expression, but also for being a business method per se.

The main prohibitions against patenting software, especially financial software, were clearly removed by the U.S. Court of Appeals for the Federal Circuit and its 1998 decision of State Street Bank & Trust Co., v. Signature Financial Group, Inc. In State Street, Signature Financial Group obtained a U.S. patent on a system for managing mutual funds whereby mutual funds pool their assets in an investment portfolio that is organized as a partnership. The system represented an advantage as it could better provide an economy of scale in administering investments with the tax advantages of a partnership. Signature sued State Street Bank for infringement of the patent and the Federal District court held that the patent was invalid as it was directed to subject matter that was not protectable because the patent was comprised of a mathematical algorithm and a business method. The Federal Circuit reversed the district court and held that the patent was valid, and that it contained patentable subject matter. The Federal Circuit held that instead of being a mathematical algorithm, the patent was instead claiming a system (or machine) which is programmed with the software to thus produce a tangible and concrete result. In regard to the patent claiming a business method, the Federal Circuit noted that while business methods were generally unpatentable, they were not inherently unpatentableŁ subject matter but rather are subject to other grounds of patentability such as novelty.

In sum, the Federal Circuit in State Street permitted the patenting of software as a system and the business method utilized by the system. In summary, when one takes the holdings of the Federal Circuit in State Street, one can conclude that software can be patented even though it: (1) may be drawn to solely a mathematical algorithm; (2) may be drawn to solely a business method; and (3) may only embrace the steps of a mathematical algorithm or a business method. This decision has subsequently caused many companies to file patent applications not only for software products, but also for the business method of the software itself. And in the e-commerce and Internet arena, many companies are currently filing patents on their method of doing business across the Internet in an attempt to completely secure their business position on the Internet.

Validity of Patents and Interaction with Other Intellectual Property

Another legal reason supporting the increasing investment by companies in procuring patents is that District Courts and the Federal Circuit are increasingly holding patents valid not only in the software and Internet applications but in all areas of technology, and also allowing patents to coexist with other forms of intellectual property. One major purpose of the creation of the Federal Circuit was to make the common law of patents more uniform than the then fragmented jurisdictional case law which existed in the various federal judicial circuits. Before the existence of the Federal Circuit, some jurisdictions were notorious for holding patents invalid or in conflict with other forms of intellectual property protection, but the Federal Circuit has since reversed that trend. The case law of the Federal Circuit has continually favoured the validity of patents and yielded an expansive view of both patentable subject matter and avenues of intellectual property protection. The significance of the increased likelihood that a patent will be held valid in court has two major consequences that a startup should be aware of: (1) it is more likely that a patent will be held valid in litigation, and this disfavours declaratory judgment actions and counterclaims of invalidity, i.e., offensive actions against a patent; and (2) it favours trail-blazingŁ in the filing of patent applications at the USPTO that may be perceived as on the current fringe of perceived patentable subject matter. Moreover, the desire to patent should not supplant the other intellectual property protection avenues for fear of conflict. Startups considering building an intellectual property portfolio with patents thus can feel more confident that the patents are firmer assets which are worth the expense of procurement.

The Increasing Pool of Venture Capital

A very popular business model today is the software or Internet startup company that receives several rounds of venture capital funding with the ultimate goal of launching an initial public offering (IPO). Many startup companies today are formed around a core of patented technology. Consequently, with the very large pool of venture capitalists seeking startup companies in which to invest, the startup are turning to patents to give them an edge in attracting the capital. In formation, a typical startup company formulates a business plan explaining its business model and intended operations. Venture capitalists then examine the business plan and determine if they feel the startup will be a viable company for capital investment. While this typical method of funding a startup has existed for some time, the recent trend has been for the venture capitalists to favour startups that enunciate plans to secure their business position through the patenting of the startup's main technology. Furthermore, the venture capitalists are becoming quite aware of the recent changes in patent law and the high profile patents and litigation. The venture capitalists not only examine the startup to determine what intellectual property assets, such as patents, that the startup has or is pursuing, but also examine the business of the startup to determine how protectable the core technologies of the startup are with patents and other intellectual property protection. It has even reached the point that many venture capitalists simply do not even consider investing in startup companies that do not have a patent application on file at the Patent Office. In response, many entrepreneurs forming the startup companies now immediately pursue patent protection at the beginning of formation of the start-up company. An entrepreneur considering a startup company should accordingly be aware of the importance of intellectual property protection in the creation and operation of a startup. Unfortunately, by the time one might realize that intellectual property protection is important for the startup, it is often too late to effectively establish a secure portfolio (as is discussed below). The expansion of patentable subject matter to include software and business methods only solidifies the fact that a modern business plan necessarily must include an intellectual property protection strategy.

High Profile Patents and Litigation

There have been very high-profile patents issued to companies and infringement suits commenced that have alerted entrepreneurs to the increasing popularity of obtaining patents and using the patent against one's competition. An example of such a high-profile company is Amazon which is both diligent in securing new patents concerning Internet applications and suing its competition to assure market dominance. Amazon has patented its one-clickŁ technology, which allows online customers to purchase an item with just one click of the mouse's button. More recently, Amazon has received a patent on its affiliatesŁ program. In the affiliate program, a first website displays a link to another seller's website, and then the first website operator receives a percentage of sales generated on the seller's website for all sales transactions that occur though referrals from the first website. Because the affiliates patent is very broad and Amazon has a history of enforcing its patents, the Internet industry is closely watching Amazon's activities in regard to the affiliates patent. Amazon has also conducted high profile patent litigation against its competitors. Amazon sued Barnesand Noble for infringement of Amazon's one-clickŁ patent and was successful in enjoining Barnesand Noble from using the technology on its sales website. Although, the lawsuit may have been instigated for revenge as Barnesand Noble launched its site on the very eve of the Amazon initial public offering and at the same time sued Amazon over Amazon's claim that it was the world's largest bookstore. Even so, with the issuance of the new affiliatesŁ patent to Amazon, Barnesand Noble is once again threatened as it has 280,000 affiliate members. Thus, due to its active patent procurement, if Amazon so chooses, it could again sue Barnesand Noble in a new and separate suit for patent infringement and selectively pressure one of its main competitors.

 General Considerations

While many startups have become aware of the need for exploiting patents in their own business activities, they are uncertain as to what areas of their endeavours they can patent and how they can go about making that determination. For some companies that manufacture a product or otherwise operate in an industry where patents have traditionally been obtained, the patent strategy basically concerns enhancing the mechanism by which it already procures patents. For companies that are in nontraditional patent industries or completely new areas of technology, the development of an adequate patent strategy is not as straightforward. There are, however, several beginning points for the non-traditional patent companies to evaluate and construct an effective patent strategy. The first consideration for patenting is the main business method of the startup. The startup must determine in essence what method it practices.

Once that method is determined, the novelty of the method must be evaluated, i.e., is there anything about the method that is unique to that startup. If there is not a central business method that is readily novel, the startup should determine if the central business method is likely to be improved upon and if the forecasted improvements might warrant patenting. The startup should not concern itself with the patentability of the subject matter of the method. If the main business method does not apparently produce any patentable goods or methods, another ground of inquiry for the startup's patent strategy is to examine ancillary goods and services and associated methods which are conducted within the startup's structure for their patentability. These ancillary goods and services may be patentable and could be enticing for competitor companies to license and thus generate revenue.

Furthermore, there are often ancillary products and methods that have been improved upon at the manufacturing or performance level which may be protectable by patent, but the entrepreneurs are unaware of such improvements and do not have a vehicle in place to have employees inform the entrepreneurs of the improvements. Consequently, the employees of a startup who work with the ancillary goods or services would be the best source to consult for determining where any novelty in these ancillary goods or services may lie. The startup may also wish to consider an incentive program to reward its employees for an idea they bring forth that leads to protectable intellectual property for the startup, be it patents or other protection. In conjunction with a patent evaluation, startups should also consider other intellectual property protection vehicles such as product and service names that can be protected through trademark, treating internal processes as trade secrets, and both the licensing and taking licenses of technology.

 Employment Agreements

A startup considering patents should ensure that the employees of the startup and any independent contractors it uses have signed agreements under which the employee or independent contractor assigns their inventions and other produced intellectual property to the startup. Without a valid written agreement, the title and rights in the intellectual property can be clouded and, even worse, can remain with an independent contractor to leave the startup without any ownership interests. Thus, a central part to building and maintaining an intellectual property portfolio is implementing or improving upon employment agreements and independent contractor agreements regularly utilized by the startup.

 Beware of Competitors and Your Own Activities

An excellent barometer for the evaluation of the benefits of patents in a specific industry is to search the patent records for patents issued to competitors. From the patent search, a startup can discern what its competitors are doing in regard to the frequency of filings and technical areas of patents, and then derive its own patent strategy. Thus, if a competitor has many patents in a startup's technical area, that startup is well advised to either obtain patents that can be used for defensive purposes (an infringement counter threat), change the process or products that might be infringing, or actively seek a license from the competitor. Moreover, if a startup determines that there are no competitors with patents in the startup's technical area and there are few patents generally in that technical area, the startup should consider an active patent prosecution strategy in that area. Therefore, a search of competitors' patents is an excellent place to begin the formulation of the direction of a startup's patent strategy.

A startup (and all inventors) must note that under U.S. and Canadian laws, several activities in regard to the subject matter of an invention can bar the filing of a patent application for that invention. In the U.S., activities such as publicly disclosing or selling an invention more that one year prior to filing an application for patent on the invention can bar patent protection. Further, if it is desired to file the patent in foreign countries, some countries have very strict laws that hold any pre-patent filing sale or public disclosure of the invention can bar a patent. An advisable first step in beginning to actively manage an intellectual property portfolio, much less beginning an invention evaluation process, is, therefore, to make sure that appropriate confidentiality about the products and services is maintained and sales of the potentially inventive goods and services are monitored. Further, as many types of activities of the startup have adverse effects on the various forms of intellectual property protection, the startup should therefore have the individuals in charge of the intellectual property strategy become familiar with the harmful activities that have adverse consequences to the startup's intellectual property.