Thought leadership from our experts

Getting Your Patent House in Order: Strategic Preparation for a Financing Due Diligence

, Cooley, US

Introduction

You've got a great product. You've got a great team. You're in a great market. Now how are you going to succeed? That is the question potential investors will ask before deciding whether to invest in your company. They will want to understand the likelihood of your success and the factors that could result in your failure.

Although risk associated with your patent position is just one of the many factors that will influence their decision, it is often given significant weight. This is especially true in the life sciences industry, where a thoughtful patent strategy can impart significant company value. During a patent due diligence, potential investors will evaluate the strength of your patent position. Having a poor position can harm your company significantly–it can prevent your company from getting financed, result in a lower valuation, or provide an investor with leverage to demand undesirable terms.

With a basic understanding of what investors look for during a patent due diligence, a company can begin laying the foundation for a thoughtful patent strategy. At the outset, it is important to note that not all patent due diligence reviews are the same. Different deal structures and different deal sizes may lead investors to focus on different factors and risks. However, a few broad areas of potential concern are normally investigated: (1) the strength of your patent position; (2) infringement risks; and (3) patent ownership issues.

Strength of Your Patent Position

Patents provide their owner with an exclusionary right, which is a right to prevent others from practicing the invention embodied by the patented claims. In this way, patents can create real barriers to entry for your competition. Thus, investors often investigate the strength of a company's patent position during a due diligence review. They want to make sure you have patents that cover your commercial products, that your patent claims are not easy to design around, and that you have a period of exclusivity on your product.

While these may sound like simple and straight forward questions, the number of times companies have been adversely affected by failing to consider these questions is staggering. I have seen numerous instances where financings fell through because of a poor exclusivity position or stale patent coverage (i.e., where the patents were set to expire shortly after the company was going to start selling their product). Consider the case of a pharmaceutical company where each day of exclusivity can result in millions of dollars in revenue. Having patents that are easily invalidated or having patents that will expire shortly after market entry will obviously be less attractive to a potential investor.

A company must devote sufficient resources to developing a sound and comprehensive patent strategy. At a minimum, your patent portfolio should cover your product, help create real barriers to entry, and provide offensive ammunition against your competitors. It is also important to realize that patent strategy is fluid. Often, products evolve over time as problems are encountered and solved through the research and development process. The company's commercial product may look nothing like their first generation product. For this reason, it is important to communicate all product changes, and the reasons for those changes, to your patent attorney.

Freedom to Operate

Many people erroneously believe that owning a patent on a product means that you can sell that product without fear of being sued for patent infringement. As noted above, a patent provides an exclusionary right, i.e., a right to prevent others from practicing the invention embodied by the patented claims. It does not provide its owner with the right to practice the claimed invention. For example, if you have a patent on a system and someone else holds a patent on a component or feature of your system (e.g., you have a patent on a bicycle, and someone else has a patent on a wheel), then you may have an infringement problem when you sell your system. Similarly, if you have a patent on a particular species and someone has a patent on the genus (e.g., you have a patent on a specific compound, and someone else holds a patent on a group of compounds that includes your compound), then you may have an infringement problem when you sell your particular species.

Typically during a due diligence process, extensive searches will be performed to identify patents that your company may infringe. In order to be prepared for this process, you should already have a good understanding of the competitive landscape and know whether any potentially problematic patents exist. Performing searches will not only help you appear savvy to your potential investors, but it will also provide you with enough time to help address potential infringement risks, by putting together non-infringement or invalidity positions, by seeking licenses or assignments, etc. Having an understanding of the patent landscape will also help you better understand the prior art and how to differentiate your own patent filings. Involving your patent attorney in this process is imperative in order to maximize the protection afforded by the attorney-client privilege, and mitigate risks of willful infringement.

Patent Ownership

The last broad topic typically investigated in a patent due diligence is ownership. Investors will want to make sure that your company owns all rights to its patent portfolio and that none of the company's inventors have an obligation to assign to another entity. They will review your employee invention and assignment agreements, they will review your consulting agreements, and they will ask questions about joint development.

One issue that often arises in this context is co-ownership resulting out of joint invention. In the U.S., ownership initially vests with the inventors. Until the inventors transfer their ownership interest to another entity through a written assignment, the inventors own the patents on which they are named. Normally, inventors are employees of a company and as consideration for their employment have agreed to assign their rights in any invention to their employer. As a best practice, companies should have their employees sign agreements with present assignment language (e.g., "I hereby assign") before they begin work.

One issue that may complicate questions of inventorship and ownership arises when a company engages in discussions with a consultant, scientific advisor, doctor, or other expert to understand what works, what doesn't work, and how the product can be made better. In this context, ideas may be discussed, improvements may be suggested, and inventing may occur. If the invention of a consultant is later claimed in a patent application, the consultant will need to be named as an inventor on the patent application and will have ownership rights. If the consultant is not under an obligation to assign his or her rights in the invention to the company, the consultant may do whatever he or she desires with the patent application, without your knowledge or approval, including licensing the patent application to a direct competitor.

The best way to protect the company against ownership issues is to talk to your patent attorney before you collaborate with others on your technology. Tell them who you will be working with and why. In this way, your attorney can help make sure that proper agreements are in place before you begin any discussions, and counsel you on how to minimize the risk of co-invention.

Conclusion

Investors will dig deep into your patent strategy during a patent due diligence. They will identify potential risks and weaknesses and will want to understand your strategy for mitigating them. Preparing for the patent due diligence process will not only demonstrate a level of sophistication and commitment with respect to your patent strategy, but it will also help you avoid potential pitfalls.