How Small and Mid-Market Firms Can Navigate Patent Purgatory

Timothy Kane, the CEO of an industrial heating and ventilation company, worries about it. So does Scott DeFelice, who heads a three-dimensional printing company that makes everything from artificial pieces of the human cranium to satellite parts. Plus, it’s a problem that almost wiped out San Francisco software entrepreneur Jason Bannert.

The issue is patents, and it bedevils CEOs of small and medium-sized companies across the U.S. in a wide variety of industries, even sectors such as heating and ventilation that wouldn’t appear at first glance to be technology-based. Battles between Apple and Samsung Electronics dominate the headlines, but they are just the tip of the proverbial iceberg.

The U.S. patent system was designed to encourage entrepreneurs of all shapes and sizes to innovate by assuring them the opportunity to make money from their inventions for a set period of time. But the system has broken down in many crucial respects. The U.S. Patent and Trademark Office can take up to five years to grant a patent, rendering it useless in the marketplace, or it can grant a patent to a company whose product is not really novel or not very clear, setting the stage for almost certain litigation. Large companies can “borrow” technology from smaller companies and hide behind a wall of expensive litigation for years. And of course, the famous patent trolls, located mostly in East Texas, attack mostly large companies, claiming they violated patents acquired by the highly litigious Texans.

Legislation that might have addressed the patent mess was not able to get through Congress in 2015 and is almost certainly dead until after the November 2016 elections. Big interest groups such as the pharmaceutical industry and the trial lawyers who benefit from litigation helped tie up the bills.

Ironically, the absence of new legislation might actually be good for smaller companies. The intent was to make it harder for trolls to sue companies because they would have to pay all legal costs if they lost a suit.

But the legislation might have made matters worse for smaller companies in bringing action against a large company that stole their technology, because if they failed to prevail in court, they would be responsible for all legal costs. That would have given large companies virtually free rein to exploit smaller companies’ technologies. “A smaller business is more likely to have its technology used without permission by a bigger company than it is to be sued itself for patent infringement” by a troll, says Jonathan Ellenthal, vice chairman and CEO of HaystackIQ, which helps companies search the federal database of patents and similar databases around the world.

Thus, CEOs of smaller companies, many of whom cannot afford in-house legal departments, are caught in the crossfire and find themselves largely on their own in this modern-day version of Dante’s patent hell.

“It takes a tremendous amount of time and money and human resources to go through these fights,” says Kane, whose Goodway Technologies, based in Stamford, Connecticut, has sales of more than $30 million in 125 countries. “That’s part of day-to-day life for anybody who’s involved with patents.”

Goodway holds 35 patents that cover designs or methods it uses to repair heating and air conditioning equipment in factories and it has applied for about 20 more. It is now engaged in a technology dispute with a larger U.S. competitor it declines to identify. “The legal assets that the larger companies have and their familiarity with the nuances of the system all lead to their advantage,” says Kane. “We have to fight for everything we get in the marketplace.”

Without a general counsel on staff, Kane relies on a three-part strategy to fight for his intellectual property (IP). He has long had a patent application attorney who understands how to describe the company’s products, but more recently Goodway added a patent litigator to review the patent applications in the event that they are ever litigated. That builds in another layer of protection.

The third, and most recent, component of his IP protection strategy is the hiring of HaystackIQ, founded by Jay Walker, the inventor of Priceline.com and many other innovations. The firm has access to the U.S. government’s database of existing patents, issued by all companies, and searches them to find technologies that would help Kane sharpen his competitive edge or to help find new uses for Kane’s existing patents at other companies, which might choose to license them.

Add it all up and Kane believes his company has developed a reputation in his industry for vigorously protecting its intellectual property—and reputation really matters to companies either thinking of suing Goodway or stealing one of its ideas. “There has to be a bit of saber-rattling to make sure your competitors are on notice that you will defend your IP,” he says.

In technology fields evolving as rapidly as 3D printing, the uncertainty over patents may prevent small startups from getting funding from angel investors or venture capitalists, says Scott DeFelice, CEO of Oxford Performance Materials, based in South Windsor, Connecticut. With about $10 million in sales, which are growing at a 40% annual clip, DeFelice says his company has 12 patents or patents pending in the U.S., Europe and Japan. About half his sales are outside the U.S.

“There is a sort of headwind against technology start-ups because you have a technology and you go to your investors and try to raise money,” DeFelice says. “You tell your story and the investors start the due diligence. They start talking about intellectual property. You tell them, ‘We have a patent.’ But everyone sort of grimaces. Investors just don’t have the stomach for these fights. At the end of the day, many new technologies are just not protectable.”

DeFelice raised $6 million in funding in 2015 and his sales are growing rapidly, so he believes Oxford Performance Materials is past the point of being a cash-starved startup. But he knows that larger companies are trying to figure out how his company uses a variety of different metals and plastics to make 3D parts for the biomedical industry, such as artificial pieces of a human cranium, as well as lightweight parts for the aerospace and space industries. “We are a test case,” he says. “What happens when a small company has something disruptive to large companies and industries? Can we protect ourselves through the patent law?”

Increasingly, he says, the answer to that question is no. “Patent law is to the benefit of a few large companies but it has become a detriment to many smaller companies,” he asserts. So although Oxford pursues patents as a kind of hedge policy, it concentrates on doing things internally that will prevent the leakage of technology. DeFelice says he structures the company so that only a few people understand its “secret sauce,” using firewalls between different groups of employees. He also uses stock options to retain the loyalty of key players. He figures that one of the biggest threats to his IP would be if a larger company were able to lure away top technical talent. “The lawyers are going to hate to read this,” he says, “but patenting as a way of protecting one’s intellectual property is becoming more irrelevant.” So far, his strategy has worked.

Not everyone has been as successful as Goodway and Oxford, and the results can be devastating for a company and for the overall cause of innovation. Aaron Bannert had been working full-time for six months on a new mobile device application called Smart Ride that tells users what train and bus schedules are in major cities.

He got some of the data from public sources, namely municipalities and cities, and bought a license to get other data from a private company. More than two years ago, he got a letter via FedEx from a lawyer saying he represented an entrepreneur in Vancouver, Canada, who had already developed the piece of software Bannert was using before Bannert had developed it, and that Bannert was in violation of his patent. The lawyer demanded the equivalent of two years of revenue from him. “That was pretty outrageous,” he recalls. “They had no idea how my app worked.”

He ignored the approach at first. “When you have a small business, you get tons of junk mail from people trying to scam you,” Bannert says. But then the lawyer called and demanded payment for a license. At the time, Bannert had only a handful of employees and scant sales. “Even if you take us to court, we don’t have any money,” Bannert recalls telling him. To which the lawyer responded: “All we have to do is punch a button and we can sue you.”

The next thing he knew, he was being sued in the southern district of Florida by a company called ArrivalStar, which had a complicated ownership structure involving Luxembourg and the British Virgin Islands, but also an office in Delray Beach, Florida. “They were coming at me from weird places,” Bannert says. He assumed the Canadian entity was linked to ArrivalStar, which is one of the most litigious firms in the patent arena.

Just responding to the complaint cost $350 to file with the court, but Bannert estimated it would cost $100,000 all in, which would have been just the opening of a protracted legal struggle. “It would have killed the company—I obviously had no choice,” he says. He acquired a license from them for an undisclosed price. Efforts to contact ArrivalStar were not successful.

Even though Bannert obtained a license, the whole experience cost him so much time and money that he is now down to being a one-man company. Efforts to raise venture capital have failed because he does not have clear patents for his applications.

“If you have something you love and believe in, you have to pursue it,” he says. “But there’s always a risk that the 800-pound gorilla is going to come after you. I hate that it kills people’s drive and innovation. That’s a huge hidden cost. I gave up my savings and time to build this thing I believe in.” Software is the most profitable field for trolls, says William J. Watkins, Jr., author of a book entitled Patent Trolls: Predatory Litigation and the Smothering of Innovation. He is a research fellow at The Independent Institute, a libertarian think tank based in Oakland, California.

“Your typical patent term runs for 20 years,” Watkins explains. “That might make sense if you are a big pharmaceutical company spending all these years developing a new drug. If the drug gets past the Food and Drug Administration, it might become the drug for cholesterol or heart disease for 10 or 15 years or more.”

But it’s “ridiculous” that software patents also last 20 years. “It allows the trolls to accumulate these software patents that are frankly worthless in many ways as far as innovation is concerned,” says Watkins. “However, it gives them the opportunity to look at newer patents and try to argue that the older patent was the genesis of the new patent.” That’s what happened to Bannert.

Many people have ideas for how to fix the patent system, but the problem is that each constituency, whether large or small companies, trial lawyers, research universities or venture capitalists, has conflicting interests. No sweeping reform is likely. Which means CEOs of small and medium-sized companies are truly on their own.

The bottom line? Take your patent strategy very seriously because it can make or break your company.

Advice for CEOs in the Patent Trenches

>>Develop a technology roadmap so you know which patents are critical to your company’s long-term strategy. Seek patents for only the most important ones.

>>Whether your patents are written in-house or by outside patent attorneys, verify that they also are reviewed by litigators to make sure they are defensible in court.

>>Pick your fights carefully. Not all patent battles make economic sense.

>>If you get involved in litigation, look for ways to license your technology to the counterparty or, vice versa, buy a license to use theirs. Don’t insist on pushing the case all the way to completion. That consumes too much time and money.

Be proactive. Look for other companies’ patents you might license if that makes more business sense than developing a technology internally. Why invent it if someone else already has?