By Dan Vo
One challenge faced by many entrepreneurs is to convince the investors, mostly angels and venture capitalists, that their startup is investment worthy. A lack of track record obviously does not help. So, it is often the case that when it is time to attract external investors, entrepreneurs look for possible ways to signal their quality. Patents are one popular signal that founders pursue.
In fact, many founders who I have interviewed in the past several years of teaching entrepreneurship and working with startups strongly believe that patents play a crucial role in attracting financing from angels and VCs. This is especially more prevalent among first-time founders.
There are good reasons for entrepreneurs to believe that patents are a convincing signal. First, patents are certifications of novel and useful inventions that have been reviewed by trained, qualified patent officers. Second, getting patents is very costly, both in terms of money and time. The average out-of-pocket cost of a patent is more than $38,000, according to a study by Clarisa Long published in the University of Chicago Law Review, and the United States Patent and Trademark Office puts the average time to acquire a patent at almost two years,. The ongoing cost to protect a patent from possible infringements can be much higher.
So it seems like getting a patent does put you in a select group. Indeed, getting a patent is, in many ways, similar to getting a degree from top-tier universities. They are both certificates of achievement, very exclusive and utterly expensive.
In my research on angel investment, which was published last year in the “Journal of Small Business Management,” I found that patents do not improve a startup’s chance of getting angel investment. It could be that they are more concerned about commitment, team and market than patents. Or it could be because these individual investors do not have sufficient resources to validate the quality of a patent. But, in such case, I would argue that they rely even more heavily on just the mere existence of a patent.
Evidence on patents and VC investment is not robust. Several studies, mine included, found a positive link between patents and VC investments. However, this positive connection seems to be spurious. Other unobservable attributes that a startup may have could generate this falsely positive link between patents and VC investments. For instance, ventures with patents only seek for, and get matched with, early-stage financiers (VCs in this case) who have the financial capacity to support their patent protection strategies. One way to resolve this spurious connection is to account for a startup’s attributes fully, which is a luxury in all these studies.
So, do patents improve your chance of getting external financing? Existing evidence suggests that they do not. From the investor’s point of view, patents are a nice-to-have and are not a must-have. Brad Feld and Jason Mendelson of Foundry Venture said it best: “If you think you are winning us over by relying on your patent portfolio, you aren’t.” And it is important for entrepreneurs to also realize that.
Valuable resources, especially for resource-constraint startups, should not be wasted on getting expensive patents that do not matter. Instead, they should be spent on building things that do matter. A solid team and a validated, sizable, robust market are just a couple of starting points.
• Dan Vo is an assistant professor of entrepreneurship and finance at California Lutheran University.