Is a patent troll watching your business now?

By Ray Felts and David DiGiammarino

You’re a venture capitalist. You just invested in a promising startup,  e-Widgets. The future looks bright. Suddenly, out of nowhere, e-Widgets gets a  certified letter in the mail. The letter claims that the company’s flagship  software is infringing on an existing patent. Instead of focusing on innovation  that e-Widgets can bring to market, the company suddenly gets sidetracked into a  legal battle that could ultimately destroy its business.

This is not an uncommon scenario.

Patent trolls, a common term for non-practicing entities (NPEs), are shell  companies that do not design, manufacture or distribute products. Rather, their  sole purpose is to acquire and license patents to unsuspecting businesses. Last  year, NPE litigation cost tech companies $29 billion, up more than 400 percent from  2005.

The “Small Change” Hold-Up Strategy

The majority of NPE litigation consists of “nuisance suits” that target  smaller companies for hundreds of thousands of dollars. NPEs take advantage of  the fact that most venture-backed companies don’t have the resources of big  corporate players, which often include a first-class legal team.

As a result, the venture-backed company is subject to something of an  old-fashioned hold up.  Here’s how it works. The patent troll threatens to  sue for significant royalties. The financial threat, business distraction and  cost of defending the company disposes the startup to a lower settlement. Faced  with possible ruin, the venture-backed company agrees to a tidy settlement of  $20,000. If they instead choose to engage in a legal battle, the settlement  threshold goes up, forcing them back to the initially intended amount. In the  end, the startup takes the path of least resistance, and the NPE makes it up on  volume.

This is how the patent trolls build their war chests to go after bigger fish.  For example Lodsys, a well-known patent troll, has settled with about 150 iOS developers so far. Startups, meanwhile, are frustrated  that instead of spending $20K to grow their business, they have to pay off a  patent troll.

New Developments to Help Small Businesses

Rather than cooperating with the scheme, entrepreneurs can invest in  solutions that derail patent trolls. When they do, they stop the “innovation  tax” in its tracks. NPEs like the path of least resistance, so companies that  earn a reputation as easy targets may be harvested repeatedly. On the other  hand, companies that earn a reputation for shielding themselves against NPEs  deter further attacks.

A small but growing body of resources is empowering smaller businesses to  fend off NPEs. One such resource involves new ways of finding prior art,  evidence that the patented idea existed prior to the patent application date.  The process of finding prior art can take months (and lots of money) due to the  amount and complexity of information available. The traditional solution to the  prior art problem is to hire a specialist to do the search, but most VCs can’t  afford the time or financial investment. New solutions can be found in  crowdsourcing prior art research, tapping into multilingual experts whose  collective experience and diversity of knowledge makes them efficient  identifiers of prior art across languages and industries.

In addition, venture-backed companies can now access a number of resources  dedicated to helping them defend themselves from litigation. The Electronic  Frontier Foundation (EFF), for one, offers an excellent knowledge base and  resources at UC Berkeley has developed the Defensive Patent License (DPL), in which inventors share  their intellectual property without worrying about being sued, and agreeing not  to sue other members.

In the private sector, patent enforcement insurance is another tool that  small businesses are increasingly considering in their fight against patent trolls.

When Will Venture-Backed Companies Stop Hiding?

Small businesses are the lifeblood of America’s economy. When innovators are  forced to divert resources from productive to unproductive uses, their very  existence is threatened and the implications are broad. It’s crucial for  venture-backed companies to understand and prepare for the growing threat of  NPEs.

[This post originally appeared at: VentureBeat]

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