Future Tense

How Patent Trolls Are Crippling Startups

Federal Trade Commission Chairwoman Edith Ramirez speaks about patent trolls and anti-trust issues.

Photo by SAUL LOEB/AFP/Getty Images

Patents were in the headlines again last week, as Google and Microsoft headed back to court in an ongoing dispute over patents related to the technology and design of smartphones.

It’s yet another battle in the “smartphone wars” between tech giants such as Google, Microsoft, Apple, and Samsung. Earlier this month, the president intervened in a patent dispute between Apple and Samsung by nullifying an International Trade Commission decision to prohibit the importation into the U.S. of older models of the iPhone and iPad after it determined that Apple was in violation of several Samsung patents.

For Apple, Google, and other tech giants, patent disputes cost millions that could otherwise be spent on research and development of new products. The cases can even force companies to redesign technologies to potentially avoid infringement.

But for startups and entrepreneurs just trying to get a business or idea off the ground, a patent dispute can be devastating.

The enforcement of patent rights—known as “patent assertion”—has ballooned in recent years. As a GAO report found earlier this month, between 2007 to 2011 “the number of overall defendants in patent infringement lawsuits increased by about 129 percent.” Additionally, about “89 percent of the increase in defendants over this period” was a result of lawsuits involving software-related patents.

Many of these suits involve patent “trolls,” also known as non-practicing entities—companies or holding companies with a portfolio of patents. NPEs are rarely the original inventor on a patent and often purchase patents from existing companies or companies that no longer exist. They don’t sell products or services—instead, they make most of their money through licensing or enforcing those patents. The GAO report estimated that NPEs “brought about a fifth of all [patent] lawsuits” between 2007 and 2011.  Another study found that “over 5,000 firms were named as defendants in patent troll lawsuits in 2011, costing them over $29 billion out-of-pocket.”

Last week, my organization, the New America Foundation’s Open Technology Institute, released a report authored by Professor Colleen Chien, an associate professor at Santa Clara Law. Chien examined the experiences of startups with the patent system. In a survey of venture capital investors with patent experience (mostly from the biotech, pharmaceutical, and IT/software sectors), 75 percent said that an NPE had made a demand on their portfolio. For tech-focused VCs, that number reached 90 percent.

More concerning: Nearly half of VCs responded that a patent assertion against a portfolio company led to one or more significant operational impacts, 24 percent said it resulted in a delay in hiring, and 12 percent said it prompted them to exit their current line of business or go out of business altogether.

Many startups simply do not have the financial resources to deal with a lengthy legal battle. When faced with a patent problem, they often decide to settle quickly, rather than risk losing in court or going bankrupt in the process—even in cases where the patent assertion is weak and could ultimately result in a favorable ruling by a court.

As an intellectual property manager said in the report: “[N]ot only did we spend $3 million in fees waiting around for a [decision], but when it finally arrived it was clear the plaintiff had no case and the whole exercise was a waste. The plaintiff immediately stipulated to non-infringement.”

Startups are also at a disadvantage to larger companies in enforcing their own patents. As one VC survey respondent noted, “[s]mall companies who file a small number of patents are still outgunned by the bigger corps who can file (or buy/license) more patents and have deeper pockets with which to fight battles.”

Sometimes startups find that their best (or only) option may be when dealing with a patent dispute may be cutting a deal with an equally ruthless and well-resourced patent troll. These opportunistic firms will agree to take on all the legal fees and defense of a startup, in exchange for a significant financial stake in the fledgling company.    

The challenges startups face with NPEs and in the patent system more broadly should be of significant concern to policymakers. Startups that survive grow more rapidly and add more jobs than more mature companies, which could be vital to the nation’s future economy. The most recent jobs report indicates that job growth has stalled, and most of the decline in unemployment is largely attributed to people dropping out of the workforce rather than a net increase in employment. According to one estimate, at current growth rates, the jobs gap may close sometime in 2023.

But Congress may finally offer startups a lifeline. Several bills have been introduced already. They include policies such as fee shifting to require NPEs to cover the legal fees of a defendant when they lose in court or broader fixes such as improving patent quality to limit overly broad software patents that are often at the core of patent disputes in the tech world. The Obama administration has also pledged to take several steps to increase transparency at the Patent and Trademark Office and provide education and outreach materials to the public on common questions for those receiving a patent demand letter.

It will take all of these efforts to help startups. Patents are awarded by the government under the justification that they reward inventors for their work and encourage innovation. And now more than ever the U.S. economy needs new inventors and innovators. But increasingly, patents and the patent system are being used to do the very opposite. Fixing these problems is not just important to providing a level playing field for startups and new entrepreneurs, but to also encourage future innovation in the United States.