Aqua Licensing is a four-year-old patent advisory and transaction firm that typically works behind the scenes, helping companies sell their patents for a variety of reasons. But it has a new proposal for venture-backed startups that are in fundraising mode: it wants them to give big tech companies like AT&T and Lenovo some of their equity in exchange for patents that the companies no longer use but could prove useful for the startups.
Put another way, it wants to create a two-sided marketplace that helps big corporations find stakes in more startups, while also pushing startups to think from an early age about their patent strategy.
The initiative makes some degree of sense. As companies mature, they often need to think more about patents as a way to protect their business. (If a company has a patent on a product or service or idea, that’s one less patent an outsider can acquire to assert against it.)
Of course, it’s also easy to imagine the many obstacles to it working, starting with startups’ priorities. “This relies on startups thinking proactively in the early stages about a need for patents,” notes Greg Gretsch, a longtime venture capitalist and a co-founder of Jackson Square Ventures in San Francisco. “In my experience, that’s generally not top of mind for founders, and if you told them it would cost them equity, they’d probably be even less interested in engaging.”
Late last week, we talked with Aqua founder Mark McMillan to learn more about how he sees this working, and why he thinks Aqua can overcome some of these challenges. Our chat has been edited for length.
TC: You’re trying to match startups with patents or defensive patents, saying it will help them protect their innovations, as well as help them scale. What was the impetus for the idea?
MM: We were working with a major client last year and a discussion came up around the challenges of selling IP assets into startups. The startups don’t have a lot of cash to buy them, and VCs don’t necessarily want them doing strategic transactions that are ancillary. Meanwhile, the patent market is growing and people — companies — find themselves with assets that may be depreciating in value and costing them maintenance fees.
TC: What are some of the big companies that you’ve signed up to this exchange program?
MM: We’re announcing Lenovo, Rambus and AT&T today, but we have a large collection of participants that are prepared to sell to the right startup at the right price.
TC: How does this process work?
MM: Startups will submit their investment plan to us, just like they would to VCs. We have analytics capabilities that will help them find appropriate assets.
TC: Given these are young companies, how can you really know what patents make the most sense for them?
MM: We start by assuming a company has started working on its own unique patents, and get a read on the competitors it’ll be disrupting. If we can find patents that likely read on these competitors, the startup’s business plan then goes to the participating member (with the relevant patents). If that member is interested in the startup and would like to sell its patent in exchange for equity, the member then values its patents and lists a price that the startup can accept or reject.
A final closing condition has to be the closure of a qualified venture funding round and [the big tech company’s] commitment to invest the proceeds of [that patent sale] into that round. It also has to give the startup at least 90 days to complete the funding round. After that, the [big tech company] gets the same terms as the VCs in the round and becomes a minor syndicate player, and the startup gets full ownership rights to the IP assets.
TC: Some startups may scoff at the idea of giving a big tech company so much information about their business, when they don’t know at the outset that they’ll want its patents.
MM: Some have asked for NDAs already. We can tell them who we’ve matched to them before we send off their business plan.
TC: And if the startup doesn’t want to do a deal anyway, because maybe the price isn’t right? Do they then need to worry about those patents being used against them in some way?
MM: The patents in the pool are for sale. The companies aren’t looking to assert these assets. If they don’t accept the offer, nothing happens.
TC: How do the companies establish how much their patents are worth?
MM: They have internal methodologies. They also look at what other assets have been [fetching] in the market.
TC: How are you paid?
MM: We receive a transaction fee from the seller of the asset based on the value of the asset.
TC: How many patents are available to you right now?
MM: 60,000 as of today; we have two other big companies coming online that we haven’t announced that will [bolster that amount].
TC: Other than through press stories like this one, how do you plan to get startups into this marketplace? Who’s going to help you convince them they should do this?
MM: We definitely have to educate startups that this is available to them. We’ve spoken to many VCs and CEOs and investment banks and private equity funds, and there’s a general sense that a strong patent portfolio adds value to a startup. We see these patents as immediately accretive, too. It gives them defensive insurance and probably increases the value of their business as they are raising venture funding.
TC: How much ownership of the startups are these big companies expecting to get in exchange for their patents?
MM: It will be a fairly small level of participation. It depends in part on the company’s age. We’re looking to participate in venture-structured rounds — so we’re not talking about seed-stage companies but rather companies that are assembling A and B and C and D rounds. Most of the [big tech companies] want to cap their participation at 5 to 10 percent of any round, and it could be less, depending on the asset.
TC: You mentioned that some patents are depreciating in value. Is there a larger trend at play here?
MM: Patent [values] are down. There are a lot of assets out there. There’s some decent value out there for acquiring IP, but patent reform [is having an impact on] non-practicing entities [also known as patent trolls], who are less active right now.
Large companies are looking for operating companies to place their patents versus [selling them] to non-practicing entities. It’s a much safer place to divest their assets.
TC: I’m guessing this isn’t the first attempt to create this kind of marketplace.
MM: There have been other attempts at creating defensive patent pools, but they’ve involved giving up rights to check a book out of a library instead of own it, whereas this is a patent sale for equity.
This is new, this takes scale. We’re going to try to break down barriers to make this ecosystem work.