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How Patent Trolls Scare Off Your Best Investors

A new study from MIT proves that fear of litigation by patent trolls can scare off your most important investors.
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Not only are patent trolls bad for your business, it turns out they can scare away your most important investors--venture capitalists.

A study from MIT's Sloan School, published in May and first reported on by Arstechnica, shows that increased patent litigation in recent years has led to dramatically lower venture capital investment. And it also gives teeth to arguments favoring changes to patent regulations, and higher penalties for patent trolls.

"We find that VC investment, a major funding source for entrepreneurial activity, initially increases with the number of litigated patents, but that there is a 'tipping point' where further increases in the number of patents litigated are associated with decreased VC investment," Catherine E. Tucker, a professor of management science at MIT Sloan, writes in the study.

Tucker explains that lower levels of patent litigation actually inspire confidence in a well-functioning patent system that protects innovation. Higher levels of litigation scare off investors, who don't want their portfolio companies embroiled in suits.

Patent trolls, sometimes referred to as non-practicing entities, are shell corporations that buy up rights to soon-to-expire or questionable patents and then sue small business owners for infringement, with no other goal than to collect a quick settlement from a small business owner who wants to avoid protracted and expensive court battles.

The study, which examined microdata like legal and settlement fees, found between $4 billion and $19 billion in direct costs to businesses associated with patent litigation between 2004 and 2012. More troubling still, it found venture capital investment might have been $8 billion higher over the same time period, except for the litigation brought by frequent litigators. It also found VC investment would have been $109 million higher over the same period, except for infrequent litigators. 

The distinction is important because some non-practicing entities, or individuals lumped into the troll camp, actually have legitimate patent claims, and presumably they'd be suing less. By contrast, the frequent litigators, who are most likely to be trolls, appear to create the most economic damage.

Tucker illustrates the venture capital disconnect with an anecdote about Union Square Ventures co-founder Brad Burnham, who was forced to reduce the size of his portfolio after one of his companies was slammed with two successive patent suits. (This is perhaps a reference to Etsy.)

So far, 2014 has been a win some, lose some year in the fight against patent trolls.

The Supreme Court recently ruled in favor or patent reform that will make it easier for you to collect costs in the event of frivolous litigation. But the Senate also punted on patent litigation reform in May, setting back business owners who had hoped for new statutes from Congress in their fight against trolls.

The number of patent suits doubled to 5,000 between 2004 and 2012, the study says, affecting nearly 13,000 defendants in 2012 alone, according to the study. 

 

 

IMAGE: Getty Images
Last updated: Jun 12, 2014

JEREMY QUITTNER | Staff Writer | Staff Writer, Inc. and Inc.com

Jeremy Quittner is a staff writer for Inc. magazine and Inc.com. He previously covered technology for American Banker and entrepreneurship for BusinessWeek.




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