Questions and Answers regarding Licensing Technology

LicensingQuestion:  I filed for patent protection. Should I still have potential Licensees sign a secrecy agreement?
Answer:  Secrecy Agreements can get in the way of licensing discussions. Many companies you approach will not sign secrecy agreements.  In fact, large companies often require you to sign an agreement confirming that they are not bound by secrecy.   If discussions are going well, do not hesitate to reveal more information. Bear in mind that a patent application is not “made public” until 18 months after its filing date. The company you are negotiating with can only see such information as you choose to share with them.  If you feel that they are just pumping you for information, do not share more information until they show their good faith by placing a serious proposal before you. These types of proposals are called Letters of Intent, they contain a financial proposal that is subject to receiving and reviewing further information.

Question:  What should I ask for?

Answer:   Generally it is best to capture the company’s interest and then invite them to make the first proposal.   There are a number of reasons for this.  A first reason is that you may undervalue the technology, whereas if you let them make the first proposal you generally will get more.  A second reason is that you may overvalue the technology.  If the company feels you have unrealistic expectations, the company may break off negotiations. A third reason is that every industry has “industry norms”, for example 5% is a typical royalty in some industries.  A fourth reason is that many companies have a “history” of past dealings that they are influenced by (i.e., “this is how we generally structure our licensing deals”).  If you can get a company to make any form of proposal at all, there is potentially a deal to be made.  The greatest problem in licensing is facing the enormous inertia in every industry.  Unless a prospective licensee is actively looking for a better way of doing things, it can be difficult to get their attention if what the industry has been doing for years is still “working” just fine.  An industry executive can lose his or her position spending money on a solution when there was no generally understood problem.

Question:  What should I expect to see in the proposals received from companies?

Answer:  It is unlikely that you will be offered a single large lump sum payment.    Instead you are likely to receive an offer that includes an initial payment of $10,000 to $50,000 and a royalty percentage of sales.  The reason for this is that an executive who pays a huge lump sum on a technology that does not work out is placing his or her career in jeopardy.   If the technology proves itself over time, a buyout offer may come down the road.

Question:  How do I know if the proposal is reasonable?

Answer:   There are “rules of thumb” that are applied to gauge whether a proposal makes sense.  One such rule is the “rule of 25”.   The rule of 25 is sometimes criticized as not taking into account all factors.  This is true, but it works for many situations.   Under the Rule of 25, the labour and materials required to manufacture a product are deducted from a wholesale price for the product to arrive at a gross profit figure.  This gross profit figure intentionally does not include overhead, advertising or administrative costs.   According to the Rule of 25, the company is taking all of the risks and should be entitled to 75% of the gross profit.  You receive 25% of the gross profit for bringing this opportunity to them and providing patent protection to protect their market.  However, the final royalty percentage is never set out in a license agreement as 25% of percent of gross profit. Instead the royalty is converted to a percentage of the wholesale invoice price.  The reason for this is that you need a number that can easily by audited by an inspection of customer invoices.

We stated above that the Rule of 25 does not take into account all factors.  For example, the Rule of 25 does not take into account additional costs that may be incurred in preparing to manufacture a new product.  This can easily be accommodated through a “step royalty”.   A step royalty is a royalty that steps up or down, depending upon the circumstances.  To accommodate the costs incurred in preparing to manufacture, you may agree to take a lower royalty until those costs are recovered and then your royalty will “step up” to a higher level.  Step royalties are used in a variety of situations.  For example, to get volumes up, royalties sometimes “step down” with volume.  In such a situation there may be a royalty of 7 % on the first 50,000 units sold each year, a royalty of 5% on the next 50,000 sold each year and a royalty of 4% on all units over 100,000 sold each year.

Question: Is there any rule of thumb for assessing a lump sum offer?

Answer:  Accounting firms can make projections to determine the amount of royalties expected to be generated over the life of a patent. The accounting firms can then give you a “current value assessment” so that you have a calculation of what lump sum is appropriate as a replacement for the royalty.  This works well when you have been receiving royalties for a number of years.   When the product has not even been on the market and has no sales history, the number is essentially a creative fiction, even working from the best information available.  Even when royalties have been paid for a number of years, the accounting firm must make some assumptions regarding changes to product price due to cost of living and growth of market share that may turn out to be false.  When you have a large lump sum offer presented to you, consider what the alternatives are and how receiving the funds will affect your life.

One client of mine received a 10 million dollar offer and turned it down.  The reason was that he was perfectly happy with the quarterly royalties he was receiving and it did not take an accountant to see that he would be making well over 10 million dollars over the next 5 years by simply keeping his existing royalty stream.  Another client of mine received a 2 million dollar offer and accepted it.  There were no sales.  He could not afford to put the product on the market himself.  If the 2 million dollar offer was withdrawn he had no viable alternative.  He had a wife, two young children, a mortgage and debts incurred in developing the technology.  Receiving the 2 million dollars now would have a major positive impact on his life.

Question:  What should I look out for in any proposal?

Answer:  It is a mistake to focus just on the financial details of the offer.  One should look carefully at what obligations are being imposed back upon you.   Those obligations could cost you more than you will receive.  Who has to pay the expenses associated with completing and maintaining patents in Canada and the United States? If the company wants foreign patent protection, who has to pay the expenses associated with completing and maintaining the foreign patents?  Who has to pay the expenses associated with enforcing the patent against infringers?
If you have granted an “exclusive” license (which often is the case), you need minimum performance requirements to ensure that your technology is not shelved.

On a human level, you and your technology need a “champion” within the company.  Someone you feel is committed to the technology and will drive the implementation of the technology within the company.   Preferably, someone you can relate to.

Infringement Insurance

Abatement InsuranceAmericans are reputed to be more litigious than the people of other nations, including Canada.  A number of our firm’s clients have been involved in legal actions in the United States.  These legal actions generally occurred when our client had commercial success, or was on the verge of having success, in the United States.   In some of the lawsuits, our client was the defendant, that is, our client was being sued for patent infringement.  For example, a client with a natural gas control product was taking substantial business away from a major company in the field.  The major company sued the client asserting infringement of a group of patents, including a claim for “convoyed” sales.   “Convoyed” sales are sales of non-patented products (wire, tubing, etc.)  sold along with infringing products, the thinking being that such convoyed sales would not have occurred except for the infringement.   In other lawsuits, our client was the plaintiff, that is, our client was suing for patent infringement.   For example, a client in the field of   non-destructive testing had patented technology for checking for gas leaks that used a non-toxic vapour that carried a dye.   When the client starting taking substantial business away from the industry leader in gas leak detection technology, the industry leader copied the technology to avoid a further erosion of its market share.  This forced our client to bring legal proceedings in the United States to enforce its patent rights.    Our client spent well over a million dollars in legal fees before finally achieving success in the litigation.  However, in order to avoid a repetition of such an expense, the non-destructive testing client subsequently purchased a policy of infringement insurance.  There are two types of infringement insurance, defensive policies to protect you when you are sued and abatement policies to protect you when your intellectual property rights are infringed.  The cost of the policies depends upon industry sector, gross revenues and other factors.  There is generally a minimum 10% co-pay requirement.  The important take away is that infringement insurance exists.  It is provided by specialized insurance companies and not by general commercial insurance companies.  Since acquiring infringement insurance, the non-destructive testing client has become involved in five U.S. patent lawsuits.  They estimate that having the infringement insurance has saved them at least 2 million dollars.  There is a further benefit in having infringement insurance.  For example, not too long ago, we sent a “cease and desist” letter to an alleged infringer, and received a very aggressive and belligerent response.  We notified the infringement insurance company.  After receiving a letter from the infringement insurance company, the attitude of the alleged infringer changed completely.    Presumably because the presence of infringement insurance demonstrated to the alleged infringer that our client had the financial backing to litigate the dispute, the alleged infringer got in touch with our office and the matter quickly settled. If your company is having commercial success in the United States that is at least in part based on your intellectual property rights, or you are operating in a field in which other players have intellectual property rights, you may wish to review your circumstances to determine whether infringement insurance would be beneficial for you.

Patents are no barrier to innovation, despite the myths

Bob BarrigarRobert Barrigar has given permission for us to post on our website this article which was published earlier this month in The Globe and Mail.

Innovation and patents are related topics, but both are complex and not well understood. A common myth has it that patents constitute barriers to innovation. Not so. Examine our patent system in detail; it will be found to promote innovation.

A fundamental requirement of our system is that the patent provide a complete disclosure of the invention in sufficient detail to enable anyone skilled in the relevant technology to manufacture and use it. Further, research and development is expensive. Companies will be reluctant to invest in R&D if their innovations are readily available to competitors to exploit. Trade secrets enjoy no statutory protection, and once the cat is out of the bag, the innovator has no further protection in the absence of a patent. In short, a weak patent system is a constraint on R&D investment.

Next, consider a Canadian corporation of medium size that has obtained a patent for its innovation. By using its own resources, the patentee is able to serve, say, the Central and Eastern Canadian market, but not the West or any foreign countries. What is the solution? The Canadian patentee may file counterpart patent applications in selected foreign countries. But for many Canadian entrepreneurs, foreign exploitation using the patentee’s own resources would be impossible or uneconomical. So the patentee may seek a licensee under each of its foreign patents. And the patentee may elect to license another Canadian company to serve Western Canada.

But patent licensing is not a simple matter. In many cases, the patentee has developed its technology beyond the bare-bones innovation described and claimed in its patent. Its prospective licensee is unlikely to be content with a bare-bones licence; the licensee wants its manufactured product to be as industrially and commercially viable as the patentee’s product. So the patentee is usually compelled to grant, along with the patent rights, know-how and trade-secret rights to its licensee. But such rights enjoy no statutory protection, and they evaporate if the details leak out.

Furthermore, once the licensee is in possession of a patent licence and adequate know-how information, it’s in a position to make its own improvements and variants in the licensed technology. Consequently, to protect itself, the patentee may require the licensee to disclose and cross-license all such improvements and variants.

We infer from the foregoing that our patent system, including its various licensing opportunities, enables R&D activity in the applicable field of technology to take place in several countries by several different licensees, all of whom have been educated by the patentee. Without the security provided by our patent system, the innovator would have to rely on its own security measures and limited application of trade-secret law to attempt to protect its innovation. There would be little or no incentive for it to disclose the details of its innovation to anyone else.

Our patent system enables several different companies to develop, share and exploit derivative innovation that is dependent on the opportunities generated by one or more primary patent licences. In short, far from discouraging innovation, patents promote innovation.

What about the benefit to society generally? Society benefits from continuing R&D, regardless of who benefits financially from its exploitation. A weakened patent system might force innovators to seek limited trade-secret protection for know-how rather than be required to publish complete how-to information in the patent disclosure. It’s almost a certainty that licensing and cross-licensing activity will generate far more R&D by more companies that will be willing to invest not only in exploitation of the patented invention but also in making improvements in the technology, than would be the case under a weakened patent system. And society has the “insurance” that patents expire after their fixed term, after which everyone is free to make use of the patented subject matter.

So who loses? Unlicensed competitors of the patentee may sometimes lose. But if the patented invention is of importance, those competitors, in order to remain competitive, may be compelled to invest more heavily in R&D than they normally would. And their R&D may generate more derivative or substitute improvements than are forthcoming from the patentee and its licensees. So again, society wins.

Canadian entrepreneurs should be vigilant to protest against measures that would cripple our patent system to the disadvantage of innovators. This vigilance should extend to monitoring changes that may be proposed to our laws pursuant to international treaty negotiations.

About the Author:  Robert Barrigar has practised and taught intellectual property law, and written a leading textbook on patent law published by Canada Law Book. He has served as president of the Intellectual Property Institute of Canada and on the international executive committee of the International Federation of Intellectual Property Counsel.

Society of Interventional Radiology (SIR) Conference

It was my pleasure to appear on a panel titled “From Idea to Intervention:  How to Develop Your Medical Device For Patient Use” at the April 2-7 meeting of the Society of Intervention Radiology.  Attached are slides from my portion of the presentation.

Also appearing on the panel were:

Gary Boseck, PhD of Vention Medical Inc, with a presentation titled “Working with a contract manufacturing organization on your device, What you need to know?”

David Chen of Wallace H. Coulter Foundation, with a presentation titled: “Leveraging university biomedical engineering programs for obtaining proof of principle”

Jonathan D. Steinberger MD of the Dotter Interventional Institute, with a presentation titled: “Developing and validating new devices within an IR group: The Dotter Experience”.

Jafar Golzarian MD of the University of Minnesota, with a presentation titled: “Embomedics: A case study”

Fred T. Lee MD of University Of Wisconsin, with a presentation titled: “Development, commercialization and clinical translation of thermal ablation devices: One physician’s experience”http://www.slideshare.net/ThompsonCooperLLP/securing-your-intellectual-property

Trans Pacific Partnership (TPP)

The-TPPI was listening to the radio the other day and caught the tail end of an interview concerning the Trans Pacific Partnership (TPP).  The comment that attracted my attention was a statement that the Intellectual Property provisions of the TPP agreement would cost Canada 57,000 jobs.  The same evening the TPP agreement was on the evening television news and the person interviewed indicated that the ability of Canada to change its laws would be hampered.  I have now read the Intellectual Property provisions of the TPP agreement, which are found in the 75 pages which comprise Chapter 18 and accompanying schedules.   The agreement indicates that countries may change their laws “provided that such measures are consistent with the provisions of this Chapter”.   As indicated by the television commentator, Canada would be in breach of the agreement if, after signing, the government chose to pass laws that contradict the provisions of the TPP agreement.   Looking for the lost 57,000 jobs, I found that most of the 75 pages are consistent with the laws of Canada as they presently exist.  The copyright term has been lengthened, but that change is unlikely to cost any jobs.  Canada’s previous copyright term was the life of the author plus 50 years after his or her death.  The TPP agreement provides for a copyright term of the life of the author plus 70 years after his or her death.   In Canada, there is a government approval process before a company can sell agricultural chemical products, pharmaceuticals, or biologics (complex molecules such as proteins that are isolated from plants, animals or micro-organisms, or made using biotechnology).  The TPP agreement provides for a “patent term adjustment”, lengthening the term of a patent when there are delays in the government approval process.  This change will give drug companies a few more years of protection and will slow the introduction of generic drugs into the Canadian market.   As part of the government approval process, companies must submit test data and, where applicable, data from clinical trials.  There is presently no law, prohibiting subsequent applicants for government approval from using test data submitted by an original applicant. The TPP agreement provides that subsequent applicants are prohibited from using the test data submitted by the original applicant for a period of 10 years when seeking government approval for agricultural chemicals, 5 years for pharmaceuticals, and 8 years for biologics.  This will also slow the introduction of generic products into the Canadian market, as generic manufacturers are forced to either wait or develop their own test data and conduct their own clinical trials.  I have no way of assessing whether 57,000 jobs will be lost.  However, it is reasonable to assume that there will be a loss of jobs in the generic drug industry as these provisions begin to affect generic drug manufacturers based in Canada.  However there are some answers missing from the dialog, that would help me decide whether or not I am in favour of TPP.  How many jobs may be gained in other sectors with the signing of TPP?   How many jobs may be lost if we do not sign TPP?  We rely upon our exports, being frozen out of TPP may not be good for Canada in the long run.

Angel Investor Event

Picture of Mayor HelpsIn Victoria, we love to criticize our local politicians from our safe seats on the sidelines with respect to everything from bridge replacement to sewage treatment.  A common complaint is that they don’t “do” anything.  I thought I would take some time to comment on an Angel Investor event entitled “A Capital Mission” that took place February 17 – 19.  This is an example of local politicians trying to make things happen for the local economy by showcasing our tech community to both local investors and investors from elsewhere in Canada and the United States. The event began the evening of Wednesday February 17 with a welcome reception at which Mayor Lisa Helps assumed the role of gracious host, first by giving a welcoming address and then by inviting Amrik Virk, BC Minister of Technology, Innovation and Citizens’ Services, and United States Consul General Lynne Platt to add their comments.  Tim Catlin of Change.org, one of the U.S. based organizations that has invested locally, indicated that with our existing infrastructure and the comparatively low Canadian dollar, Victoria is a very attractive place for a U.S. citizen to invest.  There followed a “pitch night” with the following entrepreneurs making pitches to secure capital for their ventures. LlamaZoo produces software that provides anatomy training for veterinarian students.   Cooler Heads produces auto-deploying head and face flash fire protection.  OrangeDox produces a software that adds greater functionality to Dropbox.  Craftt Technology produces a beer keg tracking system for craft brewers.  Social Nature promotes peer to peer marketing.  Chatter High is a web platform to allow junior high and high school students to explore post-secondary career options in an entertaining way.  Industrial Plankton produces low cost algae bioreactors for aquaculture. Vertical Organic Garden produces space-efficient vertical hydroponic systems for  in-home use. Plurilock produces biometric security systems that monitor keyboard dynamics. Island Circus Place is seeking to start a circus school.  On Thursday, February 18, the Angel Investors were organized in groups and taken on tours that included a number of technology incubators and co-working spaces.    In the morning on Friday, February 19, an Investor Education Workshop was held with a presentation by Josh Maher, the author of Startup Wealth: How the Best Angel Investors Make Money in Startups.  The assembled Angel Investor were then invited to spend Friday afternoon, at the Discover Tectoria trade show with over 70 exhibits located at the Crystal Gardens.  This three day event will have some modest benefits short term, but may lead to some tremendous advances long term.  Congratulations to all who had a role in making this event happen including: Mayor Lisa Helps, Victoria City Council, University of Victoria, ViaTec, Tourism Victoria, the Downtown Victoria Business Association, the Capital investment Network and the Urban Development Institute.

Kickstarter Campaign for Cable Organizer

A client of our office is launching a Kickstarter campaign at 6pm on March 3 with respect to  a family of cable organizers.  There is one cable organizer that handles the power cord for a smart phone.  There is another cable organizer that handles the earphones that are used with a smart phone.  We are happy to help “get the word out” .  The Kickstarter campaign will run just over 30 days.  We ask that you give this new product a look.   https://www.youtube.com/watch?v=XcLyLsXLc1s

Transitioning from Angel Investment to Venture Capital

Picture of Tipping Point BookVenture capitalists are generally not interested in business “start-ups”.  With business start-ups there are too many unanswered questions regarding the product or service, and the market.   That is why “angel” investors are needed to bridge the gap and assist the entrepreneur, both financially and with business advice, until a track record is developed.  If things go well, there will likely come a stage when the business needs a major injection of funds to take the business to the next level.  Rapid growth can be a curse.  Without adequate financial backing, rapid expansion of a successful business can involve an immediate increase in costs with a delayed increase in revenue, and may result in bankruptcy.  The venture capitalist is looking for a business with rapid growth potential and is prepared to provide the funds to fuel that growth.  I compare angel investment to a small stakes poker game played among friends and compare venture capital investment to a high stakes poker game played with people whose only interest is the game.  In the small stakes game, it is real money; but the small stakes moderate the tone. Within limits, the angel investor will try to accommodate the entrepreneur when problems are encountered.   In the high stakes game, the amount of money at stake increases the intensity of the players.  To make matters even more intense, expectations are sky high.  There are also time limits, as the venture has a monthly “burn rate” and must reach set milestones before the allocated funds are exhausted.  The venture capitalist is gambling.  He or she knows that out of ten businesses that receive investment capital, only one or two will realize their potential.  The potential return must, therefore, be multiples on the investment to cover the losses on businesses that do not succeed.   Those multiples can be between ten and thirty times investment funds.  It is not acceptable for the business to merely create a living for the entrepreneur and jobs for a handful of employees.  The investment must result in the business “scaling up” to provide significant returns.  If the entrepreneur does not have the skill set to guide the business to the next level, he or she may be demoted and replaced by someone who does.  If the business is unable to meet expected milestones, the business will be cut off from further funding.   Those are the rules of the game.  Sorry, it is just business.

ANGEL INVESTORS FINANCING INNOVATION

Venture Capital photoI recently had lunch with a banker friend . He related some of his daily struggles in approving loans and summed up by indicating that his bank hired him to fund viable businesses, not “dreams”. The reality of the banking business is that a banker will only grant you a loan to launch an innovative project if you have the pre-existing financial strength to financially back the new business. After the business has being operational for two years or more, the financial performance of the business over that period will clearly indicate whether or not you have a viable business rather than just a “dream”. Persons who do not have such financial strength are forced to seek assistance from investors. The quest for investors usually starts with family members and personal acquaintances who trust and believe in you. There are some investors, referred to as “angel” investors, who invest in projects of complete strangers for fun and profit. The angel investors that I have known are relatively wealthy and have a past history of entrepreneurial success. Their angel investments are like a hobby to them. The number one criterion of the angel investor is that he or she must like you and feel he or she can work with you. If you are difficult to work with, it takes the fun out of the project and the angel investor doesn’t want or need the hassle. The number two criterion is that the angel investor must believe that the project has substantial growth potential and is not merely a “create a job” project. The ultimate object of the investment is to make some money at the end of the project. Ideally, the angel investor has contacts or knowledge that can contribute to the project and help make that happen. The number three criterion is that there must be some logical jumping off point at which the angel investor can cash in on his investment. If you have a good fit with an angel investor, you may well develop a life-long friendship. You will have to do most of the work, but at critical times the angel investor will be there to assist you. The angel investor will give you advice which will help you avoid mistakes you would otherwise have made. As he or she gets to know you, the angel investor will assess your strengths and weaknesses and get others to help cover your weak areas. The angel investor will set and expect you to meet performance milestones. Consider it tough love. It is for your own good. A controlling interest (over 50% of the venture) is not essential to the angel investor, although the angel investor can exercise a measure of control by simply withholding additional funds if he or she does not approve of the way the business is being run. If all goes well, the relationship with the angel investor ends at the planned exit position. On small projects, this is often the sale of the business, at which time you both “cash in”. On large on-going projects, you will progress to the “next stage of financing” in which a venture capitalist steps into the shoes of the angel investor and puts serious money into the business to take it to the next level. I have nothing but respect for angel investors, the ones I have worked with are special people indeed. There are a number of differences between angel investor funding and venture capital funding. Those differences will be explored in a separate article.

LAMP AWARDS 2015

Buechert photoAwards are a time to stop our hectic pace and recognize how far we have come (regardless of how far we may yet have to go). I was delighted to hear that the one of our clients, AVI Inc was nominated as a finalist for the LAMP awards (Lighting Architecture Movement Project). I attended the LAMP Awards, which were held in Vancouver on November 12, at the invitation of Matt Kennedy, the President of AVI Inc. I met the other members of the AVI team including accountant Michael Manley, photographer Darryl Bueckert, and SR&ED consultant Ken Bell. The theme of the LAMP Awards for 2015 was “Crystallize”. I urge you to see some of the marvelous entries at www.welovelamp.ca . I have attached a photo of the AVI entry. I would like to thank Darryl Bueckert for allowing me to use this photo. If you like Darryl’s work, check out his website www.darrylbueckert.com. I will post some further material on how you can purchase the products of AVI Inc and about the Crowdfunding campaign of AVI Inc at a later date. Matt Kennedy has been a great guy to work with and I look forward to continuing to work with him in future.