Role of Intellectual Property in Startups’ Growth Strategy

  • Intellectual Property being Important for Growth Strategy

Intellectual Property (IP) is often said to be important in growth strategy of startups. However, we do not have any consensus yet on what kind of IP strategy is important.

As for large companies, number of IPs is certainly important. It would be symbolized by Google’s acquisition case of Motorola Mobility. On the other hand, acquiring a large number of intellectual property rights (IPRs) is often cost and human resource consuming. Thus, startups often have difficulty in acquiring a large number of IPs. It is due to its insufficient financial and human resources.

Many venture capitals (VCs) demand startups to acquire IPRs covering a certain niche in growth markets. However, except for a few numbers of venture capitals being familiar with IP-related issues, IPs are regretfully not evaluated from quality aspects.

  • IP Valuation and IP-based Lending

Under the current circumstances where IP transaction market is not developed enough, IP valuation is conducted by accumulating future cash flows based on the “income approach”. Here, “cash flow” means cash flows obtained from operating activities, free cash flows, etc.

That is, IPs are evaluated by calculating the business value based on future cash flow and deducting value of tangible assets. When startups bear negative earnings, non-GAAP based indexes such as EBITDA (Earning Before Interest, Tax, Depreciation and Amortization) might be useful. Generally, expenses associated with upfront investment are not deducted from sales when calculating the EBITDA.

By the way, IP valuation is said to be important when banking instituites set collateral on IPs. However, in many lending cases for startups, collaterals are often set on IPs together with the owners’ tangible assets. Thus, IP based lending is often limited to startups bearing relatively a large number of tangible assets.

Assuming that the IP valuation is conducted by assessing the amount of cash flow or EBITDA, we might be able to assert that IPs covering the business generating higher amounts of operating income can be evaluating as having the higher economic value.

  • IPRs improving ROA

For example, when considering Return On Asset (ROA), it means earnings yield of business and is obtained by dividing the (operating) income by gross asset. It can also be expressed as a product of the operating margin and the total asset turnover. Accordingly, IPs improving these two indexes can improve the startups’ business value. 

As for Apple’s case, they are drafting an IP strategy focusing on design patents covering their product designs. Generally, costs for installing design patents into products are lower than those for installing utility patents. It is because that installing utility patents often requires using expensive parts and materials. Accordingly, installing design patents reduces the manufacturing costs. Thus, it increases the operating margin.

Installing design patents also has effects of making product outlook sophisticated. It allows the manufacturer to set the higher price for the product. In addition, high-spec products have difficulty in being distributed in emerging economies due to insufficient infrastructure and low nominal GDP per capita in the market. Thus, product value creation via design patents might be important as the marketing strategy.

A schematic image of increasing margin. One option is rising prices and another is saving costs.
Operating margin can be increased by saving costs and/or raising prices

Concerning the well-known one-click buying patent acquired by Amazon.com, credit payment information and shipping information of users are registered in advance on the Amazon’s platform. It enabled time required for payment to be shortened. Of course, one-click buying patent had attracted a large number of customers by improving the convenience in the platform. Thus, it had improved the number of transaction on the platform. It has also improved the total asset turnover.

Amazon.com is said to be developing their business considering the “Cash Conversion Cycle (CCC)”. For example, they have expanded one-day/ next-day delivery while acquiring related utility patents. The purpose of the expansion of the one-day/ next-day delivery might be for improving their “Cash Conversion Cycle”.

A schematic image of improving total asset turnover. When we imagine sales of a product with a price of USD 100, total asset turnover will be improved by selling 5 products in a specified rather than 3 products.
Total asset turnover can be increased by improving frequency of transactions
  • Conclusion

In conclusion, when startups suffering from insufficient financial and human resources draft growth strategies emphasizing intellectual property strategies, acquiring IPs increasing cash flow might be very important. It can be accomplished by improving the operating margin and/or total asset turnover.

Reference

1. Koji Watanabe, “IPR Valuation and IPR-related Strategies of Startups”, Patent, Vol 73, No. 4, p. 46-51, Japan Patent Attorneys Association (2020) [Link]

Disclaimer & Disclosure

1. The author is holding shares of Apple (NASDAQ: AAPL) and Alphabet (NASDAQ: GOOGL).
2. This report is provided solely for informational purpose and not intended for the purpose of soliciting investment in, or as a recommendation to purchase or sell any specific products. 
3. Any opinions or statements expressed in this report are based on the author’s personal and subjective views, and are not the official views of the organization to which the author belongs.  In addition, although we have done our best efforts in making accurate assessments on the companies’ strategies, we cannot guarantee any complete accuracy of this report. We do not guarantee either that any future forecasts referred to in this report will certainly be realized. 

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