04 Nov’15
​It seems that not a day goes by without a commentary about "unicorns," a Silicon Valley-coined term used to describe a startup (pre-exit) with a valuation exceeding $1 billion.

The Role of Intellectual Property in ‘Unicorn’ Valuations

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It seems that not a day goes by without a commentary about “unicorns,” a Silicon Valley-coined term used to describe a startup (pre-exit) with a valuation exceeding $1 billion.

The number of unicorns, the vast majority of which are U.S. software companies, has recently crossed the 150 mark, according to the TechCrunch unicorn leaderboard.

Topping the list are high flyers like Uber at $51 billion and Airbnb at $25.5 billion, followed by companies that are mostly concentrated in three industries: Internet, ecommerce and software.

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Unicorns have captured the attention of investors, analysts and other market observers who are trying to understand the factors driving the formidable valuations commanded by these mythical ventures.

That being said, the one area that has not been explored yet is the role that intellectual property (IP) plays in these unicorn valuations.

Focus of research

Since we at Foresight Valuation Group specialize in analyzing the valuation of IP as a strategic business asset, we decided to look into the most recent list of unicorns and try to understand the patent position of these companies, and how it may be correlated with valuation.

We did not conduct a complete analysis, just a quick patent count of issued and pending U.S. patents, using the Innography patent analytics platform. We limited our analysis to U.S.-based unicorns — 95 out of the 151 listed — to neutralize any country-specific effects. It should be noted that U.S. patent applications only publish 18 months after filing, so our analysis is based on what has been published to date — also keeping in mind that some companies on the list might not have their asserts assigned to the company’s name, which would result in the unicorn being listed as having zero patents.

Since our sample consisted of relatively young companies (median age of eight years) and patents take a while to issue (about three to four years for a U.S. patent), we did not expect a fully mature patent portfolio with hundreds of assets. Also, software companies are less likely to have large IP portfolios, as compared with pharma, biotech of hardware companies, and our sample consisted of 65 percent software companies. Having said that, given the large resources available to these companies (median funding of $277 million), and the high exposure created by the unicorn valuations (median valuation is $1.35 billion), we were looking for indication of a solid intellectual property foundation that could mature with the company.

Key findings

Overall, we found out that 61 percent of U.S. unicorns have only 10 or fewer (issued and pending) patents in their name, accounting for more than $157 billion in valuation and $25 billion in funding. Moreover, 30 percent of U.S. unicorns have no patent assets at all!

We also found out that 53 percent of total U.S. patent assets held by unicorns are assigned to only 8 percent of companies, which account for 17 percent of the overall value and 11 percent of the overall funding, so the wealth distribution is not correlated with the IP distribution. Taken together, these high-level findings seem to lead to a preliminary conclusion that IP assets are not an important factor driving unicorn valuations, nor do IP assets seem to play a critical role in the business strategy of a large percentage of these companies.

Should unicorn investors be alarmed by the IP gap?

While this gap obviously does not hinder the billion-dollar valuations in the short term, it could pose several problems in the long term, as these unicorns strive to sustain their fast growth or approach an exit event.

Under current “first to file” patent regime in the U.S., as enacted through the America Invents Act (AIA) in 2011, the priority date on an idea goes to the first party to file a patent application with the USPTO. The AIA has also expanded the definition of “prior art,” which are public disclosures of ideas similar to the invention, raising the bar to what is considered “patentable.”

The combination of these two factors makes the priority date of filing with the USPTO a critical factor. Once a company puts a product out in the market and has not filed any patents, it’s risking its ideas leaking into the public domain and jeopardizing its ability to patent its own inventions, while at the same time also losing a valuable priority date that could strengthen its competitive positioning vis-à-vis later competitors who could have been excluded by the patent.

Unicorns that show no organic patent growth may have lost the ability to patent a large portion of their core inventions due to missing key priority dates, and may need to make up for it by buying patents (or companies holding patents) in response to competitive threats, spending hundreds of millions of dollars in the process.

Seeing vulnerabilities

There are several junctures where any company, and in particular a unicorn with an abnormally high valuation, is most vulnerable to having a weak IP position: entering new markets with established incumbents, and approaching an exit point such as an IPO.

Google and Facebook are two well-known examples of companies that had to deal with these types of circumstances:

  • Google’s acquisition of Motorola Mobility for $12.5 billion in 2011 was primarily driven by the need to grow its IP portfolio through a massive acquisition, in order to enter the mobile market. Many incumbents in that market had stronger IP positions, which put Google at a disadvantage, forcing it to assemble its own portfolio very quickly (Motorola had around 17,000 patent assets) and at a very high cost.
  • Facebook, one of the original unicorns, was hit by a patent lawsuit filed by Yahoo a month prior to its IPO, which is a very vulnerable exit point where a lawsuit can be detrimental and potentially even derail an IPO. Since it had very few patents to fight back and countersue Yahoo (a common defense strategy in patent lawsuits), Facbook ended up paying hundreds of millions of dollars buying patents from AOL, IBM and Microsoft in order fight the lawsuit and bolster its IP position to reduce its exposure in the future.

In conclusion, while some of the unicorns analyzed in the study have embarked on the journey of creating a solid IP portfolio, as many as 61 percent of U.S. unicorns seem to have fallen behind. It is in the best interest of management and investors of these companies to examine their IP position and analyze their exposure, particularly if they are planning to enter new markets or are approaching an exit event.

 

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