Patents @ KBLLP
How much my patents are worth?
Frequently inventors have difficulty in estimating the value of their patents and often gravitate toward large valuations in the absence of benchmark. This is understandable because for the inventor, his or her patents represent the recognition of their ingenuity, time, and efforts. Often, however, inventors incorrectly estimate the value of their patents. This article explores the fundamentals of patent valuation.
A Typical Situation
An inventor comes up with an invention and over the course of months or even years spends his free time improving the invention and frequently even creating a prototype. The inventor retains the services of a patent attorney or patent agent and, after two or three years and several thousand dollars obtains a patent covering the invention. Sometimes the inventor obtains two or more patents covering different aspects of the same invention or even multiple related inventions, with each patent taking additional time and money. Usually, after the first patent issues, the inventor begins to think about how to sell his or her patented invention, but quickly realizes that this effort requires a substantial investment. Alternatively, the inventor may think about how to sell the patents, but often the reality is that large players in the field do not respond to messages or return the calls.
While the inventor is in the process of researching production and sales channels for his patented invention, he learns that one or two companies in that space are selling the patented invention. In some cases, these companies may be the very ones the inventor had approached about his invention. Believing that their patent(s) entitle them to put a stop to the infringement, the inventor(s) contact the lawyer who helped them get the patent in the first place only to learn that patent attorneys who prosecute patents rarely have experience in enforcing them. The inventor is referred to other lawyers who may not want to take his case. So, what is going on?
What rights does an inventor have?
The foundational question is what rights does a patent provide? In theory, a patent provides the inventor the right to exclude others from making, using, selling, offering to sell, or importing into the U.S. products covered by the patent. In case of a method or process, a patent provides the inventor the right to exclude others from practicing the method in the U.S. (with some additional protections for products made by that method that are imported into the U.S.). In theory, the inventor can also get compensated for past infringement and either receive further compensation for future infringement or stop the infringement altogether, which is called an injunction.
In practice, however, the Supreme Court significantly restricted inventors’ right to get an injunction against infringers. As the legal precedent has developed, it is very difficult for an inventor to have the competitor stop producing and selling the infringing products. And thus, the most realistic recourse is money. The only serious consequence for the infringer—being ordered to stop infringement—is therefore unlikely to be available to the inventor. So, the question becomes: how much money can the inventor in this situation expect to recover? Frequently the inventors believe that they are entitled to the entire income stream stemming from infringing sales. Again, this is not the case.
“Damages” refers to the amount of money by which the inventor (or patent owner) was harmed through other persons’ infringement. The damages to which the inventor is entitled, according to U.S. patent law is “reasonable royalty.” Reasonable royalty is what royalty would an infringer and the inventor agree on right before the infringement began. For example, say the inventor has invented and patented a new water filter that the infringing manufacturer now sells for $200. Would the manufacturer agree to pay the inventor $200 for each filter sold? In almost every situation, of course, the answer is no; such a financial arrangement would render the enterprise of producing and selling filters unprofitable and pointless. On the other hand, would the inventor accept only one tenth of a cent as a royalty payment for each filter? Probably not either because that rate is too low to represent the true value of the invention. The “reasonable royalty” then is some value between these two extremes. But if that hypothetical negotiation had not taken place before the infringement began, how, in retrospect, can someone determine what the parties would agree to back then?
Courts developed rules and guidelines as to how to determine this value. Two concepts are at play: apportionment and reasonable royalty.
To understand apportionment, consider an example of the inventor patenting an improved car headlight. In several years, a car manufacturer begins selling cars with headlights that infringe the patent. The car manufacturer sells these cars for $30,000 but buys the headlights for $250 each, while selling replacement headlights for $750.00. One way to apportion is to consider the smallest saleable patent-practicing unit (SSPPU), which in this case is a headlight. This analysis removes the remainder of the car, such as wheels, breaks, engine, etc., from the equation because they are not even relevant to the patent, and then apply reasonable royalty, discussed below, to the value of the headlight. Another way to apportion is to consider the value of the patented invention to the entire car. For example, it may be determined that the value of the patented headlight is 1% of the entire car value, which would be $300. The apportionment step is an attempt to determine exactly what of the entire product is relevant to the patented invention.
Next, the reasonable royalty is assigned to the invention. This is not the exact science, but generally the number of patents and the extent of the coverage and the degree of technological advancement are considered. Also, reasonable royalty should not completely eliminate the infringer’s profits. And, while it is true that under U.S. law an infringer is not entitled to make a profit on its product, the reality is that attempting to strip the infringer of all profit rarely works. Thus, for example, assuming that the value of the headlights was determined to be $500 (somewhere in the middle between the cost of the headlight to the auto manufacturer and its sales price), then a 1% royalty rate on the value of the headlights would amount to $5 per headlight.
The next concept that is relevant is the “damages base,” in other words, the total amount of infringing sales. Continuing with the SSPPU of infringing headlights, if, for example, only 100,000 of infringing headlights were ever sold and then the industry moved on to more advanced headlights that no longer infringe, the maximum that the inventor stands to recover is $500,000.
In practice, if this case ends up in court each side retains an expert witness, such as an economist, that presents their theory of damages and then the jury decides what measure of damages to award to the inventor, assuming that infringement was established and the jury did not agree with any of the legal defenses. In the above example, if everything goes smoothly for the inventor, at the end he recovers $500,000. If the jury decides that reasonable royalty is 0.5%, the inventor gets only $250,000, and so on.
Risks and Expenses
The assumption in the above example was that the inventor established infringement and none of the infringer’s defenses were persuasive. If the jury does not agree that the infringer actually infringed, the inventor gets $0. If the jury agrees with the infringer that the Patent and Trademark Office made a mistake in issuing the patent, the inventor gets $0. And these are only the most common defenses. In a typical patent litigation, an accused infringer raises many such defenses. If the jury agrees with at least one, the inventor gets $0. Even if the jury returns a verdict in the inventor’s favor, the infringer can appeal and if the appellate court reverses, the inventor gets $0.
Even to get to a jury trial takes significant time. Assuming the lawyers representing the inventor agree to work on a contingency basis (which is not always the case), the inventor has to pay litigation expenses that may be substantial. Therefore, considering risks of losing and expenses that the inventor has to pay no matter what, the picture is much more sobering. Is it worth to invest $100,000 into a litigation with the maximum possible recovery is $500,000? Is it worth for lawyers to invest thousands of hours into such a case? These questions are crucial to consider at the outset and unfortunately sometimes the answer is “no.” An experienced advisor may be able to discuss these issues with you and to help you assess the potential risks and benefits.
Does it mean that inventors never get compensated? No it doesn’t. Some infringers actually respect intellectual property and patents and are willing to pay the inventors, especially if they are represented by counsel who can competently advocate the inventor’s position. Sometimes, companies want to buy a peace of mind and they buy or license patent proactively so they do not get sued in the future. Sometimes the infringement is so widespread that litigation make sense. Sometimes an inventor will receive an offer to sell patent by a company that is assembling a wider portfolio.
Each patent and situation are unique. We encourage you to submit your case for free evaluation here.