The effect of patent ownership on attracting capital for IPO firms

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MSc Entrepreneurship

Track: Joint Degree UvA & VU

Master Thesis

The effect of patent ownership on

attracting capital for IPO firms

by

Francesco Nostheide

11914947 UvA & 2630445 VU

August 16, 2018

12 ECTS Period 5&6

Supervisor:

Dr. Michele Piazzai

Assessor:

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Preface

This report is written for the ones who want to get a better understanding about intellectual propriety protection in case they have limited resources. Nowadays small technology startups and companies are competing against the large established firms. Small firms have the advan-tage of moving like a cockroach through the industry and take on quicker new inventions and jump faster into opportunities than large corporations. Nevertheless small firms must admit that they have limited resources and it is their weakest point. Therefore I as a master student Entrepreneurship wants to provide them with insights from a scientific point of view in order to let them make the best decision about protecting their intellectual propriety. An effetive and efficient protection strategy has a positive influence on growth and therefore on investors.

The copyright rests with Francesco Nostheide. Francesco Nostheide is solely responsible for the content of the thesis, including mistakes. The University of Amsterdam cannot be held liable for the content of Francesco Nostheide0s thesis.

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Abstract

In this thesis the effect of patents on attracting investor0s capital till the moment of IPO is researched. Small companies and start-ups have limited financial resources compared to large established companies. Therefore it is important to make appropriate decisions about spending money on the protection of intellectual propriety. Protection can be done by non disclosure agreements branding, trademarks and patenting. Depending on the market position where the company is operating in influence the best strategy. Therefore it is not automatically logical to patent every invention. The biotechnological industry and the iCT service industry are considered in order to take the effect of the industry into account. Only companies who performed an IPO are taken into consideration because there must be a large grow potential in order to attract investors on the stock exchange. This large growth potential can only be maintained when there is protection on their intelligent proprietary. In this research only the formal strategy of patents is statistically analyzed.

The data collected about the funding amount and rounds from the biotechnology and ICT service industry service were subjected to a correlation test and a linear regression fit The research shows that the biotechnology industry as well as the ICT service industry have an weak positive correlation relation between patents and founding as well founding rounds. The lineair regression fit shows that the data is spread round the regression fit. This confesses that the patent application is a complex process which is influenced by the particular state and environment were the company is operating in.

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Chapter 1 Introduction

Venture capitals play an important role when a company is not able to grow in an organic way. More often then not they prefer to invest in companies which owns patents. This sounds logical because the invention is protected and prevent the competitors from copying the product. Also in case the company goes bankrupt or fails in a other way the venture capitalist has some assets left over from the company giving the venture capitals list some safety. Especially firms with large growth potential are interesting for investors due to their high return investment in a shorter time period compared to firms which grow more naturally. Therefore in this research IPO firms are selected. In order to do an IPO there must be enough interest from investors. The strong relationship between IPO firms and investors makes them high valuable to use them for this research compared to privately held firms which do not perform an IPO.

At the moment when a company is founded or an entrepreneur wants to bring an invention to the market it has the option to protect their intellectual propriety by patents. Nevertheless companies like WD-40 and Coca Cola never patented their inventions ad still managed to grow to large well known firms. This was made possible by using other protections strategies than patenting which will be explained in this research thoroughly. One would expect that companies, startups also focus on the other strategies and investors should go along with it.

Previous research at the VU concluded that there is no relation between the amount of patents and growth of a company. Still this is not reflected by the behavior of the investment industry and even small startups use patents in their marketing campaign for investors and potential customers. This is a contradiction and further research is required to understand what is going on in the investor industry related to patents.

The purpose of this report is to give an answer of the following research question: Does patent ownership influence positively the ability to attract capital from investors till the moment

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of IPO?. In order to also research whether or not the industry has an influence on this ability the data of two complete different industries are taken. These two industries are the biotechnology and the ICT service industry.

The outline of this report is as follow. Chapter 2 describes the previous research done in this area which act as an basis of this report. Chapter 3 elaborates on patenting procedures and costructions. Chapter 4 describes other protection strategies like branding and non disclosure agreements a company can use to protect their intellectual propriety. Chapter 5 explains the hypothesis and the methodology, after that the results will be discussed. Chapter 6 draws the conlusion based on the data and compares it to the researches in chapter 2. Chapter 7 gives further recommendations to researches in the future about this subject

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Chapter 2 Previous Research

In this chapter the two researches who act as a basis for this master thesis are elaborated. Both of these two researches lead to different conclusions. The conclusions of these researches are described in order to get an quick overview about what the other researchers concluded about patents related to investments and growth.

2.1 Intellectual Propriety Protection SMC

This research elaborates on the findings and conclusions of PhD researcher Mischa Clement Mol about protection of innovation related to firm performance in the Netherlands (Mol,2017). The research elaborates on the literature findings that innovations of small medium capsize firms are not protected by patents or other formal protections. Instead informal protection is used to protect innovations like non disclosure agreements or trust, even no protection at all is used. The research of PhD researcher confesses the findings of literature that small medium capsize firms which are innovative dont use formal protection like patents, registered design, brand or royalties. Also the research results showed that patents and brands are more often used than registered designs or royalties. In case small medium capsize firms use patents they often go for the cheaper short term patent instead of the long duration patent. Small firms also extend their patents new period more often compared to larger companies and also small firms who rely on one innovation put more weight on patents. The research confessed that patents are related to the amount of employees, the R&D investments, product innovation (instead of process or service innovation), the usage intensity of patents in the sector, the size of the geographical market and whether or not the firm has collaborated with other parties in the innovation process. An surprising conclusion was that firms size is not related to registration of designs and copyrights In the research there are made four distinctions in types of protection:

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no protection, informal protection (lead time, relationships with high trust), non registered formal protection (licensing ,confidentially clauses) and registered formal protection registered designs, trademarks and registered copyrights.

The most important conclusion of the research which lead to do this master thesis is that one of the conclusion of the report is that there is no significant relationship between registered formal protection and growth of firms. This is in contrast to literature findings in the report. The conclusion about business growth is not related to formal protection has an influence on investors because investors want return on their money. In case formal protection does not lead to business growth then it has no benefits to perform legal protection in order to attract investors. This master thesis will dive deeper into legal protection like patents and their effect on attracting capital of investors related to IPO firms.

2.2 Effect of Patents on Seed Rounds

An other research which which is close tot his master research is the research of Sebastian Hoenen of the Wageningen University and Research Center (Hoenen et al., 2012) . The research question was if patents increase venture capital investments between rounds of financing. The research was performed on the biotechnology industry in the United States of America. The research elaborated on the general consensus that patents stimulate the growth of the firm due its protection. In this case not growth but the attraction to investors was studied between investment rounds. The research about more than 1500 United States of America biotechnology firms concluded that patent activity before the first round increased the amount of funds in round one and two. A surprising conclusion was that only pending patents have a signal on the funding amount and not already granted patents. The research suggest that the possibility of altering before the patent is granted favors the investors. Once an patent is granted the concept cannot be changed without loosing the protection of the patent. Furthermore the growth of venture capital funds is influenced by the number and size of the investors. Also the location of the firms influenced the funds due to the possibility of knowledge sharing with close institutions.

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Chapter 3 Protecting Intellectual Proprietary

This chapter elaborates on the protection of intellectual propriety. This protection can be done by the use of confidential clauses, patents and branding. The purpose of this chapter is to give more background information to the options companies and startups have to protect their intellectual proprietary. From this background information a better understanding can be attained about the decided protection strategy.

3.1 Small Businesses and Startups

Small businesses and startups have often less resources compared to established corporations (Martin, 1994). This brings them automatically in a position in where they have to make appropriate decisions in what the most efficient way is to protect intellectual propriety. The resource poverty is caused by not having enough time, money, complexity of the procedure resulting in a lower ability to enforce intellectual propriety rights compared to large compa-nies. Therefore small firms and stratups protect themselves through non legal means like lead time advantage compared to competitors and high trust relationships in business (Mol, 2017). Nevertheless patents are still often considered and are persuaded by investors at an early stage (Hoenen ,2012).

In this report it is researched if using patents to protect intellectual propriety is able to attract more capital for firms that performed an IPO. The reason for selecting only IPO com-panies is that after an IPO the focus shifts towards creating shareholder value and protecting it instead of growth and innovation (Johnson,2015). In other words companies are forced to have all their innovations running before they perform an IPO. This puts pressure on attracting

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capital from investors to let all the innovations be executed by the use of their money before the IPO. Therefore it is interesting to research if patents have an influence on investors con-sidering the attraction of capital. This is important for startups and small business to know consindering their limited resources (Martin, 1994). In section 3.2 the procedure for applying for patents is elaborated including the struglles of small firms and the disadvantages of patents.

3.2 Patent Apllication Procedure

One must note that not all the knowledge can be protected by patents. Public knowledge or inventions and products which are not new, inventive or have not an inventive step are not suitable for patenting. Also in order to have an good quality patent an invention should have fixed boundaries otherwhise the patent does not withstand in court in case of infringement (Bessen & Meurer, 2006). Besides this it is also clear for the competitor what the boundaries are of the invention so that inadvertently infringement is prevented. (The Intellectual Property Office, 2015)

Fixed boundaries mean that something can only be described in one way. For example in case H2O is patented because it is now invented in a laboratory then there can be made a good quality patent. The reason for this is that H20 is only present in one molecule structure. It is fixed it cannot be changed without actually changing the product which is water. Now for example vitamin E is patented this patent is of low quality. Vitamin E has namely 8 different forms (lester et al. , 2012) so here the flexible boundaries appear. In order to make the patent of good quality all these 8 forms should be described in detail, creating fixed boundaries to protect vitamin E in general. In other words in order to have a good quality patent the boundaries must be described in such a way that changing these boundaries will lead to a mall functioning end result. Only in this way an invention is protected watertight. One must note that this was an example in practice vitamin E and H20 cannot be patented because they occur in nature.

In case the invention can be patented a procedure has to be followed in order to patent the invention which will now be elaborated. One must note that a patent does not protect actively the invention which will be explained later on in this section.

At the first stage when a startup or company decides to patent their invention or product they have to do patent research in front . At the moment when an invention is patented, one must perform patent research in order to find out if the invention is not conflicting on someone elses patent (Westerhoff, 1990). This step will give answer on the question whether or not the

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invention, idea or product is already patented. Patent research can be done by yourself in the European Patent Office (EPO) or by an expert in patents in the particular industry where the invention belongs to. Due to the complexity of the patent law it is better to outsource patent research to a patent attorney. He knows what the best strategy is when there is some conflict with other patents or when the invention is already patented due to their experience in patent lawsuits.

Patents not only cost money at the beginning of the application procedure but also after-wards when the patent has been granted. Considering the Netherlands Enterprise Agency the costs of the Netherlands Patent Office for an patent is represented as follow (RVO, 2018). -Filling fee of 120Euro for filling an application

-Compulsory novelty search costing 100Euro (national search), 794 Euro (international search) performed by the European Patent office

The costs for writing a patent by a patent attorney costs between the 2000 and 10000 Euro depending on the complexity of the invention (RVO, 2018). After the first day of filling a maintenance fee of 40 Euro starts and this can increase to 1400 Euro annually. The patent remains valid for a maximum of 20 years. In case there is an infringement with an patent an average sum of 20.000 70.000 Euro is related to a lawsuit in court. In the Netherlands there are 25 patent related court cases a year compared to 141.000 that are in force in the Netherlands. The reason for such a low cases is that in case of infringement both parties rather settle among themselves instead of going to court (RVO, 2018).

3.2.1 Protection in Practice

One of the common problems is that a patent gives a false hope of security for the owner by thinking that a patent is a protector of your invention. One must note that a patent is nothing more than a registration that the person is the owner of an invention, nothing more than that. It does not mean that he person has the right to commercialize the invention without problems related to other parties. This becomes clear in the following example.

If there is an patent which consist out of part A B C D and you make an invention by doing A B C D E F a patent is granted to the inventor. The reason for this is that E F meet the criteria for being innovative by using specific non public knowledge. However that does not mean that the invention can be exploited because there is an infringement with the patented

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which has the A B C D invention. At the moment the invention is commercially exploited the other party can take you to court.

Patent infringement is not a crime so it is placed under the civil law which means that you have to drag the other party to court yourself (Greenhalgh, 2018). At this point it becomes clear that a patent does not protect automatically. There is nobody such as a patent police which will take care about the infringement of the patent. The party who owns the patent should always scan the data base on infringement of their own patents. In case of infringement the same party has to drag the other party to court unless if it is within 9 months after the moment the patent was granted. In the latter case a special patent commission will look at the infringement instead of the court, so a lawsuit is not needed (EPO, 2018). One must note that patent law cases are different from what people expect. In case of infringement the judge will not punish or forbid the other party to exploit the product but rather seeks an agreement. The following example will make it clear. In case my neighbor punches me in the face in patent law world the judge will not punish or forbid my neighbor to punch me. The judge will ask me how much the neighbor has to pay me in order to punch me. In other words the other party has only pay the damage that they are causing but they can not be stopped by the judge to do damage.

The conclusion can be drawn from the above example that protection by a patent is not watertight. Still worse it can be even harmful to the invention. Due to the patent all the details of the invention become publicly available. Other parties can exactly see what the invention is and what the invention is about. Companies that have the financial resources to constantly monitor new patents applicants can therefore scan for infringement and take the owners of the patent to court in case of infringement. Often these companies that have these financial resources also have the financial resources to step into a long lawsuit which can be better avoided from a financial point in case the other party has low financial resources.

Secondly other companies can see your invention and inspire them to an innovation in the same field resulting in a competitor.

Thirdly Even if the invention is patented it can still be copied without infringement of the patent by using slight modifications. These modifications are the flexible boundaries of the invention as explained before in this section. In this way the copy is strictly not an exact copy of the invention so there is no infringement. Everybody can modify the original invention till it is not an exact copy and a patent cannot avoid this because patents cannot protect inventions

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with flexible boundaries as was explained in section 3.2.

Now the drawbacks of a patent were elaborated in this section it becomes less common to straightforward pursue a patent on an invention. It can even be harmful as explained by being publicly visible.

3.2.2 Patent Ownership

In the patent industry there is a clear distinction between the patent inventor and a patent owner. The inventor is never a company but an ownership of a patent can be hold by a person or a company (Neustel Law Offices,2018). However there are multiple strategies to make use of somebody else patent without infringement which will be listed below.

1. The founder(s) of the company own the patent

2. The company has a patent on his own name

3. Attracting an investor who owns a patent

4. Licensing a patent from an other party

5. By acquisition and merges so the company can use the patent

It can be seen that the patent ownership and usage can vary widely and ownership is therefore not clearly at first glance. In this research only patents that are owned on the companies name are considered. Other constructions are not visible in the patent register without deep research for each separate company considered in the research.

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Chapter 4 Branding and Confidential Clauses

This chapter elaborates on other protection strategies like branding and confidential clauses. These informal strategies are not bound to laws like patents and are therefore more flexible to apply. Besides this the invention does not have to be revealed in detail as with patents.

4.1 Branding

Two well known examples of companies who used branding as strategy for their products are Coca Cola (Kapferer, 2012) and WD-40 (Klara, 2018). One must note that both companies used a different branding strategy which will be elaborated further in this section. Compared to patents as protection strategy, branding includes more opportunities, flexibility over time and therefore reaching more goals. Section 4.1.1 elaborates on the classification opportunities by the branding strategy. Section 4.1.2 elaborates on the influence a trademark has on the branding of an product.

4.1.1 Classification

Classification provides the ability to control how the market will interpret the product. An invention should be classified so that consumers can understand the products because they can put the product in some class. In case consumers cannot classify the product in a particular niche the invention will not be understand by the market. The effect of this will be that the invention will fail because consumers and investors dont understand the products. The branding strategy can avoid this by providing the right story around the invention which explains the invention and places is it in the right context. The consumers and investors will now have a more clear understanding about the invention. There are three main points on which classification

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has an effect on (Kuijken et al., 2016), these will now be elaborated.

First consumers who are confronted with a new product and unexpected knowledge may experience mistrust. This happens in case the expectation of the consumer does not match with the experience and feelings a consumer get at the moment after confrontation with the product. The consumer may feel that the producer provided them incorrect information.

Secondly unexpected information must never go in hand with cognitive effort. At the moment consumers have to think very thoroughly about the information about the product they feel that making the decision about it is very difficult. Providing more information to help the consumer make it even worse because consumers experience confusion because they are overloaded by the information increasing ambiguity.

Thirdly a consumer can classify the product in a wrong class as it was actually meant to be by the producer. This becomes clear by using the following example. A product is launched as mass spectrophotometer for measuring fat in products. The consumer taught it was meant for science, so they interpreted the product as scientific, let alone understanding what a mass spectrophotometer is. The producer actually classifies it as an diet tool, so here the mismatch between producer and consumer occurs.

Coca cola strategy philosophy is that they want to classifies their product by taking avail-ability, affordability and awareness. Coca cola should be in reach everywhere and must be cheap (Kapferer, 2012). This way they want to pursue their ambition for being the best and cheapest soft drink in the world.

4.1.2 Trademark

A trademark makes a product instant recognizable by consumers. In a market which is saturated with products it is important to differentiate the product from the rest of the market, otherwise it will be lost in the crowd of products.

Over time when the business grows, the trade mark increases in value (Sandner,2009). A high value makes it possible to expand your business to other categories and to be attractive for accusation by other firms which will be explained now.

In order to perform category expanding it is important to have renown in the field where the company originally started (Dubois, 2012). An example is the fashion industry where high couture firms after being successful and earned renown by producing clothes now shifted to perfume, jewelery and other accessory. The renown of the trademark made it possible to do

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that, worse still people often buy the items only for the trademark on the products (Black & England, 2018). In the fashion industry it can be seen that investing in an appropriate trademark for the industry can lead to new opportunities which without trademark were not possible.

Trademarks dont expire over the years the trademark for pepsi-cola was registered in 1896 and that of Mercedes in 1900. Still they are fresh recognizable and not outdated. By being so long visible around in the market with a trademark a company can build a story around it. This story gives them access to multiple marketing strategies. Like for example we have 60 years of experience or building a marketing strategy of nostalgia (Friedman, 2018). One company which does not make any marketing and just uses their nostalgia strategy is WD-40. This lubricant factory uses their trademark in combination with nostalgia. Everybody knows from their childhood a can or spray of wd-40 in the basement or garage. Nostalgia marketing strategy saves a lot of money and has a self enforcement effect because each new generation is affected by the old one without spending a dime on it from the producer point of view (Klara, 2018).

4.2 Confidential Clauses

A confidentiality clause is a legal agreement between parties that state to keep information con-fidential, prevent disclosing of information. Confidentiality clauses are not only used between employee and employer but also between independent contractors, inventors and suppliers (My-ers, 2018). The agreements about confidentially can be in any type of agreement from simple and straightforward to very specific and detailed. The broader and less specific the agreements are the less problems they cause over time. For example in case there is an agreement with and employer and a software engineer. The work of the engineer will change over time making the agreement about confidentiality outdated. By using a NDA (Non Disclosure Agreement) gives the possibility to claim monetary claims, although it is hard to put a money amount on the breached NDA in case of a lawsuit. One must note that an NDA strategy protection infringes with an patent strategy on the invention. NDA contradicts with a patent because a patent reveals the details of the invention to the outside world and makes it publicly known and a NDA blocks the strategy of making information publicly known (Gorman, 2018). A company should therefore always make a decision which protection strategy they will use because if they chose for an NDA the option for a patent becomes difficult.

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Chapter 5 Hypothesis & Method

This chapter elaborates further on the insights gathered about the different protection strategies in chapter 3 & 4. It became evident that patenting is not the most effective manner of protecting inventions due to the inflexibility an passiveness. In this chapter therefore a hypothesis is formed about the biomedical and ICT service industry based on the findings in the previous chapters 3 & 4. The hypothesis will be subjected to statistical methods explained further in this chapter.

5.1 Hypothesis

Based on the elaborated strategies in chapter 3 & 4 a hypothesis is developed which will be tested in this scientific research. Companies and start-ups have multiple strategies to choose from like branding, patenting, trademark and NDA. Each strategy has his advantages but also their disadvantages based on the situation where the company or startup is at that moment. This situation is not only limited to the resources of the firm but also in which market they operate in. Branding is easier to perform in the fashion industry than in hardware. The hardware industry were R&D is a core business patents as strategy to protect intellectual proprietary is unavoidable. In the food&drink industry like Coca Cola a NDA about the ingredients are enough to protect and also contribute to the marketing by introducing the additional mystic created around the product caused by the NDA. This strategy does not work at a bio chemical/medical industry about DNA modifications which is abstract and not understandable for outsiders.

Based on these insight the hypotheses is formulated that venture capitalists, when large investments are done, care about intellectual property protection but that the strategy preferred is depended on the industry. Venture capitalist pursue maximal growth of a startup or company in case of an IPO as exit strategy and therefore the startup or company has to find out which

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protection strategy lead to rapid growth without increasing competition in the market. As explained in Chapter 3 patents have as main disadvantage that the invention is revealed and that copying and adding small changes is enough to avoid infringement with the patent. In chapter 3 this was described as taking advantage of the flexible boundaries which make the patent vulnerable. The risk of generating competition the business will be less profitable and less growable so avoiding patents would be a better option.

The hypothesis is that the biomedical/technolgy industry due to its abstractness decreasing branding possibilities and heavy R&D investments it is a patent intensive industry in order to be able to attract capital. For the ICT service industry the hypothesis is that due to the boundary flexibility of the innovations the industry is less suitable for patenting resulting in less influence of patents on the ability to attract capital.

5.2 Methodology

The methodology of this research has as basis that it prevents drawing a broad conclusion. That is why two different industries are taken so that the type of inventions are separated which are industry related. In this way a specific conclusion can be drawn on a industry. In this research the biomedical industry and the ICT service industry were selected. The reason for for selecting these two is that they are totally independent from each other and also have different opportunities to protect their intellectual proprietary. As mentioned in the beginning of this chapter one industry has the possibility to do a branding and trademark protection compared to an other which only have NDA and patents as option for protection. The selection of company is based on their date of IPO. The reason why the date of IPO is important is that after an firm has done an IPO the grow an innovation stagger of an company. After an IPO the focus shifts more to adding value and generating revenue for the shareholders instead of innovation and grow (Johnson &House,2015). Therefore the executive team after an IPO is replaced by an other team who is more a protector of the shareholders value instead of being entrepreneurial. An other reason as well to select companies that performed an IPO is because they provide publicly all the information about investments and investment rounds.

After an IPO is performed the company has more financial resources than before the IPO. This may influence the ability and behavior to buy other patents or create new patents. There-fore the data us selected in such a way that the patents required after IPO are split from the group of patents required during the period till IPO. Both industries have an IPO time

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frame from 2014 till 2018. . The patents which are registered on the companies name were selected manually from the European patent office. In this way only the patents on the name of the company were selected and not the other constructions explained in chapter 3 which are possible as well. The data about fundings rounds, amount, funding date and IPO date were collected manually from Crunchbase. The data is analysed in SPSS on the correlation and linear regression fit in order to conclude something about the effect on attracting capital by patents.

Both industries are subjected to an thorough statistical analyses which considers the relation between the funding amount and the patents required before the IPO. By using an least square linear regression fit the predictability of the model will me assessed. By adding extra terms besides the standard term of patentsbefore IPO their influence on the quality of the model is visualized. These extra terms are: the amount of funding rounds, time period till IPO and funding date. The quality of the model is assessed by following the approach of examining the plots of the residuals in combination with the correlation of the predicted values vs the total amount of funding. The correlation represents the linear dependency of the input values related to the output values and visa versa. In case there is a positive relation between two factors it does not necessarily mean there is a large correlation. Also the significant of the correlation between the input and output values in order to prevent a type 1 error which is assuming a correlation but in reality there is no correlation. If the significance of the correlation is larger than 0.05 it means that the correlation is just based on luck by the distribution of the data. In case it is lower than 0.05 it can be safely said that the data distribution is of enough quality to state that the correlation is not based on luck and thus a fact.

5.2.1 Statistical Analyses Biomedical

The biotechnology industry is analysed both on the funding amount of money as the funding rounds that were performed till the IPO. The hypotheses for the biomedical industry is that because of the large investments, R&D and the lack of branding possibilities patents play an important role in attracting capital. It was assumed that large investments for R&D must be backed up with patents because in case of failure the investors have still the patents as an asset. Also the abstraction of the products prevents effective branding to the public so patents should be the only effective manner to defend the invention.

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Figure 5.1: The effect of patents on the funding amount

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Figure 5.3: Correlation between patents before IPO and total funding amount

In fig. 5.7 the regression fit shows us that there is that there is a lot of scatter around the regression line leading to an low R2 = 0.008. This means that the model explains only 0.8% of the response data around its mean. In order to look if there is a bias in our model a residual plot is made of the regression model. The residual plot in fig. 5.2 shows that the unstandarized residual are not plotted equally around the horizontal line. Only regression models which have an residual plot where the data is equally distributed contain no bias. In this case there is a bias so more terms are added to the model in order to enhance its quality. Also the correlation of 0.089 represented in fig. 5.3 with a significance level 0.568 explains that the extreme low correlation does not exist even thought the regression plot in fig. 5.7 represents a positive regression line.

In order to improve the model additional terms are added. In this case the time period till IPO is added in order to see the effect on the quality of the regression fit model.

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Figure 5.5: The residual plot of the multiple variables regression

Figure 5.6: The correlation between the variables and the funding amount

[ht]

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By introducing the time period as extra variable the R2 = 0.022 meaning that the model explains only 2.2% of the response data around its mean as can be seen in 5.4. This only an marginal improvement compared to the previous regression which included only the patents before IPO as variable. The correlation of 0.147 as represented in fig. 5.6 is still not statistically significant with 0.341. By adding the time period term to the regression numbers improve but still they are not of sufficient quality to draw any conclusion.

The model is improved further by adding an adittional variable funding rounds.

Figure 5.8: The regression including multiple variables

The extra term funding rounds the R2 _{= 0.061 meaning that the model explains only 6.1%}

of the response data around its mean as can be seen in fig. 6.1. The correlation increaes as repsented in fig. 6.3. In fig. 5.9 the residuals show that there is still an bias present so the terms are not contributing in a way to reduce the bias in the model.

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Figure 5.10: The correlation between the variables and the total amount of funding

[h!]

Figure 5.11: The coefficients of the regression fit

Now the strategy is used by removing the term time period and introducing the founding date. The removal of the time period is to prevent multicollinearity because founding date and time period are highly correlated with each other. In fig. 5.12 it becomes clear that the R2 _{= 0.016 which lower than in the case of the regression fit includion the variables time period}

and patents before IPO. The significance of the correlation between the variables and the total funding amount is decreasing as is represented in fig. 5.14. The residual plot in fig. 5.13 still

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represent a bias in the model.

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In the last case the variables funding rounds and patents before IPO are used for the regression fit. In fig. 5.16 the R2 = 0.042 and the correlation in fig/ 5.18 of 0.204 with an significance level of 0.184 are represented. The best fit till know is the one with the variables time period, patents before IPO and funding rounds. However the model is still missing important terms to increase quality. This will be discussed in the discussion part.

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5.2.2 Satistical Analyses ICT Services

The hypotheses for the ICT service industry is that due to the ability to differentiate themselves from other companies they need less patents in order to attract funding rounds. As a result

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by not having patents investors have no assets in case of failure so the companies need more funding rounds till the IPO. Althought the European union law has mentioned that from 2015 (Verlaan,2018) software and automatic processes cannot be patented. This means that software can never be patented but only hardware. This will be elaborated in section 5.3.2.

The ICT industry will be now statistically analyzed. In 5.20 a simple regression is fitted between the patents before IPO vs the total amount of funding. The R2 _{= 0.192, this means}

that the model explains only 19.2% of the response data around its mean. At first glance this is not bad but looking at the residuals plot in fig. 5.22 shows that the data is severely biased. So the regression fit is of very bad quality even thought correlation is 0.483 as represented in fig. 5.21 with an significance of 0.015.

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In order to improve the quality of the model extra terms are added like the ones in the biomedical section. The extra variable is the time period till IPO.

As can be seen in fig. 5.23 the R2 _{= 0.218 which is increased compared to the previous}

regression fit. The correlation between the variables an the total funding amount is 0.467 with an signifigance level of 0.009. The correlation doest actually exist and is positive as represented in fig. 5.25. The residual plot in fig. 5.24 shows that there is still a large bias present.

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An additional term funding rounds is added in order to improve the quality of the regression model. In fig. 5.27 the regression is plotten with an R2 _{= 0.814. The correlation in fig. 5.29}

increaed to 0.902 with a significance level of 0. The residual plot of the regression in fig. 5.28 is improved and the bias is reduced, still there is a severe bias.

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In fig. 5.31 the new regression line with founding date as variable is introduced. Time period is removed in order to prevent multicollinearity, because time period and founding date is higly correlated. The R2 _{= 0.249 and the correlation between the variables and the total}

amount of funding is 0.499 with an significance level of 0.005. The residual plot in fig. 5.32 shows still a bias.

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In fig 5.35 the last lineair fit including the variables patents before IPO and funding rounds is made. The R2 = 0.811 and the correlation between the variables and the total amount of funding is 0.9 with a significance level of 0 as represented in fig. 5.37. The residuals plot in fig. 5.36 still show an severe bias.

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Figure 5.37: The correlation between the variables and the totall amount of funding

From all the regression plots made in this section about the ICT service industry the one which includes the time period, patents before IPO and funding rounds. However the model is

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still missing important terms to increase quality. This will be discussed in the discussion part.

5.2.3 Comparison of industries

In the previous section the Biomedical and ICT service industry were subjected to statistical analysis. For both industries the linear regression line which fitted the model contains the 3 variables time period, patents before IPO and funding rounds. However one must note that both regression lines of both industries are victim of severe bias. This means that terms are missing which lead to a proper fit without bias that can be visualized in the residual plots.

The bias is for both industries different. The data for the ICT service industry is highly skewed distributed because a lot of companies do not own a patent on the name of the company. Due to the 0-side skewed distribution the added extra terms to the regression fit do not improve the bias. Due to the concentration of the data around the zero patents the correlation of the simple linear regression between between the patents before IPO and the total funding amount in the ICT service industry is already high. The further improvements by the added variables increases the colleration between the funding amount and the variables. However one must note that this picture is misleading because the residual plots show that the model are severely biased.

The Biomedical industry has a better distributed data therefore the distribution itself is more evenly distributed. Also the data is more scattered which leads to the fact that an simple regression is insufficient and a multiple regression strategy is required to asses an appropriate fit. Every regression model shows still an bias and the correlation becomes not significant. In short there is some missing term in the linear regression to get an appropriate linear fit. This is caused by the complexity of patenting leading to distortion in the data. The effect of complexity will now be explained. In the next chapter conclusions will be draw on the basis of the research results and theory provided till now. Also the missing term that leads to a better fit will be explained in the next chapter.

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Complexity will be now explained now with an example. In the case when temperatures are rising the human body produces more sweat in order to keep the body temperature normal. This is a causal process and also has a high correlation because it is a complicated process of the human body but fully predictable and understandable. The next step of producing more sweat and the consumption of H20 is also causal but there does not have to be a high correlation. This is caused by the complex process of human behaviour, where other circumstances at that particular moment can influence or even block the direct causal relationship like for an example a conversation with somebody else or something other interesting happens. These factors represented in fig 5.39 may influence whether or not the end result of the causal relationship will be visible by the noise the external factors create. In the next section elaborates more in detail on the companies which are compared with each other.

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5.3 Companies in Detail

In this section both industry are analysed in detail by picking all the companies companies which have zero patents and still were able to attract capital. In this section a better insight is gathered about the possibilities of other constructions for patent than ownership on the companies name which was explained in section 3.2.2. Therefore now a deeper look is done on individual companies which are represented in the appendix for both industries.

5.3.1 Biotechnology Industry

Nightstar Therapeutics is a spinout of the the university of Oxford. The firm focuses on treatments for rare retinal eye diseases which lead to blindness. These diseases are treated by a special gene-therapy. This therapy was developed at the university and is now further developed. The company owns the license of the oxford university.

Here can be seen that even if they dont own a patent they still have to only right to pursue these gen-therapy activities. The protection is provided here by licensing the rights of the University. In this way investors know that there will be no competition on this particular gen therapy of the eye diseases. Here the complex situation about the social environment where Nightstar Therapeutics operates in becomes visible. Their relationship with the university prevented the patent route by providing the licensing opportunity.

Bonesupport AB is a orthobiologics company that develops and markets Cerament. These are injectibles that have an effect to heal bone defects. These can be caused by trauma infec-tion disease or surgery. Bonesupport is backed by an portofolio of intelectual property which containts approximatelly 100 registered and/or pending patents.

Here it also becomes clear that the company does not own patents on their own name but are backed by an portfolio of patents which give investors security.

Lysogene focuses on clinical development and basic research of gene therapy for neurode-generative disorders. They aim to improve radically the health of patient with incurable life threatening conditions. This is done by delivering genetic material to the central nervous sys-tem. Dr Ralph Laufe hold 20 patents on his name. Here it can be seen that the patents are on the members of the board name.

From these three companies which do not own patents on their own name it become clear that they own patents but they use different constructions. Varying from licensing from uni-versities to owning a patent on the founders name. This makes it possible to influence investors

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to invest money in the company without having patents on the companies name. This complex process creates noise in the correlation graphs reducing the correlation by increasing the spread around the regression line.

5.3.2 ICT Service Industry

Looking at the companies that operate in the ICT service industry it can be seen that a lot of them don’t own a patent at all, not even under an other construction like in the biotechnology industry. The Supreme court in the United states of America did a correction in the patent application procedure about software in 2015 ( Verlaan, 2018). This lead to the discussion that many old patents before that date became invalid. The supreme court mentioned that hardware technology can only be patented because software is just only a concept or idea which can never be patented. The reason why this is the case is that software is programmed by an language and is actually a description of the idea. Patent applications require clearly defined boundaries of the concept which is impossible to do with software. As explained in section 4.2 software evolves over time which will make a NDA outdated very quickly and also by the flexible boundaries of the concept as explained in chapter 3. These are the reasons why software is only protected by copyright and not patents. Also because programming language is describing an idea or concept it conflicts with the freedom of speech as the judge said in the supreme court( Verlaan, 2018). In Europe the procedure for software patent application was already before 2015 hard compared to the USA but after the supreme courts decision in 2015 it becomes even harder due to the changing interpretation of the law now. One must note that in the patent register system both in the USA as in Europe there are registered patents which are still registered as viable because they are before 2015. In case of infringement of these patents only a lawsuit can make them invalid, this will not happen automatically after 2015. In other words they can only be made invalid by an lawsuit, until then it remains registered as valid even if it is already clear that it becomes invalid after 2015 in front of the judge.

This thesis focuses on companies that are located in Europe and also the European Patent Office was used as database. Therefore in this research the interpretation change of the law by the supreme court in 2015 in the USA has barely influence because in Europe it was already pretty hard to get a patent on software ( Verlaan, 2018). Analysing the data about the patents in the ICT service industry shows that a lot of companies are registered with 0 patents under their name and dont even have patents under an other construction like in the biotechnology industry.

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Chapter 6 Conclusion

The purpose of this research was to find an answer on the research question: Does patent ownership influence positively the ability to attract capital from investors till the moment of IPO? In this research the biotechnology/medical industry and the ICT service industry were subjected to the research. These two industries are different from each other and therefore interesting to examine in order to conclude if the effect of patents is also industry related. The biotechnology is a more abstract industry were branding possibilities are limited compared to it service industry were consumers understand the products and the direct contact with customers. In the latter industry there can more be done from a personal branding perspective.

At first glance all the scatter plots of the variables vs the total amount of funding in both industries show a positive relation. Otherwise the regression line would not have a positive slope coefficient in all the investigated cases. Nevertheless the quality of the regression fits must be enough to say something about the effect of patents on attracting capital. In the case of the biomedical industry the correlation between the patents in combination with other variables vs the total funding amount does never get significant and all the models have a bias. If the correlation between patents and funding is not positive it does not automatically mean that there is no positive effect of patents on attracting capital. There is only no linear depended effect, because correlation represents the linear dependency between the variables an the total funding amount. The fact that the models are biased and that the biases can not be vanished by the adding terms like time period, funding date funding rounds and patents before IPO means that there is an important term missing. For the biomedical industry it may be caused by the term which includes the flexibility of the boundary of the innovation. The influence of this term can be so big that the term patents before IPO is of minor importance. In other words it is about the patents before IPO with fixed boundary structures. The following plots

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and tables are related to the best fitting linear regression model for the biomedical industry.

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Figure 6.3: The correlation between the variables and the totall amount of funding

[h!]

the R2 _{= 0.061 meaning that the model explains only 6.1% of the response data around its}

mean so the predictability of the model is low. Also the correlation of 0,246 is not statistically significant with an p-value of 0.107 because it is larger than p=0.05. The residual plot is not summetric which means that there is bias.

The answer on the research question for the biomedical industry is that patents required before IPO in general do not linearly relate to more funding. In other words patenting just for the sake of patenting does not lead to funding financial benefits. There is a missing term in the regression fit and by trying multiple combinations of variables the flexible boundary of the innovation may be the missing one.

The following plots and tables are related to the best fitting linear regression model for the ICT service industry.

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Figure 6.8: The coefficients of the regression model

the R2 _{= 0.814 meaning that the model explains only 81.4% of the response data around}

its mean so the predictability of the model is high. One must note that most companies have 0 patents in the ICT service industry. Therefore the predictability of the regression is obvious high. Also the correlation of 0,942 is statistically significant with an p-value of 0 The residual plot is highly unsymmetric indicating an huge bias. Due to the fact that the variables hardly have influence on the residual plots compared to the biomedical industry it can be stated that patents have no influence on the funding amount.

The answer on the research question for the ICT service is that patents required before IPO have no relation to more funding.

This master research elaborates on two precious researches, the conclusions of these two researches are now compared with the conclusion of this report. Comparing the conclusion with the other two researches which were elaborated in chapter 2 it can be said that results of the research are in line with the research in section 2.2 which concluded that patents have are positive affect during the first 2 seed rounds in the biotechnology industry in the United States of America. One must note that this master thesis can not proof that the relation between patents and funding are correlated caused by the missing fixed boundary term.

The PhD research which was elaborated in section 2.1 which concluded that patents do not have an effect on business growth. This contradicts with the findings in this report about investments. One must note that this report shows that patent intensity is industry related. It may be that the small midsize cap which was researched in the PhD research had innovations with flexible boundaries. These innovations are not suitable for patenting as concluded in this master thesis. This may had lead to the conclusion that for small midsize cap firms patent do not lead to business growth. In order to prevent this ambiguity it is important to dive deeper into their inventions one by one in order to see if they are actually patentable. This will elaborated in the next chapter.

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Chapter 7 Further Recommendations

The results in the research show that there is a missing term for the bio medical/technology sector. This term may be the missing fixed boundary term. In order to test this each patent of a company should be tested if the innovation has fixed or fluid boundaries. By introducing dummy variables the patents of the particular company can be categorized. Flexible gets 0 Fixed gets dummy variable 1. Now these dummy variables can be added to the linear regression fit in order to see how the quality of the linear regression fit improves. If this strategy may not improve the quality of the model then there is 1 other strategy left about scrutinizing the effect of patents on funding amount. This strategy is researching if there is a causal relation between patenting resulting in more funding or that it is other way around that more funding leads to more patenting. The answer on the research question of this thesis is very important for startups because in the beginning funding attracting money costs the most equity. So it is of crucial importance that in a early stage of a startup the attracted capital is not wasted on patents if it is not needed which results in unnecessary equity loss.

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The effect of patent ownership on attracting capital for IPO firms

MSc Entrepreneurship

Master Thesis

The effect of patent ownership on

attracting capital for IPO firms

Francesco Nostheide

August 16, 2018

Supervisor:

Dr. Michele Piazzai

Assessor:

Preface

Abstract

Contents

Chapter 1

Introduction

Chapter 2

Previous Research

2.1

Intellectual Propriety Protection SMC

2.2

Effect of Patents on Seed Rounds

Chapter 3

Protecting Intellectual Proprietary

3.1

Small Businesses and Startups

3.2

Patent Apllication Procedure

3.2.1

Protection in Practice

3.2.2

Patent Ownership

Chapter 4

Branding and Confidential Clauses

4.1

Branding

4.1.1

Classification

4.1.2

Trademark

4.2

Confidential Clauses

Chapter 5

Hypothesis & Method

5.1

Hypothesis

5.2

Methodology

5.2.1

Statistical Analyses Biomedical

5.2.2

Satistical Analyses ICT Services

5.2.3

Comparison of industries

5.3

Companies in Detail

5.3.1

Biotechnology Industry

5.3.2

ICT Service Industry

Chapter 6

Conclusion

Chapter 7

Further Recommendations

Bibliography