Patent Reform for Startups

September.19.2011

The “Leahy-Smith America Invents Act” represents the most significant overhaul of the U.S. Patent System since 1952. As its provisions roll out over the next 18 months, this first post-information age revision of the U.S. Patent System will have profound effects on startups.

Key changes to the patent system will include:

  • Shifting America from a “First to Invent” system to a “First Inventor to File” system for patent applications. The contest over establishing who was the first to conceive of an invention and who was first to reduce to practice will largely be abandoned in favor of a clearly ascertainable filing date in the U.S. Patent Office, effective 18 months after enactment.
  • Establishing a post grant review process. Competitors of any size will be able to challenge published applications, searchable on the U.S. Patent Office website, effective for all patents filed under first inventor to file system.
  • Elimination of the Best Mode Requirement. An inventor’s failure to identify best mode will no longer provide a basis for invalidity, effective immediately.
  • Expansion of the prior commercial use defense. Under the new system, this defense which previously only applied to business method patents will apply to all patents. Any company that was practicing an invention during pendency of the patent will have a unique and private defense, effective immediately.

How the New System Will Affect Startups

Under the current system, startups often begin in a low-profile ("stealth") mode, during which information and ideas are exchanged among founders as well as potential investors, VCs, and advisors. Few startups invest in an initial patent application during this phase, as their plans typically change during the first year of operation. As a result, patent applications are typically filed near the end of this twelve month period.

The new Act will significantly change this common timeline, as obtaining an early patent filing date could well become critical to secure both initial and later stage funding. Imagine a case in which a company spends the first twelve months working on its business plan, securing funding and generalizing its implementation of its initial product, while waiting until the end of the year to file a patent application. Under the new system, the startup will not be able to rely on engineering notebooks or other evidence of prior conception or reduction to practice. Instead, the filing date will become the definitive date for purposes of invention and prior art.

Publication of the application will then occur eighteen months after the initial filing date. Under the new system this presents unique risks to the startup since the company is largely focused on a single product or concept. Imagine a market in which several new companies all focus on the same product space with similar product ideas. Under the prior system, it was debatable as to who first conceived of any invention and who first reduced it practice. Special rules regarding diligence also applied for those that were first to conceive but second to reduce to practice. As a result, final determination of patent rights was reserved far into the future, during which priority might be contested and settled through litigation or addressed in an interference proceeding at the Patent Office.

Under the new system, the combination of First Inventor to File and the application publication requirement will mean that a typical startup’s first patent application will be published about two and a half years into its life. At the same time, other startups in the space will also be publishing their applications. For a potential investor, it could take no more than a few hours of keyword searching through the U.S. Patent Office’s database to determine the universe of patent applications filed within a two to three year period and then determine priority among them.

This emerging patent environment stands to significantly affect later financing rounds. Prospective investors will know quickly and with relative certainty who has priority and who does not. For the lucky first filers, this may increase the value of an early stage company. On the other hand, if a quick search reveals that a company is third or fourth in line and that prior applications disclose virtually all of its product ideas and inventions, then funding opportunities may entirely evaporate or result in greater consolidation and acquisition activity.

In short, the new First Inventor to File feature, combined with the subsequent publication of patent applications, will provide a new level of certainty to the patent system. This certainty will have an effect on the startup ecosystem as, even before patent prosecution, First Inventor to File status will have significant value.

Potential Response

Another legal shift likely to affect startups is the addition of new post-application and post-grant procedures at the Patent Office, which will allow later entrants to directly attack patent applications during the prosecution stage. Thus, where startups focus on a relatively small group of products or a single product idea, it may become common practice to bring a post-application or post-grant attack on a competitors’ patent. For example, in the new derivation proceeding, the first filer may be challenged by a later filer claiming to be the true inventor. The new post-grant review will allow a wide range of attacks on a patent. These lower cost methods for attacking patents will serve as alternatives to full scale litigation, which may eventually lessen overall legal costs, but are also likely to impose higher intellectual property costs earlier in a startup’s history. Rather than deferring litigation fees for several years, startups will now have incentives to launch early attacks on competitors’ patents through various proceedings at the Patent Office.

Further, in order to ensure that early patent filings are complete and robust enough to encompass maximum coverage and withstand attack, filing an early provisional patent application should be done with the help of patent attorney. Although retaining an attorney in this capacity may create early costs, the failure to do so could shrink or wipe out later opportunities. Specifically, if a company’s provisional patent application is weak or thin, waiting to file could be disastrous, as the early filing date is only useful in light of the disclosure set forth at that time. A provisional application lacking disclosures carefully crafted to support subsequent filings can profoundly undermine the value of a patent, and in turn, the valuation of a company.

Overall Effect

While the goal of the present patent act is to improve the system by creating greater certainty, that certainty will not be welcomed by at least half the population of startup companies generally focused in the space. It could lead later entrants into to a particular product space to launch attacks almost immediately against earlier entrants, leading to greater expenditures on patent prosecution, litigation, and administrative fees, which are likely to increase over time. However, the initial expectation is that the process will simply delay prosecution and allowance of claims and will further delay the issuance of patents since the impact of an issued patent in a product space with an early First to File date would be highly disruptive to the industry. Thus, attacks on a patent must be made early and hard, with well-researched and significant effort made in those attacks.

Conclusion

The patent reforms in the Smith-Leahy Act aim to improve the U.S. Patent System, by providing greater certainty to both investors and startups. But, in the context of early-stage companies -- with limited product lines which can be blocked by a relatively small number of patents -- that certainty comes at a hefty price. We expect savvy investors to insist upon full protection and immediate filing of all patents. The failure to do so could substantially affect later-stage investment and valuations.
Moving forward, in an ideal scenario, startups should consult closely with patent attorneys within one or two months of initially focusing on a product – as the best advice may very well be to file an initial provisional application earlier than prior practices dictated. Over the next 18 months, important strategic concerns will include filing high quality provisional applications as well as all possible high quality utility patent applications. Once the new system goes into effect 18 months from now, it will be critical to adopt the practice of filing high quality provisional patent applications as soon as possible.