Strategic Patenting in Venture Capital Backed Firms Ed Egan BPP Student Seminar Presentation Fall 2010

Three Reasons to Patent To appropriate economic value (Nelson 1959, Arrow 1962, and so on…) For signaling reasons (Spence 1970, Haeussler, Harhoff and Muller 2009, etc) For strategic purposes – TCE based strategic reasons (Williamson , Cockburn and MacGarvie 2009, etc) – Other strategic reasons? Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Teece (1986) Preparadigmatic (IP is of less importance) Paradigmatic (IP may matter) – Claim to Dominant Design: Need generalized assets to commercialize, but have strong TCE bargaining position (i.e. Holdup Immunity) – Technology dependent on others: Cospecialized Asset Problem, particularly a need to license underlying technologies and a weak TCE bargaining position – Importance of IP depends on appropriability regime Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Ziedonis (2004) Patents are exclusionary rights Not a right to commercialize if underlying rights are held by other parties Citations made are an indicator of underlying rights Fragmented citations made indicate: – Need to negotiate with many parties – Each piece of IP must be evaluated separately, not as a bundle Particularly a (TCE) problem without a “proud stack” Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Data VentureXpert: 26,583 VC portfolio firms from GNI: 10,134 IPOs (essentially the population on Amex, Nasdaq, NYSE) from of which 1,376 (14%)VC backed SDC M&A: 71,915 acquisitions from of which 4,088 (6%) VC backed NBER Patent Data: 2,414,214 patents (i.e. the universe of patents with valid assignees) from , with 20,063,230 forward citations. – Our 82,049 firms filed 104,129 (4%) of all patents from founding to exit and received about 6% of all forward citations. – About a quarter of successful VC backed firms have at least one patent, compared about 7% of non-VC backed firms. However, many non-VC backed firms will be effectively discarded by the fixed effects. Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Descriptive Statistics (p16) Average number of patents is low because most firms have no patents Conditional on patenting, patent counts are roughly comparable across VC and non-VC samples Without controls patenting is comparable across (successful) exit types VC backed firms take an average of 5 years to secure investment, and then 4 to 5 years to exit. Non-VC backed firms have comparable mean age at exit, but higher variance. Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

TCE Measures The Cospecialized Asset Problem variable is high when the firm’s patent portfolio is made up of only a small number of patents and the citations that the patents make (to other firms) are highly fragmented: The Holdup Immunity variable is high when the firm’s patent portfolio is made up of a large number of patents, which are cited by a highly fragmented set of other firms: Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Determinants of M&A (p25) The “Cospecialized Asset Problem” measure is positive, meaningful and highly statistically significant. The “Immunity from Hold- up Measure” is negative and weakly statistically significant VCs appear to solve the cospecialized asset problem! Immunity from holdup is correlated with IPOs for both VC and non-VC Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

A shock to the IPO market In terms of both volume and counts, IPOs dropped further than acquisitions following the dot com crash. VC backed IPOs were particularly badly hit Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation This shock is used as an (attempted) instrument for the TCE strategy ‘choice’ by venture capitalists.

Instruments For the appropriability regimes: – Could work at the industry or patent class level – Long list of court cases that have shocked certain classes: Diamond v Chakrabarty (1980) - Genetic organisms Diamond v Diehr (1981) - Software Texas Instruments (1985/6) Kodak-Polaroid decision (1986) State Street and AT&T vs. Excel decisions (1998) - Business methods – Some policy shocks: Hatch-Waxman Act (1984) drug firms 1994 TRIPS agreement Cockburn and MacGarvie (2009) use various shocks to software in the mid 90’s Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Problems Distinguishing Hypotheses Example: – Patents that cite or are cited by a future acquirer might be valuable for: Economic value reasons: they may measure technological “goodness of fit” and so economies of scale or scope Information asymmetry mitigation reasons (i.e. signaling): The denote technologies that both parties are intimately familiar with, and can accurately judge value Strategic reasons: The target can holdup the acquirer or vice versa, suggesting value from vertical integration (first best economizing) To distinguish between them, we need good instruments or discriminating measures. These are hard to find (more later). Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Patenting by VC Backed Firms Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

VC Patenting by Round (p19) The tables show patent incidence and conditional patenting rate. Successful exit goes up, persists, then drops below. – IPO goes up and stays above. – M&A goes up then drops below and stays below. No exit drops and stays below. Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

VC and Non-VC Patenting Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

VC vs. Control – Patenting (p22) Dependent Variable: Patenting Incidence VC backed firms are associated with higher incidence of patenting Difference between IPO and M&A is statistically significant Controls are loosely as expected Age control is only available for IPOs (with good coverage) Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation Z-scores in parenthesis

VC vs. Control – Patenting (p23) Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Citations to/from acquirers Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Citations to/from acquirer (p30) Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Citation timing (p30) On average the first patent with a citation to an acquirer is filed about 1.5 years after the first round of VC Citations to futures acquirers continue up until the acquisition Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation

Things to discuss Other Instruments (other than for the appropriability regime) – VC supply shocks (Prudent Man, CALPERS, SBIC program, Obama’s pledge) – Information asymmetry measures (Brander & Egan 2008) Key assumptions: – Granger causality and milestones – No predetermined exit path Comparing VC sample with the control – Problems with the acquisition sample – robustness checks may help – Notional problems – were these firms really at risk of getting VC – Suitability for some tests and not others – Other objections? Egan, Edward J. (2010), “Strategic Patenting in Venture Capital Backed Firms”, BPP Student Seminar Presentation