How to use freedom to operate to reduce risk and help you close investment deals

If you don’t have internal IP expertise in your business then you’re probably not paying proper attention to freedom to operate (or FTO) and that will be exposing your business to significant risk. Not only that, but any exit or investment event will attract questions about IP risk and having FTO analysis ready to go will really help close those deals.

In my experience, FTO is probably the most neglected and misunderstood IP risk facing hi-tech SMEs. Many businesses are not alive to it at all or, worse, think that they must be okay because they’ve filed a patent (another blog explains why that’s a bad assumption). Of those companies that are alive to FTO, they often do it sporadically, too late and, I’m sorry to say, badly.

Aside from the business risk, if you’re looking towards an exit or investment event then people will start asking what shape your IP is in and whether you are likely to be infringing anyone else’s IP. Not having answers will make you look amateurish and might ruin the deal.

Let’s illustrate with a story…

You’ve had some customer feedback and identified a need in your target market. You have an idea for a new product that will meet that need and you talk to your R&D engineers and set them going on developing that product. This takes them off of other things, but you see this as important so you’re comfortable with that opportunity cost.

Over the next year or so, your engineers develop a prototype that does a great job. You demo the prototype to a few friendly customers (under NDA, of course) and they love it so you gear up for production. This means having tooling done, signing contracts for manufacturing (in Asia) and designing a new marketing campaign — a large part of your business is now focussed on this. It’s expensive, but you’re convinced this is going to be a key product so you stump up the cash and commit the resource. And anyway, you’re already taking orders and signing supply contracts with those friendly customers so you know it won’t lose you money.

You start to sell and the orders come flooding in. In no time it’s 40% of your total revenue and that’s growing rapidly. You’ve been talking to VC who is keen to inject capital so you can take the product global.

The VC starts asking all sorts of questions and wants to understand your IP position — have you protected the product and what is the situation with competitors and their IP? You don’t have any answers and it’s causing a problem with the VC, who is now expressing doubts and starting to chip away at the valuation of your business citing the increased risk.

And then you get a letter from a patent attorney who says their client (your competitor) has a patent that your product infringes. They want a meeting.

You have your own legal team look into it and they think the situation on infringement looks bleak. The VC is no longer taking your calls.

A stitch in time…

The above scenario is pretty ghastly, but it illustrates the point. If you don’t get FTO work done early then you risk losing all the resource you’ve invested, and investors will notice that risk and try to chip away at your valuation and in some cases walk away altogether.

Some work done at the very beginning would probably have identified the competitor’s patent. You might then have stopped the process there or guided the R&D effort to avoid it.

How should it be done?

I’m going to set out a methodology below that I’ve seen work well. There will be different flavours that others might favour and it can certainly be made more sophisticated, but this is a very good start.

The key point is that FTO should be done early and then used proactively as part of the R&D process, the analysis getting deeper as the risk to the business increases.

Phase 1

Right at the start of a new R&D project, have a patent search done that looks at the existing patent landscape. The search can be quite high level at this stage. You will need a patent attorney to analyse the search results, but the analysis can also be high level and you will need to guide your attorney on that. You just want to identify red flags and probably don’t need a report — delivering the results over the phone should be fine.

You now have some confidence that the direction you intend to go is clear and that you can avoid major risks, making it much more comfortable to commit the resource.

Phase 2

Build in a stage gate for when you will revisit FTO. This might be based on time (i.e. in 6 months) or a project milestone. Do a deeper search and have some deeper analysis conducted. This makes sense now as you will have a better idea of what the final product will look like and so the search and analysis can be more targeted.

You probably still don’t need a full FTO report, but it might be useful at this stage to understand what features of your product are new when assessed against the patent documents returned in the search. A high level document setting that out, possibly in a table, would be a good reference for you as you develop the next phase of project work. Again, you might need to give explicit instructions to your attorney here to let them know what level of work you need.

Phase 2 can help guide further R&D as well as those novel features helping with marketing and possibly opening areas where you might start to protect your own IP. You will also feel confident as you commit further resource and begin to sign contracts.

For large projects there may be a number of iterations of Phase 2.

Phase 3

When the project nears completion and the product is almost ready for sale, you might then want to finish off the FTO work with a final top-up search and bring everything together into a full FTO report. There should be no major surprises at this stage and the main point of the exercise is to get documentation (the FTO report) so that it can be used to demonstrate risk management during an exit or investment event. The FTO report should summarise the work done at Phases 1 and 2 so that the full story is told and can be seen by investors.

What I have seen more typically is that nothing is done on FTO or that Phase 3 is done too early. If all 3 phases of the process are followed then the FTO work you have done will be proportionate to what your business needs, can guide R&D and will give you and any investors comfort at each step on the journey that the risk is being managed.

Photo by Sora Shimazaki from Pexels

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