Various companies I meet every week constantly bring to the forefront the ownership of some IP patent. Some of these companies believe that the patent by itself will guarantee that investors will be knocking down the door. I am always skeptical of these valuations. As such I always beg to differ, and I have a real life experience example to demonstrate the issues raised when IP patents become the key valuations for a company.
When I was working for a VC fund in New York, I had been introduced to a company with a patent that serviced certain components of on-line banking. The company had been attempting to raise money for over a year without success after the final patent had been granted. The CEO, a Korean immigrant, had been a successful banker having established the largest Korean-American bank in New York City. One of the principal investors had successfully sold banking software to Japanese banks. The company also included senior managers from notable companies, albeit located in different parts of the U.S. With no revenues, the books indicated a valuation of $1 million. I inquired as to the valuation, and the CEO informed me that the IP law firm made that determination.
I familiarized myself with the PowerPoint presentation for investors and recommended that it had to be re-written. After rewriting the presentation, I later forwarded it to a VC fund located in Boston that focused on banking technologies. An afternoon meeting was set up in Boston. Mind you that I did not have the opportunity at looking at the company’s financials and long term strategy as of yet.
The group travelled to Boston together. A couple of hours prior to the meeting, the head of marketing decided to make changes on the presentation, something that immediately concerned me. The timing was inappropriate. And I always suggest that changes should be discussed with the team, not done unilaterally. Presentations made for Wall Street, VC funds should be meticulously prepared, not changed willy-nilly.
During the presentation, the subject about the projected sales came up. The Managing Director pointed out that in his decade of experience, companies with similar products only sold 30% of this company projected. In fact, companies in this industry sold very few of these products annually. When I heard this, I knew something was wrong.
When we returned to New York, I labored in doing the due diligence on the product and industry. Through various Internet searches, I found a published study by a MBA student. I also met with the Venture arm of the principal banks in New York, and asked how their investment fared for a similar product in the metropolitan region.
After these evaluations, I came to the following conclusion: the patented software product that facilitates on-line banking would never be a big money maker. Is anyone ever charged a fee to access on-line banking? The New York VC fund manager admitted that the investment in the IT for a similar company was simply used as a means to retain banking customers. The MBA study also came to the same conclusion. Somehow or another, the Company team never bothered to analyze the market and do a comparative analysis. The patent, however valid, would never be a profitable product. Therefore, the mere existence of a patent is not a guarantee for positive cash flows.