Patent Strategy Could Be Essential to Your Private Equity Business Plan

A friend of mine recently joined a small, privately-held consumer product company as its innovation manager. The company, which I will call "Cool Stuff," is owned by a private equity firm. The private equity firm purchased Cool Stuff about a year ago. Cool Stuff was essentially an established “mom and pop” company with a core product line. Cool Stuff has a couple of manufacturing facilities, but the primary value of the company is its relationships with existing customers (such as department and grocery stores) that will make it possible for new products to gain shelf space in department stores.

The private equity company's payback model centers on growing the sales of Cool Stuff by introduction of several innovative and differentiated new products (hence, the reason for hiring my friend). After these products are shown to provide sustainable profits for Cool Stuff, the private equity firm plans to sell Cool Stuff and earn several multiples of its investment within about 3-5 years of its initial investment. Of course, this short timeframe does not allow for misfires: execution of the private equity company’s business plan must be virtually flawless to be successful.

The private equity firm's plan is based on a tried and true business model—grow a previously somewhat moribund company to make it an attractive target of a larger company seeking to quickly grow its product line by acquisition. However, as an IP Strategist owner of an IP Strategy and Consulting services (more info here: http://www.jackiehutter.com/), I see a critical flaw in this business plan as it applies to Cool Stuff. Namely, the private equity firm does not understand the importance of patent strategy to realizing the desired payback from its investment in Cool Stuff.

Although innovative and differentiated, Cool Stuff’s products will be easy for a competitor to knock-off. For example, Cool Stuff is introducing a line of home products into a major department store chain in the next few months. These cleaning products are innovative and differentiated because they are made from recycled plastic and sustainable components. The products are also likely patentable because no one has ever put these components together before to obtain the unique properties exhibited by these products in use. Nonetheless, Cool Stuff’s products are effectively plastic and wood. If these products are successful in the marketplace, any competitor will be able to copy them. Cool Stuff will have developed the market for these innovative and differentiated home products, but will see this market deteriorate or disappear due to competition.

So, however innovative and different Cool Stuff's products are, why would a company pay several multiples of Cool Stuff's earnings to acquire this company if Cool Stuff's products can be copied by anyone? In other words, “why buy the cow when you can get the milk for free”?
Why some might say that it is not fair to "steal" the products of another company, without a patent or other type of intellectual property protection, this is the basis of competition. Therefore, for the private equity firm to obtain its desired payback, its management needs to ensure that Cool Stuff's innovations are associated with a strong patent strategy so that they can remain differentiated and solely owned by Cool Stuff. Moreover, if at least some of the company's innovations are not patentable, Cool Stuff should re-evaluate whether these products should be introduced at all. It is not necessary for all of Cool Stuff’s products to be patented, but the core innovations must be protectable and protected in order for Cool Stuff to constitute a viable acquisition target within its owner’s timeframe for sale of the company.

Of course, if Cool Stuff was valuable for reasons other than its product lines (such as in manufacturing facilities or the like), patent strategy might not be so critical to its owner’s ability to recoup its investment in the desired timeframe. But, this is not the case. Because innovative and differentiated products are the core of the payback strategy for Cool Stuff’s private equity owners, a strong patent strategy is a must.