If I'm an inventor, and I have an idea for a valuable patented invention, why can't I pitch investors for funding, in exchange for an interest in the IP?

Or does this exist? If so, what is it called?

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The premise isn't exactly right here. There are venture backed companies that primarily develop and license IP, like Qualcomm, ARM, and RAMBUS. Plus, like, the entire biopharma industry. Sometimes companies make spinoffs that just hold IP for joint ventures with other companies. So this does happen; there just needs to be infrastructure to use the IP, like people to manage the licensing process and a corporation to actually hold the IP, since it always needs to be assigned to someone (IP cannot legally exist in the ether). Investors do also sometimes take royalties in exchange for funding, which is like taking a stake in a patent.

What is true is that this isn't quite institutionalized in the sense that there aren't patent funds that just invest in patents. The closest is companies that acquire patents, like Intellectual Ventures. Note that in all of these instances there is a lot of diversification; you probably will attract investment in an ongoing R&D effort that monetizes through patents more so than just a patent itself, even in the above examples.

I think the reason for this is that the risk/reward profile isn't there. Inventions have the same risk regardless of monetization method, but you have less control in the outcome if you just get an interest in a patent since so much of the commercial success has to do with other things which require people. Plus your margins will be higher but your revenue will be lower.

It's called getting a job.

The returns to patents follows a power law distribution (PLD), just as VC-backed companies do, but it is even more extreme. The exponent for VC-backed startups is close to but just under 2*, it seems, while Nordhaus writes that the exponent for the return to patents is between 1.3 and 1.7**.

I don't have an answer to your question! But it has always struck me that venture capital returns should cluster just below the PLD alpha of 2. This value is important because when you calculate the mean of the PLD, it goes to infinity as alpha goes to 2. (This means that if venture capital follows a PLD, and if the alpha is less than 2, and if there is no tail-off, that the mean return on a company would approach infinity. Each single return is finite, of course, but the more companies you invest in, the higher the mean return you will get.)

There is also some evidence (Neumann, op cit) that VCs can choose their alpha. That early-stage investors choose a slightly lower alpha than later-stage investors and that private equity investors choose an alpha greater than 2.

Alpha, besides determining the average of the PLD, also determines its variance. The lower the alpha, the higher the variance. The variance, in turn, is a useful measure of investment risk.

So, a hunch: as you lower the alpha of the PLD you choose to invest in, you increase both risk and mean return. But when the alpha goes below 2, mean return goes to infinity. There's no point in going any lower.

Of course, a portfolio of patents should approach infinity faster than a portfolio of startups (meaning you would need fewer patents in the portfolio to expect a desired return than you would need startups) but this is misleading: the lower alpha PLD has a longer tail, offset by a bigger base...any single pick from that distribution is likely to be worse, while that one single homerun is likely to be much better. So, in theory, you should expect a better return with a smaller portfolio than you would with startups, if you are optimizing to a specific overall return (say, 3x) then you would have to have a larger portfolio. (That is, you have fewer hits, though the hits are bigger.)

You can see this if you look at press releases of university tech-transfer offices. They often brag about that one patent that has been 90% of their return over their history.

If you are managing someone else's money, you want to maximize your return, but you are also motivated to minimize your minimum return, so you can keep your job. In this case, you would need to build a really, really big portfolio of patents, much larger than the portfolio of startups you would need. You would also need more time for the patents to come to fruition. It's not a stretch to see why, under these conditions, patents would primarily be funded by entities investing their own money (universities, large corporates, individuals, etc.)

 

* Neumann, Power Laws in Venture, https://reactionwheel.net/2015/06/power-laws-in-venture.html

** Several papers: Nordhaus, W.D., (1989). “Comment on Zvi Griliches’ ‘Patents: Recent Trends and Puzzles'”, Brookings Papers on Economic Activity: Microeconomics, pp.320-325; Scherer, F.M., Harhoff, D. & Kukies, J., “Uncertainty and the size distribution of rewards from innovation”, Journal of Evolutionary Economics 10, 175-200 (2000); Scherer, F.M., “The Size Distribution of Profits from Innovation”, Annales d’Economie et de Statistique, No. 49/50, (Jan-Jun 1998), pp. 496-516.

VC works because making a startup can be extremely profitable. Making patents used to be quite profitable, but is that still the case? I can't recall seeing someone make lots of money from their patent in recent years. (The exception is the pharmaceutical industry, where patents seem to de facto work differently than the rest of the economy. This industry does have financial mechanisms for incubating patentable innovations, which is fortunate because developing the patented products is ridiculously expensive.) When I hear about patents being used these days, it's mostly as passive deterrence weapons in lawfare between giant corporations, or bad-faith patent trolls, and not as the basis of profitable production like you'd hear about in earlier times (again, except for pharmaceuticals).

So my guess is that something in the legal system changed to make patents not lucrative for most people, and the apparent lack of funding for patents is a rational response to that.

It's probably worth noting that this could also just be because this pipeline doesn't seem to exist. Like I know Peter Thiel comments that today a letter from Einstein would get lost in the mailroom of the white house.

Today, I could probably email HP the specs and proof of concept of a brand new kind of printer that printed an order of magnitude cheaper, was way easier to connect to, etc. And there's little chance they'd see it or respond. I think discounting the possibility that this just doesn't happen often because corporate bureaucracies aren't set up ... (read more)

So this is interesting because I have no clue if it exists. But it did!! This was the one and only thing the small R&D departments of large companies did in the US in the very early 1900s. 

Tons and tons of home inventors/amateurs would submit patents/specs to them to look over. The department would assess their scientific/technical validity and think about if they could profitably use the invention.

If they could, they'd come to an agreement with the inventor who sent it in. And it was efficient because there was no expectation for the inventor to also start the business that built on their patent. The company that already had the scale and ability to do that just bought your idea and then you could go on to the next one.

This equilibrium started to dissipate some time around like 1920-ish very roughly as more and more companies built internal R&D teams that did actual research/contracted with university professors to do it.

I talk more about some of this here: https://freaktakes.substack.com/p/is-americas-applied-and-basic-research?s=w

But in general, I completely agree with you that this is a criminal market oversight if it doesn't exist. And, more than that, it would just be cool and fun. 

Interesting to think what changed in that time period. Ideas prior to 1900 or so would have been primarily mechanical, and the patent system was designed for this. Even though all patents represent ideas, ideas prior to the electrical age were about mechanical objects that could, perhaps, be instantiated in one best way. Ideas in the electrical age could probably be instantiated in many ways, making patents harder to enforce. And now, in the information age, the idea itself can be articulated in many ways, making patents somewhat useless for information-based products except as post-hoc bludgeons.

1Jason Benn6moI don't think ideas in the information age are any harder to articulate. I do think that it's harder to identify patent theft, though. You don't get to read the source code of a tech company, but if you buy a mechanical product, you can just open it up to see if they're using your patent.

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4Answer by Arjun Narayan6moMy basic thesis on why IV failed is that the property rights are terribly defined in intellectual property in general, since pretty much every single case has to be adjudicated by the judicial system, which means that markets fail for standard 'tragedy of the commons' reasons (in the strict economic model sense, not just the commonly applied metaphor). It's as if land rights to houses were defined with the specificity of "the 3rd house after you turn the street corner, from about where the road bends for about twenty paces". The entire system begs for expensive lawsuits at every turn the moment disputes about borders come into play. The only way to deal with this scenario is exactly what economic models predict when dealing with commons - you have to internalize the externalities and manage the commons under a single ownership that cares for the stewardship of the ecosystem in totality. So most IP ownership is internalized inside firms. The only way to make liquid IP markets is to bring down the transaction costs so that, in the Coasean sense, it makes sense for IP owners to trade it at arms length. There are definitely standard contracts that could work, if the ownership boundaries were cleanly defined. The trillion dollar question is:can the ownership boundaries ever be cleanly defined? IV simply assumed the system worked, and what you needed was to increase trading volumes to bootstrap a market. They never succeeded, and I think it's because that question still needs answering. It's also worth studying the one situation where IP rules do result in working markets: pharmaceutical drugs. Here, there is something that can be defined pretty clearly: a specifically enumerated molecule, sometimes with a specific endpoint. It's also interesting that the approach usually taken is to wrap that molecule in a firm, apply VC funding to it, and IPO it!