What Is a Patent Troll?

The investing landscape is always changing, and over the years, the universe of investment vehicles only tends to get larger and more complex. Whereas decades ago Wall Street was largely just a matter of stocks and bonds, more and more acronyms began to creep into everyday investing lingo.

Real estate investment trusts (REITs), mortgage-backed securities (MBS), credit default swaps (CDS), and now the likes of cryptocurrencies and special purpose acquisition companies ( SPACs) all — to one degree or another — play important roles in markets.

It’s arguably never been more important than it is today to have a broad understanding of the different investment opportunities to choose from. And one such entity is known, informally at least, as a patent troll.

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What Are Patent Trolls?

A patent troll is a company that owns the intellectual property (IP) for products and services that it doesn’t actually provide. Instead, it monetizes that IP by suing companies for infringement upon its patents, claiming a violation of an intellectual property right.

Unsurprisingly, the term “patent troll” has a negative connotation.

“Such persons or entities are also referred to less pejoratively as ‘non-practicing entities,'” or NPEs, says Bruce Dahl, patent attorney at Fennemore Craig.

How IP Is Acquired

“There are two common scenarios to how one becomes a patent troll. The first is the unfortunate scenario of a failed business,” says Yuri Eliezer, Founders Legal partner and patent attorney.

“Ultimately, when a business fails there are assets that remain. One of those assets may be an intangible asset or a patent right,” Eliezer says. Those patents can then be sold or licensed to NPEs with more financial resources to pursue litigation.

For example, one of the larger patent enforcers around today, Fortress Investment Group, now owns the intellectual property it got from Theranos, the disgraced former blood-testing company.

There’s also another common patent troll scenario.

“Universities have restrictions on using public funding for commercialization,” Eliezer says. “Nevertheless their professors and researchers constantly generate IP.” Unable to bring it to market themselves, they’ll often license or transfer out their technology, becoming an NPE that licenses patent rights.

“Not all patent trolls are failed businesses or sitting on a pool of assets for the purposes of monetizing them,” Eliezer adds.

The Role of Patent Trolls

Non-practicing entities are entirely legal, and at their best, they can perform a valuable economic service. They can also be a nuisance.

Pros. NPEs “do play an important role in markets because they provide a way for patent owners to monetize their patents,” Dahl says.

“Many patents are granted to persons who are unable to commercialize them. If an NPE suspects a commercial product infringes one or more patents, that NPE will identify those patents and purchase them from the patent owner,” Dahl says.

Dahl also argues that NPEs are kept in check through the market: If the licensing fees NPEs demand are too high, it incentivizes companies to design around the patents, resulting in innovation.

[SEE: 6 Investments to Offset Potential Inflation.]

Cons. Of course, not all so-called patent trolls do business the same way, and absurd legal threats and hardball tactics can be used in ways that are arguably nothing more than drains on the economy.

Ben Hodges is a registered patent attorney at Foster Garvey where he focuses on complex litigation and technology counseling.

“A drag on innovation occurs when an entity overreaches any realistic view of a patent’s claims or enforces a patent that clearly shouldn’t be valid,” Hodges says, using its IP as a cudgel with which it can extort settlements and hamper investments in innovation.

The Wall Street Journal published an article in 2016 that highlighted a particularly extreme example of what critics dislike about patent trolls. That year, an NPE called Shipping & Transit (formerly known as Arrivalstar) was the most litigious filer of patent lawsuits in the U.S. Specifically, it filed suit against more than 100 companies, mostly small businesses that sent tracking notifications to customers, claiming it owned IP for such widely used status updates.

Especially for smaller companies, the calculus of settling versus mounting a defense in court is one-sided.

“Those businesses don’t generally have the luxury of profuse resources to fight out of principle, so they take the financial hit to their business to pay off a patent troll with a relatively small amount of money, much smaller than the cost of fighting in court, but possibly equal to paying an employee’s salary for a year,” Hodges says.

That expense diverts money that could’ve been spent on employee salaries or investments in research and development, Hodges notes.

Instead of spending hundreds of thousands of dollars in the courts, companies may be able to make the lawsuits disappear by settling for tens of thousands of dollars. That’s easy math, especially for smaller companies without the luxury of deep coffers.

Bottom Line

Investors should be aware of this corner of the markets if only to better understand the value — and costs — associated with intellectual property. Look no further than public companies like Marathon Patent Group (ticker: MARA), Xperi Holding Corp. ( XPER) and Acacia Research Corp. ( ACTG) that are often considered patent trolls: These three businesses are each worth between about $410 million and $3.5 billion.

A business model that depends on litigation and arcane intellectual property issues tends to make investing in patent trolls a risky prospect for individual investors. No one would characterize NPEs as blue-chip businesses, with predictable and steady cash flows.

For larger investors, however, NPEs can actually be worthwhile investments. That’s why billionaire investor Mark Cuban, an outspoken critic of the patent system, took a 7.4% stake in Vringo, a company taking Alphabet, then Google ( GOOG, GOOGL), to court for patent infringement, in 2012. Cuban viewed Vringo as a hedge against the patent risk he faced in other investments.

Private equity firms and hedge funds can also see value in NPEs, which can be looked to as alternative investments largely uncorrelated to broader market movements.

The heyday of patent trolls “appears to be in the past now, but there is still a steady enough stream of cases” to know it’s not completely in the rearview mirror, Hodges says.

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What Is a Patent Troll? originally appeared on usnews.com

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