Charles River VC, a $300M Investor in Intellectual Ventures, Says Patents Are Huge Market, Not a “Dirty World”

5/4/11Follow @gthuang

Quick, which Boston- and San Francisco-area venture firm has invested hundreds of millions of dollars into the burgeoning—and controversial—market of intellectual property and patent protection over the past five years?

If you said Charles River Ventures, you are correct. In fact, CRV is the only big venture investor behind Intellectual Ventures, the Bellevue, WA-based firm known for its unique (and often criticized) approach to the business of invention. Charles River says that, together with its limited partners, it has poured some $300 million into the company since 2006.

That’s an astounding figure, and it shows that Charles River is betting on intellectual property in a huge way—perhaps more so than anything else in its portfolio. Besides Intellectual Ventures, the VC firm is also invested in RPX, a San Francisco-based defensive patent aggregation firm, which filed for an IPO in January and plans to go public today—more on that coming in a separate story. (Kleiner Perkins Caufield & Byers and Index Ventures are also investors in RPX, which was co-founded by two former employees of Intellectual Ventures.) Yet most venture firms still treat the field of intellectual property as a bit of a scourge—or, at best, a fringe area—even though it has great ramifications for VCs and their startups. So why did CRV decide to take the plunge?

The story goes back to 2001, the year after Intellectual Ventures was formed, when Nathan Myhrvold, the company’s polymath, founder, and CEO (and Microsoft’s former chief technology officer), came to Boston and met with Izhar Armony, a partner at Charles River Ventures. After some intensive Myhrvold-speak—for example, “invention is the essence of innovation”—he drilled down to his main point. Venture firms, Myhrvold argued, spend almost all their money on things that are essentially commodities—engineers, business people, infrastructure for startups—but what’s actually unique, and arguably most valuable, is invention.

Many would disagree—people and execution are pretty essential to businesses, after all—but the seed was planted. “Nathan helped open my eyes to the notion that IP [intellectual property] is a very important market—it’s actually a very big market in tech,” Armony says. He adds that there’s a $50 billion-plus market in IP rights and licensing, versus a $6 billion litigation market based on legal fees.

So in 2003 he led CRV’s investment in Intellectual Ventures’ “invention science fund,” which aimed to create new inventions across a wide range of fields, in part by bringing together renowned scientists and inventors and brainstorming ideas in a structured way. Such “invention sessions” have led to major projects and spinouts such as TerraPower, the Bellevue, WA-based nuclear-reactor firm (in which CRV also became an investor). In total, CRV committed $39 million to the invention science fund, co-investing with the likes of Bill Gates and Microsoft.

But the really big business opportunity came along in 2006, when CRV and its limited partners decided to commit an additional $300 million—I’ll say it again, $300 million—to Intellectual Ventures’ “invention investment fund,” which totaled $500 million at the time. (The fund has since grown to several billion, Armony says.)

The sheer size of the deal made it look more like private equity than VC, but Charles River must have seen something special in this opportunity. Armony, for one, says he had been thinking about new ways to apply “market-based mechanisms to valuing patents, trading patents—all the things that happened in real estate or the stock market—and innovating on the business front. So CRV went all in. “My partners were generous with me,” Armony says. “They gave me a lot of rope to hang myself.”

The focus of that part of Intellectual Ventures’ business is on buying and licensing patents—at a huge scale. The company’s IP portfolio now totals more than 30,000 patents, the great majority of which were bought. (Others came out of the fruits of the investment science fund.) And that’s where most of the controversy comes in. Critics say Intellectual Ventures is a “patent troll” that buys up intellectual property and squashes innovation by forcing companies to license patents or buy IP protection—all without developing many of its own inventions.

Intellectual Ventures would say it is getting companies to pay a fair price for patents, and that it tries to avoid litigation—which it would say is its last recourse. “Some companies that have not joined are concerned IV will sue them,” Armony admits. “IV is asking for very large amounts of money for its vast portfolio. It can be hard to swallow. Those are boardroom-level sales.” He adds that Myhrvold has earned the “respect and fear” of the big companies in tech. Indeed, Intellectual Ventures filed its first set of patent-infringement lawsuits last December, against McAfee, Symantec, and seven other firms.

The bottom line is that the business has been lucrative, and it seems to be gaining steam. Intellectual Ventures says it made $700 million in patent licensing revenue in 2010, and a total of about $2 billion to date. Licensing makes up some 90 percent of the firm’s business. “More and more corporations are recognizing the value. The quality of the IP they buy is good. They go into areas that are happening right now, but the inventions happened 10 years ago. And companies weren’t worrying about that then,” Armony says. “2011 will be the biggest year.”

And as Armony sees it, Intellectual Ventures plays a key role in providing liquidity for inventions. The firm has paid about $350 million to universities and inventors since its inception. In terms of providing IP rights to companies, he says, the approach is to “do away with middlemen and litigation costs.”

So why haven’t many other VCs gone into the sector yet? A big part of it might be perception. “Others have the idea that IP is a dirty world controlled by lawyers,” Armony says. “But those VCs, when they become directors of large companies—companies who grew their revenue much faster than their own IP—they may have to pay a tax on litigation. People prefer to do business in inefficient ways, just because of the old-world view that IP is somehow dirty.”

In case you haven’t noticed, it seems like everyone is suing each other in the tech world these days—from Tippr and BuyWithMe in group-buying and daily deals, to Skyhook Wireless and Google (and many others including Nokia and Apple, Microsoft and Motorola) in mobile, to EveryScape and Adobe in graphics, and, yes, Intellectual Ventures and a host of companies in software security and hardware.

So have things changed in the world of tech intellectual property and its perception? Armony thinks so, and he has some insights into the trend. For starters, IP has taken on far more importance beyond just defensive patent protection. A decade ago, he says, “most tech companies viewed IP as a necessary evil and did not invest in IP. They almost held IP in contempt. But biotech and pharma have always understood it. Pharma has been willing to pay for IP, and that’s the whole basis for the biotech business model.”

Now, he says, the concept in the technology world has evolved. “All tech companies have a much more sophisticated view of patents and invention rights. The most sophisticated are inventing more and filing more patents [like Microsoft]. They buy defensively more, assert more patents, do more cross-licensing deals, and participate in defensive groups like RPX.”

Still, he says, “the people who are least sophisticated and most behind the 8-ball are venture capitalists. They view IP as crown jewels”—that is, as something to be protected, not really something to invest in. But big companies understand the value of IP better, he says, because “for many of them, IP is yet another discipline they have to master”—just like engineering, sales, products, marketing, and quality assurance.

Another major shift is that “an asset class has been created,” he says. “Some large hedge funds are playing in the field.” Big players in intellectual property finance now include Altitude, Coller Capital, and Fortress Investment Group. And notable public tech companies that have evolved their IP models include Qualcomm and Dolby, as well as pure IP assertion firms like InterDigital and Acacia Research, he says.

Closer to home, Armony notes, “There’s a lot to be done on the VC level as well. It’s still a super early market.” It’s not easy to understand how to invest in IP rights companies, he adds. “There are lots of misconceptions.”

Myhrvold, for his part, seems to have foreseen much of this unrest in the tech sector—and he’s just starting to reap the rewards. “The world is more than happy to risk money in crazy, risky ventures once people have established a model and established a marketplace. If we’re successful, we personally will channel billions of dollars towards invention, but if we’re really successful, people will imitate us,” he told me in 2008. “We have a venture economy, we have a private equity economy, we certainly have a public markets economy, but we don’t have an invention economy—yet. That’s our simple goal!”

Judging from the current state of affairs, that goal might be close to being achieved.

Gregory T. Huang is Xconomy's Deputy Editor, National IT Editor, and the Editor of Xconomy Boston. You can e-mail him at gthuang@xconomy.com or call him at 617-252-7323. Follow @gthuang

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