Intellectual Ventures Creates a New Kind of Market from Scratch: Tales From the Wild West Era of Patents

3/30/11Follow @curtwoodward

[Updated at 9:35 a.m. with a correction, see Page 2.]Don Merino used to be the guy sitting across the table when someone went to Intel looking to sell a patent—sometimes he dealt with inventors, but a lot of times it was patent lawyers. Merino liked to say the job was about dealing with “random $40 million events.” It was hard to know when, but eventually, a company would find itself in a must-have position for intellectual property.

So when Merino joined longtime colleague Peter Detkin at Nathan Myhrvold’s Intellectual Ventures, the Bellevue, WA-based patent licensing company and invention incubator, Merino had a pretty good idea of the inefficiencies in the patent market. And that’s what he and Intellectual Ventures have set out to get rid of.

Not everyone is a fan of that work. There’s been plenty of ink spilled over whether Myhrvold’s firm is simply a “patent troll” on steroids, seeking mostly to profit from the ownership of ideas that it isn’t actually using. Myhrvold himself offered a defense of the company’s vision for a new “invention capital” industry last year in Harvard Business Review, keying on the idea that his work could lead to a better way of financing inventions. The company also sees itself as cutting down the cost of dealing with intellectual property conflicts for businesses.

Wherever you fall on that discussion, I’d say Merino’s stories are a pretty fascinating instant business history. It really is kind of mind-boggling that in the 21st century, with everything good and bad that modern finance has been able to conjure up, there was an unquestionably valuable asset being traded in a market that was still relatively wild, highly illiquid, and unpredictable.

As one of the key people helping Intellectual Ventures build up its massive trove of patents, Merino has been on the front lines of its mission to create a new kind of market for intellectual property. Merino is now the company’s senior vice president of licensing, spending a lot of time in Asia. When he started in early 2004, the company had been around for a few years, but had only recently corralled enough capital to bankroll large-scale patent acquisitions.

Don Merino

“The question was, were we going to be able to get to critical mass? When I showed up there was $150 million committed to the fund, and I remember Nathan one time grabbing me and saying, ‘You know, Don, it’d be so great if we could buy 3,000 patents over the next couple of years and spend the $150 million we have.’

“About a year later I came back and said OK, I spent the $150 million, Nathan. Now what?” Merino says with a big laugh. “So we went from $150 million to $1.5 billion in the first fund, between basically 2004 to 2008. It was a bit of a rocket ride, needless to say. We did about 1,200 deals in the first fund, and I personally did about half of them. “

Merino sees some comparison in the problem of dealing real estate in the frontier days of the American West. It was hard to know who owned what, where the boundaries were, and how valuable the land was. In modern times, land boundaries and values have all been sorted out and there are plenty of people to assess and document the history of those assets, everywhere from the local county courthouse to Zillow.com. But there is nowhere near that much transparency for patents—or at least, there wasn’t.

“One of the very simple things that we ended up having to do in the buying was understand if the person selling the IP to us actually owned it or not. There’s no title companies in IP. And IP lawyers are great at describing technology, but you never want one of them to do a house closing for you,” Merino says. “That was a level of complexity that was really something that we had to work on because understanding who owned what, what rights could they actually transfer to us, and what rights would we own, was a very important aspect of our business.”

So if there was no equivalent of an IP title company to sort out who owned what, did Intellectual Ventures just make one up?

“That is exactly what we did. And yeah—it’s a significant operation for us. Basically the whole second floor is dedicated to that … it’s a bunch of paralegals,” Merino says. “Simple example: A company goes bankrupt and has a set of IP. A lot of people might say well, the IP court can transfer everything. Well, you’re right, the IP court can transfer everything—that you actually own. But the question is, do you actually own that or not? And as you go through the tech booms and busts, companies might have gotten merged and divested three, four, or five different times.”

“We’ve actually thought at various times, is this a service that we provide to the entire industry?” Merino adds. “But right now it serves our needs. We think it is a competitive advantage. But I’ll tell you, it really is something that gives you a sense of how nascent that market is.”

Today, Intellectual Ventures says it manages a portfolio of more than 30,000 patents. Myhrvold recently said the company pulled in $700 million in licensing revenue last year, and the company says its cumulative licensing revenue has reached about $2 billion. Merino estimates that licensing generates about 90 percent of the company’s revenue, as opposed to the other long-buildup processes of inventing or incubating ideas and spinning them off into companies, such as the TerraPower nuclear energy venture.

Why in the world was there such a space just sitting there for Intellectual Ventures to swoop in and seize? Surely there have been plenty of financial whizzes in the past who could have done the same thing, since it’s applying some pretty basic economics to an asset market.

“When I first went out and was creating the market for buying, I’d go to these cities and—typically in the states—go and hit all the law firms and give them a little pitch. And invariably, every second or third law firm I’d walk into, someone would say ‘You know, I had the exact same idea two years ago … but the problem is, I had no idea how to get the capital,’” Merino says. “So what happened was, frankly, it was access to capital. This was the first time somebody really applied capital to this.”

Now that the market is somewhat more established, Intellectual Ventures is seeing some interesting opportunities for monetizing its portfolio—the kind of thing that typically turns up the volume on allegations of troll-dom. And the revenue doesn’t just come from seeking licensing fees with lawsuits as an enforcement mechanism, although the company isn’t shying away from that tactic. Merino points to two recent deals, one with Verizon and another with Vlingo, where Intellectual Ventures’ patent portfolio was employed in the separate company’s intellectual property battle, basically as a sort of commodity. [Corrected first deal example to Verizon, not AT&T.]

“In both of those cases, we worked with those companies to basically get the patents that we’d bought so they could use them as kind of an equalizing factor in a lawsuit,” Merino says. “This is a very common sort of practice for us now, and what it comes out to be is a bit of a hedge. It’s no different than creating a currency hedge or anything else—it’s an IP hedge.

“We’re creating a hedge where, for relatively reasonable cost, somebody can get access to a tremendous amount of IP, both for defensive purposes as well as licensing purposes. We like to think that’s something that is reasonable and good. For anybody else to do what we’ve done, which is to go out and buy all these assets, it would cost them a tremendous amount more.”

So if Intellectual Ventures sees itself as a new breed of broker making a new kind of market in intellectual property, you have to wonder where these guys see the market going. After all, if they start showing a good business opportunity, they won’t be the only ones in the space forever. Merino says an efficient patent market will probably happen, but, “I’m not so sure that we’re going to get there in my lifetime.”

“Where would we like to see this go? … I think all of us realize the American economy is about knowledge,” Merino says. “I’d love to see a whole bunch of garage inventors who are getting compensated for their inventions, and are moving products and services and new ideas forward, having somebody else commercialize them, but are getting compensated fairly. And that would be a great testament to the American way.”

Curt Woodward is a senior editor for Xconomy based in Boston. Email: cwoodward@xconomy.com Follow @curtwoodward

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