Financing patent costs

Too often patentees are forced to abandon their patenting foray due to a lack of finance. The common reasons therefore are the patentee's: desire to "perfect" the product before commercialisation; wish to "go it alone", largely ignorant of future patenting costs; singular focus on obtaining either government funding (e.g. Technology Innovation Agency (TIA) funding, which is available to small to medium enterprises (SMEs) with technologically innovative ideas that are already the subject of provisional patent applications) or venture capitalist funding, which fails to materialise; or misguided optimism regarding the timeframe to set up a manufacturing facility, market the product and generate sufficient cash flow from sales of the product. Whatever the reason, the end result is that the patentee reaches the patenting deadline without sufficient capital to continue.

To patent internationally is expensive. The initial cost of approximately around R7,000 and to file a provisional patent application in South Africa is relatively insignificant. Filing a provisional application puts a peg in the ground to mark a date on which the invention's novelty is determined and grants the patentee one year to raise a further R28,000 to R68,000 to file a PCT patent application. During the 18 months following filing of the PCT application, the patentee can expect to incur a further R5,000‐10,000 on reporting fees and costs to amend the specification/claims in response to PCT search and examination reports. At the end of this period, costs accumulate significantly. For each country that protection is sought (national phase applications), the patentee can expect to incur an average filing fee of approximately R25,000 per country (excluding any translations) and prosecution fees during the following three years amounting to between one and two times the filing fee (depending on the opinions of the patent examiners). Even after patents have been granted in the various countries, annual renewal fees in the region of R2,000 per country are payable.

This is an expensive exercise and your cash flow must be sufficient to meet the demand.

My advice is: do not focus on "perfecting" the product (the product does not need to be perfect to attract investors); do not "go it alone" unless you will have at least R300,000 available during the coming 3‐4 years; do not focus solely on obtaining government grants or VC funding (the process is often lengthy and your chance of obtaining funding is generally not that good); and do not duplicate manufacturing and marketing facilities that are expensive and time‐consuming to set up and that are otherwise relatively easily accessible by licensing the technology.

Your principal focus should be on raising funding and all potential options should be put into practice simultaneously. There is no time to apply them consecutively.

In my opinion, the power of licensing is too often overlooked. First, the patentee must recognise that without good patents, there is nothing to license. So, a licensee that assumes the costs of patenting in his licensed territory in consideration for a discounted royalty‐rate is a "gift‐horse". Instead of the licensee accepting obligations to finance the patenting costs, the licence could alternatively provide for an upfront licence fee together with discounted running royalties. However, this arrangement may prove less tax efficient. Second prize is a licensee that is prepared to pre‐pay a portion of the royalty expenditure. Just beware as to how this is structured otherwise the patentee may lose up to 40% of the royalty pre‐payment to tax. Third prize is a licensee that accepts a running royalty with minimum royalty payments. These minimum royalty payments can be discounted and converted into a lump sum amount.

You may even consider transferring the patent into an IP Holding Company, which then assumes the responsibility for commercialising the patent ‐ just beware of potential tax pitfalls. The sale of shares in this company to an investor could finance the patenting costs. However, before implementing this option, first quantify the potential value of the patent. Furthermore, depending on the shareholding taken up by the investor, it may be more efficient to issue shares in the IP Holding Company before "selling" the patent to the company. This could secure a future tax benefit, which would increase the company's after‐tax profits.

If you already has a few licensees (with minimum royalty rates) lined up, consider discounting the royalties to a financier to convert the future royalty streams into upfront funding. Alternatively, conclude a sale a leaseback transaction in respect of the patent. However, this is accompanied by a significant tax risk if not properly implemented.

If you are in a tax‐loss position, consider approaching "investors" to reimburse your R&D expenditure. The additional 50% tax deduction (granted by s11D) will then flow to the investors, who should in turn discount your quid pro quo.

It may also be prudent, despite filing a provisional patent application, to maintain the invention secret (with all disclosures being subject to obligations of confidentiality) until the filing date of the PCT application. Doing so, will secure a fallback position of abandoning the priority claim in the PCT application and thereby delaying the national phase filing expenditure by a further 12 months. However, this is a risky option and should only be considered as a last resort.

Ultimately, the aim is to secure proper patent coverage. Accept whatever funding you can raise, even if it means combining: self‐funding, licensing, discounting of royalties, sale of shares in an IP Holding Company; government, IF or VC funding; and redirecting R&D tax allowances.

As a last resort, consider selling the invention/applications to a third party (even for a substantial discount) in consideration for a portion of the royalty receipts/profits, failing which, for a lump sum. It is better to receive a portion of something than the whole of nothing. At this stage, ignore past expenditure and focus solely on saving the patent applications from abandonment and maximising your future return.

(Updated 2007)

Articles: Funding