Do Patent Assets have a Second Life When Startups Fail? An Analysis of the Redeployment Likelihood and Mode of Transfer
By Carlos J. Serrano and Rosemarie H. Ziedonis
Venture capital-backed startups are fertile sources of patented inventions, yet they often go out of business. Ewens & Farre-Mensa (2022) report that up to 40 percent of startups that received VC financing between 1992 and 2009 shut down and were terminated at a loss. Little is known about what happens to the patent assets of VC-backed startups when they go out of business. Do the exclusionary rights lapse and fall into the public domain? Or do they have a “second life” through redeployment to new owners? This study, recently published in the Strategic Management Journal, provides new evidence and investigates factors that shape the redeployment likelihood and mode of transfer.
Understanding the redeployability of patent assets from failed startups is important for several reasons. If patents originating from technology startups are redeployable in the event of failure, it could stimulate investments and debt sources of financing earlier in the entrepreneurial life cycle. Alternatively, even if the inventions cover technologies viable on the market, the value in next-best use could be limited if the secondary market is illiquid or if follow-on use requires access to the original organization and private knowledge of the team. In this latter scenario, patent assets could be non-redeployable as in Williamson (1985): rendered worthless to third parties when startups fail and teams disband. In this event, the rights may either not be sold or may remain tied to the human capital post-exit.
Despite evidence that disbanded ventures are important sources of human capital and learning spillovers for others, little is known about what happens to their patents. Given this lack of evidence, we first document the phenomenon by tracing patent sales and inventor movement post-exit for a sample of VC-backed startups that go out of business. We distinguish between two modes of transfer: patent sales as standalone assets and “co-mobility” in which patents move with an inventor to the purchasing organization. We then model and empirically test how the redeployment likelihood and mode of transfer are affected by: (1) the degree to which the value of the patent assets is tied to the original venture and tacit knowledge of one or more of the inventors (i.e., the “firm-specificity” of patent assets), and (2) the thickness of trading activity in the secondary market in areas relevant for the startup’s inventions.
Our descriptive findings reveal an active resale market for patents originating from failed startups in our sample. The evidence is based on 264 VC-backed startups in three innovation-intensive sectors that collectively produce 1,514 U.S. patents prior to shut-down. Most patents (64%) are redeployed to a new owner post-failure, typically to a surviving company in the same sector. Among patents that are sold, 87% are transferred as standalone assets while 13% co-move with an inventor to the purchasing organization. In summary, we find that most patents originating from the failed startups are redeployed to new owners and that most are sold as standalone assets. It is equally true that some patents in the sample are not sold and that others co-move with an inventor.
To probe more deeply into factors affecting the redeployment likelihood and mode of transfer, we develop a formal model and investigate implications that are feasible to test with our data. The model builds on a patent sale model by Serrano (2018), where a patentee decides whether to pay a transaction cost to sell a patent as a standalone asset to a potential buyer who may have greater valuation for the patent. Extending that model, we focus on a patentee facing liquidation, allow heterogeneity in the degree to which the patent assets are firm-specific, introduce co-mobility of the patent assets and inventors as a potential mode of transfer, and allow for a continuum of trading conditions in the secondary market (“patent market liquidity”).
The regression analysis yields several important findings. First, we find that when the patent assets of failed startups are highly firm-specific, the assets are less likely to be sold but they are more likely to be transferred when sold through co-mobility with an inventor. This finding is intuitive and is consistent with the view that hiring inventors facilitates the transfer of firm-specific knowledge when entrepreneurial firms have disbanded. We also predict and find an increased likelihood of redeployment, both as standalone assets and through co-mobility, when the patent market is more liquid. The magnitude of the effect is substantial. A one percentage point increase in patent market liquidity is associated with an increase of 5.4 percentage points in the predicted probability that a patent sells as a standalone asset, or 9.7% of the average of this probability, and a 2.2 percentage point increase in the predicted probability of co-mobility with an original inventor, a 27.3% boost in the average probability of co-mobility in our sample.
Finally, and consistent with insights from the formal model, we find that when knowledge in the patent assets is more firm-specific and ties between the assets and the human capital of the inventors are important for preserving value, liquidity in the patent market facilitates the co-movement of patents and inventors to the new owner. In contrast, when patents of failed startups are less firm-specific (i.e., more likely to be valuable on their own to third parties), liquidity in the patent market disproportionately stimulates sales as standalone assets. Importantly, these findings suggest that liquidity in the secondary market not only affects whether patent assets originating from failed startups are sold but also shapes the channels through which those assets are transferred.