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Freedom to Operate Analysis Could Be Key to Crowdfunding Success

Friday, May 31, 2013

By Scott J. Popma, Seth R. Ogden, and M. Andrew Holtman

Scott J. Popma, M. Andrew Holtman, and Seth R. Ogden practice intellectual property law with Finnegan, Henderson, Farabow, Garrett & Dunner, Washington, D.C.

Crowdfunding is rapidly being adapted as a tool to raise capital from a large number of small investors. A number of crowdfunded projects have already crossed the million-dollar threshold, and this trend will likely accelerate after the U.S. Securities and Exchange Commission implements the Jumpstart Our Business Startups Act, which clears the way for equity-based crowdfunding.1

But to engage the network of potential consumers and supporters, companies have had to publicize substantial information about their projects, including technical details of the products, the fundraising goal, and the fundraising period's closing date.2 Similar requirements will likely be required for equity-based crowdfunding.3

Competitors can use this information to evaluate the proposed products, determine whether their intellectual property is being infringed, assess potential damages, and prepare to file a lawsuit at the optimal time. 4 These disclosures, combined with the ensuing elevation of successfully funded crowdfunders' profiles, make crowdfunders a target for future patent litigation.Though crowdfunding unquestionably provides a small business venture with new and greater access to capital, it fails to address another crucial barrier to product commercialization—IP owned by competitors. A competitor's patent portfolio may block market entry and threaten current and future profits, even with appealing product design and flawless execution of a crowdfunded offering. In fact, the more successful the offering, the more likely a competitor will pursue litigation to prevent further product commercialization and disgorge any profits already realized. Thus, companies contemplating a product launch via crowdfunding would be well served to examine the freedom to operate (FTO) in their product area of interest before launching fundraising efforts.Failure to perform a comprehensive FTO analysis before a crowdfund offering cannot only derail a project, but also could result in a damages assessment well beyond the capital earned during the offering. This danger is illustrated by a recent suit against Formlabs Inc.Founded by a small group of graduates from the Massachusetts Institute of Technology, Formlabs sought to build an inexpensive 3D printer, turning to crowdfunding to raise capital. After being descried by several heavily trafficked tech blogs, Formlabs raised almost $3,000,000 in less than a month, obligating it to ship 1,028 3D printers to its backers.5 But just three weeks later, 3D Systems Inc. brought suit seeking to enjoin Formlabs from filling those preorders and payment of unspecified monetary damages.6

A. Freedom-to-Operate Analysis

An FTO analysis, at its heart, serves as a risk-management tool by identifying third-party IP that may threaten a new product launch. Typically, patents represent the most significant IP hurdle a company may face, so this article focuses on analyzing the patent landscape. But a fuller FTO analysis should also examine other types of IP, including copyrights, trademarks, and trade dress.

An FTO analysis generally follows a three-step process:

(1) deconstruct the planned or existing product into its component parts;

(2) perform a search for relevant patent literature with non-expired, enforceable claims; and

(3) assess the claims of the relevant art and compare those claims to the product to determine the likelihood of infringing third-party patent rights.

Because a patent grant extends for a defined time period, the FTO analysis should be thought of as an iterative process to be performed early and regularly updated.

Finally, because the value of an FTO analysis depends on proper, thorough legal and technical execution, companies should consider seeking proper assistance.

1. Deconstruct the Product

To ensure a comprehensive analysis, a company must know where to focus its search. Thus, a company must first dissect its product into its component parts.

For example, a bicycle, in its most rudimentary form, has at least six component parts: a frame, a seat, wheels, a steering mechanism, pedals, and a chain connected from the pedals to the rear wheel. Of course, many bicycles are far more complex. Some have more than one gear, which necessitates multiple chain-rings, a chain stay, and front and rear derailleurs. Further, even the rudimentary bicycle can have its parts subdivided into their individual hardware components (e.g., a wheel consists of a rim, hub, tube, and tire). Obviously, a search incorporating all of a bicycle's parts would be excessively time-consuming and costly. To keep it manageable, the company should focus on the components it anticipates to be novel or inventive.

Patents cover both tangible inventions and methods and processes, meaning that third-party patents could block the ability to sell a product that contains a component produced by a patented process. Consequently, for each component identified during the deconstruction, the company should identify any methods or processes used to create that component, again focusing on those methods and processes anticipated to be novel or inventive.

2. Create a Search Strategy and Execute

Second, the company conducts a patent search, also known as a prior art search, for each of the components and associated methods/processes identified during product deconstruction.7 A company could outsource this to one of the many services that specialize in prior art searching, or, alternatively, those with a strong relevant technological background may be able to do some of the initial research using public patent databases available on the internet.8

When choosing where and how broadly to search, two key attributes of patents must be considered. One, patents are temporal in nature, with old rights expiring and new rights being granted regularly. As mentioned above, an FTO analysis is an iterative process that must be consistently repeated and updated. Moreover, determining a patent's expiration date may require going beyond the filing date on the face of the patent.9 Two, patents are territorial, not global. Thus, a company need only search for patents issued where the product will be made, used, or sold. However, foreign patent databases may provide information useful for identifying competitors who may have applied for patents in the jurisdiction of interest.

Once the proper databases have been identified, most searches begin with a keyword query. However, if a specific competitor has already been identified, a search could be done to retrieve all patents assigned to a specific competitor.

For all patents of interest, the relevant art cited within should be retrieved, reviewed, and catalogued. Because patent applicants have a duty of disclosure, the patent document should reference most relevant prior art documents. For particularly relevant results, the company should perform a secondary search for references that cited to the reference of interest.

3. Determine Likelihood of Infringement

Third, the company should determine the likelihood that the product or methods infringe the third-party patents identified during the search. This determination can begin by ascertaining the scope of the patent claims, which define patent coverage. Subsequently, the company utilizes the information regarding claim scope to categorize the level of risk associated with a product launch.

Though a patent specification may contain a broad description of a technology, the patent claims define the exclusive right granted by a patent. The claims, loosely analogous to the “metes and bounds” of real-estate deeds, provide a qualitative description of an invention's limits. Certain rules govern the art of claim interpretation,10 but during litigation, the court, not the parties, determines the boundaries of patent coverage.

Ideally, the claim scope determination should be used to categorize the relevant patents based on likelihood of infringement. This can be done in a number of ways, but the focus should be on identifying three main categories:

(1) those likely to be infringed, so as to block market entry;

(2) those that may be infringed depending on a court's determination of claim scope; and

(3)  those that fall outside of the field of the company's product.

This categorization should be tailored to the circumstances attending a company's specific product launch but should be designed to adequately inform an array of possible future business decisions.

B. Following Up on the FTO Analysis

A current, thorough FTO analysis allows a company to prepare for a successful product launch by minimizing the risk of infringement of third-party patents. If potentially troublesome patents are identified, several approaches may be appropriate depending on how the infringement risk has been categorized.

Business-oriented approaches include:

  • Play the waiting game. In other words, launch the product and wait to see if the patent holder approaches you to take a license.
  • Abandon the project. Though not the optimal outcome, if a third-party has carved out broad protection and has a history of aggressively enforcing its patents, this may be the least expensive option. Ideally, the decision to abandon the project would be made before launching a crowdfund offering.
  • Propose a merger. A company well positioned with its own IP, talent, or other valuable assets may be able to generate merger interest from the patent-holding party.

Alternatively, a company can pursue research-and-development options:

  • Design around. Come up with a novel product design that falls outside the scope of the third-party patent, or incorporate product designs already within the public domain. This can be done by practicing the prior art, assuming that prior art is not covered by its own separate patents.
  • Finally, legal options can also help mitigate infringement risk.
  • In-license. Pay the patent holder for a license.
  • Cross-license. In a situation where a crowdfunded company owns its own patent on its product, it may license that patent to a patent holder in return for a reciprocal license under that party's patent.
  • Seek to invalidate the patent. This option may be prudent where the FTO analysis identifies invalidating prior art that the patent office failed to identify during examination. There are several mechanisms available to attempt to invalidate patent claims, and proceedings can be before a court or the U.S. Patent and Trademark Office.
C. Conclusion

As famous inventor and statesman Benjamin Franklin said, “By failing to prepare, you are preparing to fail.” Likewise, risk of infringement can be mitigated only if identified before a product launch.

A reasoned FTO analysis embodies the preparation needed for success, allowing a company to more confidently proceed with a crowdfunded offering and avoid the situation experienced by Formlabs. Moreover, disclosure regarding that FTO analysis can engender the interest of potential investors by demonstrating both the business acumen of the company seeking funding and the viability of product commercialization.


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