Patent Litigation Risk and VC Investments

Aymeric Bellon, Finance, The Wharton School, and Tong Liu, Finance, The Wharton School

Abstract: As VC firms have an acute interest in high-tech companies, they potentially bear substantial risk of patent litigation. In this project, we aim at looking into the following questions: how do ex-ante and ex-post patent litigation risks affect VC firms’ investment strategies and how those risks is propagated among all portfolio companies they have invested? How do VCs respond and attempt to mitigate the risks of patent litigation? Is it optimal? Using an economic theoretical model, we identify two slightly different concepts of patent litigation which have never been studied to our knowledge in the finance literature: ex-ante risk and ex-post risk. Ex-ante patent litigation risk means that litigation regarding certain patents is not realized yet. However, VCs or invested companies might perceive related litigation risk in the future. According to Feng and Jaravel (2017), patents that are granted by more lenient examiners are more likely to suffer patent litigation later on. Based on this fact, we are able to construct a measure for patent’s ex-ante litigation risk potentially perceived by VCs and see how it could affect VC firm’s decisions (e.g. valuation, investment rounds). Ex-post litigation risk means that patent litigation has realized and related patents are involved. In this case, we could look into how VC firms respond to the scenario when one of their portfolio companies is suffering ex-post litigation risk. Right now we have finished designing our tests and are currently hiring a couple of RAs to help us manually collect data regarding past patent litigation at the US district courts. To our knowledge, at least in the field of finance / economics, no one has collected such a complete database. We almost finish the litigation data collection and next we plan to clean the data and merge them with VC investment records from SDC Platinum. We expect to have our first set of results before this summer. In general, there are very few papers (at least in finance/management) that are trying to evaluate the impact of patent litigation. Our new project could potentially open up a research agenda in the sense that several other related projects could also be tried, such as the relationship of ex-ante patent litigation risk and the cross-section of expected stock returns, how patent litigation affects the relationship banking, to name of few.

Michelle Eckert is Marketing and Communications Coordinator for the Mack Institute, where she works to engage students, researchers, and corporate partners in opportunities for collaboration. Michelle received her B.A. in Art from Valparaiso University in 2007. Her background includes two AmeriCorps terms of service working to teach mathematics, computer literacy, and job readiness skills to out-of-school youth in Philadelphia, focusing particularly on promoting access to post-secondary education.