Why should startups choose patents over keeping their innovation as trade secrets?

Patents are open letters (litterae patentae) that act as property deeds. Similar to a land survey they pen down and describe an idea in detail with the aim of demarcating its borders. In exchange for such full disclosure the innovator gets the right to exclude unauthorized use for 20 years.

Patents are a relatively new instrument that was first introduced by the Venetians in the late 15th century. The purpose of patents is to diffuse knowledge. Trade secrets on the other hand have been around forever. Their purpose is to avoid diffusion. They do not demarcate the borders of the encompassed ideas, which remain hidden from sight. Yet, if a competitor invents around the technology the innovator has no means of protecting her knowledge.

The general assumption that prevailed for many years was that patents, being legally binding contracts, should be preferable to keeping a secret. To put it plainly, as long as you get to legally exclude competitors for a lengthy period of time why opt for secrecy and risk losing everything if aspects of the technology are unmasked?

The presumption of “patent superiority” proved to be shortsighted as empirical evidence indicated that innovators prefer secrecy. The assumption that patents fully excluded competitors proved unrealistic because in reality patents face a difficult task in demarcating the borders of an idea. Ideas are not physical property. Unlike land, they are porous and vague. In short, their borders are uncertain, and uncertain borders offer imperfect protection from competitors. This leads to costly property disputes that are particularly acute for small firms like startups.

This uncertainty shifts the presumption of superiority back to trade secrets: as long as you get to indefinitely exclude competitors why opt for patents, disclose your idea and end up with many competitors and big legal bills? In view of this, we try to understand why should firms like startups choose patents over trade secrets? Our thesis is that patents are preferable because they are transferable bargaining chips.

We build our argument by first accepting the sad truth that: for a startup a patent is a “liability”, because it can invite costly ownership disputes from competitors with patents that border the vague technology terrain broadly outlined in the startup’s patents. However, with a note of optimism we note that: the same patent in the hands of established firms who hold not one, but a portfolio of patents, may not be a liability. Why?

Scholars have long viewed patents as bargaining chips that can be used in licensing negotiations when ownership is contested. In such an instance a patent can be understood as a “foot soldier” who aids the firm in its legal jousting with other patent holding competitors. As in real wars, in such legal fights victory often depends on the size of each firm’s “patent army” (its patent portfolio), in which case an additional patent is a welcomed expansion of power that increases the firm’s ability to defend its terrain. This view of affairs suggests that the same patent that was considered as a “liability” for a startup becomes an “asset” at the hands of a portfolio holding incumbent.  In brief, the value of the patent depends on who its owner is.

Since patents are transferable, when a startup sells its patent to an incumbent holding a patent portfolio in need for additional foot soldiers, it does not just transfer a technology. It also transfers bargaining power. Therefore, the price of a patent should deserve a premium over the price of a technology that is transferred via a trade secret for the simple reason that trade secrets, with their borders hidden from sight, cannot be used as bargaining chips in ownership disputes.

Overall, considering that patents can command a higher price than trade secrets they are better suited as an R&D incentives mechanism.