Correcting the record of venture capital’s views on patent reform

As chair of the National Venture Capital Association (NVCA), I’m responding to a recent blog post on this forum by venture capitalists Brad Burnham and Jason Mendelson on the issue of patent reform.  I admire both men and believe that their contributions to venture capital and the entrepreneurial ecosystem have been significant.  However, I believe their personal views of what should be achieved through patent reform are out of whack with the realities on the ground in Washington, DC.

Let me begin by saying there is no daylight between the authors and the rest of the venture community on many of the broad goals of patent reform.  Through my role as chair of the NVCA Board of Directors, I have had many conversations with my venture peers on this topic and virtually everyone agrees that action should be taken to curb abusive behavior by non-practicing entities (NPEs), or “patent trolls.” 

{mosads}To date, much of the focus and attention has centered on H.R. 9, The Innovation Act of 2015.  While well intended, we have serious concerns with H.R. 9 and believe certain provisions in the bill will have a devastating impact on startups trying to enforce their patents against large incumbents and on small companies facing legal challenges by larger, well-financed competitors.

Contrary to the beliefs of Burnham and Mendelson, H.R. 9 will have a far greater impact on the ability of small companies to protect their ideas than on our shared goal of curbing abusive behavior.  The authors believe that legislation should “empower courts to require the patent trolls to pay the legal fees incurred by a winning defendant.”  Far from simply allowing the courts discretion to assign legal expenses in frivolous litigation to a plaintiff troll, H.R. 9 effectively mandates the payment of legal expenses by the non-prevailing party in almost all cases. 

This means that any entrepreneur who seeks to defend their patent will have to take into account the risk that losing in court could bankrupt their company.  The net result of this blunt instrument will empower large companies to pay less attention to the patent rights of small inventors.  Ironically, this will also encourage NPEs to bully smaller companies under the belief that the combination of the potential burden of paying a larger entity’s legal fees with the uncertainty inherent in all trial outcomes will force most to decide that protecting their idea is too risky. 

This misguided provision alone will have a chilling effect on entrepreneurship and innovation, but there is another piece of H.R. 9 that will be particularly burdensome to the venture community.  Through a joinder provision, H.R. 9 provides not only that startups would be on the hook for legal fees, but so too would their venture investors if a startup trying to enforce its patents went out of business.  Federally mandating a rule that would treat shareholders as indistinguishable from the company itself – a practice known as “piercing the corporate veil” – will have a devastating impact on American business and should be uniformly opposed by venture capitalists no matter their investment strategy.  

In addition to the damaging precedent it sets, the joinder provision will have the practical effect of increasing the investment risk beyond the total amount invested.  Venture capitalists have to have a strong appetite for risk in order to be successful, but one of the bedrock principles of our industry is that the downside risk is limited to the total investment capital we provide.  H.R. 9 would actually introduce risk beyond the total investment for venture capitalists.  Creating additional liability for venture firms will raise the risk level and force us to focus on companies that are less dependent on their patents to protect their technology.

The bottom line is that many of the provisions in H.R. 9 simply make litigation more expensive by increasing the costs and risks of litigation.  Simply raising the cost and risk of litigation for all parties, which appears to be the most likely consequence of H.R. 9, may deter some bad apples but will benefit others, particularly when their targets are small startups.  

In their piece, Burnham and Mendelson reference to a letter signed by a great number of venture capitalists in support of patent reform.  I know many that signed that letter and have to believe that—absent their support for the broad goal of curbing abuses—once they learn more about the unintended consequences of H.R. 9 many of them will understand why they shouldn’t support the bill.  As chair of the venture industry’s national trade association, I will be reaching out to them and the rest of venture community to make sure that our colleagues understand how damaging H.R. 9 will be for venture capital and the portfolio companies we support. 

Sandell is managing general partner at New Enterprise Associates (NEA) and chair of the NVCA Board of Directors.