U.S. House Report on Competition with Chinese Communist Party

On December 12, 2023, U.S. House of Representatives, select Committee on the Strategic Competition Between the United States and the Chinese Communist issued a 53 page report titled, “Party, Reset, Present, and Build: A Strategy to Win America’s Economic Competition with the Chinese Communist Party.”  Unsurprisingly, the report notes concerns with market access and intellectual property theft.  The report also takes on U.S. companies, including venture capitalists for funding China’s development, and China's WTO participation.  The report sets forth three pillars with key findings:

Pillar I: Reset the Terms of Our Economic Relationship with the PRC

1. The PRC’s economic system is incompatible with the WTO and undermines U.S. economic security.

2. Despite the heightened risks associated with U.S. investment in Chinese companies, the full extent and distribution of that risk and the implications for U.S. national security and financial stability remain unknown.

3. The United States lacks a contingency plan for the economic and financial impacts of conflict with the PRC.

4. The PRC uses an intricate web of industrial policies, including subsidies, forced technology transfer, and market access restrictions, to distort market behavior, achieve dominance in global markets, and increase U.S. dependency on PRC imports.

5. The widespread adoption of certain PRC-developed technologies in the United States poses a significant risk to U.S. national security and data protection concerns and threatens long-term U.S. technological competitiveness.

Pillar II: Stem the Flow of U.S. Capital and Technology Fueling the PRC’s Military Modernization and Human Rights Abuses

1. American investors wittingly and unwittingly support the PRC’s defense industry, emerging technology companies, and human rights abuses.

2. U.S. export controls have been slow to adapt to rapid changes in technology and attempts by adversaries to blur the lines between private and public sector entities, particularly the PRC’s strategy of Military-Civil Fusion.

3. The Committee on Foreign Investment in the United States (CFIUS) needs additional authorities and tools to effectively evaluate inbound investments from the PRC.

4. The PRC exploits the openness of the U.S. research environment to steal U.S. intellectual property (IP) and transfer technology to advance its economic and security interests to the detriment of the United States.

Pillar III: Invest in Technological Leadership and Build Collective Economic Resilience in Concert with Allies

1. The United States is falling behind in the race for leadership in certain critical technologies.

2. The PRC is gaining on the United States in the race for global talent.

3. By working with allies, the United States can increase U.S. exports, reduce supply chain reliance on the PRC, and counter the PRC’s economic and technology mercantilism.

4. The United States is dangerously dependent on the PRC for critical mineral imports.

5. The United States’ dependence on the PRC for pharmaceutical and medical device supply chains poses a distinct national security risk.

6. Through its Belt and Road Initiative, the CCP has expanded its influence around the world and gained significant positions in key supply chains and strategic infrastructure, such as ports and space facilities.

The findings are followed by specific policy prescriptions. For example, for pillar two, finding four, the policy prescriptions include:

Recommendation 4: Strengthen U.S. research security and defend against malign talent recruitment.

1. Build upon cross-agency disclosure guidance produced under National Security Presidential Memorandum 33 (NSPM-33) by the National Science Foundation (NSF) to mitigate research security risk by requiring all federal research funding applicants to disclose details about past, present, and pending relations and interest with foreign governments, foreign government controlled entities, or entities located in foreign adversary countries, in the past five years for themselves and any key member of their team who will be involved in fundamental research supported by the grant and update such disclosure annually throughout the funding period.

2. Create and maintain an unclassified database using open-source information to keep track of PRC research entities that engage in defense and military research and civil military fusion programs. This database can inform U.S. universities and researchers about current and future research collaborations and help federal grant-providing agencies vet grant proposals for risk mitigation.

3. Enact legislation that would prohibit U.S. entities from engaging in research collaborations with PRC entities involved with military and defense research and development (R&D), to include those that are on the International Trade Administration’s Consolidated Screening List, the Department of Defense’s Chinese Military Companies List, and the U.S. Air Force’s China Aerospace Studies Institute’s list of PRC Defense Science and Technology Key Labs.

4. Require U.S. research institutions to obtain an export control license if they intend to use any export-controlled item that has a clear and distinct national security nexus, during the course of research collaboration on critical and emerging technologies with any foreign adversary entity.

5. Exercise oversight on enforcement of existing rules in Sec. 117 of the Higher Education Act of 1965 (HEA) (P.L. 89–329) that requires U.S. universities to disclose of foreign gifts and contracts reaching certain threshold to the Department of Education.

6. Strengthen Sec. 117 of HEA by requiring U.S. universities to apply the “know-your-customer/donor” rule to understand who the benefactors are for foreign gifts and contracts channeled through U.S.-incorporated 501c(3) entities.

7. Require the Department of State to establish “human rights” and “military end-use” guardrails in any Science and Technology Agreement with the PRC and ensure sufficient consultations with appropriate Congressional committees throughout the negotiation process, as outlined in the Science and Technology Agreement Enhanced Congressional Notification Act of 2023 (H.R. 5245).

8. Require universities that receive federal grants for fundamental research to fully implement NSPM-33, to create and implement risk-based security reviews to detect and counter PRC malign influence and technology transfer risk.

Free Webinar: "Structuring Funds and Portfolio Companies to Withstand U.S.-China Decoupling Contingencies"

The well-regarded California law firm (international), Morrison & Foerster, has an interesting webinar coming up titled, “Structuring Funds and Portfolio Companies to Withstand U.S.-China Decoupling Contingencies.”  The details are below. 

Morrison & Foerster (Wednesday, September 14: 10:00 am Hong Kong; 7-8 pm PST (minus one day)) (registration here: Webinar Registration - Zoom).

In this timely webinar, our leading corporate, intellectual property, national security, and tax partners will share their insights on how PE/VC investors and their portfolio companies can build resilient structures to withstand this current period of geopolitical instability. Our focus will be on group company structures, cross-border intellectual property development and data flows. Important considerations for planning and executing new rounds of equity financings and exit options within and outside of China will also be discussed. Speakers Thomas Chou – Partner, Co-head of Asia Private Equity Group Matthew Lau – Partner, Tax Ruomu Li – Partner, PE/M&A Chuan Sun – Partner, Technology Transactions B. Chen Zhu – Partner, National Security

Morrison and Foerster Sponsors Webinar titled, "In a Founders Market, Strategic Capital Thrives."

The law firm Morrison & Foerster (a very famous law firm based in California known as MoFo) is sponsoring a free webinar on the “buyer’s market” for capital titled, “In a Founders Market, Strategic Capital Thrives.”  The webinar is scheduled for “Tuesday, November 16, 2021[,] 9:00 a.m. – 10.00 a.m. PT[,] . . . 5:00 p.m. – 6:00 p.m. GMT.” 

Additional details are below:

2021 is turning out to be a record-setting year for investment in VC-funded startups and private companies. This vast global liquidity has caught the eyes of non-traditional investors including sovereign wealth funds and limited partners, both of whom are looking to boost returns with direct investments. This makes it a buyer’s market for startups, and the best entrepreneurs have access to what seems like unlimited capital. In an informative webinar hosted by venture capital firm Pegasus Tech Ventures and law firm Morrison & Foerster, partners of both firms will discuss: How strategic capital is thriving in today’s venture environment How startups can benefit from strategic capital How corporate executives investing in startups make their organizations more innovative Panelists Include: Anis Uzzaman Ph.D., CEO & General Partner at Pegasus Tech Ventures. Anis overlooks all management investments and operations. Located in Silicon Valley, Pegasus Tech Ventures has $1.5 Billion AUM and provides early stage to final round funding. Anis has invested in over 180 startups in the United States, Japan, and Southeast Asia. Anis is also the Chairman of Startup World Cup, a global startup pitch competition with 70+ regional events across 6 continents leading up to $1 Million Dollar investment prize. Jim Krenn, Partner at Morrison & Foerster. Jim has extensive experience representing private and public companies and investors in business transactions from formation through liquidity. His practice focuses on mergers and acquisitions, venture capital financings, and emerging company counseling. Alastair Goldfisher is the Venture Capital Editor with PEI Media. His primary duty is publishing Venture Capital Journal as well as the daily email alerts. Venture Capital Journal reports on the venture community, creating content for venture firms raising funds and seeking investment opportunities and limited partners looking for compelling investments in venture capital.

RSVP is available, here. 

Alliance for Regenerative Medicine: 2019 is Second Best Year in History for Regenerative Medicine Financing

The Alliance for Regenerative Medicine (ARM) has recently released its annual report.  Notably, ARM states that 2019 was the second-best year in history for regenerative medicine financing.  A whopping $9.8 billion US was raised globally.  $7.8 million was raised for gene modified and cell therapy.  Tissue engineering received $442 million.  The report further specifies deals for significant sums as well as public offerings.  The financing numbers are also broken down by type, such as venture capital, with comparison to 2018 and 2017 numbers.  VC financing is up almost a billion dollars in 2019 over 2018.  Financing numbers are also reviewed for the EU and Israel.  The report also specifies that there are 1,066 clinical trials proceeding at the end of 2019.  New approvals and expected approvals are also discussed. 

The U.S. Industrial (Technology) Military Complex is Alive and Well: Microsoft and the Defense Innovation Unit

The LA Times recently published an article titled, “Microsoft will Give the U.S. Military Access to ‘All the Technology We Create'.”  The article discusses Microsoft’s recent announcement as well as the tension in some U.S. technology companies concerning working with the U.S. military.  For example, some Google employees have expressed displeasure with Google’s decision to work with the U.S. military.  The article notes that:

The Defense Department has established the Defense Innovation Unit, which is intended to provide capital — without taking an ownership stake — to companies that want to work on prototype projects that help address problems faced by the U.S. military.

The Defense Innovation Unit’s website is here.  The Defense Innovation Unit focuses on five areas: artificial intelligence, autonomous systems, human systems, information technology and space.  Their team includes: “about 75 military and civilian personnel. Prior to joining DIU, we’ve launched and sold companies backed by tier-1 VCs; led teams at the Joint Staff, the Office of the Secretary of Defense, and the White House; served with our military around the world; and helped build some of Silicon Valley's most iconic companies.”  Notably, the program is built around speed—a contractor will know if they have a “pilot” agreement within 30 days with a quick follow-through for a more involved contract.  The 2017 Annual Report states the mission of the Defense Innovation Unit:

The U.S. Department of Defense (DoD) established Defense Innovation Unit Experimental (DIUx) to accelerate commercial innovation to the warfighter in order to meet the changing demands of today’s strategic and technological environments. The Department’s 2018 National Defense Strategy (NDS) boldly acknowledges that our nation’s military-technical advantage is eroding as our competitors and adversaries have the same access to the global technology marketplace driving innovation. Without significant changes to DoD’s acquisition culture and processes, the U.S. military will continue to lose its long-held technological superiority.

Military-technical competition is dramatically different from past decades when key technologies were developed in government labs, often exclusively for military use. A technology first-mover up until the end of the Cold War, DoD must now adopt a fast follower posture to keep pace with commercial refresh cycles. The commercial sector leads the way in many cutting-edge areas from artificial intelligence to autonomous systems to space, the convergence of which generates the prospect of dramatic changes to the character of warfare. The implications of global access to advanced commercial technology are visible in today’s conflicts and the loss of exclusivity means the likelihood of technological surprise is far higher.

It is DIUx’s mission to lead DoD’s break with past paradigms of military-technical advantage to become fast adapters -- as opposed to sole developers -- of technology, integrating the advanced commercial capabilities necessary for strategic advantage. In this hyper-competitive environment, DoD needs to prioritize speed of delivery, rapid and modular upgrades, and quick operational adaptation on the battlefield. Success in this new era of military-technical competition no longer goes to those who seek the most exquisite systems, but rather to those who move fast and think creatively.

Headquartered in Mountain View, CA, with offices in Central Texas (Austin); Boston, MA; and in the Pentagon. . . . 

On intellectual property, the Frequently Asked Questions page states:

How is intellectual property treated and protected?

Prior to the start of a project, it is important that a company identify rights in pre-existing data. In general, companies retain ownership of IP assets created during the effort. DoD is usually licensed certain rights to use these assets in accordance with the agreed OT (i.e., pilot contract) terms and conditions. These rights control, inter alia, how DoD can use, disclose, or reproduce company-owned proprietary information.

What are the different ways IP is licensed under an OT agreement (i.e., pilot contract)?

Unlimited Rights. These give DoD the ability to use, disclose, reproduce, prepare derivative works, distribute copies, and perform publicly, in any manner and for any purpose, and to have or permit others to do so (absent any separate security classification or export control restriction). We usually don't need this and do not anticipate awarding any OT agreements (i.e., pilot contracts) with unlimited rights.

Government Purpose Rights. These give DoD the ability to use, modify, reproduce, release, perform, display, or disclose data only within the Government (including competitive re-procurement). However, DoD cannot release the data for any commercial purpose.

Limited Rights. DoD may use the company’s data, other than computer software, within DoD but not release the data outside of DoD except in limited circumstances. DoD may not use the data for manufacturing additional quantities of the item. Data may not be released without company permission/associated nondisclosure agreement.

Restricted Rights. These apply to noncommercial computer software only. DoD may only run the software on one computer at a time, and may make only the minimum copies needed for backup. The software may not be released outside of DoD except with company permission/associated nondisclosure agreement.

University of California Office of Innovation and Entrepreneurship Opens Liaison Office in Beijing

The University of California [UC] has opened a “liaison office” in Beijing to provide opportunities for UC startups to access China’s large market for products and services as well as its venture capital market.  The press release states, in part:

Office Opening

In June, 2018, UC’s Office of Innovation and Entrepreneurship (I&E) established a liaison office in Beijing at TusStar, a leading tech incubator and early-stage investment fund. The key objective of this liaison office is to provide business development and business-matching services as well as overall administrative support to UC startups looking to expand their business in China.

TusStar operates over 160 incubators globally; it has deployed over $2 billion in investment capital since 2001.  It is owned by Tus Holdings, a large integrated enterprise with 500+ subsidiaries and $15+ billion in investment capital.  

The new UC office will be located inside TusPark, the largest science park in Zhongguancun, the “Silicon Valley hub” of Beijing where multinational tech companies, such as Google, are based. 

Key Objective

The creation of this new office and relationship with TusStar will help UC startups connect with resources to market their products to Chinese customers, find additional sources of investor funding, connect with strategic manufacturing and distribution partners, and network with other UC alumni and UC entrepreneurs in China.

The Beijing office will also provide UC’s Office of Innovation and Entrepreneurship with the necessary business network and program support to coordinate alumni events and other programs connecting with Chinese investors and industry partners, i.e., cross-border tours, pitch competitions, conferences, forums and symposiums.

China Sends a Message: Invest in Me

In recent posts (here and here), I have discussed China’s increased protection of intellectual property rights.  Recently, Ian Harvey, the chair of the IP Center Advisory Board at Tsinghua University x Lab in Beijing, sent me his excellent paper on China’s IP law.  Notably, his paper outlines how China’s enforcement of intellectual property has improved and does not deserve its past reputation.  Powerpoint slides relating to his paper are available, here. 

Recently, China’s Supreme People’s Court issued a ruling recognizing Michael Jordan’s rights to his name in Chinese characters.  This decision sends a powerful message both in China and outside China that intellectual property rights will be respected.  Importantly, this is the enforcement of IP rights that were arguably not secured by Michael Jordan in China and there are strong reliance interests by the Chinese company.  I believe the symbolic importance of this decision cannot be overstated.  Interestingly, there are more reports concerning venture capital moving from the United States to Europe and China because of recent developments in U.S. intellectual property law, such as the Alice decision. What will be Donald Trump's reaction?  For more on the decision, please see the New York Times article, Michael Jordan Owns Right to His Name in Chinese Characters, Too, Court Rules. 

How to Create an Excellent Innovation Outpost

Start-up guru and Lean Launchpad developer Steve Blank has published a fascinating set of four blog posts on Innovation Outposts with co-author Evangelos Simoudis, venture capitalist.  In the first post, the authors discuss a history of corporations and their response to technological change.  The post notes how corporations became very good at development and have spent less time on research.  Essentially, corporations were unable to keep up with innovation occurring outside their specific development field.  In part, this was because of the number of scientists and entrepreneurs moving to start-ups because of the opportunity to do cutting edge work—and this was helped along by the availability of venture capital.  Because of this dynamic, corporations have needed to monitor (“sense”) and “respond” to the development of new technologies that may impact their existing lines of business, particularly in an “innovation cluster,” such as Silicon Valley and Boston.  The second post describes innovation outposts.  It provides several examples of innovation outposts and discusses the functions of those outposts: primarily to “sense” or monitor new technologies and second, to “respond,” such as by acquiring technology or partnering with companies with attractive technology.  The authors note that there is a danger that most innovation outposts will become innovation theater—essentially very good at sensing, but not at responding. 

To address the danger, the authors, in the third post, provide six questions that should be considered at the C-Level.  And, the authors emphasize that those questions must be considered at that senior management level and not at the corporate R&D level.  The questions provide focus for the corporation and its goals for the innovation cluster.  Finally, the last post provides the nuts and bolts for how to develop an innovation outpost, including having the right staffing and “corporate buy-in for productization.”  The authors plan to write a book based on the subject of the posts.  It would be interesting to see a complimentary discussion of the role of intellectual property and the intellectual property lawyer.  We eagerly await publication of their book!

Reducing risks in VC investments Part II: investing in software

Here's the second part of a two-part feature on venture capital, risk and investment, by Martin Callinan (Source Code Control) and Kate Andreeva (Protecode). Their first post dealt with general issues regarding due diligence. The sequel, below, focuses on the special issues facing anyone thinking of investing in innovative software.

Technology risk

Not just the software: the business
strategy must be robust too 

Following the strategy review comes a technology review. In the case of a software-driven enterprise, the focus is typically on the ability of both the software and the development team to deliver on the product roadmap in line with the investor’s timelines. There will be a detailed review of the software architecture, code quality, software engineering quality, scalability, and robustness. 

If the company is a software start-up, an expected pre-requisite is that software development leverages open source software. There may well be valid reasons why a start-up would use open source software but, in the due diligence of a deal flow, the start-up will need a clear and strong justification as to why open source software has not been used. 

The reality is that many young companies do not understand the value of intellectual property and risks that can be engineered into software applications.  The types of risks that investors will look for are: 

• Software architecture, scalability, and extensibility

• Exposure to third-party platforms

• IP value: an objective view of the software’s unique value in the market

• IP and patent evaluation – are there any patent infringements?

• Third party dependencies

• Open source software risk exposure

To identify these technology risks, typically a third party specialist will be contracted to perform a source code review. This review can be initiated by the technology organisation before seeking investment, by the VC or private equity organisation as part of the due diligence process, or both. If the organisation goes into a funding exercise without visibility of the quality of their code and associated risks, there is a good chance that investors will view the investment as risky, regardless of the functionality of the technology in question 

Why due diligence should include an independent source code review

Apart from identifying current issues in the source code, such as licensing irregularities, problematic intellectual property, or potential security vulnerabilities in software components, which typically can be remedied, reviewing the source code can identify inefficiencies and flaws in the development process.  It can also identify the need to have a proper code inspection process during the development cycle, thus eliminating problems before they arise. 

It may be appropriate to create an open source software adoption process with proper tooling, which can help lower compliance costs, not to mention minimising disruptions during key transactions. Similar to bugs in software, it is far more efficient and cost-effective to catch issues early. 

Before discussing source code reviews it is important we are clear what we mean by “source code.” 

What is source code? 

Source code is a set of programming language statements and commands a software developer creates that becomes part, or all, of the applications that use website or device runs. There are a plethora of languages used by developers such as C, C++, C#, Java, or scripting languages such as JavaScript, PERL, Python, or PHP. The source code is compiled into an executable which the target device will execute.

What is a code review or audit? 

A code review or audit should be performed by an independent third party specialist. VC and private equity firms are unlikely to have these skills in-house. A software company seeking investment is however likely to have somebody in-house with the skills needed to perform the review – but that person may not be able to produce a reliable and objective report. 

Why is a code review imperative? 

Developers today rarely code a complete application from scratch. Applications are made up of components of code from a variety of sources which are stitched together to create the finished application. This makes for dynamic and agile development, but with it comes a number of inherent risks. Each component will have a number of attributes, such as how it is licensed and its version. 

Outside of the function of the application(s), investors need to have details of the make-up and provenance of the code components in the following areas: 

• Intellectual property and licensing

• Security of the software

• How the software be maintained and supported

• The capabilities and maturity of the components being used

• Ability to integrate with other applications

• Quality of the components that make up the application

• Innovation – if the application be evolved over time

• Viability of the open source community around the components being used

Fundamentally, the review boils down to assessing the overall quality and consistency of the code. The source code is an indicator of the quality of the organisation seeking investment. Software development is a creative exercise and developers should be allowed to express their personal style and approach, but in line with the organisation’s standards which all developers should follow. 

The code audit process 

First, a non-disclosure agreement (NDA) must be in place between the reviewer and the organisation. Once the NDA is in place, the reviewer will question key stakeholders in the organisations to ensure there is a clear understanding of the reasoning behind the audit and the organisation’s environment, such as the size of the portfolio, languages, and tools in use particularly any automatic code generators. A Statement of Work is then produced and agreed upon. This includes:

• A breakdown of the software portfolio into audit segments 
• Full automated source code scanning, analysis, and reporting 
• Resolve copyrights, standard headers, and author tags discovered in the portfolio 
• Analyse, verify modules, and issue regular audit progress reports 
• Quality review and sign off of licensing and copyright attributes of every software file in the software portfolio 
• Delivery of audit report(s), review of the reports.

The report will be reviewed and signed off by the organisation's management. Once signed of the final reports will be completed and delivered to the organisation. The reports will include:

• Audit Report: a high level executive report, containing information and graphic representation of licences, copyrights, OSS projects, security vulnerabilities, and encryption content within the software portfolio.
• Overview Report and Detailed file-by-file Reports: verified machine-generated reports on the software portfolio. The overview report should be delivered in pdf format. A detailed file-by-file report should be delivered in in CSV (readable by Microsoft Excel application) format.
• Concatenated Licence List report: containing a consolidated text of all available licences within the software portfolio in pdf format.
• Security Vulnerability Report: a cross reference of all security vulnerability information as reported by the National Vulnerability Database in pdf format.
• Encryption Report: a list of open source software projects detected in the portfolio that could be subject to export control, in pdf format.

About the authors

Martin Callinan has over 20 years’ experience in the software industry with a focus of Software Asset Management, IT Governance, and risk avoidance. He is currently the director at Source Code Control. Martin contributed to Working Group 21, the group responsible for authoring Standards relating to Software Asset Management, such as ISO/IEC 19770-1. In the past, he worked for Microsoft Limited, FrontRange Solutions, Centennial Software, Snow Software, and Express Metrix Limited.

Kate Andreeva is the Director of Solutions at Protecode and has over 15 years’ experience in the technology industry as an engineer and sales professional. With a background in electrical engineering and software development, Kate has honed her skills at companies including Performance Technologies, Level Platforms, Klocwork, and Coverity.

Reducing risks in VC investments Part I: risk and due diligence

If only ...

Here's the first part of a two-part feature on venture capital, risk and investment, by Martin Callinan (Source Code Control) and Kate Andreeva (Protecode). This post deals with general issues regarding due diligence, which this blogger regards as a small headache that one suffers in order to avoid a heavy hangover at a later stage. The second post, which will be published tomorrow, focuses on the special issues facing anyone thinking of investing in innovative software.

What should be included in the due diligence process?

The rapid pace of innovation in the technology sector attracts both venture capital (VC) and private equity investment into UK companies, with the bulk of investment in London-based organisations. The first quarter of 2015 saw London technology smash previous funding records. The amount raised by London companies comprises 80% of all UK companies with a value of $856.7m.With the technology sector being so buoyant, investors are inundated with deal flow, which influences the way investors exercise risk assessments. Early stage investors would review a few good companies each week. With such a competitive landscape, the challenge for technology entrepreneurs is getting the attention of investors. Key to this is clearly presenting the company’s strategy. A solid business plan is important but, if the overall strategy is weak, investment is unlikely to result.

Risk versus reward 

VCs are cautious with their investment money with good reason. Generally, they take enormous risks on untested ventures which they hope will eventually transform into the next big thing. With mature organisations, the process of establishing value and the prospect of a sound investment is reasonably straightforward, as there is a track record of sales, profits and cash flow with early stage ventures, VCs will delve deeper into the business, the opportunity, and the underlying technology behind the business.

Key considerations by late round investors include

• Management: who is the team behind the organisation and what is its track record? 

• Size of market: demonstrating the target market opportunity which will indicate the returns investors might expect from any investment. 

• Product quality: investors want to invest in a great product with a competitive edge that is long-lasting and sustainable. 

• Current revenue status of the early stage company. 

• Generation of actual and pipeline sales prior to any investment. 

• The risks: VCs take on risk; their skill as investors is understanding all risks and making fully informed decisions for a successful outcome. 

The entrepreneur needs to understand that not all money is the same and not all funding sources are equal. The entrepreneur must carefully consider the implications which may follow from the investor and other requirements of various financing sources. Some examples:

• Require board member status for investors.

• Require the employment of advisors.

• Require the creation of an advisory board.

• Investor invests and observes, but does not play an active role.

Business risk 

The business risk investors look at will depend on whether it is an early stage investment or a late round investment. 

The skill of early stage investment funds is being able to identify the potential of a technology even if the product (today) is not right or needs significant evolution to become successful. This way allows an early stage investor to maximise its return while minimising its initial investment. 

Outside of the technology, early stage investors will view the current revenue status of the early stage company to decide which investment fund(s), if any, the company would fit into. 

Late round investors would, by nature of the investment, seek clarity in the company’s business plan, which would include:

• Is this the right product for today and the future?
• Is there enough money in the fund to fully meet the opportunity?
• Is there an eventual exit from the investment, a chance to see a return?
• What are the regulatory or legal risks?

About the authors

Martin Callinan has over 20 years’ experience in the software industry with a focus of Software Asset Management, IT Governance, and risk avoidance. He is currently the director at Source Code Control. Martin contributed to Working Group 21, the group responsible for authoring Standards relating to Software Asset Management, such as ISO/IEC 19770-1. In the past, he worked for Microsoft Limited, FrontRange Solutions, Centennial Software, Snow Software, and Express Metrix Limited.
Kate Andreeva is the Director of Solutions at Protecode and has over 15 years’ experience in the technology industry as an engineer and sales professional. With a background in electrical engineering and software development, Kate has honed her skills at companies including Performance Technologies, Level Platforms, Klocwork, and Coverity.

Berlin's Hi-Tech Future: High, Low, or Somewhere in Between?

This blogger had not really devoted much time to considering the start-up environment in Germany, beyond a general awareness that Berlin was a magnet for creative types from all over the globe. That all changed when his son recently informed him that he was taking his newly-minted double degree in computer science and psychology and joining a start-up in Berlin. It was good timing, then, that the October 5 issue of The Economist included an instructive article entitled “A Slow Climb: Business Creation in Germany”, here, with the sub-heading: “A vigorous start-up scene has yet to produce its first big breakthrough.” Both for this blogger and his son, the article discusses a number of key factors that distinguish the hi-tech start-up scene in Berlin from other creative hot-beds, an environment that is falling short, at least for the moment, from the carry-through from seeing a start-up being “founded every 20 hours” to the flotation and exit atmosphere that characterizes a start-up milieu such as Israel.

Let’s begin with a sobering fact: Germany does not appear to have spawned a world-beating hi-tech start-up since the founding of SAP in 1972 here. While German ingenuity, encapsulated by the industrial success of its family-owned Mittelstand, is well-recognized, here, this industrial model does not seem to have translated well into the digital world. This is so even as venture capital flows into Germany, in general, and Berlin, in particular (more such investments were reportedly made in Berlin than in London during the last quarter). The article discusses some of the possible reasons for this.

First, Germans appear to have a less enthusiastic view of entrepreneurs than do many of their neighbours. Fewer than 50% of those surveyed in Germany had a positive view about starting a business, compared with 65% in France, 68% in Poland and 79% in the Netherlands. This may be connected to another data point, namely, Germans have a higher level of fear of failure (42%), as compared with 32% in the US.

Secondly, the environment for financing start-ups in Germany has some serious deficiencies. Angel investors and venture capitalists, the life-blood of many start-ups at their formative stage, appear to be less robust than in the US. Thus, it is reported, while the average such investment in Germany is around $1 million dollars, the comparable figure is $6 million dollars (though this blogger is not quite sure what is the basis for these figures). Added to this is the fact that successful entrepreneurs in Germany are far less likely than their US counterparts to then become angel investors themselves.

Thirdly, it appears that German investors are more cautious. Instead of betting on a lot of companies, with the hope that a small number will succeed, German investors tend to invest in a smaller number of companies. In addition, German investors appear to have shorter time horizon for expecting the company to reach a break-even point. In part this can be explained perhaps by the nature of the typical start-up investor, which tends to be a large German company, such as Deutsche Telekom and the publisher, Axel Springer Verlag, here. While such a litany of corporate behemoths is impressive, it is hardly the kind of investment dynamic that one senses in the likes of Sand Hill Road in Menlo Park, California here, where a world-beating number of venture capital companies are seemingly found on every corner.

Pushing against this gloom are a number of factors that, it is argued, point to a much brighter future for German start-ups (and Berlin in particular). These include relatively low costs (from employee salaries to rents), the ever-increasing concentration of creative types, and the cutting-edge reputation of Berlin, especially for “20 (and 30)-somethings”. The German government is also committed to increasing financial support, although the relative pros and cons of government support in hi-tech endeavours continues to be debated.

The article ends with a luke-warm (as compared with the US) assessment of the likely future of the Berlin hi-tech environment, stating as follows:

“Digital Berlin is now nurturing the sorts of companies that could make pulse-quickening stockmarket debuts, if Germany had a shareholder culture vibrant enough to welcome them. As it is, many are likely to wind up in the hands of incumbents like Telekom and Springer. A few will soar on their own. Germany may not produce the next Google, but perhaps the land of Mercedes and the Mitttlestand does not need to.”

Perhaps this is too bleak an assessment. After all, how many imagined “swinging Berlin” at the outset of German reunification.
What Digital Berlin will look like a decade hence may also yield unimagined hi-tech surprises. At the least, this blogger will have an inside view of the dynamics taking place there.

"A Great Story about Patent Trolls or How to Make an Offer You Can't Refuse": It's Not What You Think

Thanks to fellow blogger Mike for bringing to the attention of our readers the article by David Segal, "How a Typical Patent Battle Took an Unexpected Turn", which appeared in the 13 July 13 issue of the New York Times, here. The article recounts the tale of a Chicago entrepreneur, Peter Braxton, whose app, "Jump Rope", which enables users to pay a fee to jump to the head of a queue, fell afoul of a law suit filed by an arguable patent troll, Smart Options. Braxton prevailed in the action (at summary judgment no less), but he was then threatened with an appeal and the filing of another first-instance patent infringement suit. Braxton, facing financial ruin even as he was prevailing at the legal level, ultimately joined forces with the (for some) notorious patent troll Erich Spangenberg and his company, IPNav. The upshot was that patent troll IPNav became a form of venture capitalist, putting in $200,000 in capital, and agreeing to handle Braxton's legal issues with Smart Options, in exchange for a 40% equity stake in company.

For Segal, the black and white hues of the actors seem pretty clear, as he concludes his piece with following observation: "…Peter Braxton's story suggests that there is really only one way to deal with a patent bully: team up with a bigger bully." While this summary makes for a good sound bite as the sardonic dénouement of a morality play, I think it does a bit of a disservice to the more nuanced context in which patent trolls operate. In particular, Segal seems to view the world of patent trolls as a closed lake (with apologizes for the metamorphosis of "trolls") in which defenceless entrepreneurial fish are preyed upon by sharks of various sizes. Under such an approach, the only strategy available for the entrepreneur is "the enemy of my enemy is my friend", under the assumption that the only thing that a patent troll may enjoy more than preying on a defenceless entrepreneur is to best a competing troll for the patent prize.

It seems to me, however, that the better way to understand what took place in the New York Times piece is to view it in terms of shifting marketing dynamics. I spoke several months ago with a veteran of the IP commercialization world in Silicon Valley. She recounted how disheartened she was in encountering twenty-something investors, with or no IP background, who are seeking to create funds of tens of millions of dollars in support of what seems to be straight-up troll-like activity. This is the kind of disconnect between the traditional purpose of patent system to encourage innovation and invention, on the one hand, and the lucrative opportunities to game the litigation system to reap potentially large pay-outs from vulnerable defendants, on the other, that has led to the current furor against not only so-called patent trolls, but the patent system itself.

In the short term (or likely even in John Maynard Keynes famously elusive "long term"), nothing will be done to address the main sources of the inefficiencies in the patent system that have enabled patent trolls to flourish. In particular, I refer to the widespread claims that too many "bad" patents are being granted and later exploited by patent trolls (although the New York Time article does not indicate that the patent at issue was a "lousy" one, but only that Mr. Braxton's business method and system did not infringe). As well, the inefficiencies derive from the crushing cost of funding a defence in a patent litigation action, with virtually no opportunity under U.S. law to receive an award of costs (see my blog post of October 25, 2012 "Patent Litigation Funding: What About the Underfunded Defendant?", here). In such a circumstance, the opportunity to game the patent system to the benefit of the patent troll is clear.

As Arthur Levitt, the former head of the U.S. Securities and Exchange Commission, intimated in a radio interview this week, the opportunity to make millions of dollars on the back of arguably (or palpably) illegal conduct means that illicit behaviour will likely always be part of Wall Street, human nature being what it is. In the case of patent trolls, at least, there is little or no accusation that they are acting in an illegal matter. To the contrary, the story of Mr. Braxton, Smart Options, Mr. Spangenberg and IPNav suggests that at least some of the actors in this world are increasingly behaving like main-stream (at least in a context akin to venture capital) investors. Accordingly an opportunity is identified and an agreement is reached that arguably benefits both parties: the investor and the entrepreneur. True, the latter may be able to dictate the terms, but that is often the case in a garden-variety investment in a start-up. At the end of the day, the deal still has to enable the start-up to achieve its commercial goals for the mutual benefit of the parties.

Seen in this way, Mr. Spangenberg is simply being quicker off the mark in spotting the business opportunity, given his familiarity with the circumstances involved. There is nothing that precludes others for investing in a similar fashion. Not quite David Segal's morality play, but rather a more promising outcome for trying to mitigate the damages caused by the deep-rooted inefficiencies in the patent system.

Three Stories About China: Yum Brands, the Venture Capital Market in China and More, and Hollywood

Several years ago, Yum Brands, the company that owns KFC (Kentucky Fried Chicken), Taco Bell and Pizza Hut, was lauded as the company that had figured out how to succeed in China.  Indeed, a substantial portion of its profits were based on its sales in China—specifically KFC (4,200 restaurants in China) and to a lesser extent Pizza Hut (almost 800 restaurants in China).  When asked about the cause of its success, a representative from Yum Brands said “a first mover advantage.”  And, a big part of that first mover advantage was a very strong brand.  Unfortunately for Yum Brands and its investors, times have been very tough for Yum—a strain of bird flu plus regulatory challenges based on claims of “excessive antibiotics and hormones” have led to empty restaurants.  Consumer confidence is dropping and the value of the brand with it.  How should Yum Brands rehabilitate its brand in China?  Any suggestions?

Stanford business school professor Steve Blank recently visited China on a book tour concerning startups and has many, many interesting observations concerning venture capital and startups in China in his five blog posts titled “China -- The Sleeper Awakens.”  Blog posts three and four are very interesting; although I believe they are all worth reading.  Here are his lessons learned from his fourth post titled “Zhongguancun in Beijing – China’sSilicon Valley”:

• China has the biggest Venture Capital industry outside the U.S
• For software, the action is in Beijing
• China has closed its search, media and social network software market to foreign companies
• Beijing’s VC’s primarily invest in the Technology, Media and Telecommunications segment
• Liquidity is via IPO’s not buy outs

Finally, the New York Times recently reported on how Hollywood’s latest releases are not doing as well as expected in China.  The reason given is something between Hollywood’s blockbusters have no depth and are just bunch of explosions, and China’s moviegoers are more interested in domestic films.  Interestingly, several of the Hollywood movies discussed in the article concern films arguably with a “built in” fan base that loved an earlier work the movie is based upon.  I wonder if they will move to capturing the power of nostalgia by reworking more Chinese tales.  What do you think? 

"Boulevard of Broken Dreams": Late But Not Forgotten

A book review is a tricky matter. Being an author myself, I am never quite how sure what my role is as a reviewer. That is particularly so when the book that I am reviewing does not leave me with a favourable impression. To write a lukewarm review and potentially damage a fellow author's likelihood of success, or simply to decline to write a review in such circumstances. I am not sure of the correct answer.

Another circumstance for declining to review a book is the feeling that I am not really the right person for the job. That is the sense that I had when I received the book, Boulevard of Broken Dreams (Princeton University Press, here) by Professor Josh Lerner of the Harvard Business School. Lerner is that rare blend of world-class thinker with hands-on experience who has made major contributions to the way that we think about innovation and entrepreneurship. At the time that I received a copy--18 months ago, I did not think that I could do justice to the book. And so I demurred, as the book lay on my bookshelf, unread and unattended. Over the ensuing 18 months or so, however, I have found myself more and more drawn to the subject of Lerner's book, in practice, writing and teaching. Eventually I read the book itself from cover to cover and later relied on portions of the book in preparing a talk. I suddenly realized that I had been engaged by the book at multiple levels. I am now ready to write a review.

Lerner's book is really two books in one, each about 85 pages in length. The first, entitled "Can Bureaucrats Help Entrepreneurs?" is what Lerner calls the "39,000 foot" look at the public role of entrepreneurship and venture capital. The second part drills down a much more granular and local view of the subject. Three chapter headings are particularly telling: "How Governments Go Wrong, Bad Design" (chapter 6), How Governments Go Wrong, Bad Implementation" (chapter 7) and "The Special Challenges of Sovereign Funds" (chapter 8).

Despite the doom and gloom of these titles, his discussion reveals a much more mixed bag and two countries of particular interest to me--Singapore and Israel-- serve as positive (though not perfect by any means) models of the potential for government involvement in entrepreneurship. It is these latter chapter from which I drew insight and inspiration in preparing my own public talk.

So what do I make of the Lerner book? First and foremost, I could not shake the impression that each of these two parts should have been the subject of a separate book. Short of that, I would have preferred if Lerner had expanded the second part of the book and provide further discussion of developments on the ground. I relished his discussions in this regard and I had only one complaint when I came to the end of chapter 8--it is such a pity that there is not more of it. Indeed, I cannot say that the first part aided much in my understanding of Lerner's elegant and edifying exposition of the granularity of the intersection between government involvement and entrepreneurship.

Perhaps another of saying this is that I remain a skeptic about the extent to which one can draw more generalizable lessons from the examples that Lerner describes. Lerner is no deductionist, and he does not impose a top-down view of the subject, even in the first part of the book. However, even inductive conclusions from these latter chapters should be be treated with caution. It is true that Lerner addresses "Lessons and Pitfalls" in his final chapter, but I am not sure that his descriptions warrant these conclusions. There is nothing surprising here--the subject matter that Lerner addresses is inherently "messy" for any analytical treatment. In that connection, I recall the observation of the March 10, 2012 issue of The Economist in its concluding words of obituary in memory of the great Harvard social scientist James Q. Wilson:

"Problems remained, however. None was more thorny, for him, than the qualifying of evidence. Many of the social problems he pondered seemed to boil down to culture and ways of thinking. for which the data were ungathered and ungatherable. As a scientist, political or social, he needed to count and collate things to find the answers to his questions. But nothing that was really important about human beings, he [James Q. Wilson--njw] once said. could be measured in that fashion." 

Wilson may have been a bit too pessimistic about our ability to reach durable social truths about ourselves, including the world of entrepreneurship and innovation. That said, better for the reader to consider the chapters in part two of the book in depth and to draw his own conclusions, based on the reader's own experiences. This in my view is the special contribution of the Lerner book and why it is worthy of reading, more than once.

The Missing IP Narrative

It remains my most vexing professional challenge. The "it" is how to integrate IP/IC into management education. The vexation comes from the seeming paradox tha, while intellectual property and intellectual capital are routinely described as cornerstones of innovation, if not modern business itself, their systematic presence in MBA curricula remains sporadic at best. I was reminded of this in connection with two quite different experiences that I had during the week.

In the first, I had occasion to spend some time with the dean of a local business school. Recently appointed, he was taking bold action to modify the schools's MBA program to make it more appropriate for today's student body. In that connection, he wanted to hear more about my class on IP and Management that I teach elsewhere. His question, half  "devil's advocate", half an expression of curricular skepticism, was simply this: "I have space for 20 or so courses in the program. Why should a course such as yours be part of the curriculum?"

The case in favour of inclusion is not simple. In the face of multiple courses in strategy, finance, marketing, and operations, the role of a course focusing on IP is dfficult to explain. The uneven diffusion of IP subject matter throughout an organization, the origin of IP as a branch of legal practice and its intangible character all give IP a bit of orphan status within the school's curriculum.

The Dean pushed me for examples of how the course works in practice. A pregnant pause ensued, finally punctuated by several examples of IP and management that seemed to pique his interest. All the while I stressed that one can look at MBA education as a platform for imparting relevant narratives to the students. Taken from this perspective, the ultimate justification for the course is that it highlights the IP narrative in a manner that is front and centre: "Can you imagine a manager who does not have the ability to apply the IP narrative to his daily businsess?", I asked. I am not sure that I convinced him that the answer is "yes". If I failed, cohort after cohort of young managers will be trained at his school without receiving any systematic tranining in this field. The managerial narrative for these students will simply lack a meaningful consideration of IP.

This absence of a narrative for IP was reinforced in listening to a podcast that featured a well-known venture capitalist describing the foundations of the VC world. The speaker did not disappoint. He described the flow of foundation money from university and similar endowments as the turning point for VCs to attract substantial investment capital. He emphasized the importance of the human dimension in any investment, and observed that any prospective company that puts special emphasis on an exit strategy for the company lacks the necessary patience. He distinguished between great innovative ideas and market potential. There are a lot more of the former than the latter.

These multiple narratives about the VC enterprise were interesting and instructive. Except for one thing: the speaker mentioned IP only in passing. Based on his words, IP was not a central part of the VC narrative. In follow-up correspondence with the speaker, he replied briefly that the company "of course" takes an interest in the company's IP, ie., "FTO and patentability." In his view, IP is largely limited to patents, and the work required is the purview of patent technocrats, far removed from most of the company's managers.


This podcast and email correspondence reinforced the sense of frustation that I had felt in my meeting with the dean, namely that IP is not part of the mainstream MBA narrative for most students. The upshot is that most MBA students will continue to go through their programs with scant or simply no attention being paid to IP. Is there a price to be paid for this? Perhaps. It is frequently observed that innovation has materially declined over the last few years. There are no doubt a number of reasons for this troubling state of affairs. Against that backdrop, one wonders whether the absence of a meaningful narrative regarding IP within the context of most MBA programs is another source of the innovative malaise. This is at least narrative food for thought.

Experiences of IP and VCs

Next Thursday 29th April in London, Jon Calvert of ClearView IP will be sharing his experience of investors and their views on intellectual property in an evening presentation for the Licensing Executives Society.

According to Jon, the likely programme will include:
- IP in early stage companies
- The management team's knowledge of IP
- Divergence between the IP and the product/service being sold
- The patent landscape
- Variations in due diligence with the amount to be invested

The meeting is open to non-members as well as members of LES. More information is available here.