The New Rules of Angel Investing (NYT)

The New Rules of Angel Investing

By KERMIT PATTISON

Angels still have wings, but they aren’t flying quite so high.

The rules of the game of angel investing have changed in the post-crisis world. The average deal size shrank by 31 percent in the first half of this year, according to a recent study by the Center for Venture Research at the University of New Hampshire. The study shows that total angel investments fell to $9.1 billion in the first half of 2009, a 27 percent decline from the same period last year, but the number of companies getting venture investments actually increased by 6 percent, to 24,500.

Angels are still financing deals, but at lower valuations and with more specific milestones. They have grown more picky and less tolerant of risk. “What you’re seeing now is a real flight to quality,” said David S. Rose, chairman of New York Angels. “If you are the real deal, you can get funded.”

What’s the real deal? Angels are looking for companies with more modest capital requirements. They seek companies that bootstrap, beat quicker paths to profitability and have proven management teams. “The most striking change is angel investors are way more discerning about where they deploy their capital,” said Bruce Cerullo, a Boston-based angel investor who specializes in health care. “Now groups like ours are looking for more fully baked ideas that are much closer to revenue generation.”

Do It Yourself

There has been a sea change in risk sensitivity; the more self-sufficiency a company demonstrates, the less risky it appears. “Bootstrap it as long as you possibly can to validate your business model and to get some traction,” Mr. Cerullo said. “The more traction you have, the more leverage you are going to have in a valuation negotiation with an angel or private equity investor.”

Entrepreneurs should find ways to finance their own growth: working without salary, moonlighting, seeking grants, running lean operations and focusing on an aspect of the business that can generate revenue.

Bear in mind that the worst of times for the economy can be the best of times for starting a company. Labor is cheap and plentiful. The costs of starting an Internet-based company have fallen sharply thanks to cheaper technology, including open-source software. “Work hard to figure out if there’s a business plan you can pursue where your capital requirements are zero,” said Ian Sobieski, founder and managing director of the Silicon Valley-based Band of Angels Fund. “The easiest way to raise money is to not absolutely have to raise money.”

Angels are looking for companies that can get to break even on the angel investment. In return, they are willing to be more patient, Mr. Rose said. In the old days, angels invested with the idea that they would finance the company at an early stage, then venture capitalists would step in with a large injection of cash that allowed it to blast off on a hockey-stick growth trajectory.

“Now we’re prepared to give up the immediate hockey stick in exchange for you being able to reliably get to break even on our cash while building value for the company,” Mr. Rose said. “The minute the market comes back, we can inject V.C. cash — and then you have the hockey stick.”

Be Realistic About Valuations

Valuations have fallen sharply — as much as 40 percent, Mr. Rose estimates. The upside is that the costs of starting a company have fallen, too.

Yet some entrepreneurs still cling to over-inflated valuations. They get hung up on achieving the highest valuation without regard to how it may undermine their long-term prospects.

“The biggest error they make, in my experience, is they focus solely on this round and take money based solely on whether they can fill out the round at the absolute highest valuation,” said John Huston, who invests with Ohio TechAngels and is chairman of the Angel Capital Association. “They do not select investors who know the market and are willing to write follow-on checks.”

Unrealistic valuations will make serious investors roll their eyes. Even if entrepreneurs can get above-market valuations, they run the risk of getting a lower valuation on a subsequent round, a phenomenon known as the “deadly down round.” Mr. Huston said inflated valuations are a sign that the company picked the wrong investor and “took money from neophytes who were only attuned to this round and the promises of grandiose success.”

Lay Out Milestones

Mr. Huston warns that entrepreneurs should beware of “one-check Willy” — the angel who finances just one round. Instead, entrepreneurs should look for angels who are willing to discuss long-term plans with milestones and follow-on investments that guide the company “from here to liquidity.”

The exit market has changed drastically because of a decline in mergers, acquisitions and initial public offerings. As a result, venture capital firms increasingly are concentrating on their existing portfolios and forcing angels to support start-ups for longer.

Many angels now expect to write checks for follow-on rounds because they can no longer count on V.C. money being available down the road. John Morris, chairman emeritus of Tech Coast Angels in Southern California, said that angels were now keeping reserves of 200 to 300 percent — up from zero a few years ago.

“That’s probably the single biggest difference in angel land,” said Mr. Morris. “Angels are learning about reserves and the need to parse out the money in a series of tranches, keeping some dry powder for the next round.”

Practice Your Pitch

Get good at pitching the same way major leaguers do: practice, practice, practice. Entrepreneurs should be ready to present a full business plan, a 20-minute PowerPoint, an executive summary and a two-minute elevator pitch (which is what gets you in the door in the first place). Rehearse with anybody who can offer good advice. Go to industry events. Many angel groups hold quick-pitch events where entrepreneurs are invited to make brief presentations.

Susan Preston, general partner of CalCEF, a clean-energy angel fund in San Francisco and author of two books on angel investing, said entrepreneurs might have to pitch to 50 or 100 investors before they got venture funds: “In tight times, only the absolute stars rise to the top to receive funding. If they want to have a chance, they’ve got to be well prepared.”

Know Where to Look

Angels often don’t advertise themselves because they don’t want to be deluged by suitors. And lists or directories have their limits (although this one from the Angel Capital Education Association can help you get started). “Look farther, network a little harder,” said Jeff Sohl, director of the Center for Venture Research. “Turn over those rocks like you should have been doing all along, rather than taking the easy route of Googling and looking at the first 10 hits. That might have worked in the go-go times of 2000, but it doesn’t even get you close now.”

Consider both lone-wolf angels and organized groups. Angels tend to focus on regional companies but increasingly are specializing in niches like medical devices, technology and clean energy.

One classic mistake is to look at angels solely as sources of cash. Ms. Preston considers money to be an angel’s third most important contribution after expertise and networking. She urges entrepreneurs to scrutinize potential investors: What expertise can they provide? How do their strengths complement your weaknesses? Who can they introduce you to?

Coached by an Angel

Murat Ozsu weathered the recent sea change in angel investing — and survived to tell about it.

Mr. Ozsu had spent more than two years bootstrapping his Long Island-based start-up, innRoad, an online platform that helps independent hotels manage guest bookings. He had moved to a smaller house, borrowed from family and friends, worked out of his son’s bedroom and spent many nights laboring into the wee hours so he could coordinate with his software development team in India. He pitched to hundreds of angels before he attracted the interest of a few investors who began coaching him. Just when he had built up a base of customers and was poised to get financing, his plans hit a major snag: the financial collapse of 2008.

Mr. Ozsu took his plan and ripped it apart. On the advice of his angels, he recalibrated for leaner times and cut his capital requirements in half. “These are all guys who have run their own companies,” he said, “and they’ve all been through this before. I’d much rather learn from other people’s mistakes. I’m going to make my own mistakes, so why make theirs?”

Ultimately, innRoad won the backing of 15 angels and a New York State investment program and raised $1.2 million — twice its goal and, surprisingly, the same amount it had planned to seek before the crisis. InnRoad recently did a second investment round of $300,000, which Mr. Ozsu said would sustain the company until it reached breakeven next summer.

Along the way, he said he learned to think like an investor — often a difficult step for entrepreneurs who have poured their souls into their companies. “Trying to raise money is not the goal,” Mr. Ozsu said. “The goal is a business plan that makes sense on its own merits. Money is just one of the tools that you need.”

Quick Tips:

• Bootstrap as long as you can. Finding early ways to get revenue.

• Get to break even quickly and remember that VC financing has gotten harder to obtain.

• Be realistic about valuations. Be coachable.

• Practice pitching and be prepared to make your case to dozens or hundreds of angels.

• Look for angels who complement your strengths and can help you with more than money.

Suggested Readings and Resources:

• An overview of angel investing and a list of resources from Angel Capital Education Foundation.

• What Entrepreneurs Should Know About Angels from the Angel Capital Education Foundation.(pdf)

• A directory of angel investors from the Angel Capital Education Association.

Patent Auctions Offer Protections to Inventors (NYT)

Patent Auctions Offer Protections to Inventors

By STEVE LOHR

The world can be a rough place for independent inventors. They can often find themselves in court, battling big corporations, spending piles of money on lawyers and leaving it up to judges and juries to determine the value of their hard-won patents.

That could be changing. Wrangling over patents is beginning to move out of the courtroom and into the marketplace. A flurry of new companies and investment groups has sprung up to buy, sell, broker, license and auction patents. And venture capital and private equity is starting to pour into the field.

The arrival of these new business-minded players, according to patent experts and economists, could lead to a robust marketplace for patents, where value is determined not so much by court judgments but by buyers and sellers, perhaps, someday, like eBay.

And patents, after all, are ideas. Any market mechanisms that speed up the process of figuring out what a patent is worth should hasten the flow of ideas into the economy, accelerating the pace of innovation, policy experts say.

“What you want is a market that can promote innovation and reduce the huge costs of litigation,” said Robert P. Merges, a professor at the University of California, Berkeley and a director of the Berkeley Center for Law and Technology. “And that market is starting to take shape.”

A classic small-inventor firm, Zoltar Satellite Alarm Systems, is planning to sample that market by auctioning off its patents next month. Professor Merges and other patent experts point to it as an intriguing case to watch.

To date, the Zoltar story has been one of innovation, persistence and litigation. One founder of the company, Dr. Daniel Schlager, got his inspiration nearly two decades ago, crouched in medevac helicopters flying over Northern California. Locating people in distress was often difficult and costly, in time and lives. What was needed, he figured, was some sort of personal alarm device that transmitted a person’s location.

He sought out an old high-school classmate, William Baringer, a computer scientist and telecommunications expert. Using global positioning technology seemed promising, even though it was clunky and expensive at the time. They came up with a solution, and filed their first patent application in 1994 for a “personal alarm” device that used GPS technology. A year later, Zoltar was founded, and it filed for a patent on personal alarms with navigational receivers in cellphones that was granted in 1997.

Zoltar’s prospects got a lift after the Federal Communications Commission in 1996 required most wireless phones to be able to identify their location during 911 calls by 2001. The move opened a large potential market for Zoltar.

The two men designed and built prototypes, hired a patent licensing expert and showed their technology to cellphone equipment makers in the late 1990s in the hopes of licensing it. “It’s an industry with huge companies who crosslicense patents with each other and tell little guys to take a hike,” said Robert Megantz, a former general manager of licensing for Dolby and the consultant who worked with Zoltar in the late 1990s.

Eventually, Zoltar’s founders say, their ideas and designs started to turn up in big companies’ products. They raised money, mostly from friends and family, hired lawyers and went to court.

In 2001, Zoltar sued Qualcomm, the cellphone chip-set maker. After three years, a jury found that Zoltar’s patents were valid, but that Qualcomm was not infringing on them. The two sides settled in 2006.

In 2005, Zoltar sued several handset makers including Motorola, LG and Samsung, and settlements were reached with all of them by 2007.

By now, Zoltar has spent millions in legal fees, and collected millions in settlements. The company is ahead financially, Dr. Schlager said, but some of its 60 investors have not been paid back. Mr. Baringer remains a full-time consultant engineer, and Dr. Schlager is still an emergency-room physician, though he does not practice full time.

Today, the fast-growing makers of smartphones like Research in Motion, Apple, HTC and Nokia have no agreements with Zoltar. Dr. Schlager said he did not plan to sue them. Instead Zoltar will sell its patents in an auction, hoping for a faster, simpler and less risky payoff.

“We felt this was the way to go,” Dr. Schlager said. “It’s an option that wasn’t available a few years ago.”

The auction will be run by Pluritas, a patent broker based in San Francisco. Robert Aronoff, its managing director, says Zoltar has strong, court-tested patents that apply to a huge industry, at a time when there is an increasingly brisk market for intellectual property. “They are entering into this vastly changed marketplace with a hot property,” he said.

Whether the patents will prove to be a hot property is not clear. “They were certainly innovative over the years, but I do think there is a question here if the industry and technology has passed them by,” said Professor Merges of Berkeley.

Mr. Baringer insists this is not the case. “We continue to see our designs and concepts implemented every day” in smartphones, he said.

In an auction, of course, the patents’ value will be judged by bidders, which could be handset makers, but also patent-buying groups like Intellectual Ventures and Rational Patent Exchange and Allied Security Trust, a nonprofit organization.

Other players in the emerging patent marketplace are specialized investment banks, brokers and licensing companies including Acacia Technologies, Altitude Capital Partners, Intertrust, IPotential, Ocean Tomo, Rembrandt IP Management and Thinkfire. Venture capitalists are also interested in this field — Kleiner Perkins Caufield & Byers, for example, is backing Rational Patent Exchange, a company that buys reservoirs of patents in crucial fields and charges fees to corporate “members,” who participate as a defensive tactic to limit potential patent litigation costs.

The long-term vision at Rational, said Randy Komisar, a partner at Kleiner, is to become a marketplace or clearinghouse, perhaps the way Ascap is for copyrighted music, collecting fees and distributing payments to artists.

“The goal is to be a place where the patentholder is fairly compensated, but the corporate users have access to technology with minimal transaction costs,” Mr. Komisar said. “It has the potential to make innovation more efficient and less risky for both sides.”

But some patent experts question how far the marketplace model can be extended to patents. They note that patents are typically trickier to value than financial investments like stocks or bonds.

“Yes, you can move in the direction of trading markets for patents, but these are complicated assets that are individualized and hard to value,” said Josh Lerner, an economist at the Harvard business school. “They are more like works of art than stocks.”

Biotech Tries to Shrug Off Setbacks (NYT)

Biotech Tries to Shrug Off Setbacks

By JAMES FLANIGAN

FROM one perspective, the life sciences industry — the biotechnology companies that develop drugs and treatments to combat disease and the biomedical firms that create medical devices — is a picture of expanding horizons and confidence.

Young companies are taking advantage of advances in medical and computing sciences to develop new ways of dealing with intractable health problems.

One new company has developed a disposable device with software that would help surgeons to perform knee replacements with greater accuracy. Another has a microscopic device implantable in the eye that would continuously release medicines to alleviate glaucoma or macular degeneration.

Other companies have developed potential vaccines against staphylococcus infections and drugs to preserve cardiac function after a heart attack. Indeed, the biotech industry is spreading globally to India and China, where capital is abundant and research is increasing.

But even as the industry seems to be making progress, its biggest benefactors are pulling back. The traditional providers of venture capital in the United States are university endowments and pension funds, whose assets have been reduced sharply over the last year in the collapse of financial markets.

Even a successful investor in the life sciences industry sees danger now. Domain Associates, a company based in Princeton, N.J., and San Diego, raised $500 million for a new venture fund in August. It is the eighth such fund Domain has started in 24 years, and in that time, it has backed more than 200 life sciences companies. But few other venture funds were able to raise money, said James C. Blair, a Domain partner.

The people investing “in our area are hurting, and this will have long-term implications for venture capital in general,” he said. Without new communities of capital, he said, “we worry about where we will find other investors to participate in our best opportunities in two to three years.”

He is not alone in worrying. The PricewaterhouseCoopers MoneyTree survey of venture capital recently reported a surge in financing for life sciences in the second quarter of this year. Yet the firm also reported that venture fund assets were down to levels of the mid-1990s, before the last decade’s financial expansion.

The Southern California Biomedical Council, an organization of 240 companies in life sciences in the Los Angeles area, has set “ways to cope with the current drought of capital” as the agenda for its annual investors conference starting Thursday. So is the outlook bright or gloomy? Most companies, even those that have had difficulties, say it is still bright. “We’re seeing the coming together of information technology and medical science,” said Sharon Stevenson, a co-founder of Okapi Venture Capital, a three-year-old company in Laguna Beach, Calif.

Okapi this year backed OrthAlign Inc., a company founded in 2008 that is awaiting approval from the Food and Drug Administration for a palm-size disposable device that attaches to instruments used in knee replacements to help surgeons do more precise cutting of the bone to improve the fit with the joint replacement.

“There are about 550,000 knee replacements every year in the United States, and that is expected to grow to 3.5 million by 2025,” said Pieter Wolters, president of OrthAlign. More people, he said, want an active lifestyle into late age and “technology allows longer lasting function of knee replacements.” OrthAlign has received $7.2 million in venture financing from Research Corporation Technologies of Tucson and Okapi Venture Capital.

Replenish Inc. of Pasadena, Calif., was founded in 2007 on technology developed at the Keck School of Medicine and Viterbi School of Engineering at the University of Southern California as well as the California Institute of Technology. Replenish plans to enter trials for F.D.A. approval next year for a refillable and programmable pump that would be implanted in the eye to feed medicine for glaucoma or for age-related macular degeneration.

The Replenish device can last more than five years before replacement, much longer than current treatments, said Dr. Sean Caffey, chief executive of the company. Replenish is backed by a $10 million investment from a large pharmaceutical company, Dr. Caffey said, and the Stevens Institute for Innovation at the University of Southern California and Caltech have acquired small equity ownerships for their licenses.

In 2005, six scientists from the University of California, Los Angeles, who were working at LA BioMed, a nonprofit research institute, founded NovaDigm Therapeutics. There, they have developed a vaccine that could prevent infections acquired in hospitals, including candida and staph infections, said Fred Haney, a venture capital investor and chairman of NovaDigm.

The company will begin its initial clinical trials for F.D.A. approval next year. It is backed by $18 million in venture investments from Domain Associates and has received grants from the National Institutes of Health and the United States Army to support its research.

Clinical trials extend over three phases and can take years, making investments in life science companies prohibitively long term. “But, in reality it is not so long,” Mr. Haney said. “If we can demonstrate safety and strong immune responses in phase one or two, we could then enter a partnership or merger with a large pharmaceutical company and obtain long-term financing.”

In a possible sign of major things to come, the Zensun Science & Technology Company, based in Shanghai, has raised $30 million to perfect a treatment to strengthen cardiac structure after a heart attack. Zensun is backed by Morningside Investments of Hong Kong and the Shanghai city government, said Jack Z. Chen, chairman of the Transworld Capital Group, a consulting firm based in Arcadia Calif., with offices in Beijing and Shanghai.

Zensun was founded in 2000 by Dr. Mingdong Zhou, who earned a doctorate at the State University of New York, and Dr. Xifu Liu, whose doctorate is from the Genetics Institute at the China Academy of Sciences. Its heart treatment is now in phase two F.D.A. trials, which measure effectiveness.

Such trials are demanding and sometimes treatments do not win approval. The Orqis Medical Corporation spent nine years perfecting a system of increasing blood flow to help damaged hearts but did not receive F.D.A. approval. So backers decided last year not to invest fresh capital. The company is for sale to any firm that would continue development and try again for F.D.A. approval.

The president of Orqis, Kenneth Charhut, said he regretted the setback but remained positive about the industry outlook. “Given advances in technology and growing needs of aging populations,” he said, “this is a time to invest in life sciences.”

This column about small-business trends in California and the West appears on the third Thursday of every month. E-mail:
jamesflanigan@nytimes.com.

Priced to Sell (New Yorker)

Priced to Sell
Is free the future?
by Malcolm Gladwell July 6, 2009

At a hearing on Capitol Hill in May, James Moroney, the publisher of the Dallas Morning News, told Congress about negotiations he’d just had with the online retailer Amazon. The idea was to license his newspaper’s content to the Kindle, Amazon’s new electronic reader. “They want seventy per cent of the subscription revenue,” Moroney testified. “I get thirty per cent, they get seventy per cent. On top of that, they have said we get the right to republish your intellectual property to any portable device.” The idea was that if a Kindle subscription to the Dallas Morning News cost ten dollars a month, seven dollars of that belonged to Amazon, the provider of the gadget on which the news was read, and just three dollars belonged to the newspaper, the provider of an expensive and ever-changing variety of editorial content. The people at Amazon valued the newspaper’s contribution so little, in fact, that they felt they ought then to be able to license it to anyone else they wanted. Another witness at the hearing, Arianna Huffington, of the Huffington Post, said that she thought the Kindle could provide a business model to save the beleaguered newspaper industry. Moroney disagreed. “I get thirty per cent and they get the right to license my content to any portable device—not just ones made by Amazon?” He was incredulous. “That, to me, is not a model.”

Had James Moroney read Chris Anderson’s new book, “Free: The Future of a Radical Price” (Hyperion; $26.99), Amazon’s offer might not have seemed quite so surprising. Anderson is the editor of Wired and the author of the 2006 best-seller “The Long Tail,” and “Free” is essentially an extended elaboration of Stewart Brand’s famous declaration that “information wants to be free.” The digital age, Anderson argues, is exerting an inexorable downward pressure on the prices of all things “made of ideas.” Anderson does not consider this a passing trend. Rather, he seems to think of it as an iron law: “In the digital realm you can try to keep Free at bay with laws and locks, but eventually the force of economic gravity will win.” To musicians who believe that their music is being pirated, Anderson is blunt. They should stop complaining, and capitalize on the added exposure that piracy provides by making money through touring, merchandise sales, and “yes, the sale of some of [their] music to people who still want CDs or prefer to buy their music online.” To the Dallas Morning News, he would say the same thing. Newspapers need to accept that content is never again going to be worth what they want it to be worth, and reinvent their business. “Out of the bloodbath will come a new role for professional journalists,” he predicts, and he goes on:



There may be more of them, not fewer, as the ability to participate in journalism extends beyond the credentialed halls of traditional media. But they may be paid far less, and for many it won’t be a full time job at all. Journalism as a profession will share the stage with journalism as an avocation. Meanwhile, others may use their skills to teach and organize amateurs to do a better job covering their own communities, becoming more editor/coach than writer. If so, leveraging the Free—paying people to get other people to write for non-monetary rewards—may not be the enemy of professional journalists. Instead, it may be their salvation.

Anderson is very good at paragraphs like this—with its reassuring arc from “bloodbath” to “salvation.” His advice is pithy, his tone uncompromising, and his subject matter perfectly timed for a moment when old-line content providers are desperate for answers. That said, it is not entirely clear what distinction is being marked between “paying people to get other people to write” and paying people to write. If you can afford to pay someone to get other people to write, why can’t you pay people to write? It would be nice to know, as well, just how a business goes about reorganizing itself around getting people to work for “non-monetary rewards.” Does he mean that the New York Times should be staffed by volunteers, like Meals on Wheels? Anderson’s reference to people who “prefer to buy their music online” carries the faint suggestion that refraining from theft should be considered a mere preference. And then there is his insistence that the relentless downward pressure on prices represents an iron law of the digital economy. Why is it a law? Free is just another price, and prices are set by individual actors, in accordance with the aggregated particulars of marketplace power. “Information wants to be free,” Anderson tells us, “in the same way that life wants to spread and water wants to run downhill.” But information can’t actually want anything, can it? Amazon wants the information in the Dallas paper to be free, because that way Amazon makes more money. Why are the self-interested motives of powerful companies being elevated to a philosophical principle? But we are getting ahead of ourselves.

Anderson’s argument begins with a technological trend. The cost of the building blocks of all electronic activity—storage, processing, and bandwidth—has fallen so far that it is now approaching zero. In 1961, Anderson says, a single transistor was ten dollars. In 1963, it was five dollars. By 1968, it was one dollar. Today, Intel will sell you two billion transistors for eleven hundred dollars—meaning that the cost of a single transistor is now about .000055 cents.

Anderson’s second point is that when prices hit zero extraordinary things happen. Anderson describes an experiment conducted by the M.I.T. behavioral economist Dan Ariely, the author of “Predictably Irrational.” Ariely offered a group of subjects a choice between two kinds of chocolate—Hershey’s Kisses, for one cent, and Lindt truffles, for fifteen cents. Three-quarters of the subjects chose the truffles. Then he redid the experiment, reducing the price of both chocolates by one cent. The Kisses were now free. What happened? The order of preference was reversed. Sixty-nine per cent of the subjects chose the Kisses. The price difference between the two chocolates was exactly the same, but that magic word “free” has the power to create a consumer stampede. Amazon has had the same experience with its offer of free shipping for orders over twenty-five dollars. The idea is to induce you to buy a second book, if your first book comes in at less than the twenty-five-dollar threshold. And that’s exactly what it does. In France, however, the offer was mistakenly set at the equivalent of twenty cents—and consumers didn’t buy the second book. “From the consumer’s perspective, there is a huge difference between cheap and free,” Anderson writes. “Give a product away, and it can go viral. Charge a single cent for it and you’re in an entirely different business. . . . The truth is that zero is one market and any other price is another.”

Since the falling costs of digital technology let you make as much stuff as you want, Anderson argues, and the magic of the word “free” creates instant demand among consumers, then Free (Anderson honors it with a capital) represents an enormous business opportunity. Companies ought to be able to make huge amounts of money “around” the thing being given away—as Google gives away its search and e-mail and makes its money on advertising.

Anderson cautions that this philosophy of embracing the Free involves moving from a “scarcity” mind-set to an “abundance” mind-set. Giving something away means that a lot of it will be wasted. But because it costs almost nothing to make things, digitally, we can afford to be wasteful. The elaborate mechanisms we set up to monitor and judge the quality of content are, Anderson thinks, artifacts of an era of scarcity: we had to worry about how to allocate scarce resources like newsprint and shelf space and broadcast time. Not anymore. Look at YouTube, he says, the free video archive owned by Google. YouTube lets anyone post a video to its site free, and lets anyone watch a video on its site free, and it doesn’t have to pass judgment on the quality of the videos it archives. “Nobody is deciding whether a video is good enough to justify the scarce channel space it takes, because there is no scarce channel space,” he writes, and goes on:


Distribution is now close enough to free to round down. Today, it costs about $0.25 to stream one hour of video to one person. Next year, it will be $0.15. A year later it will be less than a dime. Which is why YouTube’s founders decided to give it away. . . . The result is both messy and runs counter to every instinct of a television professional, but this is what abundance both requires and demands.

There are four strands of argument here: a technological claim (digital infrastructure is effectively Free), a psychological claim (consumers love Free), a procedural claim (Free means never having to make a judgment), and a commercial claim (the market created by the technological Free and the psychological Free can make you a lot of money). The only problem is that in the middle of laying out what he sees as the new business model of the digital age Anderson is forced to admit that one of his main case studies, YouTube, “has so far failed to make any money for Google.”

Why is that? Because of the very principles of Free that Anderson so energetically celebrates. When you let people upload and download as many videos as they want, lots of them will take you up on the offer. That’s the magic of Free psychology: an estimated seventy-five billion videos will be served up by YouTube this year. Although the magic of Free technology means that the cost of serving up each video is “close enough to free to round down,” “close enough to free” multiplied by seventy-five billion is still a very large number. A recent report by Credit Suisse estimates that YouTube’s bandwidth costs in 2009 will be three hundred and sixty million dollars. In the case of YouTube, the effects of technological Free and psychological Free work against each other.

So how does YouTube bring in revenue? Well, it tries to sell advertisements alongside its videos. The problem is that the videos attracted by psychological Free—pirated material, cat videos, and other forms of user-generated content—are not the sort of thing that advertisers want to be associated with. In order to sell advertising, YouTube has had to buy the rights to professionally produced content, such as television shows and movies. Credit Suisse put the cost of those licenses in 2009 at roughly two hundred and sixty million dollars. For Anderson, YouTube illustrates the principle that Free removes the necessity of aesthetic judgment. (As he puts it, YouTube proves that “crap is in the eye of the beholder.”) But, in order to make money, YouTube has been obliged to pay for programs that aren’t crap. To recap: YouTube is a great example of Free, except that Free technology ends up not being Free because of the way consumers respond to Free, fatally compromising YouTube’s ability to make money around Free, and forcing it to retreat from the “abundance thinking” that lies at the heart of Free. Credit Suisse estimates that YouTube will lose close to half a billion dollars this year. If it were a bank, it would be eligible for TARP funds.

Anderson begins the second part of his book by quoting Lewis Strauss, the former head of the Atomic Energy Commission, who famously predicted in the mid-nineteen-fifties that “our children will enjoy in their homes electrical energy too cheap to meter.”

“What if Strauss had been right?” Anderson wonders, and then diligently sorts through the implications: as much fresh water as you could want, no reliance on fossil fuels, no global warming, abundant agricultural production. Anderson wants to take “too cheap to meter” seriously, because he believes that we are on the cusp of our own “too cheap to meter” revolution with computer processing, storage, and bandwidth. But here is the second and broader problem with Anderson’s argument: he is asking the wrong question. It is pointless to wonder what would have happened if Strauss’s prediction had come true while rushing past the reasons that it could not have come true.

Strauss’s optimism was driven by the fuel cost of nuclear energy—which was so low compared with its fossil-fuel counterparts that he considered it (to borrow Anderson’s phrase) close enough to free to round down. Generating and distributing electricity, however, requires a vast and expensive infrastructure of transmission lines and power plants—and it is this infrastructure that accounts for most of the cost of electricity. Fuel prices are only a small part of that. As Gordon Dean, Strauss’s predecessor at the A.E.C., wrote, “Even if coal were mined and distributed free to electric generating plants today, the reduction in your monthly electricity bill would amount to but twenty per cent, so great is the cost of the plant itself and the distribution system.”

This is the kind of error that technological utopians make. They assume that their particular scientific revolution will wipe away all traces of its predecessors—that if you change the fuel you change the whole system. Strauss went on to forecast “an age of peace,” jumping from atoms to human hearts. “As the world of chips and glass fibers and wireless waves goes, so goes the rest of the world,” Kevin Kelly, another Wired visionary, proclaimed at the start of his 1998 digital manifesto, “New Rules for the New Economy,” offering up the same non sequitur. And now comes Anderson. “The more products are made of ideas, rather than stuff, the faster they can get cheap,” he writes, and we know what’s coming next: “However, this is not limited to digital products.” Just look at the pharmaceutical industry, he says. Genetic engineering means that drug development is poised to follow the same learning curve of the digital world, to “accelerate in performance while it drops in price.”

But, like Strauss, he’s forgotten about the plants and the power lines. The expensive part of making drugs has never been what happens in the laboratory. It’s what happens after the laboratory, like the clinical testing, which can take years and cost hundreds of millions of dollars. In the pharmaceutical world, what’s more, companies have chosen to use the potential of new technology to do something very different from their counterparts in Silicon Valley. They’ve been trying to find a way to serve smaller and smaller markets—to create medicines tailored to very specific subpopulations and strains of diseases—and smaller markets often mean higher prices. The biotechnology company Genzyme spent five hundred million dollars developing the drug Myozyme, which is intended for a condition, Pompe disease, that afflicts fewer than ten thousand people worldwide. That’s the quintessential modern drug: a high-tech, targeted remedy that took a very long and costly path to market. Myozyme is priced at three hundred thousand dollars a year. Genzyme isn’t a mining company: its real assets are intellectual property—information, not stuff. But, in this case, information does not want to be free. It wants to be really, really expensive.

And there’s plenty of other information out there that has chosen to run in the opposite direction from Free. The Times gives away its content on its Web site. But the Wall Street Journal has found that more than a million subscribers are quite happy to pay for the privilege of reading online. Broadcast television—the original practitioner of Free—is struggling. But premium cable, with its stiff monthly charges for specialty content, is doing just fine. Apple may soon make more money selling iPhone downloads (ideas) than it does from the iPhone itself (stuff). The company could one day give away the iPhone to boost downloads; it could give away the downloads to boost iPhone sales; or it could continue to do what it does now, and charge for both. Who knows? The only iron law here is the one too obvious to write a book about, which is that the digital age has so transformed the ways in which things are made and sold that there are no iron laws.

A Small-Business Guide to Intellectual Property (NYT)

A Small-Business Guide to Intellectual Property

By DARREN DAHL

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Quick Tips:

From Mark Blaxill and Ralph Eckhardt, founders of 3LP Advisors, an intellectual property consulting company in Boston, and co-authors of a guide to I.P., "The Invisible Edge" (Portfolio, 2009).

• Securing your intellectual property involves more than patents. Trademarks, trade dress and even Web site addresses are all part of I.P.

• Think strategically when it comes to international rights. Start with countries where you might sell.

• Don't sit on unused I.P. Use it to open additional revenue streams or bring about new partnerships through licensing.

Suggested Reading:

• The U.S. Patent and Trademark Office , for more information about I.P. for small business.

• The World Intellectual Property Organization , for more about international I.P. rights.

• An easy-to-use online global directory for I.P. resources.

• Use Google's patent site to perform your patent search. You can also search here and here.

• Patently-O by Dennis Crouch is one of the most popular blogs on the subject of I.P. law.

The two most precious resources for any small-business owner are time and money. That’s why when the subject of intellectual property comes up, many owners run in the other direction. They see images of expensive lawyers and use that as an excuse to ignore the topic, reasoning that it is a problem for big companies to worry about.

The trouble is, with the rise of competition through the Internet and on the global market, understanding intellectual property is more critical than ever for small-business owners. Let’s explore some of the common fallacies:

1. For small-business owners, it’s not worth the time or effort to secure intellectual property rights.

Daniel Lubetzky, chief executive of New York City-based Kind Snacks, had high hopes when he and his company attended the Natural Products Expo West in Anaheim, Calif., in March. And who could blame him, since his Kind Plus bars had been named the best new product at the Natural Products Expo East last October?

But it didn’t take long before Mr. Lubetzky knew something had gone wrong: He kept hearing how one of his competitors had copied the packaging, look and feel of his bars.

Fortunately for Mr. Lubetzky, he had secured crucial components of intellectual property like trademarks, trade dress (the look and feel of a product) and Web addresses after founding his company. Unlike a patent, which can cost up to $25,000 to secure, trademarks and Web addresses can be obtained relatively cheaply and without the aid of a lawyer.

With the legal documentation to back up his intellectual property rights, Mr. Lubetzky sent the offending company a cease-and-desist letter, which achieved the desired result. “Too many entrepreneurs forget there is more to I.P. than just patents,” said Mr. Lubetzky, who happens to be a lawyer.

2. Once I get a trademark, my brand is safe.

It may be. But consider what happened to Tracey Deschaine, who runs a restaurant called Dixie Picnic in Ocean City, N.J.

When Ms. Deschaine opened her business in 2006, she secured trademarks on her business name and logo and on the name of her signature item, “upcakes,” which are upside-down frosted cupcakes. The problem, she says, was that even though she had obtained the trademarks, someone monitoring the activity on the United States Patent and Trademark Office’s Web site had spotted her application and secured upcakes.com as the Web address, or U.R.L., before she could.

“I had no idea that even though I have a trademark, someone else could just go register the U.R.L.,” she said. “I wish I had planned ahead and bought the site before I did that.”

3. Having a patent gives me the right to produce something.

This is a very fundamental misunderstanding. Actually, what a patent does is give you the right to prevent someone else from producing what your patent covers. “Having a strong I.P. position helps ensure that other people pay you for your innovation like they would a toll on a road,” Mr. Kocher said.

But even if you do have a patent, there’s no guarantee that someone won’t try to get around it. There’s also no guarantee that you will win if you fight that person. But if you have your I.P. ducks in a row and a commitment to do whatever you can to defend those rights, you do have a fighting chance — even in a fight against a much larger company.

Consider the example of Cryptography Research, a 20-employee technology firm in San Francisco that specializes in data security. Beginning in 2004, the company made the decision to pursue litigation against the credit card giant Visa, which Cryptography asserted was infringing on its patents covering smart cards. To pursue the case against Visa, however, Cryptography’s founder, Paul Kocher, knew he needed a serious war chest in addition to his patent portfolio.

That’s why he decided to sell off another piece of his business, patents covering technology that protects Blu-ray discs from piracy, to Macrovision, which is now known as Rovi, in 2007 for $45 million. “All of a sudden we became a formidable opponent for someone who thought we couldn’t fight,” Mr. Kocher said. In the end, the gamble paid off, as the two companies settled out of court, with Visa’s agreeing to license the technology from Cryptography.

4. If I have a patent or trademark in the United States, I don’t need to worry about the rest of the world.

It depends on your business model. Intellectual property rights, which also include country-specific U.R.L.’s, need to be obtained country by country, some of which protect them better than others. The cost can vary, too.

In Japan, for example, it is notoriously expensive to acquire patents. In addition, the annual fees required to maintain the patents there are often prohibitively expensive for small businesses, said Gary Johnson, chief executive of Blue Spark Technologies, a manufacturer based in West Lake, Ohio, that makes small, flexible batteries used in things like radio frequency identification tags.

“What we have done is to develop a strategy to go after I.P. protection in a limited number of countries that we think we are most likely to sell or manufacture in, like the U.S. and China,” he said. “A lot of the choice comes down to what your business plan tells you.” To decide what your international I.P. strategy should be, consult a lawyer and conduct some cost-benefit analysis to see if expanding your I.P. rights makes sense.

5. People who collect patents but don’t actually make anything are “patent trolls,” parasites who can make money only by filing lawsuits against real businesses.

The term “patent troll” was coined in the wake of the epic lawsuit fought between NTP, a small holding company, and Research in Motion, which makes the hugely popular BlackBerry. The focal point of the dispute was a patent for wireless e-mail delivery held by NTP — something that R.I.M. eventually would pay millions of dollars to license. But what most people remember about the story is the lawsuits and the notion that NTP was somehow in the wrong for trying to enforce its patent, mostly because it didn’t make any products itself.

But consider that many inventors never set out to build a company, only to partner with someone who would bring their products to life. Thomas Edison, for instance, received more than 1,000 patents — many of which he licensed to other companies. “He created what we might consider the first innovation factory,” says Mark Blaxill a co-founder of 3LP Advisors, an intellectual property consulting company based in Boston.

A more recent example is Trident Design, a company founded by an inventor, Chris Hawker, which patented and then licensed the design for the PowerSquid. Like Edison, Mr. Hawker’s company invents products, builds an intellectual-property wall around them and then licenses them to other companies.

The PowerSquid is now manufactured by a division of Phillips Electronics and sold by a spinoff of Trident called Flexity. “Our entire business model is leveraging our I.P.,” Mr. Hawker said.

The Crowd Is Wise (When It’s Focused) (NYT)

The Crowd Is Wise (When It’s Focused)

By STEVE LOHR

FEW concepts in business have been as popular and appealing in recent years as the emerging discipline of “open innovation.” It is variously described as crowdsourcing, the wisdom of crowds, collective intelligence and peer production — and these terms apply to a range of practices.

The overarching notion is that the Internet opens the door to a new world of democratic idea generation and collaborative production. Early triumphs like the Linux operating system and the Wikipedia Web encyclopedia are seen as harbingers.

In the new model, innovation is often portrayed as a numbers game. The more heads, the better — all weighing in, commenting, offering ideas. Collective knowledge prevails, as if a force of egalitarian inevitability.

But a look at recent cases and new research suggests that open-innovation models succeed only when carefully designed for a particular task and when the incentives are tailored to attract the most effective collaborators. “There is this misconception that you can sprinkle crowd wisdom on something and things will turn out for the best,” said Thomas W. Malone, director of the Center for Collective Intelligence at the Massachusetts Institute of Technology. “That’s not true. It’s not magic.”

The Netflix Prize is a stellar example of crowdsourcing. In October 2006, Netflix, the movie rental company, announced that it would pay $1 million to the contestant who could improve the movie recommendations made by Netflix’s internal software, Cinematch, by at least 10 percent. In other words, the company wanted recommendations that were at least 10 percent closer to the preferences of its customers, as measured by their own ratings.

(Cinematch analyzes each customer’s film-viewing habits and recommends other movies that the customer might enjoy. More accurate recommendations increase Netflix’s appeal to its audience.)

The contest will end next week because a contestant finally surpassed the 10 percent hurdle on June 26, and, according to the rules of the competition, rivals have 30 days from that date to try to beat the leader. The frontrunner is a seven-person team, and its members are statisticians, machine learning experts and computer engineers from the United States, Austria, Canada and Israel. It is led by statisticians at AT&T Research.

The leading team is a very elite crowd, indeed, but it is also one that was made possible by the Internet. The original three AT&T researchers (one has since joined Yahoo Research, but remains on the contest team) made good strides in the first year of the contest. But to make further progress, they went looking for people with other skills and perspectives. So they reached out eventually to a pair of two-person teams, who were among the leaders in the rankings posted on the contest Web site.

“The leader board was right there,” said Chris Volinsky, director of statistics research at AT&T. “It was pretty obvious who the top teams were.”

Though leading, his team may not win. But the teams in close pursuit are similar collaborations of skilled researchers and engineers.

The Netflix contest has lured experts worldwide not only because of the prize money but also because it offered a daunting challenge. The contestants’ algorithms must find patterns nestled in a collection of more than 100 million movie ratings. What is learned in tackling such a large-scale data analysis and predictive-modeling problem could well be applied in many industries, like Web commerce or telecommunications. “It made sense for us both from the perspective of AT&T and scientific research,” Mr. Volinsky explained.

In the Netflix contest, the winning idea is simply the one with the highest score. But often, companies rely on a contributing crowd for ideas, though management then chooses. I.B.M., for example, conducts online brainstorming sessions it calls Jams — 13 over the last seven years.

I.B.M. used one session to guide its strategy for investing in new growth fields, starting in 2006. An estimated 150,000 employees, clients, business partners and academics participated. Management sifted through the ideas and committed $100 million to invest in several opportunities to apply technology innovations to energy saving, health care and smart electricity grids.

“It starts out as crowdsourcing and it is culled to a set of action items,” said Jeffrey T. Kreulen, a researcher at the I.B.M. Almaden Research Center in San Jose, Calif.

Open-innovation models are adopted to overcome the constraints of corporate hierarchies. But successful projects are typically hybrids of ideas flowing from a decentralized crowd and a hierarchy winnowing and making decisions. In Linux’s case, anyone can submit code, but Linus Torvalds and a few lieutenants decide what code will be included in the operating system, noted Mr. Malone of M.I.T. Even Wikipedia — produced by collaborating clusters of contributors focused on particular areas of interest — relies on administrators to make final judgments on whether to delete a challenged article, he added.

“Most of the interesting examples of collective intelligence contain many different design patterns,” Mr. Malone said.

In a recent paper, “Harnessing Crowds: Mapping the Genome of Collective Intelligence,” Mr. Malone and his two co-authors, Robert Laubacher, a research scientist at M.I.T., and Chrysanthos Dellarocas, a professor at the University of Maryland, use a biological analogy in calling the design patterns of collective intelligence systems “genes.” They studied the genelike building blocks in more than 250 examples of collective intelligence enabled by the Web. The intent, they write, is to provide a systematic framework for thinking about collective intelligence, so “managers can do more than just look at examples and hope for inspiration.”

OPENING the corporate doors to ideas and inspiration from the collective crowd holds great potential, but there are pitfalls, warns Henry Chesbrough, executive director of the Center for Open Innovation at the University of California, Berkeley. To succeed, Mr. Chesbrough said, a company must have a culture open to outside ideas and a system for vetting and acting on them.

“In business, it’s not how many ideas you have,” he observed. “What matters is how many ideas you translate into products and services.”

Collaborating for Profits in Nanotechnology (NYT)

Collaborating for Profits in Nanotechnology

By JAMES FLANIGAN

THE economic news in California has been pretty bleak lately. Its businesses, small and large, are becalmed by the recession. The state has taken to issuing i.o.u.’s in the wake of political wrangling over how to resolve a $26 billion budget deficit. Most ominous, the state’s once-great public universities and its community colleges and local schools face budget cuts that amount to critical surgery.

Yet in the midst of all that, there is a promise for the future in the collaboration by California’s university research centers, small companies and venture finance firms in an emerging area called nanotechnology.

Working with materials that are a thousandth the diameter of a human hair, nanotechnology companies do not produce finished products in any one industry. Rather, nano particles improve performance and open new possibilities in activities as varied as water purification, biomedicine, battery power, environmental repair and agriculture.

The universities have been essential in this development process. In some cases, they make direct equity investments in start-up companies. Other times, universities grant licenses to their research and give small companies access to expensive laboratory equipment in return for user fees. And some universities have set up incubators where small companies develop technological products and processes.

Why are universities investing scarce budget cash in start-up companies? “Partnerships with private industry are a way of making this new technology available for public benefit,” said Leonard H. Rome, interim director of the California NanoSystems Institute at the University of California, Los Angeles. Also, in times of strained budgets, such partnerships bring needed funds. The NanoSystems Institute, Mr. Rome said, “has attracted more than $350 million in research and development grants from industry.”

Moreover, the new nanotechnology industry demands interdisciplinary collaboration. “The medical school needs to be collaborating with the engineering school,” said Mr. Rome, who is also senior associate dean of research at the university’s School of Medicine. In fact, the institute was first authorized in 2000 as part of a $100 million grant from the state of California to spur university research.

Examples from several universities and fledgling companies demonstrate the potential. NanoH2O Inc., for instance, uses nano materials to improve the performance of reverse osmosis membranes in making dirty water clean or in desalination. Two years ago, the company licensed the membrane research of Eric Hoek, a professor of environmental engineering at U.C.L.A. Then it leased lab space in the NanoSystems Institute, which opened in 2007, because being at U.C.L.A. allowed the company to use expensive electron microscopes and other equipment.

“Being able to use the core facilities of the university couldn’t help but accelerate our progress,” said Jeff Green, chief executive of NanoH2O. It also helped attract $20 million in venture capital from Oak Investment Partners and Khosla Ventures. Now, NanoH2O is moving to a factory where it can manufacture membranes composed partly of nano-size elements of alumina and silicon. The membranes filter out salts and impurities yet allow water to flow faster, thus saving energy in desalination or water reuse processes.

Matrix Sensors Inc. is a new tenant at the NanoSystems Institute. The company is developing nano membranes that are so sensitive to resonance they can detect molecules of bacteria as well as proteins and DNA and thus diagnose early stages of illness. Matrix Sensors is working on licensed research of three professors, James K. Gimzewski of U.C.L.A., and Calvin F. Quate and Butros T. Khuri-Yakub of Stanford University. U.C.L.A. and Stanford have invested in the company, along with Miramar Venture Partners of San Diego, which has put in $1 million. That is a sign, said Michael Cable, chief executive of Matrix, that investors, even in the recession, are supporting nanotechnology.

QuantumSphere Inc., in Santa Ana, Calif., is approaching nanotechnology on a broad scale by making an array of catalysts that allow batteries to operate for longer periods, electronic displays to be manufactured at lower costs and ammonia fertilizers to be produced using less energy while also generating less carbon dioxide.

“It’s not a question of making nano materials alone but what applications are you using nano for,” said Kevin D. Maloney, president of QuantumSphere, a seven-year-old company that got its start with $100,000 investment from two angel investors: Jon Faiz Kayyem, a trustee of California Institute of Technology, and Marc H. Goroff, who has a doctorate from Caltech and is the founder of several companies.

The reason infinitesimal nano particles can give batteries more power is, paradoxically, “that at the nano stage there are more atoms available on the surface of a molecule proportionate to its volume, so there are more active atoms to store and release electricity,” said Douglas Carpenter, co-founder and senior science adviser of QuantumSphere. Mr. Carpenter designed rocket fuel for aerospace companies for many years and helped invent Quantum’s nano catalysts.

“At the nano level, elements change their properties,” Mr. Carpenter explained. Aluminum, for instance, cannot burn at micron levels, or one millionth of a meter, but burns and gives off an intensely glowing light at nano levels, or one billionth of a meter. QuantumSphere gets to do research on powerful microscopes and other equipment at the University of California, Irvine, paying fees to the university for each use. It has raised $17 million from private equity and venture funds, including $2 million from OM Group Inc., a specialty chemicals company based in Cleveland.

In an example of global collaboration, Rachid Yazami, research director of France’s National Center for Scientific Research, has done his work on battery technology since 2000 at Caltech. He is co-founder along with a Caltech professor, Robert H. Grubbs, of CFX Battery Inc., of Azusa, Calif., which makes lithium ion batteries that can power electric cars, medical devices, mobile phones and computers. The technology transfer office at Caltech invested in CFX and helped raise $15 million to get the company started.

“But lithium is expensive and coming into short supply,” Mr. Yazami said. So he is trying to develop a battery powered by nano particles of sodium and water. “You know the work of Jules Verne,” Mr. Yazami asked, referring to “20,000 Leagues Under the Sea.” “He wrote of using seawater as a battery.”