FTO Analysis Necessary for Crowdfunding

Financing through crowdfunding is an attractive way for startups and small businesses to raise capital by receiving small amounts from a large number of investors.  The method will only increase in popularity after the SEC finalizes the provisions for equity-based crowdfunding.  There are, however, potential IP problems inherent in crowdfunding.  In order to attract investors, companies have to publicly disclose detailed information about their business.  Competitors can then use this information to find IP violations and sue the budding business.  In order to prevent or prepare for this situation, companies using crowdfunding should conduct a thorough freedom to operate (FTO) analysis.

Scott J. Popma, Seth R. Ogden, and M. Andrew Holtman have observed that “though crowdfunding unquestionably provides a small business venture with new and greater access to capital, it fails to address another crucial barrier to product commercialization – IP owned by competitors.”  If a startup offers a successful product, a competitor is more likely to “pursue litigation to prevent further product commercialization and disgorge any profits already realized.”  In order to avoid this problem, companies should conduct a FTO analysis in their product area before crowdfunding.

Conducting a FTO means “determining whether a particular action, such as testing or commercializing a product, can be done without infringing valid intellectual property rights of others.”  In general, there are three parts to an FTO analysis: 1) deconstruct the planned or existing product into its component parts; 2) perform a search for relevant patent literature with non-expired, enforceable claims; and 3) assess the claims of the relevant art and compare those claims to the product to determine the likelihood of infringing third-party patent rights.  See here.

It is important to conduct an FTO before crowdfunding requests or activity begins, especially if a potential IP problem arises.  Popma, et al., believe that a “current, thorough FTO analysis allows a company to prepare for a successful product launch by minimizing the risk of infringement of third-party patents.”  Furthermore, “disclosure regarding that FTO analysis can engender the interest of potential investors by demonstrating both the business acumen of the company seeking funding and the viability of product commercialization.”