Barriers to Entry I: Patent or Trade Secret?

“As a founder you will most likely face a decision on your business model that will imply thinking about patents or trade secrets. The earlier in your business creation timeline that you start discussing the challenges in this area the better…”

When considering investment on a business funders will usually try to find that key element, crucial to a business model that cannot be easily or legally replicated by competitors: a Barrier To Entry.

Barriers can come in many forms an today we will discuss two: Trade Secrets, Patents.

Trade Secrets refer to procedures, formulas, devices or other ways or components used to produce a good or service which are exclusively known to the business or person that is benefiting from it.  Perhaps the most widely known example is the famous Coca-Cola formula, safeguarded in a Vault for more than a century.  Other famous example include the KFC original recipe which was originally only know to Colonel Sanders and that was later put in a safe where allegedly only a handful of employees have access to it.  Another famous trade secret is the Google Search Algorithm, which besides being secret is continuously changed to prevent the competition from decoding it.  Other examples to mention are the formula for WD-40, Twinkies, the procedure to select the books that make it to the New York Times Best Sellers list; which contrary to what one may think does not include books based only on the number of copies sold.

Unlike Trade Secrets, patents are public, and work as a legal mechanism that protects the owner of that patent (formally called assignee, it is the person or business that has the commercial rights on the invention) and prevents third parties from developing or creating a product that functions in the same way as the patented one does without permit from the assignee.  In order for the protection to be granted the Inventor has to apply for a patent, and through a very thorough process he must to explain his invention, how it functions and the specific areas that he claims as his fabrication.  Patents have a time limit and in the US are valid for 20 years from the filing date, also they are national in scope which means that if you want to protect your invention in other countries you will have to follow the requirements of each one of them to obtain protection

From a business model standpoint Trade Secrets and Patents are quite different.  Patents offer the advantage that they can be offered for third parties to use and pay a royalty for it, so the escalating component of the model can have several avenues for income and is not limited to the assignee only for commercially using it.  On the other hand, the fact that patents have an expiration date after which they become public domain may make the profitable timeline too short in some cases, which is actually an incentive for owners to issue royalties and generate as much revenue as possible during the period of protection.  In the case of Trade Secrets there is neither time limitation nor requirement to make your invention public.  You can theoretically profit from your invention for as long as you wish, assuming that you are able to keep your secret as such.  There are also however barriers to grow your business from the fact that you need to impose control mechanisms that allow you running your commercial operations while keeping the security of your secret; think of cooking recipes that are prepared in two parts from two different locations and blended later before selling the product just to maintain the secrecy of the formula.

As a founder you will most likely face a decision on your business model that will imply thinking about patents or trade secrets.  The earlier in your business creation timeline that you start discussing the challenges in this area the better, as a model for profiting from a patent may not work for a trade secret and viceversa.  The patent granting process can be lengthy and costly for a start-up while keeping a process secret is quite a challenge in this era of digital information where hackers abound.

So, which route will you be taking? Hit me an email or comment on my blog, I’d like to hear your point of view!