What it means
Most patent holders use their patents to protect products they sell. A patent troll behaves differently, as it buys or holds patents mainly to bring claims.
Its business model is based on payments from others, not on selling anything itself. The tactic often works because patent disputes are expensive.
Defending a case can cost many times more than the licence being demanded, so businesses frequently pay to avoid the cost and distraction. Trolls may send many letters to many firms in the hope that enough will pay.
Critics say the practice drains money from innovation and hurts small companies that cannot afford a fight. Supporters of patent owners reply that some non-practising entities are legitimate, such as universities or inventors who license ideas, and that enforcing patents is a lawful right.
The line between a troll and a legitimate licensor is often disputed. For a finance team, the issue is risk management.
A claim creates a possible liability, legal costs and a decision between settling and fighting. Companies often buy insurance, join defensive patent groups or review patents held by others before launching a product.
Law makers in several countries have reformed their rules to make abusive claims harder. Changes include making it easier to recover legal costs and requiring more detail in demand letters.
Prevention is cheaper than cure. A company can reduce the chance of a claim by checking for existing patents before launching a product, keeping dated records of its own work, and avoiding public statements that suggest copying.
Many firms also set aside a legal reserve in the budget, so a claim does not arrive as a financial surprise.
In practice
Real-world examples.
Example
A small online retailer receives a letter saying its shopping cart infringes a patent. The letter offers a licence for $50,000. The owner's lawyer estimates that fighting would cost far more, so the retailer considers settling. The owner also asks whether the retailer's insurance policy covers the legal costs of a claim.
Example
A large software company is sued by a patent holding firm over a minor feature. It decides to fight because settling would invite similar claims. The company wins on the basis that the patent is invalid. The ruling discourages other claimants who might have expected a quick payment.
Example
A group of start-ups pays an annual fee to join a defensive patent pool. The pool buys patents before they can reach claimants and licenses them to members. The members budget the fee as a cost of doing business. The members also share information about claimants, which helps them respond consistently.
Formula
Calculation
Expected cost of fighting = defence cost + (chance of losing x damages)
A company receives a demand for a $150,000 licence fee. Defending the case would cost $600,000, and the company thinks there is a 30% chance of losing and paying damages of $1,000,000. Expected cost of fighting = 600,000 + (0.30 x 1,000,000) = 600,000 + 300,000 = $900,000. Settling costs $150,000, so from a purely financial view settling looks cheaper by 900,000 - 150,000 = $750,000, though it may encourage further demands.Case study
Seen in the real world.
Brindle Apps is an illustrative, fictional business with 25 staff and annual revenue of $4,000,000. It received a letter from Stonegate IP, an illustrative, fictional patent owner, demanding $120,000 for a licence to a patent on online payment screens.
The owner, Tom, asked his lawyer to review the claim. The lawyer estimated that a defence would cost at least $400,000, and noted that the patent was broad and might be invalid, though the outcome was uncertain.
After negotiation, Brindle settled for $45,000 and a licence covering all of its products. In the illustrative result, the company used insurance to cover part of the cost and added a legal risk line to its annual budget. The company also added a contingent liability note to its accounts for the unresolved period, explaining the possible cost to its lender.
Watch out
Common mistakes.
- Ignoring a demand letter, which can lead to a lawsuit with a much higher cost. A prompt, polite reply that asks for details is usually the safest first step.
- Paying immediately without checking the claim, when the patent may be invalid or may not cover your product.
- Assuming only large companies are targeted, when small firms are often chosen because they cannot afford a long fight.
Questions
People also ask.
Is it illegal to be a patent troll?
In general it is not, because owning and enforcing patents is lawful, although abusive or bad-faith claims can be challenged in court. The legal position varies by country, and some have passed laws aimed at abusive demand letters.
What is a non-practising entity?
It is a company that owns patents without making products with them, and the term is used when people want to avoid the negative tone of troll.
How can a business protect itself?
It can search for existing patents before launching, keep records of its own invention dates, consider insurance and get legal advice early. Joining an industry group that shares information on claimants can also help.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related