======Patent Assertion Entity======
Patent Assertion Entity (also known as a [[Non-Practicing Entity]] or, more pejoratively, a 'Patent Troll') is a company whose main line of business is making money by suing people. More specifically, a PAE acquires [[patents]], not to create a product or service, but to enforce them against companies that are allegedly infringing on them. These entities don't invent anything or run factories; their primary asset is a portfolio of patents, and their primary activity is litigation. Imagine someone buying the deed to a small, unused alleyway and then charging every person whose window opens onto it a "trespassing fee." That's the PAE business model in a nutshell. They leverage the astronomical cost of defending a patent lawsuit to extract settlements from their targets, who often find it cheaper to pay the "troll toll" than to fight a lengthy, expensive court battle, even if they believe they are in the right.
===== How Patent Trolls Operate =====
The strategy is a well-oiled, three-step machine: acquisition, assertion, and monetization.
  * **Acquisition:** PAEs are hunters. They scour the landscape for patents, often buying them for a bargain from struggling or bankrupt companies, or from individual inventors who lack the resources to defend their own intellectual property. They particularly love broad or vaguely-worded patents, especially in the software space, as their ambiguity makes it easier to claim infringement against a wide array of products.
  * **Assertion:** Once armed with a patent, the PAE identifies potential targets. This is often a numbers game. They might send out hundreds or thousands of demand letters to companies big and small, alleging that a common business practice—like using a scanner to email documents or offering Wi-Fi in a café—infringes on their patent.
  * **Monetization:** This is the crucial step. The demand letter comes with a threat of a lawsuit and an offer to settle. Defending a patent infringement case can easily run into millions of dollars in legal fees. The PAE, knowing this, typically offers to make the problem "go away" for a much smaller, yet still substantial, sum (say, $100,000). For many businesses, paying the settlement is a painful but economically rational decision compared to the alternative.
===== The Value Investor's Perspective =====
For a [[value investor]], PAEs are rarely seen as an investment opportunity. Instead, they are a significant risk factor that can erode the value of otherwise excellent businesses.
==== A Hidden Tax on Your Investments ====
The activities of PAEs act like a tax on innovation and profitability, directly harming the companies you might own.
  - **Draining Cash:** The most obvious impact is the direct financial cost. Settlement payments and legal fees are a direct hit to a company's [[earnings]] and [[free cash flow]]. Money spent fighting a patent troll is money that can't be used for research and development, paying dividends, or buying back stock—all things that create value for shareholders.
  - **Stifling Innovation:** The fear of litigation can have a chilling effect. A company might shelve a promising new product or feature simply to avoid the crosshairs of a known PAE. This erodes a company's [[economic moat]] by slowing its pace of innovation and allowing competitors to catch up. It's a hidden cost that can cripple long-term growth.
  - **Management Distraction:** A CEO and their top engineers spending their time in depositions and legal strategy meetings are not spending that time creating value. This management distraction is a significant, if unquantifiable, drag on a business's performance.
==== How to Spot the Troll Risk ====
When analyzing a potential investment, particularly in the tech or biotech sectors, it's wise to do a "troll check."
  * **Read the Fine Print:** Dive into the company's [[10-K]] or annual report. The 'Risk Factors' and 'Legal Proceedings' sections are required reading. Companies must disclose significant lawsuits, and a pattern of litigation from PAEs should be a red flag.
  * **Assess the Industry:** Some industries are troll magnets. Companies operating in fields with dense, overlapping patent rights (known as "patent thickets") are at higher risk.
  * **Check for a Shield:** Does the company have a strong patent portfolio of its own? A large collection of patents can act as a deterrent, as it gives the company ammunition to countersue—a strategy known as 'defensive patenting.'
===== An Unlikely Investment? =====
Could a dedicated value investor ever buy shares in a PAE? It's highly unlikely. While a PAE might, on paper, have a high [[return on investment]], its business model runs contrary to the core tenets of value investing.
The philosophy of legends like [[Benjamin Graham]] and [[Warren Buffett]] is built on investing in productive businesses that create value for society. PAEs are purely extractive entities; they don't build better products or provide useful services. They simply transfer wealth from productive companies to themselves.
Furthermore, their business is inherently speculative. Valuing a PAE requires you to guess the outcome of future lawsuits—a task fraught with uncertainty. Add in the significant regulatory risk (as governments periodically try to rein in troll-like behavior) and reputational damage, and you have an investment that is far from the predictable, durable, value-creating businesses that a true value investor seeks. For us, PAEs are best viewed as a hazard to avoid, not a stock to buy.