Patent Assertion Entities

Patent Assertion Entities (PAEs), more commonly and colorfully known as Patent Trolls or Non-Practicing Entities (NPEs), are companies with a fascinatingly simple, yet controversial, Business Model. Unlike a company like Apple or Ford that creates products, a PAE produces nothing but lawsuits. Its sole purpose is to acquire Patents—not to protect its own inventions, but to sue other companies for allegedly infringing upon them. These entities often buy up patent portfolios from bankrupt companies or individual inventors for pennies on the dollar. They then target successful, cash-rich companies, demanding substantial fees through Licensing agreements or threatening costly legal battles. The core of their strategy relies on the fact that defending a patent lawsuit is incredibly expensive, often running into millions of dollars. For many targeted companies, it's cheaper to pay the PAE a settlement—even if they believe the claim is baseless—than to fight it in court. This makes the PAE a formidable player in the world of Intellectual Property.

The business of a patent troll is a calculated, multi-step process that feels more like a legal shakedown than a traditional enterprise. It typically unfolds in three stages:

• Acquisition: The PAE scours the market for patents. They are particularly fond of those that are broadly or vaguely worded, making it easier to claim a wide range of modern technologies infringe upon them. Prime hunting grounds include patent auctions and the liquidation sales of failed startups.
• Assertion: With a patent in hand, the PAE identifies its targets. These are almost always operating companies that have developed a successful product or service. The PAE sends a demand letter, claiming the target's product infringes on its newly acquired patent and demanding payment.
• Litigation (or the Threat of It): This is the PAE’s trump card. If the target refuses to pay, the PAE files a lawsuit. The astronomical cost and time commitment of patent Litigation puts immense pressure on the defendant. The PAE isn't betting on winning every case on its merits; it's betting that the sheer cost of fighting will force the target to settle.

For a value investor, understanding PAEs is crucial, not as a potential investment, but as a potential risk to your investments.

When a company you've invested in gets targeted by a PAE, it's bad news. The financial resources diverted to legal fees and settlements are funds that can no longer be used for productive purposes like:

• Research and Development (R&D): Creating new products and improving existing ones.
• Capital Expenditures: Expanding operations and improving efficiency.
• Shareholder Returns: Paying dividends or buying back stock.

Essentially, a PAE acts as a tax on innovation, siphoning cash away from productive enterprises and potentially depressing long-term Shareholder Value.

As a prudent investor, you should actively look for a company's exposure to this risk during your analysis.

1. Read the Annual Report: In the U.S., a company's 10-K filing includes a 'Risk Factors' section. Search for terms like “patent,” “litigation,” or “intellectual property” to understand the company's perceived threats.
2. Scan the News: A quick search for the company's name plus “patent lawsuit” can reveal any ongoing or recent battles with PAEs.
3. Consider the Industry: Tech and biotech companies are the most frequent targets due to their complex products and vast number of patents.

While some PAEs are publicly traded, they make for a poor fit with a Value Investing philosophy. Their revenue is unpredictable and “lumpy,” entirely dependent on the outcome of a few large court cases or settlements. They don't generate the steady, reliable cash flow that investors cherish in a high-quality business. Investing in a PAE is less like investing and more like speculating on the outcome of a series of complex legal coin flips.

While most of the business world views PAEs with contempt, a sliver of debate exists.

• The Defense: Proponents argue that PAEs provide a vital service for the “little guy.” They give individual inventors and small companies, who lack the resources to sue a giant corporation, a way to monetize their intellectual property and see justice for infringement. In this view, they are market-makers for dormant IP.
• The Reality: Critics argue this noble image is a fantasy. In practice, PAEs overwhelmingly use weak, low-quality patents to target legitimate innovators who have developed technology independently. They exploit the high cost of the legal system, not to protect genuine invention, but to extract payments from productive companies. For most investors and innovators, the “troll” moniker fits perfectly.