Investing in inventions
By Robbie Woliver • Bankrate.com

The secret to a successful investment just might be lurking in your eccentric neighbor's basement.

There are thousands of innovators who are trying to get their bright ideas to market, and investing in inventions, a cornerstone of economic progress, is becoming a more viable means of making money. Just think about being on the ground floor of another ATM, MRI, Furby or Barbie doll.

While some investors are self-funded, most need capital, says Joanne Hayes-Rines, publisher of Inventor's Digest magazine. And there are many ways investors and inventors can seek each other out. From the United Inventors Association to America's Inventor Magazine, there are numerous organizations to join, seminars and trade shows to attend, Web sites to be searched and magazines to be read.

When seeking an inventor, investors should first identify the fields in which they would like to invest, says Bob DeMatteis, co-developer of the plastic grocery sack and author of From Patent to Profit. "It should be a field in which the investor has a degree of knowledge and comfort," he says.

Carefully evaluate
The next step is to seek out inventors and inventions. Stephen Paul Gnass, executive director of the National Congress of Inventor Organizations, says that an investor should carefully evaluate the new invention's sales potential and its ability to capture that potential. Then check out the inventor and his or her support team, if there is one. Do they seem knowledgeable? Is this someone with whom you can stay in business? Are they committed to the project? And, absolutely, check the worth or potential of the patent.

In evaluating the patent protection, it is best to consider the number of patents pending or granted, notes DeMatteis. "Is it a new castle of technology surrounded by a moat of patents? Or, is it only a simple improvement with one patent pending?

"Generally speaking, the more pending or granted patents it has, the better the protection and the more difficult it would be to design around. It's like a basket full of cobras -- one or two of them may not bite you, but sooner or later, one of them will." But the most important aspect of earning money on new ideas, most experts say, is to be the first to market.

Gnass, who also runs Invention Convention, a Web portal for inventors that lists inventions available for licensing, says that since inventors and investors are so opposite, they make for a good pairing. "It's obvious. One brings common-sense business organization, the other provides the dream and creativity. Inventors usually are not polished when it comes to business."

As in all business transactions, due diligence is the key to success: "More so than any other field," Gnass says. "You need to find out how strong or broad the patent is. Is there a market big enough? Will it sell more than a dozen products a year? Will a new technology make it a dinosaur? The marketability of the product is very important.

"Yes there are risks, but the payoff is so great. It's high risk, but an extraordinarily high return."

Investment and return
The size of the investment depends on the track record of the inventor, the invention and the stage at which the investor is entering. It could vary from a few hundred dollars to get a new inventor set up with lawyers and engineers to $100,000 for a simple invention with an easy-to-capture market (maybe a new product that piggy-backs onto an existing product line), to several hundreds of millions of dollars.

And what kind of return can they get? DeMatteis says to expect a very low rate of return for the first two to three years -- from nothing to 5 percent. "Then little by little, that should grow to become substantial. By the fifth year, the rate should be at least 20 to 25 percent and growing."

He also suggests, "A key decision at the three- to five-year stage should be to
determine if further research and development would improve returns and the future potential, or would it be a better plan to just run with what has already been developed. Usually it is a wise approach to continue the development, which at this time should be self-funding or close to it. Then the ROI will increase exponentially on the initial investment."

How big a stake?
The process from idea to product can take up to 20 years, and investors and inventors can come together at any point.

Early on, inventors typically need more help and carry a bigger risk. Investors should be prepared to take a larger role and be compensated with a larger equity stake. According to Gnass, 50 percent to 80 percent of inventions are from first-time inventors. With rookie inventors, the investor may step in to help an inventor find a development team. In such a case, an investor may want to have a controlling interest, in excess of 50 percent, even as great as 100 percent.

Experienced inventors who have already developed new product concepts will be in a position to ask for more financial support and maintain a higher degree of ownership and control. In that case, an investor's ownership may be as little as 25 percent, maybe even less.

The earlier on in the product-development stage, the more equity an investor should seek, says DeMatteis. A financial commitment should include drawing the funds at various stages of development. For example, with a $1 million investment, there could be an initial $250,000 draw for completing and perfecting prototypes, filing of patents, developing a sales/marketing plan and conducting some basic testing. A second draw of $250,000 for stage two would provide capital for the manufacture of working models, some real-time test marketing, finalizing the sales, marketing and packaging plan, and perhaps additional filing of patents. Upon confirmation of the test market results, the third draw of $250,000 would be for building inventories and pursuing sales on a broader scope. DeMatteis suggests holding a final draw of $250,000 in reserve for anticipated growth pains during the first year or so and to have a second-phase of investment capital available for normal business operations if the new entity is a startup.

Focus on profits, not gadgets
Inventors, particularly rookies, can become dazzled by their own wizardry and believe that everyone will be pursuing their invention. That's not the case. Hayes-Rines estimates that perhaps 5 percent of all patented items become viable products. DeMatteis: "Patents don't earn money. Sales do. That's the key. That's where an inventor and an investor should focus their effort. Patents only protect the sales long-term."

According to the U.S. Patent Office, only 3 percent of independent inventors ever earn any money from their inventions. Experienced inventors with several patents tend to have a much greater level of success -- as great as 100 percent, DeMatteis says.

"This year there will probably be about 40,000 patents issued to independent inventors," he said. "Only about 1,200 of them will make any money from their ideas. There is no doubt in my mind that the rate of success would dramatically improve with greater access to investor capital. It is rare that a first invention patent earns much money for an inventor." It usually takes several tries for an inventor to come up with a breakthrough that results in sales and profits.

Hayes-Rines says that investing in an inventor makes good business sense. "If everyone does their due diligence, keeping in mind that investing in a good product is the whole basis of our economy, they will find that investing in inventors is highly profitable with very nice returns."

Robbie Woliver is a freelance writer based in New York.

-- Posted: April 13, 2001