Entrepreneurship and innovation are powerful forces that, when combined, can lead to the creation of great value. Last week, the local startup community saw one of its finest recent examples of entrepreneurial innovation, Color Kinetics (CK), deliver nearly $800 million in cash to its shareholders—myself among them—upon the completion of its merger with Royal Philips Electronics. With about $80 million in revenue run-rate and a current year EBIT (earnings before interest and taxes) expected in the $4-6 million range, Color Kinetics garnered a valuation that far exceeded typical multiples. Instead, the company’s value reflected the unbounded potential of its innovative LED-based lighting solutions as evidenced by CK’s rapid profitable growth over the past five years under the exemplary leadership of CEO Bill Sims.
Looking back, an early share in a large or growing marketplace, an outstanding team, satisfied and loyal customers, and competitive advantage are often present in such high-value transactions and share between them most of the credit. In the case of Color Kinetics, one additional factor deserves significant credit and that is the intellectual property estate built by the company during its decade of existence. Atypical of many high-technology companies, but quite typical in biotechnology, the strategy of patenting early and often contributed ultimately to the company’s ability to protect and deliver the substantial value it created.
I was approached by one of the founders of Color Kinetics and its first CEO, George Mueller, exactly 10 years ago this week. At that time, he and his co-founder Ihor Lys had the vision of a world filled with color-changing, LED-based, intelligent lights. They had a functioning prototype and the need for capital to begin manufacturing and selling their new lights. Not knowing a lot about the lighting market put me in the company of most, if not all, potential investors in CK. The limited market diligence I could do confirmed that there was a very large lighting market that was stagnant and vulnerable to innovation. Much more exciting than the market-disruption potential, however, was the vast and open IP landscape that existed around the team’s innovations. Based on experiences from the biotechnology industry where the prevailing wisdom is to “patent or perish,” it became apparent that Color Kinetics should establish patents as core to its strategy for value creation.
Building a large patent estate proved to be a very costly undertaking for Color Kinetics. With limited capital, the company had to continuously balance investments in marketing or product development with further investment in new patent filings or enforcement. This balancing act was made even more difficult by the doubt, scrutiny, and even scorn expressed at the value of CK’s patents by prospective investors, the press, and eventually competitors. (This Forbes Magazine article from 2002 provides a nice snapshot of a time when it wasn’t clear what the future would hold for the company.)
Since the first patent was granted in January 2000, Color Kinetics’ patent portfolio has grown to 79 issued U.S. and foreign patents and over 180 pending patent applications. The company implemented a broad-based licensing program that has made the IP available to nearly 50 licensee companies, including industry leaders such as S.C. Johnson, B/E Aerospace, and Ford Motor Company. These licenses are expected to contribute about $5M in licensing revenues this year, most of which drops straight to the bottom line. The company also enforced its IP rights through two patent infringement suits, one of which resulted ultimately in a paid license and damages recovered by CK, and the other was settled as a result of the Philips merger (Philips had previously acquired the party involved in the second suit).
LED-based lighting is well on its way to transforming the lighting industry. The combination of Color Kinetics and Philips represents a formidable alignment of innovation and marketing power. Moreover, both companies have an intense focus on creating intellectual property to protect their investments in R&D and deliver value to their shareholders. While the entrepreneurial phase of Color Kinetics’ life may be ending, the innovations and value creation should persist for a long time.
Noubar was a founding investor and board member in Color Kinetics from inception until last week. He is a co-founder, Managing Partner, and CEO of Flagship Ventures. Since 2000, Noubar has also been a Senior Lecturer at MIT’s Sloan School of Management, where he teaches a course on Entrepreneurship (15:390B) on Monday nights.
