Q2 Goes Public — with Patent Problems Looming

Q2 (formerly Q2 EBanking) may have some patent problems.

Austin-based Q2 Holdings, the parent company of Q2 which is going public today, offers cloud-based banking services to some 300 community banks and credit unions as customers. Its software-as-a-service offerings are some of the most innovative in the industry, with an early emphasis on mobile account opening and the tablet experience.

But that might all be for naught considering that the company may face some acute challenges related to intellectual property law. Q2, apparently, has not done much to protect its IP from patent trolls, and that neglect seems to already be harming the company. Q2 reports in its S1 IPO filing that it has been hit with allegations of IP violations — and expects to be hit with more such claims. Q2 had but one U.S. patent application pending and one issued U.S. patent at the time of today’s IPO. That compares to six issued patents and 80 patents pending at Twitter at the time of its IPO late last year.

The company writes (our emphasis has been added):

Despite substantial investment in research and development activities, we have not focused on patents and patent applications historically. We license third-party technologies, such as bill pay technologies, that are incorporated into some of our solutions.

The efforts we have taken to protect our intellectual property rights may not be sufficient or effective. It may be possible for other parties to copy or otherwise obtain and use the content of our solutions without authorization. Failure to protect our proprietary rights adequately could significantly harm our competitive position and operating results.

Sadly, Q2 appears to be facing a stiff headwind of legal battles to come:

… We have received in the past, and will likely in the future, receive notices that claim we have misappropriated or misused other parties’ intellectual property rights. … Any intellectual property claim against us, regardless of merit, could be time consuming and expensive to settle or litigate and could divert our management’s attention and other resources. These claims could also subject us to significant liability for damages and could result in our having to stop using solutions found to be in violation of another party’s rights.

Q2 goes on to say that it may be required to spend more money on IP licenses, even though such licenses “may not be available on commercially reasonable terms, or at all.” Q2 acknowledges that such licenses could require the company to pay “significant royalties, which would increase our operating expenses. We may also be required to develop alternative non-infringing solutions, which could require significant effort and expense and which we may not be able to perform efficiently or at all.”

The company’s most dire warning is that these IP legal issues could literally shut the business down.

That doesn’t sound great. The company has devoted considerably more money to marketing — about $12 million in 2013 — than to research and development — about $6 million over the same period. This may not be surprising for a young company looking to grow its customer base, but in the light of these IP risks, Q2 might want to put some money and legal muscle into protecting its intellectual property before it is too late.

Nevertheless, Q2 [ticker: QTWO] raised about $100 million in its IPO today.