(FORTUNE Small Business) – When Tom Hazzard and his wife, Tracy, launched their company, ttools, in 1998--selling a combination stylus-ink pen that can go back and forth from electronic organizers like PalmPilots to paper--they thought they had something good. They found out just how good when six months into business, just as sales were taking off, 3Com, then maker of the Palm, started selling its own stylus-ink pen, one that looked suspiciously like--too much like--ttools' pen.

"We were devastated," says Tracy, the Providence company's president. "They say a copy is the sincerest form of flattery. But not in this case, not in business." All the Hazzards had ever wanted to do was sell unique products they created. Graduates of the Rhode Island School of Design, the two had between them already fashioned more than 200 products on the market, mostly furniture and office supplies, for such companies as Crate & Barrel, OfficeMax, Ethan Allen, and Herman Miller. But instead of battling for customers in the marketplace, ttools grappled with a corporate giant in court, a fight that took the fledgling company to the brink of extinction. "Having a better product is our edge against the big guys," she says. "They took that away. We couldn't let them do that to us."

The spat ttools had with 3Com is not uncommon. Small businesses are encountering a rash of intellectual-prop-erty thefts of patented products and copyrighted and trademarked business tactics. Infringement has been worth the risk for larger companies because they know that many smaller firms cannot afford the high cost of a drawn-out legal battle. (The average cost to litigate a patent-infringement case is $1.5 million.) However, the climate has changed, and companies like ttools are fighting back when faced with Fortune 500 rip-offs. "At first you think, I must be pretty smart if they took my idea. But that wears off quickly," says Eric Hicks, owner of Game Over, a small sports-gear manufacturer currently suing Nike (which declined to comment) over a marketing technique involving dance moves (see "A Whole Lotta Shakin' Goin' On").

This fighting spirit builds as the problem gets worse. Although no official data are kept on these kinds of lawsuits, in general, federal patent lawsuit filings have increased 60% since 1993. Anecdotally, Richard Apley, a director of the U.S. Patent and Trademark Office in charge of independent inventor and small-business issues, says his office now receives a half dozen calls a day from firms that say they are being ripped off by bigger companies. "It has gotten so bad," jokes Apley, "that I'm thinking of asking the EPA if we can list the individual inventor on the endangered species list."

In all seriousness, all the PTO can do is to raise awareness. Its role is to issue patents, which are already supposed to ward off theft. The office's major initiative has been to recommend patent insurance as the best protection against infringement. This new type of policy acts as a reserve fund for litigation: If a small business needs to go to court, the insurance kicks in to defray the costs. Litigation Risk Management, which pioneered patent insurance, offers a $1 million policy for as little as $4,500 a year. The number of firms that offer insurance to small businesses has doubled to four since 1999.

What has emboldened companies to take on industry bullies is not only the financial means to do so but also the opportunity for justice. The breakthrough came in a landmark 1997 case in which Fonar Corp. finally beat General Electric after a decade of fighting over the invention of the magnetic resonance imaging machine (MRI). The court ordered GE to pay Fonar $128.7 million, ten times the small company's annual earnings at the time. The ruling was upheld on appeal, making it the largest patent jury verdict to date.

Small-business owners were energized, and the floodgates opened. Attorneys who once shied away from patent-infringement cases because of their technical complexity are not only courting small companies but also taking their cases on a contingency-fee basis, a practice usually used in personal-injury cases.

The corporate m.o. in such cases tends to be predictable, according to a number of lawyers FSB spoke with. Big companies have been known to flagrantly copy products they see on the shelves. Even more shattering to small businesses is to be duped into handing over their property willingly because they think they're in partnership with the bigger company, a partnership that evaporates once the larger company gets all the information it needs to make the product itself. "It's like going to the same play over and over again but with different actors," says Ray Niro, a Chicago attorney who in the past six years has netted some $350 million in jury verdicts for small businesses in intellectual property theft cases. In the case of ttools, there was a little bit of everything--broken relationships, accusations of theft, and legal stalling.

It all started in 1996 when Tom gave Tracy a new gadget called a PalmPilot for Christmas. She liked it so much that Tom got one for himself a month later, and the couple was hooked on the handheld electronic organizer. There was only one problem--the stylus used to write on it. Always armed with a sketchpad, Tom hated having to switch back and forth from the "little plastic stick" to a pen. On a train ride home from New York, inspiration hit. By the time he reached Providence, his sketchpad was filled with the design for the PDApoint, a two-in-one stylus-pen. The stick with ink has a hard tip that loosely resembles a fountain pen to use on a PDA screen and allows room for a ball point ink tip to spring forth to write on paper. Tom spent 1997 refining it, filed for patents on the tip and the pen, and received them in December 1998 and June 1999, respectively.

In March 1998, before the formal launch of the company, Tom and Tracy went to Palm for the first time, revealing their design plans in order to gauge its interest in their invention. They hoped to get their product into the company's accessory catalog once they went into production. Palm didn't have anything like the PDApoint and was very excited about it, according to the Hazzards, though no deal between the two was struck just then. (Palm Computing and 3Com refused to comment on ttools.)

Although the PalmPilot was still a novelty, it was quickly gaining a devoted customer base. Encouraged, the Hazzards officially launched ttools in May 1998, relying on credit cards and a $75,000 loan from Tom's mom. A month later ttools began manufacturing Tom's pens. They sold their invention online to individuals, but soon began to do customized bulk orders for companies such as AT&T, Casio, Motorola, and ESPN.

After a few months on the market, ttools thought it was ready for the Palm catalog and approached the company again. Only this time Palm wasn't interested. Palm was now developing its own two-in-one stylus. The Hazzards were shocked. But unsure exactly what Palm's new stylus was going to be like--there was a chance that the company had come up with its own creation--ttools plowed ahead and all communication with Palm stopped.

A month after ttools received its patent on the pen in mid-1999, Tracy spotted a picture of Palm's new dual stylus in a magazine. It had the same (newly patented) fountain pen-like tip, and the products were so similar that ttools got e-mail from customers wondering whether the new Palm stylus was their creation. "I wanted to crawl into bed and never get out," says Tracy. Instead the small company went into survival mode. After tense discussions in the couple's living room with their 14 investors, they decided to fight back and file a lawsuit. "I knew that, fighting this, we could go down in a big ball of flames," says Tom, who did not have patent insurance. "But we had no choice."

3Com tried to win the case by stalling, according to ttools' attorney, Kas Decarvalho. It did not file a response to the suit. Instead, at each court appearance, the company asked the judge for an extension, dragging proceedings on for more than a year without forwarding the case. The stall tactics were working; ttools' business ground to a halt. It discovered it could not expand because retailers and investors did not want to deal with a small business involved in a pending lawsuit. The Hazzards maxed out their credit fighting for their business as they struggled to support their newborn daughter.

On ttools' side was Tom's sketchpad. Tom had used the bound book to keep extensive records documenting his idea for the two-in-one pen. Each design sketch, every minor change, was dated, creating a complete picture of the product's development. Whenever Tom showed the sketches to anyone, including Palm executives, he had them initial and date the page. Phone conversations, patent applications, brainstorming sessions, were all documented. The bound book told a compelling story. It also gave ttools the strength to defy Palm and keep fighting. "We always knew we were right," says Tracy. "If we weren't going to protect our invention, then why did we start ttools in the first place? We couldn't give up."

Forty-eight hours before a mandatory court appearance in November 2000 that finally would have begun the process of discovery in the case, Palm settled. More interested in protecting its business than a monetary settlement, ttools halted the unfair competition suit after 3Com agreed not to produce any new versions of the dual-stylus pen. Palm also agreed to pay ttools royalties and licensing fees for the Palm two-in-one pen already on the market. The case was officially put to rest in January.

While ttools won't reveal how much it spent on the suit, because the case never reached the discovery stage, legal experts estimate costs were probably less than $100,000, a bargain in patent litigation. Still, the costs were significant. "We could have made a whole new product for what we spent," Tracy admits. An unhindered ttools is now thriving. The company recently opened its new headquarters in downtown Providence, and staff is up to 12 employees from two. Sales hit $1.5 million in the first quarter, and its stylus pens are also now available in Wal-Mart, Target, Circuit City, and Office Depot. Ttools' latest innovation, a holographic security screen for handheld computers, came out in September.

The efforts of ttools, Fonar Corp., and others give hope to any small companies facing intellectual property theft. What works? Meticulous documentation--and a healthy amount of grit and determination--can lead to victory. Size matters too. "In the eyes of a jury," says Philadelphia patent attorney Fred Tecce, "you usually don't want to be the Goliath but the David."