In the context of a recent presentation I delivered on IP issues in M&A transactions I had cause to reflect on the disproportionately high value attributed to IP Assets compared to that attributed to physical assets. Put simply, the enterprise value of most enterprises is heavily weighted in favour of their IP Assets. Plant and equipment, real property, leases, inventory etc are so yesterday.
This gives rise to challenges of ensuring the proper protection and transfer of these types of assets. But it’s worth getting it right.
Properly transferred, a buyer will enjoy the exclusivity and monopoly rights afforded by IP Assets and the continued competitive advantage conferred by a target’s brand, patented AI products and confidential trade secrets etc.
Oh, and the seller receives the maximum value for its historical efforts in managing its IP and can ride off happily into the sunset.
So, when considering a range of recent and historical transactions, a few salient issues emerge.
Not all IP is equal. The Buchanan IP Spectrum™
IP Assets really are the jewel in the crown of most modern companies. A rather dated Harvard Business Review Study from the year 2000 informs us that IP represents about 70% of an average firm’s value. A lot has happened since 2000, most relevantly the exponential growth and sophistication of digital commerce, and we can reasonably speculate that the value of IP to today’s average firm is more like 90+%.
So, how do we get all of that IP safely from A to B? To answer this question, the parties to a transaction must understand the qualitative aspects of the deal’s IP, not just mere quantitative elements (e.g. x number of trade marks, y number of patents etc).
On the issue of IP quality, experience tells me that there is a worrying disconnect between what directors and business owners regard as Intellectual Property vs what the law actually regards as a true intellectual property right conferring genuine exclusivity and, like real estate, capable of transfer. This leads to confusion at best, and at worst, failed transactions .
IP is not a binary thing but rather a company’s various IP Assets will vary in strength, enforceability, and transferability. In the context of any form of IP, be it trade marks, patents, copyright etc, an enterprise will not enjoy absolute exclusivity but neither will it have nothing at all. There really is an IP spectrum.
Where a company’s IP sits on that spectrum depends not only on the type of IP but also the quality and relevance of the registration (in the case of registrable rights) and the systems, processes and corporate knowledge (in the case of other non-registrable intellectual assets such as confidential know-how).
It is this spectrum which requires expert IP analysis in the due diligence phase of an M&A transaction. So, this leads to the question of what does a proper IP due diligence entail?
Lifting the hood and conducting a top-notch IP Due Diligence
A proper IP due diligence has a couple of key components which I refer to as Catalogue and Interrogate. The former is pretty straight forward, the latter is where, as advisors, we earn our stripes.
Cataloguing, as the term suggests, entails a stock-take of the target’s IP Assets with a focus on identifying and listing all of the enterprise’s various intangible assets. Typically this is done via a questionnaire sent to the target’s legal counsel for completion.
This brings us to interrogation, the fun part. No, really, stick with me, you’re almost there. The goal here is to understand whether the Target’s IP Assets will be retained and functional in the new owner’s hands post completion. I reckon there are two sides of the coin when it comes to performing an effective IP interrogation. And here I’m talking to the lawyers (and other nerds). You must first scrutinise the target and its IP. But you mustn’t stop there, even though so many do (to their detriment), you must understand your buyer client’s post-completion plans for the commercialisation of the IP.
Asking the right questions of the target
Effective interrogation of the Target’s IP is all about asking the right questions. The following questions, offered as a guide, have at their core the determination of whether the Target has systems of Good IP Governance in place that justify the value attributed to their IP assets.
Answers to the following types of questions will prove insightful:
- What’s the target’s policy for identifying, capturing, registering, protecting, commercialising and enforcing its IP Assets? Or are these things left to chance?
- How IP aware are the Target’s directors, executive, legal counsel?
- How, and by whom, are decisions made that relate to IP?
- Does the Target’s contracts adequately capture IP created by employees and contractors (i.e. noting different rules of ownership apply depending upon the type of engagement)?
- Are freedom to operate clearance searches conducted before launching a new product or brand?
- What is the status of each of the catalogued IP Assets? Are they owned by the right entity, protected in the right jurisdictions etc?
- What does the Target perceive as their biggest infringement risk?
Don’t forget the buyer’s plans for the IP
The above represents a good start but the buyer must know their strategy and ensure their lawyers do too! Why are you, the buyer, interested in the acquisition and what is your IP strategy post completion? Putting this into practice, in relation to trade marks (but also extrapolating to other IP categories), answers to the following will be essential:
- What are the Target’s most important trade marks (brands, names, slogans, logos)?
- What are the buyer’s plans for using these trade marks once they own them? On what products or services will they be used?
- In what geographic areas will the buyer use them?
- Will the trade marks be used online?
- Who are the target’s biggest competitors?
With the above information you can then properly evaluate the strength of the Target’s IP having regard to the Buyer’s intentions by confirming, for example:
- Are the IP assets transferable or are they non-property rights such as know-how requiring more careful treatment in their transfer (e.g. retention of key people contracted to formally transfer their knowledge)?
- Are the IP assets owned and used by the right entity or are they, e.g. in relation to trade marks, potentially vulnerable for cancellation on grounds of non-use?
- Do the IP assets exist in all of the required jurisdictions and, again in relation to trade marks, are they registered across all goods and services of relevance to the buyer?
- Are there third party IP licensee rights to be managed? Both in terms of IP that is licensed into the enterprise but also licences granted by the Target to commercial partners.
- Can the Target demonstrate a convincing chain of title to the ownership of the key IP assets?
- Are there infringement risks associated with the Buyer’s use?
- Are the IP assets unencumbered or subject to any registered security interests?
IP Upfront, not an afterthought
The earlier the due diligence is undertaken the better. Early discovery of strengths and weaknesses of a target’s IP position can shape transaction value, risks to be managed, warranties to be negotiated, defects to be cured and even the overall deal structure. For example, in relation to deal structure, a buyer might be well-advised to ensure a suitable percentage of the purchase price is linked to a successful earn out period in circumstances where the target’s IP is more heavily weighted in knowledge based assets (trade secrets, processes, culture, relationships etc) as compared to formal registered IP rights.
The above hopefully serves to demonstrate, whether you are a buyer, or looking to be acquired, there’s great value in devoting sufficient resources and attention to your IP.
Director | Principal Lawyer
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