An IP due diligence is a part of the due diligence process. In this deep investigation is conducted to understand the value of the intellectual property portfolio of the target company before a merger or an acquisition. This portfolio includes all the intangible assets such as patents, trademarks, copyrights, software, designs, processes, etc.
An IP due diligence is mandatory before making a purchase of the intellectual property, a merger or acquisition. It is a very important part of the due diligence process, especially in the case of companies that have a vast portfolio of intellectual property.
Why conduct IP Due Diligence?
With the rise in technology, intangible assets have become the most important assets for any company, thereby making intellectual property a critical factor in any investment. Let’s understand the importance of IP due diligence in detail –
Understanding the Value and Cost
The trickiest part of an IP due diligence in determining the value of the intellectual property. This is because the value of the intellectual property is all about the market perspective, there are no physical features that can be the determinants. An IP due diligence helps determine the value closest to the actual value.
Furthermore, a very important piece of intellectual property is the cost of maintaining it. The cost includes legal fees, registration costs, marketing and branding cost, and other maintenance costs. It is critical to conduct a cost-benefit analysis before investing in intellectual property. An IP due diligence helps an investor in understanding the costs and benefits.
To Avoid Defects
Defects in conducting an IP due diligence can lead to a less than reasonable deal value. The value of intellectual property is a result of a series of assumptions about intellectual property. A healthy IP due diligence tests the validity of each assumption. For example, suppose the target company owns a copyright on a series of published books. They decide to determine the value of this copyright by assuming future cash flows from sales of these books. The IP due diligence will check whether this assumption is valid i.e. whether these books will bring in the assumed sales or not. This helps the investors in avoiding any defects in the assumption and reaching a fair bargain in an M&A deal.
To understand the protection factor, we must first understand the types of IP due diligence, namely – defensive and offensive
Defensive IP due diligence is sellers side due diligence, i.e. if you are selling the intellectual property, you must conduct this due diligence. Defensively, the seller must ask questions such as –
- What is the actual value of the intellectual property?
- Am I getting the maximum value in the deal?
- What can I do to maximize the value of my portfolio of intellectual property?
Offensive IP due diligence is buyers side due diligence, i.e. if you are a buyer, then this due diligence is apt. Offensively, the buyer must ask questions such as –
- Is the price quoted by the seller for the intellectual property in question is value for money?
- Is the coveted intellectual proper covered by patents? If so are the patents enforceable, and can the ownership of patents be transferred?
- Is there pending litigation on the intellectual property which might affect its prices in the future?
Both sides want the best for their buck, thus the protection factor comes into the picture. An IP due diligence helps both the buyer and the seller understand the risk involved in the deal of a certain intellectual property, so they can plan on how to protect themselves from these risks.
Process of IP Due Diligence
IP due diligence has a very straightforward three-step process as follows –
Prioritizing goals is one of the most important steps in IP due diligence. A set of defined goals help save time, money and manpower. When it comes to IP due diligence there are mainly two goals – the acquirer is either paying for the full company, or he is just interested in the portfolio of intellectual property.
In the first case, which is the most regular kind of M&A deal, the acquirer wants the entire company i.e. its interest lies not only in the target company’s intellectual property but also in its production facilities, retail operations, customers, supply chains, management, and human resource, etc.
In contrast, certain mergers and acquisitions only take place because the acquirer is interested in the target company’s intellectual property portfolio. The buyer doesn’t necessarily eliminate the possibility of acquiring the full company, but the target is intellectual property and customer loyalty linked to it. The best example is Facebook’s acquisition of Instagram, Facebook didn’t want Instagram as the company, but it wanted Instagram as a brand and its users.
It is very important that the buyer first understands and prioritize the motive behind the M&A deal, this, in turn, will help define the IP due diligence.
After understanding the goals, it is now time to investigate based on these goals. The very first step when conducting the investigation is asking the following two questions –
- What product and/or services are involved in the M&A deal?
- Do intellectual property cover these products/ services?
Answer these two questions will give the buyer a good understanding of the IP portfolio. Here onwards the buyer should focus on the relationship of intellectual property with products of interest, and its alignment to M&A goals.
After completing the primary analysis, the acquirer undertakes the secondary analysis. This includes the quality and legal aspects of intellectual property. The acquirer conducts an investigation on the following factors in secondary analysis –
- Operational freedom with respect to intellectual property.
- Potential risk and liabilities attached to the intellectual property.
- Its legal validity and enforceability.
- Ownership, status, and control of the intellectual property.
- Strength and economic value of the intellectual property and the underlying intangible asset.
The final stage is deriving the results. This stage involves combining, tabulating and analyzing the information collected up until now. The analysts derive the conclusion from this body of information. Buyer conducts the risk-benefit and cost-benefit analysis to determine the viability of this deal. If they require further information, then they will send requests to the target company and further, they will include this updated information in the analysis.
The baseline is that in the final report the buyer will understand that if he goes through with the M&A deal, what exactly he is getting in terms of intellectual property. Therefore the buyer must check two things – is the deal in alignment with his goals and is it value for money. The buyer doesn’t want to overpay for the intellectual property while the target company wants to maximize value.
This whole exercise is very important for transactions involving intellectual property because there is no straightforward way to determine its value. Its intrinsic value is considered its actual value, and the intrinsic value can be grossly miscalculated. IP due diligence smoothens out the entire process.1