A company has a patent portfolio that it is proud of; the portfolio proves that the company is innovative, that it owns the results of its creative work and its competitors cannot copy its technology. Perhaps the company already has products on the market or perhaps it is still months or even years away from making a sale. Perhaps the company needs fresh capital or maybe it is getting ready for an exit. If the company is looking for investment, it must be prepared to show potential investors what they would get for their money; to do this it must prepare for due diligence and IP portfolios play an important role in this process.
This update will look at how to prepare for IP due diligence to ensure that a company can get the most out of its IP portfolio in a favourable deal. While the focus is on patents, the general principles apply to trademarks, industrial designs and even unregistered rights like copyright and trade secrets.
When an investor performs due diligence the intention is to obtain some kind of assessment of the value of the object he or she is about to invest in and determine risk. While risk is not necessarily bad and investors are not interested in eliminating risk, higher risk can be justified only by a higher expected return on investment or by some form of risk mitigation. Higher risk for an object with a certain expected return means lower price, and risk mitigation typically means a deal structure that is unfavourable to the seller or recipient of the investment (eg, in the form of payment being partly contingent on certain future events). Anything discovered during due diligence research that deviates from the presentations made by the seller and the buyer will be presented in the due diligence report as factors that will affect the expected return on investment or risk, and that may ultimately change the value and structure of the deal.
Preparation should start long before due diligence is undertaken. With regard to patents – and intellectual property in general – IP owners should address the following questions from the day on which their first application is filed:
- What is the intended purpose of the IP rights?
- How will they support the company's business strategy?
- How will prosecution be handled?
- How will the rights be managed?
Over time rights holders should maintain records of prosecution, legal status and costs and regularly review their portfolio to identify and abandon applications or registered rights that are no longer relevant and incur unnecessary costs to keep. Ideally, IP portfolio audits should be completed at least once a year to remove redundant IP rights and assess whether any assets are inadequately protected, so that the company's IP strategy can be updated or any other action taken. By keeping on top of portfolio maintenance, a company will be better prepared for due diligence.
When a deal is underway it is important to understand what the buyer or investor wants. For example, if a company is being bought to recruit a workforce of highly skilled engineers, a patent portfolio may not be important at all; however, if the deal is all about securing a patent portfolio, it may be all that matters. Most deals lie somewhere in between. Intellectual property is one of several elements that will affect the value and structure of the deal, but it will not make or break it. Understanding the buyer's objectives will help to prioritise what is the most important information to present.
Based on what is known about the buyer or investor and their intentions for making the investment, the seller should prepare and present all of the relevant information in a concise and accessible manner. This usually entails uploading documents to a virtual data room. The information should be presented consistently and with an equal level of detail. Lists of patent applications and granted patents should also include application numbers, publication numbers and patent and reference numbers, all presented in a manner that makes it immediately apparent what they are. Products that are covered by patents should be referenced and described in the same way and with a consistent level of detail.
Relevant IP information may go beyond company rights:
- Has the company performed any freedom-to-operate analysis or obtained legal opinions with respect to potential infringement?
- Does the company hold any licences to third-party rights that an investor may need to know about?
- Have any licences been granted that may produce future income or limit the company's or a potential buyer's freedom to exploit its IP rights?
Any company subject to a due diligence must be prepared to answer questions. Invariably, a potential buyer or investor will use a team of experts to perform due diligence, and these experts will come up with questions that cannot be answered based only on the information already provided. To answer such questions efficiently and satisfactorily a company should decide who is responsible for responding to questions, whether that be the chief executive officer, chief technical officer, chief financial officer or any other company representative.
It is also necessary to understand the composition of the team performing the due diligence. In an ideal world due diligence teams consist of highly skilled and experienced individuals. However, the team may be inexperienced or may consist of different experts from different firms and they will not necessarily divide tasks optimally between themselves. The firm administrating the process may want to do the majority of the work to retain most of the fees. For example, a transaction attorney may ask questions that should have been asked by a patent attorney and fail to request pertinent information. If this happens the company representative should respond to the question and provide any additional information that should have been requested. Questions must be responded to with an appreciation for who is doing the questioning.
The ultimate aim when responding to due diligence questions is to provide all of the required information in a manner that creates confidence. If a company presents a perception that they do not fully understand why they have a patent portfolio and why it is important for their business, this kind of information may be included in a due diligence report.
This list includes the most essential information that should be provided about a patent portfolio and other IP rights. Some of this information will always be requested, but some may be requested only if the portfolio is an important part of the deal or particularly relevant to the buyer:
- A presentation of the overall purpose of the IP portfolio, including:
- a description of why it is important and valuable;
- how it supports business strategy;
- which products it covers; and
- why specific jurisdictional protection has been chosen.
- A list of every item in the portfolio, with information that:
- clearly identifies patent families;
- lists relevant dates, numbers, priority information, applicant and legal status; and
- shows that all renewals have been paid.
- Documentation of chain of title, including assignments from inventors to applicants. Document that assignments have been recorded with authorities in jurisdictions where this is required.
- Documentation of prosecution history – some patent authorities may provide this online, in which case it may not be necessary to provide copies. For a large portfolio it may be impractical to provide everything – if something is left out, ensure that this is not an attempt to hide unfavourable information.
- A description of products that are covered by the patent portfolio, with sufficient detail to enable an expert to determine whether the product is covered.
- Any documents that demonstrate the strength of the portfolio and the company's ability to operate without coming into conflict with third parties, including:
- freedom-to-operate analyses;
- landscape studies;
- competitor surveys;
- IP audits; and
- legal opinions.
- Any contracts and other information relating to IP licences.
- Information about any lawsuits or other unresolved conflicts relating to:
- infringement; or
- validity of owned or third-party IP rights.
- Relevant information about standards or patent pools the company is committed to and their patent policies.
- Whether the company uses any open source software and how that may affect its ability to exploit its own intellectual property.
It is important to prepare for due diligence to:
- maximise the value intellectual property adds to a deal;
- facilitate a smooth deal structure; and
- avoid findings that may jeopardise these objectives.
A company can do this by being honest and forthcoming in its presentation of IP-related information. The best way to prepare for due diligence is through long-term measures: develop an IP strategy, implement it and maintain a record of the portfolio's status at all times. This should be done with the long-term goal of building value that will be identified and appreciated by a potential investor and reflected in a favourable due diligence report.
All this being said, it may still be important to remember one thing – particularly in a process where there are several potential buyers, at least some of whom will not end up as party to any deal: in a due diligence process, the company may be requested to provide information that it considers to be trade secrets or information that is protected under an attorney-client privilege that it does not want to compromise. It may be necessary to find ways of addressing this problem. If in doubt, discuss this with a competent attorney and find ways to balance competing interests.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.