As technology-focused companies become more IP-centric in their approach to business strategy, investor attention is increasingly focusing on the benefits of funding and purchasing IP, but they shouldn’t forget the risks. Dan McCurdy, CEO of Thinkfire and Peter Spours, head of IP at TomTom, explain the importance of due diligence in any IP transaction

When Blackberry manufacturer Research in Motion (RIM) settled with
Network Time Protocol (NTP) over patent infringement for $612 million, it focused management and investor attention on the value of patents as never before. Technology-driven companies began to use their IP to encourage investment to their business, while venture capitalist (VC) and private equity (PE) companies started to recognise the potential of IP as a value generator worthy of investment.

However, as the Blackberry case also made clear, patent ownership courts risks as well as benefits, and not all patent rights are as clearly defined as they may first seem. On one hand, patent rights may generate a high proportion of a company’s earnings, but on the other, the need for settlements can also make IP a significant business cost. This potential for profit and loss needs careful analysis when it comes to mergers and acquisitions (M&A), investment and licensing.

As many foolhardy investors have shown, only with careful due diligence can you be sure of not paying against the odds for a company’s IP – or buying something that doesn’t exist in the first place. IP due diligence should evaluate the extent of a target’s IP Rights, ensure that the paperwork is in order, and allow you to account for the value of the IP you are purchasing, licensing or investing in.

Evaluating risk
But, IP due diligence isn’t just about legal or accounting issues, it should also be used to inform business decisions. In order to grow, companies need IP Rights that afford them the ‘freedom of action’ to sell products or services in their chosen markets. Legal due diligence can measure the seriousness of patent infringement claims and infringement actions in which the target is involved; however, from an investor’s point of view, it also needs to evaluate whether the company’s patent arsenal will be sufficient to negotiate itself out of any conflicting situations, thereby preserving the right to pursue its corporate strategy.

Likewise, many investors are attracted by established patent licensing operations; particularly where this activity provides a major proportion of a targeted company’s profit. But although an investor can purchase this cash flow outright, the sustainability of the revenue is another matter altogether. IP due diligence is needed to establish whether (a) the IP-related profit can be grown and (b) the revenue stream is long term.

To answer these questions, investors need to look at the company’s ‘production patents’ (those tested in assertions or by the courts) and the durability of the licenses (the age of the licensed patents and the life expectancy of the licensed products). They also need to measure the size of the ‘unlicensed’ market and evaluate the likelihood of success. To ensure these questions are answered as accurately as possible, experience of IP exploitation is a must.

What informs due diligence?
Targeted companies have an opportunity to anticipate the investor’s questions and present compelling materials to support a high valuation of the IP portfolio. However, thorough due diligence will uncover a more realistic understanding of the portfolio by taking into account product and market trends, and strategies to minimize payments to others and to maximise freedom of action. However, to be successful it requires a combination of technical, market, legal and licensing expertise.

In one recent example, a PE fund was evaluating investment in a profitable high-technology company where the IP revenue contributed over one third of the overall profit. The PE fund wanted to know if the IP produced a stable revenue stream and what was needed to double it. Analysis uncovered some real problems in the company’s business plan; particularly in the revenue streams predicted after relevant patents had expired. The evaluation also revealed that some of the patent clusters had a much broader application than the company’s IP team realised and stalled licensing programmes had not been fully assessed for litigation. As a result, a new plan was prepared for the PE fund that would increase royalty income by more than 50% year on year through a diversified licensee base, thereby reducing the risk involved in the transaction.

Often, training and staff support can deliver an investor’s plans effectively, and the relationships built during the due diligence phase are often key to delivery of these advanced plans

Choosing a due diligence expert
In making these assessments for investors, companies and their traditional advisers are not always ideally equipped. The answers to these questions depend not only on assessing the strength of patents and their applicability to products or sectors (a judgement best made by technologists with lawyers), but also assessing the technical and market direction of the infringing products: Are sales of licensed products increasing, decreasing, at what rate, and why?

Similarly, strategy consultants, who understand markets and market dynamics, are not experienced in IP analysis. Hence they can answer questions about market trends, revenue and profit generation, but they cannot overlay the IP components to make the judgements required by investors. Even if all the critical skills were in place in a law or strategy-consulting firm, the judgements reached must be filtered through detailed knowledge of the behaviour of the industry sector and that of specific players with relevant IP.

The approach also necessitates the use of HR skills. When VC or PE funds invest in companies, they are also investing in its staff. As such, they need confidence that the IP management team can deliver change and better performance; or, they need to analyse what personnel changes will be necessary to achieve their new objectives. For example, investors need to balance the existing skills of the department with the cost and time involved in recruiting and integrating new staff into the IP team. Often, training and staff support can deliver an investor’s plans in a much more effective way, and the relationships built during the due diligence phase are often key to delivery of these advanced plans.

IP provides an edge
Those investors who understand the connection between the opportunities and risks presented by the target company’s IP will have a profound advantage in IP transactions. They will find and exploit hidden assets to build revenues and profits. They will discover risks that other investors may miss that materially – even dramatically – impact profitability and free cash flow. And, most importantly, they will have an integrated view of IP, technology and business strategy that provides the edge that distinguishes their successful transactions from misplaced investments.

10 KEY QUESTIONS TO ANSWER BEFORE YOU COMMIT:

1 Does the company own the rights?

2 Has the chain of ownership been kept up-to-date?

3 Is the company constrained from following its current business plans?

4 What is the effect of the changes to the corporate ambitions planned by the investor?

5 If the company is approached by a patent asserter, does it have a suitable patent arsenal to counterattack?

6 Has the company made adequate financial provision for IP settlements?

7 Does the company have an IP licensing programme?

8 Can this be grown or revenue delivered faster?

9 Is the current revenue stream sustainable?

10 Is the IP team skilled and able to deliver the investor’s new plans?


This article first appeared in IP Review, issue 17

User Comments

Post a comment