Chapter 17: Avoiding Transaction PerilValue-Based IP Due Diligence

Tiffany VukasinovichApril 19, 2010

IEOR 190G

Outline

• Introduction• The Present State• Our Mission• Phase I• Phase II• Phase III

INTRODUCTION

• Motivation: More than ¾ of the total market value of S&P 500 corporations derives from intangible assetsHas the process for conducting due diligence in

business acquisitions changed?Need to reconsider intellectual property

Conduct pre- or post-deal analysis of the fit between the IP portfolio of the buyer and target

Minimizes risk, increases potential to discover valuable off-strategy assets

New Approach!

THE PRESENT STATE

• Deficient in review of underlying benefits and risks associated with related IP and other intangible or intellectual assets (IA)

• Current IP Due Diligence addresses whether1. The IP rights are owned by the seller2. There are technical defects in these rights3. The rights are valid4. The rights are enforceable (all legal factors)

OUR MISSION

• Overall phases of IP due diligence reviewPhase I: Strategy and Scope

1. Understand transaction objectives and plan due diligence• Understand the transaction objectives• Develop critical questions• Pick the IP due diligence team

2. Characterize IP culture and fit of acquirer and target• Will the cultures mesh easily• What impact does this have on the scope and depth of IP

due diligence effort

OUR MISSION• Overall phases of IP due diligence review

Phase II: Strategy and Scope3. Inventory products and services changing hands

• What is needed to make the integration a success• What is core to the deal, what is extra

4. Inventory IP changing hands• Consider all intellectual property changing hands including trade

secrets• Conduct interviews to uncover full list

5. Inventory contractual obligations• Are the contracts transferable• Are there other important restrictions

6. Inventory other intangible assets changing hands• Which key employees must be kept• Which key relationships (customers, distributors, etc) must be

maintained

OUR MISSION• Overall phases of IP due diligence review

Phase III: Analysis and Response7. Link intellectual assets and related intangibles to products and

services and evaluate impact• Identify strengths and weaknesses in protection- can weaknesses be

corrected, indemnified• Is there surplus IP of value

8. Evaluate the competitive landscape and other external IP/IA influences• Are third-party licenses needed• Will acquirer receive IP that can be offensively used against competitors• Consider industry, customer, competitor, antitrust, and regulatory trends

for IP/IA9. Estimate the value to enable pre- or post-deal action

• Consider key risk and value drivers from above• Consider value from internal and external exploitation• Formulate and execute actions

PHASE I: STRATEGY AND SCOPE

• Objectives and planning– Goal of due diligence: to provide the party

proposing the transaction with sufficient information to make a reasoned decision as to whether or not to complete the transaction as proposed• Need understanding of the purpose for the transaction

– Consider portability and risk to evaluate whether a transaction will achieve objectives

PHASE I: STRATEGY AND SCOPE• Acquirer’s Questions

1. Will the patented subject matter be adaptable to the acquiring company’s products, services, and/or processes?

2. What effect will the protected process/features have on the quality and marketability of the acquiring company’s product?

3. What activities are ongoing at competitors that may lessen the value of the obtained protected process/feature?

4. Could the patented subject matter be adapted to other products manufactured by the acquiring company?

5. Is there a right (and value) to both exclude others from the practice as well as to practice without infringement upon the rights of others?

6. Is there an opportunity to license the IP to others (those who do or do not compete with the acquiring company)?

PHASE I: STRATEGY AND SCOPE• Acquirer’s Questions

7. Are competitors developing next-generation products or do they have IP that will lessen the impact or relevance of the acquired IP?

8. Are there key engineering or manufacturing individuals working for the target who are critical to the success of implementing the patented technology at the acquiring company?

9. What additional value is the acquirer obtaining from the other IP in the target’s portfolio that might redefine the objective or strategies driving the transaction? Can this IP be sold for value that decreases the cost of the deal?

10. Is this the best technology (and most cost-effective means) for solving the problem or are there better/cheaper alternatives?

11. What additional IP risks is the acquirer inheriting through the purchase of the target?

12. Have the above issues been analyzed to determine their effect on the overall value of the transaction?

PHASE I: STRATEGY AND SCOPE

• Seller’s Questions1. Does the seller have a good understanding of all of the IP being sold

as a part of the transaction (i.e. an IP inventory)?2. Do other subsidiaries or divisions aware of the sale of the IP and the

right to practice the process or use the technology and what losing the rights might do to their future plans?

3. Are other subsidiaries or divisions aware of the sale of the IP and the right to practice the process or use the technology and what losing the rights might do to their future plans?

4. Is there an opportunity to license the IP to others who do not compete with the target company?

5. What other IP of the target included in the sale is currently or might potentially be used by other subsidiaries or divisions of the seller’s parent?

6. What additional non IP intangible assets are being transferred from the target to the acquirer and what value is being given away?

PHASE I: STRATEGY AND SCOPE• Acquirer’s Questions

7. Are there key employees of the target who should be retained rather than becoming employees of the acquired company?

8. Would licensing the patented process to others while maintaining ownership of the targeted subsidiary provide a better long-term return to the parent than selling the subsidiary to the acquiring company?

9. Are there potential shareholder liability risks associated with selling the subsidiary?

10. Are there existing legal obligations to others associated with the IP?

11. Have the above issues been analyzed to determine their effect on the overall value of the transaction?

PHASE I: STRATEGY AND SCOPE• Culture of IP management– Will synergies/management cultures mesh

• Method of developing, perfecting, maintaining, and enforcing IP rights

• Similar importance on role of technology in success of business, etc

– Identify what factors make the target a success in the market

– Confirm that integrating the target into the acquiring company will not place these factors at risk

– KEY QUESTION: Will the IP culture of the combined firm be able to support the target’s product and services at the level required to ensure their continued success after they are integrated into our company?

PHASE II: INVENTORY AND REVIEW• Products and services changing hands

– Review of products and services changing hands– Understanding of complete inventory– Interview key employees

• Inventory intellectual property – Develop complete list (effects value)

• Examples of failure to do this beg the questions1. How many acquirers might never have discovered this IP right linked to the

acquired product?2. How many times is such incremental value in these deals never identified?3. How many good deals never got done due to the failure to identify this

type of IP value?4. How many opportunities exist for astute buyers to get a better deal or even

a windfall by identifying a valuable IP asset that the seller didn’t even know they had through careful due diligence?

PHASE II: INVENTORY AND REVIEW

• Contractual Agreements Affecting IP Rights– Consideration of the risk associated with

contractual agreements and terms affecting the IP rights of the parties to the contract• Consider limitations and constraints on rights resulting

from agreement– Representations, warranties, indemnification, university

agreements, government agreements, assignment restrictions, geographic restrictions, other restrictions, and non-compete agreements

PHASE II: INVENTORY AND REVIEW

• Other intangible assets and intellectual capital– Review and understand the broader set of

intellectual assets and intellectual capital linked or related to IP• R&D efforts under way related to potential new

products or potentially patentable discoveries• Manufacturing and business process know-how• Sales force components with key technical knowledge

and/or customer contacts• Information technology and systems supporting the

company’s business

PHASE III: ANALYSIS AND RESPONSE

• Products and services linked to IP• Competitive landscape and other risks

– IP due diligence also considers the IP held by competitors and other third parties, as well as the implications of IP-related government regulatory requirements and the influence of industry consortiums and standard-setting bodies• Third parties can block patents, improvement patents, obsolescence, trade secrets,

design-arounds, and/or ongoing development– “landscape” analysis should include review of recent popular publications, internet searches,

consultants’ reports, industry studies, trade publications, competitor annual reports, and other disclosed competitor documents

– Multi-Term Frequency Analysis technology• Consider impact of regulations and industry standards

– Tax regulations, government industry regulations, and product or technology standards existing or pending can impact value

• Consider impact outside influencers can have on the combined entity’s other intellectual assets and intellectual capital– New distribution media, customers’ alternatives for inputs to production, regulatory issues and

other broad-based factors that influence demand• Corporate liability

– “IP wasting”- failure to steer R&D away from potential infringement problems are the root of many lawsuits

PHASE III: ANALYSIS AND RESPONSE

• Estimating the value and impact– Patent portfolios face unique risk factors• Probability of issuance (if pending)• Ability to enforce the property rights• Penetration of technology into a market• Alternative technologies available to the potential

target• Fraction of the market that will adopt a particular

technology• Value of other technologies that must also be adopted

PHASE III: ANALYSIS AND RESPONSE

• Estimating the value and impact– ?????– Assess issues with information and details collected

during due diligence proces• Value of a patent is assessed based on legal, financial,

marketing, industry-specific, and economic issues– Multidisciplinary team (IP counsel, corporate employees involved

with the technology, and finincial experts knowledgeable of the industry and market dynamics)

• Dynamic valuation model– Quantify specific elements that form the key underpinnings of

value for negotiations

PHASE III: ANALYSIS AND RESPONSE

• Advances supporting due diligence– Technologies allow for automated means for

reviewing history and trends in atent citations, filing and compiling information on the technology portfolios of targets and competitors, analyzing large portfolios of technology through attribute clustering of like technologies based on user-defined groups, and graphically comparing the overlap with target or competitor portfolios• Secured through web• Available through USPTO, WIPO

PHASE III: ANALYSIS AND RESPONSE

• Benefits outweigh costs– Creating the foundation for a strategic plan– Helping to define the future direction of the company and long-range

planning– Learning more about products in the pipeline and discoveries on the

drawing board– Identifying key factors in the company’s success– Discovering untapped market opportunities for the company– Ensuring that the company receives the appropriate level of value for its

purchase (or the right price for its divestiture)– Improving the company’s management of the assets it is acquiring (or its

understanding of how to succeed without divested assets)– Enhancing knowledge of key trends in the industry, market, and regulatory

environment

PHASE III: ANALYSIS AND RESPONSE

• Benefits outweigh costs– Uncovering hidden IP jewels– Discovering alternate revenue sources through licensing or sale of IP– Unearthing new competitive weapons that stem from the combination

of portfolios– Improving the company’s ability to negotiate more favorable

transaction terms– Enhancing knowledge of the company’s own IP portfolio– Enhancing the company’s understanding of the link between its own IP

portfolio and its products and services– Improving the company’s knowledge about the IP portfolio and IP

strategies of its competitors– Acquiring into potential strengths and vulnerabilities of competitors

PHASE III: ANALYSIS AND RESPONSE

• Benefits outweigh costs– Improving the company’s understanding of contractual agreements and

obligations in existence and their effect on the success of the company– Reducing merger integration time and cost– Acquiring “insurance” against a catastrophic IP-related event that can

have sever financial consequences and may even result in shareholder action and director and officer (D&O) liability

• The new reality– Value of IP and other intangible assets > Value of hard assets– Value proposition key in deals– Rely on IP due diligence that recognizes realities of the new economy

and changing source of value