Selling Your Company or Raising Capital: Intellectual Property Considerations
In a previous Frank, Rimerman + Co. LLP article, dated April 28, 2010, we outlined how the due diligence process can give a buyer the time and—for an unprepared seller—the opportunity to renegotiate key deal terms such as purchase price, timing of payments, indemnification, representations and warranties, and others. In this article, we examine due diligence considerations related to a company’s Intellectual Property (IP).
IP is often a key component of a company’s value. This is especially true for technology companies, but it can also be true for traditional brick and mortar enterprises (which often own and rely upon IP assets as integral components of their business). IP can be incredibly varied and often includes patents or patentable subject matter, copyrights, trademarks, domain names, trade secrets, mask works, inventions, works of authorship, hardware, and devices.
Over the past several years, buyers have become increasingly sophisticated and thorough in their assessment of a seller’s IP. A buyer’s due diligence review of your company can be very wide in scope, ranging from examining the business and competitive implications of the IP utilized in your key products and services (such as technical design, integrity, and scalability) to evaluating ownership risks (such as potential or existing claims from third parties or employees, patent issues, license agreements, and transferability). IP concerns discovered during due diligence can have significant impact on key deal terms and, in some cases, can prevent a transaction from closing.
As an example, in a recent business sale in which IP was a key element of value, the buyer’s due diligence team conducted a thorough IP analysis and discovered a potential patent overlap. In this case, a third party held a patent that could be argued to overlap with a technology patent held by the seller. This fact was unknown to the seller until the buyer raised the issue. Although the patent was for a secondary technology of the company, the buyer had raised a concern that needed to be addressed. The seller quickly attempted to purchase the patent from the third party to resolve the issue, but was unable to strike a deal at a reasonable price because the third party owner perceived their negotiating leverage. Ultimately, the seller was required to lower the company’s purchase price and increase the escrow hold-back in order to close the transaction.
If the seller had conducted a pre-transaction due diligence risk assessment before entering into a Letter of Intent with the buyer, these IP issues could have been discovered and resolved without affecting key deal terms. Or, at a minimum, the seller could have disclosed the issue to the potential buyer so it would have been reflected in the terms of the negotiated Letter of Intent and removed as potential leverage to renegotiate the purchase price and escrow.
There are many things a seller can do to prepare for IP due diligence. Here are a few examples:
- Conduct an internal review to identify all IP that the company utilizes in its products, services, or operations.
- Review all relevant employment agreements to ensure that the company is the sole and exclusive owner of all results of employee services and labor, free and clear of any potential claims or liens.
- Examine all agreements in which the company acquired any IP to ensure proper documentation regarding ownership and transferability.
- For any company-owned IP that is not patented, examine the advisability, cost, timing, and potential benefits of a patent filing.
- Conduct a preliminary patent search to identify potential ownership counter claims.
These tips are sound advice for any seller, but each company should conduct a pre-transaction due diligence risk assessment that is unique to its particular assets and circumstances. Frank, Rimerman + Co. LLP offers Transaction Readiness Services that are tailored to your company’s needs. Our unique team—with expertise in investment banking and transactional, valuation, tax, and accounting skills—provides a highly effective and efficient risk assessment to help you prepare for due diligence. Our Transaction Readiness team can provide you with an extraordinary return on your investment by helping you protect the key terms in a sale or financing transaction.