WITH THE DEVELOPED WORLD becoming reliant on knowledge-based economies and the valuation of companies depending to a much larger degree on the knowledge they own, the value and commercial potential of intangible intellectual property (IP) assets are more important than ever in mergers and acquisitions.
But greater realisation of the significance of IP – e.g. trademarks, designs and, above all, patents – in an M&A valuation does not always mean that IP due diligence is being carried out consistently and effectively. In the past, the focus in such transactions was on the ‘tangible’ assets, for which it’s easier and more straightforward to determine a value. Today, however, the real value of many companies is tied-up in their ‘intangible’ assets, particularly their IP. And that’s where the real challenges can arise. Investment bankers are not IP specialists and the valuation of IP assets, particularly patents, is still allied too closely to accounting-based procedures that are designed primarily for valuing tangible assets.
Historically, IP due diligence was largely a back office, ‘tick-box’ exercise based on a rudimentary assessment, often conducted at the eleventh hour. If the IP department was consulted, they would be asked to answer a set of questions such as: “Do these people own the IP they say they own? Are they going to maintain these IP Rights throughout the life of the deal? Are any of the IP Rights licensed to a third party? And do we need to review these arrangements before we acquire the IP portfolio?”
These basic questions haven’t changed in recent years. What has changed is that IP is now more frequently addressed up front in the deal process; and, arguably, for some deals, it’s the driving force behind the transaction. This trend is exemplified in technology-intensive industries where the majority of a company’s value resides in its intangible assets. But it’s not just the inherent value of the assets that’s attractive to potential acquirers; the deal is equally important in terms of how the assets are currently being leveraged and, crucially, whether they can be deployed/exploited to provide competitive advantage, secure even greater commercial returns, fill technology gaps in an IP portfolio, and/or mitigate the risk of being outmanoeuvred by competitors.
Take, for example, the 2011 acquisition of Nortel Network’s patent assets following the Canadian telecoms company’s bankruptcy. The value of the patents prompted a bidding war by Nortel’s erstwhile competitors in the telecoms sector, with the eventual sale realising approximately $4.5bn. In January this year, Eastman Kodak, in the midst of chapter 11 proceedings, sold its digital imaging patents for approximately $525m to a consortium of technology companies. Also, in January, Ericsson announced a deal to transfer over 2,000 of their patents to Unwired Planet – the company credited with inventing the mobile internet – in a tie-up that creates a new channel for licensing IP.
So what are the key disciplines that need to be employed when assessing the IP assets of a target company?
The first thing is to start early. IP due diligence has to be top of the agenda as soon as potential target acquisitions are identified. Clearly, it’s important to gain a comprehensive understanding of the target’s IP portfolio and its IP strategy – whether it’s designed to boost the company’s competitiveness and drive commercial growth or simply to protect what the company has. You will also need to identify and understand:
• The IP assets that are critical to the company’s ongoing and future commercial success.
• How the acquired portfolio will complement your existing IP portfolio – the gaps it will help fill and where there may be overlap.
• Whether the patent(s) provide you with competitive leverage / competitive advantage.
• The relevance of the target’s patents – are they just for defending their own products or are there patents others might want to license?
• The strength of the relationship between the target company’s research and development (R&D), IP portfolio and product/service range.
• The age profile and geographical scope of the patents – for how long and where can they be enforced?
• If the company is still filing patents. If so, what and where?
• Whether the patent portfolio is reliant on only a handful of key inventors.
• Possible encumbrances – are some patents licensed to third parties or currently the subject of litigation?
It is not always easy to value IP; even for IP specialists. However, by factoring in many of the considerations above, an acquirer can start to get a feel for the value of the target company’s IP portfolio and any significant upside that may exist, while also identifying potential risks to future growth.
In many circumstances, the upside and/or risk associated with the IP portfolio may help to define strategies to ensure the future success of the acquisition. Indeed, in certain cases, these factors may well drive the acquisition decision.
Whatever the scenario, it no longer makes sense to keep IP considerations to the eleventh hour.
Haydn Evans is vice president of intellectual property Service Solutions at CPA Global