Jan Walaski of Venner Shipley discusses the intricacies and idiosyncrasies of using intellectual property due diligence as a commercial tool to support a business valuation.
For many companies, the value of their business is intrinsically linked to both the quality and the quantity of their intellectual property and how well it is protected. Due diligence can be used to value a business when raising investment, or when selling all or part of a business. It is also an essential part of investing into or acquiring all or part of a business.
Equally, due diligence can involve investigating the existence and status of other parties’ intellectual property rights and an assessment of how these rights could affect a business’s proposed activities.
A due diligence exercise prior to sale or acquisition of a business will result in a better understanding of the value of the intellectual property that the business holds. It may also provide useful information as to which aspects of its intellectual property are not fully utilised and whether more can be done in terms of greater levels of protection or to benefit from further commercial exploitation.
There are many articles explaining the concept of conducting due diligence on intellectual property assets. Most explain what needs to be done – identifying intellectual property rights which exist and their status, ownership and enforceability issues, look at the validity and the scope of the intellectual property and any subsequent infringement issues. As simple as it sounds, the reality can be considerably more involved.
In an ideal world, the IP adviser would be involved from the beginning, assisting in arriving at that part of the value of the business which is derived from the IP assets. Such involvement is important since it provides an overview of the transaction, so the importance of the IP assets can be accurately assessed and an appropriate valuation reached. In the real world, IP due diligence is often something that is only considered once the value of the deal has been set, asking not “what is the value of my IP?” but rather “is there any reason why the value isn’t the amount that I have already decided it to be?”
As patent attorneys, we are often provided with a list of patents and asked to perform “due diligence”, without a clear indication of the commercial imperatives behind the deal. As with most legal transactions, there is no definitive answer – the degree of due diligence required depends on the importance of IP to the transaction. With the increasing availability of online registers and databases, it is relatively straightforward to determine ownership and status of registered rights, but determining the validity of patents or predicting the likelihood that a patent application will be granted poses considerably greater challenges and costs. In these circumstances, a high level of scrutiny is justifiable only for those businesses, for example in the pharmaceutical industry, where a single or small number of patents cover key and exceptionally valuable products, or where the patents form the major asset of the business being sold.
The ultimate aim of the due diligence process is to support a business valuation. However, assigning a value to assets such as patents can be more of a (black) art than a science. There may be safety in numbers; in the sales of the telecommunications portfolios of Nortel and Motorola in 2013, the patents numbered in the thousands, with an average sale value per patent in each transaction of around $750k. At that time, the value of a substantial patent portfolio in the telecommunications field could be relatively easily determined. It is unlikely that much effort was expended during due diligence in checking whether the patents were valid. It has even been reported that a significant number of the patents in these portfolios were expired or abandoned.
It is understood that in licensing negotiations in fields such as electronics, quantity trumps quality, because assessing the quality of a very large number of patents is so difficult, timeconsuming and ultimately, subjective. Even in litigation, where some of the largest players in the telecommunications arena assert numerous patents against each other, arriving at an accurate validity assessment of each asserted patent can be less important than accepting validity and calculating damages/royalties based on the overall patent position of each party.
In the case of smaller companies, it is not unusual to find that the list of provided patents significantly overstates the company’s patent portfolio. The list often includes expired or abandoned patents, patent applications and patents in different countries. Patents are of course territorial, so it is entirely legitimate to consider patents in different countries separately. However, it is also the case that a company boasting over 30 patents may be found to have just a single patent family including, for example, a pending application in Europe, designating 28 states. On the other hand, if that portfolio includes a granted US patent covering the key sales territory, a valuation based on just that patent may be fully justified.
Whether the transaction is large or small, due diligence should be considered primarily as a commercial tool rather than a purely legalistic one. When dealing with large portfolios, entirely different rules are likely to apply than when dealing with small companies with a limited number of patents. In all cases, the more involved the IP adviser is in the commercial background, the more likely that the business valuation will reflect the underlying assets.
Company: Venner Shipley
Name: Jan Walaski
Web Address: www.vennershipley.co.uk
Address: 200 Aldersgate,
London, EC1A 4HD,
Telephone: 44 (0) 20 7600 4212