INTRODUCTION
Mergers and acquisitions (M&A) are extremely important in the modern corporate world for growth and expansion of a business. These days companies often resort to undertaking mergers or acquisitions to enter new markets, diversify their portfolio, or even secure stronger market presence. Prior to finalizing a merger, the due diligence process involves assessing the company’s assets, with intellectual property (IP) being a key component of this evaluation as IP is highly valuable.
It is precisely for this reason that due diligence of IP assets is essential to the success of an M&A transaction. Conducting detailed IP due diligence can help determine the true value of a target company and also mitigate potential risks and liabilities. The failure to do so, on the other hand, can lead to unfavourable consequences, including legal disputes, financial losses, and reputational damage.
UNDERSTANDING INTELLECTUAL PROPERTY IN MERGERS AND ACQUISITION
Intellectual property encompasses a wide range of intangible assets including patents, trademarks, copyrights, and trade secrets. Each IP asset provides a distinct advantage to the business, as it effectively dictates business operations and value. Therefore, the valuation and assessment of IP assets is critical in determining the worth of the target company in an M&A deal.
In the context of mergers and acquisitions, IP often serves as a key asset driving the deal’s valuation. For instance, a technology start-up’s patent portfolio or an established brand’s trademarks can significantly enhance their market value. However, if these assets are not adequately protected or are involved in legal disputes, they can quickly turn into liabilities for the acquiring or merging company. Moreover, if the IP assets of the business come with hidden risks such as unresolved infringement claims, contractual obligations or even usage limitations, it can place impediments. This makes IP due diligence in the M&A process, essential.
OBJECTIVES OF INTELLECTUAL PROPERTY DUE DILIGENCE
The aim of IP due diligence is to provide a clear and transparent picture of the target company’s intellectual assets, specifically, their nature, value and associated risks. The process of evaluating and assessing a company’s IP portfolio is exhaustive. Evaluation of the IP assets is usually undertaken in compliance with the relevant laws, especially in the case of cross-border M&A deals, and agreements between the transacting parties.
- Inventory of IP Portfolio – The most basic step of the due diligence process is to first create a details inventory of the company’s IP assets, including trademarks, patents, copyrights and trade secrets.
- Ownership verification – Determining clear ownership of IP assets is crucial in an M&A transaction. In case of joint ownership, licensing agreements and the like, the exercise of IP rights may be restricted.
- Risk assessment – A detailed risk assessment facilitates identification of potential liabilities such as infringement claims, pending litigations, or other third-party conflicts. The importance of such assessment is even more enhanced in the case of cross-border transactions.
- Contractual review – Clauses related to ownership, restrictions, royalty conditions and termination rights in IP-related contracts like licensing agreements, R&D contracts and employee contracts, must be thoroughly examined.
CHALLENGES IN INTELLECTUAL PROPERTY DUE DILIGENCE
In spite of its critical role in mergers and acquisitions, the process of conducting IP due diligence is complex and has several obstacles. Intellectual property is complex by nature due to diverse nature of legal and technical frameworks it is governed by, specifically in cross border M&A. Some of the key challenges to be overcome in intellectual property due diligence are as follows:
- Incomplete documentation – Companies often neglect to maintain comprehensive IP portfolios. The lack of record keeping, incomplete or outdated information can make it difficult to assess IP assets. This can result in major oversights in detecting potential liabilities and risks associated with the IP.
- Jurisdictional complications – Cross border transactions make IP due diligence even more complex as it requires navigation between the different IP legislations, enforcement frameworks and valuation procedures.
- Valuation of Trade Secrets – IP due diligence is challenging in the context of assessment, valuation and protection of trade secrets. Since trade secrets do not undergo any formal registration process like patents or trademarks, they are harder to document and evaluate. Trade secrets are also highly vulnerable to human error and disclosures, posing significant risk to the acquiring or merging company.
- Contractual agreements – In some instances of joint development of an IP asset through joint ventures or research collaborations, the ownership and usage of the intellectual property is governed by contracts. Hence, it becomes a complex task to analyse these contractual provisions in order to foresee potential risks, disputes and restrictions which can reduce the value of the asset, and consequently, the value of the M&A deal.
- Technological changes – In industries driven by high-level of innovations, technology upgradations are constant and rapid. Hence, when businesses operate on a fast-moving cycle, existing technologies can quickly become obsolete. This can lead to major fluctuations in the value of IP assets, like patents, during the due diligence process itself, resulting in difficulty to value the asset accurately.
- Volume and complexity – Large multinational companies, or companies engaged in IP-heavy industries maintain voluminous and diverse IP portfolios. In larger M&A transactions, this can overwhelm the due diligence process and make it harder to go through the finer details for assessment. A substantial and varied IP portfolio, without planned due diligence, can result in costly oversights.
- Human factor – Often, the human factor is overlooked in the IP due diligence process, especially in the case of patents and trade secrets. Employees privy to confidential information, proprietary knowledge, and trade secrets are potential liabilities. Although non-disclosure agreements and confidentiality clauses provide legal safeguards, they are not entirely effective in preventing the transfer of knowledge.
BEST PRACTICES FOR EFFECTIVE IP DUE DILIGENCE
The importance of IP due diligence in a merger or acquisition transaction cannot be understated in modern day business. Effective IP due diligence is crucial in mitigating risks, minimising liabilities and maximising the value of the M&A deal. Ensuring a systematic and comprehensive approach in conducting the due diligence process through expert insights and streamlined processes is crucial.
- Assessment by Legal and Technical Experts – Involving experienced professionals with the legal and technical knowledge, required to accurately evaluate and assess IP portfolios, is crucial to a successful due diligence process.
- Integrating AI-based tools – Advanced AI models can be used to streamline the due diligence process by using them to complete tasks related to organisation, record keeping, and report generation. Routine and repeated tasks can be automated using AI-based software to prevent wastage of human resource.
- Collaboration and Transparency – It is important to have transparency in communication and collaborative approaches between the acquiring company and the target company. This would expedite the due diligence process without unnecessary delays. Transparency is also crucial to demonstrate good faith between the parties to the M&A transaction, and reduce the likelihood of disputes.
- Post-M&A integration and expectations – As important as the due diligence process is, it is also equally crucial to consider the operation of the IP assets post-merger or acquisition. This includes assignment and transfer of the IP portfolio, compliance with domestic IP frameworks and notifications to the concerned entities. Additionally, it can also include the execution of agreements governing specific aspects, including retention of certain intellectual properties, division of royalties and so on.
CONCLUSION
In the modern age, intangible intellectual property assets hold far greater value than the tangible assets. Therefore, overlooking or ignoring the IP due diligence process as part of the overall M&A due diligence can be a costly mistake. Innovation and competitiveness lie at the heart of any M&A deal, and intellectual property is a major factor in determining the same. IP due diligence is no longer an insignificant procedure, but a comprehensive process which can determine the success of an M&A.
Hence, in order to derive maximum value and benefit from their M&A transaction, companies must recognise the strategic importance that intellectual property holds. The due diligence process helps to identify and value IP assets while also anticipating risks and liabilities. A well-executed IP due diligence process can ensure successful mergers and acquisitions.
Written by Varshika, Legal Intern at Intepat IP
