Anyone looking to acquire a company or a share in one, whether as a business owner, venture capitalist, or investor, must undertake due diligence to ensure they understand the true value of the target company and include all the necessary intellectual property in a deal.
In this guide, our intellectual property solicitors explain why due diligence is such an integral part of any company acquisition and describe the potential ramifications of getting it wrong. They provide an overview of the steps involved in the process and highlight the post-acquisition considerations you should be aware of.
Contents:
Why conduct intellectual property due diligence?
Due diligence is a deep dive into a target company’s business, legal, and financial affairs. It involves collating and assessing all relevant information and documentation to ascertain key issues, such as the company’s value and levels of risk.
Intellectual property due diligence is a key part of any due diligence process. Its purpose is to identify all intellectual property owned and used by the target company, ascertain its value and sufficiency, and highlight any potential inadequacies and liabilities.
A company’s intellectual property includes business-critical assets, such as:
- Its name.
- Its logo.
- Its branding.
- Its product design.
- Its patents.
- Its software code.
These assets form the company’s intellectual property portfolio. A strong, well-managed intellectual property portfolio is instrumental in:
- Attracting consumers.
- Encouraging consumer loyalty.
- Protecting a brand.
- Preventing third parties from using the company’s branding without permission.
- Monetising a brand, for example, through licensing programmes.
- Maintaining a competitive edge.
- Securing investment.
- Entering new markets.
The importance of due diligence ahead of an acquisition cannot be overstated. Instructing our intellectual property solicitors to undertake the task will ensure:
- You understand the target company’s true value.
- You understand the extent of the target company’s intellectual property.
- The target company has registered all relevant intellectual property rights.
- You acquire all relevant intellectual property under the deal.
- You are aware of any ongoing or threatened intellectual property-related litigation.
- You are aware of any liabilities or issues that may affect the target company’s ability to use its intellectual property before you sign the deal. For example, if it has granted an exclusive licence of its intellectual property to a third party, you cannot use that intellectual property until the licence expires.
The consequences of failing to undertake effective due diligence can be disastrous. They include:
- Paying over the odds for the company because the deal price included intellectual property that the target company does not own or subsequently proves problematic.
- Failing to include business-critical intellectual property in the deal and being unable to use it post-completion.
- Acquiring a company whose intellectual property is weak. For example, if the target company has not used one of its registered trade marks for five years, that trade mark is at risk of trade mark revocation.
- Becoming embroiled in legal action. For example, if the target company’s branding infringes third-party intellectual property rights, you may be liable for that infringement and be forced to undertake an expensive rebrand. If the target company has not properly policed the use of its branding by third parties, you may be forced to take extensive legal action to preserve the brand’s integrity.
- Reduced profitability. If you cannot use the target company’s intellectual property, or if its intellectual property is extensively infringed, your ability to exploit the brand can be severely hampered.
- Loss of consumer trust and reputation issues because the market is flooded with substandard imitation goods.
- Problems with attracting investment. A comprehensive intellectual property portfolio can be used as leverage for loans and to attract investors. If the target company’s intellectual property portfolio is weak, you will struggle to attract the investment you need to expand.
A much-cited example of intellectual property due diligence gone wrong involved Volkswagen’s multi-million dollar acquisition of assets owned by Rolls-Royce and Bentley in 1998. Volkswagen did not realise until after the event that the Rolls-Royce trade mark – one of the target business’s most crucial assets – was, in fact, owned by BMW and so did not form part of the deal. As a result, while Volkswagen could manufacture cars that were, for all intents and purposes, Rolls-Royce cars, they could not brand them as such.
What are the key steps in the due diligence process?
When undertaking the intellectual property due diligence process, our solicitors will go through the following key steps to gain the information they need to advise you effectively. They’ll obtain some of the information from the target company through a detailed questionnaire, and carry out their own investigations to verify that information and glean anything else they need.
Determine your objectives
While the magnitude of the process depends on the nature of the target company and the extent of its intellectual property, the primary objectives of intellectual property due diligence are largely the same in any deal. It allows a potential purchaser to identify all the intellectual property owned and used by the target company and assess its scope, quality, duration, and value. The exercise verifies the target company’s ownership of the intellectual property or the basis on which it purports to use it, highlights any risks, and flags any liabilities.
Identify and catalogue all the intellectual property owned by the business
Identifying the target company’s intellectual property is a crucial step in any intellectual property due diligence process. It involves establishing the existence and validity of intellectual property rights, including trade marks, patents, copyright, and design rights, and highlighting any gaps.
To establish the target company’s intellectual property rights, your solicitor will undertake a variety of tasks, including:
- Requesting an inventory from the target company of all the intellectual property it owns and uses, including its scope, duration, and territories.
- Searching the target company’s name in the relevant intellectual property public databases to identify what registrations it holds.
- Obtaining ownership documentation from the target company relating to unregistered intellectual property rights, like copyright. It’s easier to identify registered intellectual property rights than non-registered ones, and the time your solicitor spends on identifying and cataloguing unregistered intellectual property rights will depend on how important those rights are to the business. Checking with the target company for any pending intellectual property registrations.
- Checking that the business’s current intellectual property facilitates your expansion plans. For example, if you intend to expand into a different country after completion, your solicitor will check whether the target company owns the relevant intellectual property there. If it doesn’t, they may conduct trade mark clearance searches to ascertain whether any prior rights might hinder your plans and impact the deal.
Verify the ownership of any intellectual property rights
Confirming that the business owns and can assign all business-critical intellectual property assets is an essential aspect of all intellectual property due diligence processes. Our solicitors will check that the target company is the rightful owner of the relevant intellectual property and has the legal right to transfer it. If they don’t, the intellectual property cannot form part of the deal, and you may end up in a dispute with someone else claiming to own the intellectual property if you use it following completion.
We can verify that the target company owns the intellectual property you wish to acquire in several ways. For registered intellectual property, such as trade marks and patents, they will conduct searches of the relevant public databases to confirm ownership, validity, scope, and duration. If the results of these searches show that the target company does not own the intellectual property, for example, because it is held in the name of an associated company, your solicitor will ensure the intellectual property is transferred to the target company before completion and forms part of the deal.
For non-registered intellectual property, such as copyright, they will request documentation to evidence the target company’s ownership. This might include items such as employment contracts, supplier agreements, and intellectual property assignments.
Many businesses overlook the fact that when they engage third parties like freelancers to create material, the freelancer retains ownership of their work unless they expressly assign it to the company. If there are any gaps in the chain of title, your solicitor will prepare documentation to remedy the issue before completion.
For all intellectual property, they will check whether the target company owns it exclusively or jointly with third parties. If third parties have any interest in the intellectual property, our solicitors will take the necessary steps to ensure ownership is transferred to you in its entirety on completion.
Review agreements
Your solicitor willreview all relevant agreements for any provisions that may impact the deal. As part of their review, your solicitor will check key terms, such as those relating to scope, duration, royalties, and termination.
If any agreements raise issues, your solicitor will flag them to you. One example of a potentially problematic agreement is an exclusive licence from the target company to a third party to use its intellectual property, the effects of which will render you unable to use that intellectual property while the licence is in place. A further example is a licence allowing the licensor to terminate following a change of control of the licensee. Any use you make of that intellectual property post-completion will infringe the licensor’s rights.
Establish whether the intellectual property is being used as loan collateral
Businesses are increasingly using their intellectual property as collateral for loans. The arrangements work in much the same way as those involving tangible assets and enable the lender to seize and monetise the asset if the borrower defaults on their loan repayments. While the intellectual property owner usually retains ownership of the asset, the lender may impose conditions on how the intellectual property can be used. For example, they may prohibit the owner from transferring or licensing the intellectual property to third parties until the loan has been repaid.
Your solicitor will establish whether the target company has used any of its intellectual property as loan collateral and advise on the effects of any such arrangement.
Determine the value of the intellectual property
The value of the target company’s intellectual property will have a significant impact on its value overall. A valuation of the companies intellectual property is essential in understanding how much the target company is worth.
Valuing intellectual property isn’t easy. It involves considering not only the assets’ current value, but also their potential future value generated by, for example, integrating the intellectual property within your existing products or licensing it to third parties.
Identify potential issues
As part of the due diligence process, your solicitor will identify any issues with the target company’s intellectual property that may cause problems in the future. Examples of the types of issues they’ll look for include:
- Any existing or potential litigation. For example, if the target company has used material that might infringe third party rights, your solicitor will assess the target company’s legal position and the likelihood of a rights owner bringing infringement proceedings.
- Any validity issues. For example, if the target company has not used a trade mark it owns for five years, your solicitor will assess the risk of a third party seeking to revoke the mark and the potential impact of such action on your future plans.
- Problems with the target company’s brand protection policy. If the target company has not properly enforced its intellectual property rights against infringers, its intellectual property may be compromised. Your solicitor will advise the extent to which this impacts the intellectual properties worth and the target company’s value.
Analyse the due diligence results
Your solicitor will carefully analyse the results of their due diligence as they unfold to assess the significance and potential impact of any issues that arise. They’ll consider whether the issue can be easily resolved by putting additional documentation in place ahead of completion or negotiating special provisions in the Sale and Purchase Agreement, or whether it is so fundamental that you may need to reconsider the entire deal.
Some issues are commonplace and can be easily remedied. Sometimes, for example, a business founder registers intellectual property in their own name rather than that of the company. Provided there are no complicating factors, your solicitor will address this issue by arranging for the intellectual property to be transferred to the target company before completion.
Other issues are not so easily addressed. For example, if the target company does not own its main trade mark, it cannot sell it to you. This can be a dealbreaker and is a stark example of the need to take nothing for granted when undertaking IP due diligence. Had Volkswagen realised before completion that it was not acquiring the Rolls Royce trade mark, it could have avoided the disastrous situation described above.
Any issues that come to light may delay the deal and increase your costs. Working with experienced corporate and intellectual property solicitors who will have experienced issues of a similar nature many times before, is essential.
Post-acquisition considerations
Closing the deal isn’t the end of the matter; your solicitor will then consider and implement any post-completion steps required to secure your ownership of the target company’s portfolio.
The exact steps your solicitor will take depend on whether the acquisition was structured as a share or an asset sale. In a share sale, you effectively step into the target company’s shoes and take over control of all its intellectual property rights. Very few, if any, post-completion steps are required in the case of share sales. One notable exception is where you have acquired licences of registered intellectual property. In these cases, your interest in the relevant intellectual property may need to be recorded at the appropriate registry.
If you acquired the target company through an asset sale, the main post-completion consideration is ensuring you are registered as the new owner of the intellectual property. This is more than merely a procedural requirement; failing to act within the relevant timescales can have severe consequences. For example, if you neglect to register a patent assignment within six months of completion, your ability to recover your costs in any infringement proceedings may be affected.
Our solicitors will take care of all post-completion requirements on your behalf, ensuring everything is finalised by the applicable deadlines.
Summary
Due diligence is a pivotal exercise in any company acquisition. Understanding the scope and strength of a target company’s intellectual property portfolio is crucial in determining whether the acquisition is worthwhile and placing a value on the target company. A thorough review by specialist solicitors like ours will clearly establish the extent of the target company’s intellectual property rights and highlight any dealbreakers, like the target company not owning key aspects of its branding, avoiding potential disasters post-completion.
