Whether a company acquires intellectual property (IP) assets alone or outright merges with a target company, its underlying intellectual property can dramatically affect the price of the acquisition. For instances in which the IP is the driving force for the merger, the importance and need for adequate diligence on the assets becomes even more important. From a buyer’s perspective, there are obvious needs in analyzing assets (ownership, current status, intended use), as well as underlying factors (foreign protection, term, pendency). Each of these can have a material effect on a negotiation, and a buyer should seek to uncover all identifiable factors before acquisition to understand exactly what it is buying.
As part of a due diligence analysis on a target company, an acquiring entity has many factors to take into account, with some playing a more significant role in a negotiation than others. A proper due diligence analysis should focus on a target company’s patents and other IP assets for sure. But the impact of a target company’s IP can be much greater and an acquisition negotiation can be driven by other factors, such as a target company’s licenses of IP to other third party companies, as well as a target company’s use of third party IP in its own products and/or services.
The business goals of an acquiring entity can trump the findings of a diligence analysis; however, the results of a diligence analysis ultimately should play a significant role in an acquisition negotiation under any circumstance. If an acquiring entity is going to merge with a target company no matter the IP involved, then a diligence on the IP assets of the target company should be minimal. The results will basically have no affect at all on that negotiation. A due diligence analysis on IP assets plays a greater role if the IP of the target company is a driving force of the merger. Thus, depending upon whether the merger is strategic or purely financial, the results of a due diligence analysis on the IP assets of the target company should play a larger role in cases where the merger is purely financial driven due to the IP assets.
In considering the factors of a due diligence analysis that affect a negotiation, clearly an IP asset that is enforceable is an important factor. IP assets found invalid in a U.S. court or in a proceeding before the U.S. Patent and Trademark Office, or unenforceable for failure to pay required maintenance fees, obviously should drive a negotiation price down to some extent. Aside from whether an IP asset is actually in force, ownership is the single most important factor in a diligence analysis for the simple fact that an acquiring entity must know that, no matter the warts, the entity will at least own the asset after a merger. A clean chain of title from the inventors to the target company must be present. Any question of a loss of ownership in the chain can affect the price of a sale since ownership is not clear.
An additional major determination from an IP due diligence that can affect a negotiation is the pendency of the assets in the portfolio. Flaws and issues, even significant ones, associated with an IP asset almost always can be corrected if the asset has a pending case still before the U.S. Patent and Trademark Office. Poorly drafted claims and claims with narrow scope in an IP asset can be sacrificed if the asset has a child application pending. New claims and corrected claims can be drafted and pursued in the child application. Accordingly, during a negotiation, an acquiring entity can bring up the flaws and issues in an attempt to bring the price of an acquisition down while still knowing that corrections and additions can be made. More importantly, if the flaws are so bad, an acquiring entity can get out of the deal all together.
Any due diligence analysis should conduct a prior art invalidity determination in order to assess the prior art that a defendant could use one day. For one, there are different standards for determining validity before an examiner at the U.S. Patent and Trademark Office, before one or more administrative judges, and before a U.S. district court judge. Just because an IP asset with broad claims is allowed by an examiner and issued by a patent office does not mean it will survive a contention of invalidity brought by a defendant or other third party. Thus, an in-depth prior art search should be conducted against an IP asset in a merger since an examiner has limited time and resources to conduct such an in-depth analysis.
Validity of an IP asset also may change over time and this assessment must be taken into account. Federal laws and court decisions on patents can change over time. A manner of best practice 10 years ago in drafting claims or specifications to patents may now be considered wrong following a Supreme Court or Federal Circuit decision. In other cases, Congress can draft new statutes or amend current statutes, and these changes can have a dramatic effect on the value of an IP asset. Accordingly, a negotiation to acquire IP assets can be affected by these new decisions and laws, and their impact on the to-be-acquired IP assets.
Other factors beyond the IP of a target company can drive the negotiation process. The existing licensing program of a target company and to which third party companies that company has licensed its IP can have a significant effect. If a target company has a restrictive licensing program or one that directly licenses IP assets to a competitor of the acquiring entity, then these encumbrances on the IP of the target entity may make them worthless to acquire. Similarly, a target company’s use of third party IP in its own products and/or services can affect a negotiation. If the target company’s products and/or services read on a third party’s IP, then an acquiring entity can expect to face a higher risk of liability. Further, if the target company is small and the acquiring entity is much larger, the acquiring entity may face an immediate lawsuit upon acquiring the target company. A small company has small pockets while the target entity, being large, has deeper pockets for a third party to pursue.
So, whether IP assets included in a merger or acquisition have an eventual offensive use or fill a need for defensive protection, the outcome of a due diligence analysis can materially affect the negotiation process. Knowing the issues and flaws and being able to distinguish the minor financial headaches from the incurable errors should allow an acquiring entity some ability to drive down the costs in an acquisition.
John Fleming is a principal shareholder in the Washington, D.C., office of Banner & Witcoff, Ltd., concentrating on due diligence.