Kim Walker, partner and Iain Richardson, associate at Thomas Eggar LLP cover some of the potential issues faced when buying or selling a business with an IT asset base.
Where intellectual property (IP) forms a key part of the business and is the engine for generating revenue, it is important that a comprehensive due diligence exercise is carried out by an acquirer. A business which is being prepared for sale can equally use this as an opportunity to carry out a mini IP audit and make sure that it will have ready answers to the enquiries which the purchaser’s lawyer will make.
When assessing the IP rights owned by a business it is important to first understand the business’ approach to protection: do they have a rigorous IP filing program and maintenance practices, or is the portfolio tired and near to expiry. The first step is to identify the IP rights which exist. These could include registered and/or unregistered rights. Certain rights, such as copyright, are not capable of registration in the UK. Other rights such as trademarks and design rights can exist in both registered and unregistered form. Patents are registered rights.
Searching and verifying ownership of registered rights
To develop an effective IP due diligence strategy it is important to first understand what IP assets are most significant to the deal, any key markets and what products (if any) are in the pipeline. The schedules provided by the target company may only tell part of the story so searches might be necessary to ascertain the rest by verifying the information is correct. It is worth bearing the following in mind:
- A poorly managed portfolio could have out of date information. Any inaccuracies could have an impact on the overall value placed on the IP.
- Searches can be carried out on publicly available databases for some jurisdictions but where access is unavailable online it may be necessary to instruct search providers or other local agents.
- When carrying out searches, it is recommended to identify any affiliates and subsidiaries of the target company and include these in any proprietor searches, as depending on the target’s filing practices there may be IP rights owned by predecessors.
- In this regard, it is important to ensure proper chain of title for each right and whether there are any joint ownership issues which could complicate post-completion matters. Does any other party have a right to the IP or are any rights subject to a commercial co-existence agreement?
- For trade marks a search will reveal any rights that are vulnerable to cancellation for non-use or whether the registered rights adequately protect the goods or services used under the mark. Will new trade marks need to be filed? IP that is due to expire could possibly mean a hefty renewal fee is due or if there is abandoned or expired IP is there any possibility to resurrect these.
IP due diligence can be a complex and time consuming process and often involves more than mere searching. The relationship between registered and unregistered rights as well as third party rights needs to be considered when assessing the status and ownership of any IP.
It is not so easy to verify either the existence or ownership of unregistered rights. Some businesses will have signed up to an unofficial recordal system, for example ACID which is particularly favoured by design led businesses. It is important to note that these do not create registered rights, but can provide useful evidence of creation.
The business owner should be the best placed to help list all of the unregistered IP in use in the business. When compiling such a list, the business should be encouraged to give as much information as possible about the provenance of unregistered rights. This also applies to the creation of IP which is subsequently registered. For copyright (and, once the provisions of the intellectual property bill are in force, design right) first ownership lies with the creator. It is very common for a business to use third party sub-contractors or freelancers to create works, whether software or artwork. It is essential that the contractual chain can be established so that appropriate warranties can be given that the business is the owner, as it will very likely be required to do on any sale or a licence of the IPR.
Unregistered rights may subsist in software such as copyright or database rights in the data within it. Software raises another issue in that it is important that any open source code used is identified fully and the underlying licenses examined to establish what limitations, if any, this might place on the commercialisation of software developed on this basis. This is important if the key asset of an IT business is code developed in this way. (These issues are explored elsewhere in the e-bulletin in the article entitled “Tips on avoiding software intellectual property infringement”).
IP contractual due diligence
Understanding the contractual relationships around the ownership and exploitation of the IP rights is just as important in any due diligence. The following non-exhaustive list is worth bearing in mind:
- Obtain copies of all agreements related to IP and technology.
- Review all agreements that establish IP, including assignments and licences and agreements that limit or restrict the use of IP.
- If any third party IP is integral to the business, are there any provisions that could affect the transaction, for instance in an asset deal, do any agreements contain restrictive assignment terms or, if a share deal, are there any ‘change of control’ provisions?
- If any IP rights are licensed in or out, a thorough review of the licence arrangements will determine how reliant the target business is on licensed IP and identify royalties to be paid out or that are received for the foreseeable future.
- Consider whether the agreements are still valid and necessary, how long does the term run for and what will happens to the IP when terminated.
The business should be able to explain and verify steps taken under the IP policy in relation to creation and licencing, both in and out of intellectual property. This will enable the right questions to be asked in order to establish the limits of ownership and any restrictions there might be on use of a business’ own IP if it has licenced it out. We would encourage businesses which are in the growth stages and pre-sale to adopt an intellectual property policy, having first assessed how IP is relevant to the business.
This can also be a key factor in maximising the value of IP which will have an impact on the price which can be achieved. The IP needs to address:
- New work, inventions and other developments which should be routinely assessed at predetermined milestones.
- At which point assistance is obtained from lawyers and patent attorneys to register rights where possible.
- The approach adopted to ensuring that third party infringements or potential threats to IP are dealt with appropriately will find that this pays dividends at a time when it is under intense pressure in relation to achieving a sale of investment.
The identified IP can then be recorded and will make the due diligence process much more straightforward.
The value of IP in a business will often be a factor in underlying financial projections. Providing information about any third party requests to buy or obtain a licence of any of the target company’s IP might assist in that valuation process. Equally, information on any recent challenges to the IP or threats to validity could have the reverse effect.
Licensing disasters have been brought before the Courts on a number of occasions, a significant number of these relating to disputes in the pharmaceutical sector. Problems have consistently arisen in one or more of the following areas:
- Defining the licensed product.
- Calculating the royalty base, particularly where sales are generated in a number of territories.
- Identifying the licensed IP rights; patents which are the subject of applications at the stage the licence agreement is entered into may not proceed fully to grant or may be divided and the rights be given different levels of protection across the territories in which the licensed product is sold.
- Dealing with improvements; ensuring that the obligations on a licensee to pass details of improvements back to the IP owner and their right to be remunerated do not fall foul of EU technology transfer provisions.
Finally, it is important to understand the industry specific issues which might affect valuation of the relevant IP and to what extent the market might change so that risks are appropriately allocated between the buyer and seller.