Acquiring an understanding of the intellectual property (IP) position of a company should be important to any financial investor.  The IP position of target portfolio companies should also be important to private equity (PE) sponsors in a wide variety of transactions, including acquisitions, divestitures, mergers, strategic investments, recapitalizations and opportunistic financings.

Understanding the IP position of a Target Portfolio Company is often essential to private equity investment managers who need to advise the senior teams of their portfolio companies, drive operational changes across their enterprises, and provide advice critical to the execution of strategic plans for portfolio companies in their respective areas.

Frequently, these management activities involve assessing the IP positions of the portfolio companies, and driving the value of the portfolio company's IP assets as a rational way of supporting its private equity (PE) or financial investment value  in the marketplace.

 IP due diligence is the process that helps private equity investors and managers get a grasp on the value of this property asset, in relation to its private equity investment and management activities.

 What Is IP Due Diligence ?

IP due diligence is essentially an audit of a company’s IP Portfolio, typically undertaken prior to a business transaction such as a private equity investment, a merger, or an acquisition, to assess the quantity and the quality of intellectual property (IP) assets owned by, or licensed to, a company, business or individual.

IP due diligence is an investigative process, involving detective work seeking to discover things that will or may impact the Target Portfolio Company’s right to operate its business free of IP infringement claims, as well as its right to assert and enforce its IP claims against competitors for IP infringement, to protect the Target Portfolio Company’s products, services and market share.

IP due diligence involves (i) assessing the strength of a Target Portfolio Company’s IP Assets/Rights (e.g. patent portfolio) to determine if the IP Assets/Rights cover the Target Portfolio Company’s products and services, as well as competitor product design-arounds; (ii) determining whether or not the Target Portfolio Company has the freedom to operate (FTO) to make, distribute, sell and use its products and services free of FTO problems (e.g. potential IP infringement); and (iii) where FTO problems exist, assessing the strength of third-party blocking patents to determine whether or not the patents are valid and enforceable, and whether or not the target portfolio company has a clear non-infringement position.

IP due diligence involves deep research, intelligence collection, and knowledge processing, with attention to meticulous details, to discover findings of fact, and perform technical and legal analysis that will support generation of the Deliverables: an IP Audit Report; IP Risk Assessment and Mitigation Report; and Supporting Documents.

Typically, IP due diligence is carried out by a private equity sponsor (e.g. prospective purchaser) in relation to the IP assets of the target company or business. Typically, through a private equity investment, the target company becomes a “portfolio company” of the private equity investment firm.

However, IP due diligence can also be carried out by any company on its own portfolio of IP Assets/Rights for various purposes including (i) developing greater freedom to operate its business (e.g. offer its products and services) and gain leverage over competition in the marketplace, or (ii) preparing for a transaction, such as a business sale, a merger, or a major licensing deal, whatever the case may be.

Why Conduct IP Due Diligence Before A Private Equity Transaction ?

There are many reasons why a private equity management/investment firm should want to conduct IP due diligence with respect to the intellectual property (IP) Assets of a Target Portfolio Company, and its Competitors in the marketplace, before closing a private equity transaction.

In general, acquiring this knowledge requires understanding the intellectual property (IP) risks, IP assets and potential IP liabilities associated with a particular business venture. This also requires understanding what is necessary to execute a strategic plan in the marketplace, including identifying possible acquisitions or strategic partners, and often guiding the development of an intellectual property (IP) creation plan focused on generating a significant impact on the Target Portfolio Company’s business operations and value-building objectives.

Also, this may require aligning IP asset development with key performance indicators (KPIs) for the Target Portfolio Company and its venture(s), and tracking these key performance indicators to assess progress toward specific IP asset development goals.  For these reasons, pre-investment IP due diligence assessment of a Target Portfolio Company is very helpful in providing fair and accurate reporting on a particular Target Portfolio Company’s operational risks, assets and liabilities.

There are also many reasons why a technology-based company should want to conduct IP due diligence with respect to its own intellectual property assets. Foremost, intellectual property assets are increasingly becoming one of the most important assets of a technology-driven business or company, especially in emerging high-technology, Internet-of-Things (IoT), fintech, insurtech, and life science fields. Also, the company should also be able to identify intellectual property assets that are not being utilized, or that are under-utilized, and whose maintenance might represent an unnecessary cost.

Thus, it is important for the management of a company to understand the quality and quantity of the company’s intellectual property assets so that others (e.g. investors and valuators) are able to assign a fair and accurate economic value to these IP assets in a given marketplace.

What IP Assets/Rights Should Be Studied and Assessed During IP Due Diligence ?

During IP due diligence, the IP audit should thoroughly study and assess: (i) the intellectual property (IP) Assets/Rights of the Target Portfolio Company and whether or not they cover the Products and Services of the Target Portfolio Company and its Competitors in the marketplace; as well as (ii) the IP Assets/Rights of Third-Parties who are direct or indirect Competitors of the Target Portfolio Company, and anyone who might hold IP rights with enforceable IP claims that might impact the Target Portfolio Company’s right to conduct its business (i.e. make, have made, distribute, market, sell and use its Products and Services).

What Should Private Equity Managers Know About A Target Portfolio Company's IP ?

The private equity management firm should understand the processes that have been put into place at the Target Portfolio Company so as to fully capture all the Intellectual Property (IP) Assets being created in the company through R&D and product/service development efforts so that these IP assets can be adequately protected and used in its business.

The private equity management firm should have a complete and accurate understanding of the chain of title, from which the company derives the legal ownership of its intellectual property assets to ensure that the Target Portfolio Company holds all the necessary rights to its IP Assets, and others do not have claims of ownership to these valuable IP assets.

The private equity management company should have an understanding of whether or not the Target Portfolio Company’s Products and/or Services are infringing the IP Assets/Rights of third-party Competitors or other legal entities (including non-practicing entities) in the marketplace, so as to restrain the company’s “freedom to operate” its current and/or future business activities (i.e. to make, distribute, market, sell and/or use its products and services) without risk of infringement.

Also, private equity management firm should have an understanding of whether or not any third party is, or is suspected to be, infringing the Target Portfolio Company’s intellectual property (IP) rights, indicating the need to protect its IP assets and secure leverage and gain fair competitive advantage, if necessary through litigation.

During the IP Audit, the private equity manager should ascertain the following things about the Target Portfolio Company prior to a private equity transaction:

• Whether or not the Target Portfolio Company adequately captured all the intellectual property assets it generated from its R&D and product/service development operations, as well as strategic acquisitions;
• Whether or not the Target Portfolio Company holds adequate legal title to all of its intellectual property, however acquired through ownership acquisition or licensing;
• Whether or not proper procedures are in place in the Target Portfolio Company to assure its employees and subcontractors are working under hire to properly assign patentable inventions to the target Portfolio Company;
• Whether or not the Target Portfolio Company maintains suitable patent protection about the globe within all regions with potential for profitable expansion; and
  
• Whether or not the Target Portfolio Company maintains suitable patent protection in those regions of the globe most likely to fabricate infringing products that might permeate the market and dilute the Target Portfolio Company’s profit margins through competitor product/service infringement.

During the IP due diligence process, the private equity manager will be wise to ascertain:

• Whether or not any third-party’s IP Claims might be infringed by the Target Portfolio Company’s Products and/or Services, and if so, whether or not infringed such IP claims are valid in view of the prior art and enforceable against the Target Portfolio Company, and whether or not the Target Portfolio Company has a valid non-infringement defense against such IP Claims;
  
• Whether or not there are any invalidity challenges to be made against the IP Assets/Rights of third-party Competitor(s) which may be infringed by the Target Portfolio Company’s Products and/or Services offered in the marketplace;
• Whether or not the third-party Competitor has granted to others, any prior licenses to use the third-party Competitor’s IP Assets/Rights that are being infringed by the Target Portfolio Company’s Products and/or Services, to prove that a preliminary or permanent injunction should not be granted against the Target Portfolio Company (because money will make the IP owner whole, and licenses should be made available to the Target Portfolio Company to avoid disruption of its business operations).
  

How Is IP Due Diligence Carried Out On A Target Portfolio Company?

To carry out due diligence assessment of a Target Portfolio Company’s IP, we request and collect essential information about the Target Portfolio Company’s Business Plans, Operations, Products and Services, Competitors, and Intellectual Property (IP) owned by the Target Portfolio Company and the Competitors and Third-Party Entities in the marketplace.

In general, this pre-investment IP due diligence will involve a multi-stage process involving:

•  Identifying, recognizing and recording the IP Assets/Rights (e.g. Patents, Trademarks, Copyrights, Trade Secrets, Licenses) owned by the Target Portfolio Company, and the IP Assets/Rights (e.g. Patents, Trademarks, Copyrights, Trade Secrets, Licenses) owned by the Third-Party Competitors and other Third-Party Legal Entities which may impact the Target Portfolio Company’s freedom to operate its business (e.g. make, have made, distribute, market, sell and use its Products and Services) without incurring legal liability under specific market conditions (and contributing to damages).
  
•  Assessing the recognized IP Assets/Rights of the Target Portfolio Company, and the IP Assets/Rights of Third-Party Competitors and other Third-Party Legal Entities, recorded in the Target Portfolio Company’s IP Audit Report to determine whether or not the Target Portfolio Company possesses the legal right and freedom to operate its business in the marketplace in view of the IP Assets (e.g. granted US Patents) owned by Competitors (or third-party legal entities) existing in the marketplace.
  
•  Assessing the Target Portfolio Company’s IP Assets/Rights (e.g. granted Patent Rights, registered Trademarks, registered Copyrights, Licenses, etc.) that may be asserted against specific Competitors in the marketplace, to provide leverage in carrying out the Target Portfolio Company’s business plans.
  
•  Reviewing the IP Audit Report, assessing recognized IP Assets and potential IP Liabilities reflected on the IP Audio Report, and providing an IP Risk Assessment and Mitigation Report to support private equity decision makers.

The IP Audit Report is custom produced for the Target Portfolio Company and populated with information records and document links pointing to pdf, Word, PPT, and other documents stored in a secure database, and color-coded with RED, AMBER and GREEN colors to indicate HIGH, MEDIUM, and LOW risks, respectively.

When taken together with other material and relevant financial assessment and reporting documents related to the Target Portfolio Company, the IP Audit Report and IP Risk Assessment and Mitigation Report can be used to rationally support negotiations, financial structuring, risk allocation, and decision making operations.

Contact us today to learn more about how IP due diligence can identify opportunities within a company, unlock hidden value in its IP Portfolio, and help support its private equity (PE) value in the marketplace.