Part 2b: IP Due Diligence
This follow-up article in our series “Corporate transactions in the SME sector – insurmountable hurdle or manageable challenge?” deals with IP due diligence and, in view of the previous article by my colleague Sebastian Keilholz, it makes sense to quote his first sentence – slightly adapted – here at the beginning:
“A proper IP law review is crucial for buyers of companies with regard to the valuation of the company to be sold in the run-up to an M&A transaction.”
The topic of due diligence is still primarily associated with the review of tangible assets, business relationships or the workforce of the company to be sold. With globalization and digitalization, this focus has shifted when determining the company value: today, IP rights in particular determine the purchase price of the company to be acquired and often influence the purchase decision.
This is particularly true when foreign buyers target German companies. Of particular interest here are the patents and know-how to develop or acquire innovative technologies or brands that (still) stand for “Made in Germany”. Foreign investors are particularly interested in the technology and healthcare sectors, i.e. the areas that have come under even greater scrutiny due to COVID-19, especially software products and IT systems. According to a PWC study from 2020, private equity investors were most frequently involved in small and medium-sized transactions.
What is IP due diligence all about?
It is a matter of taking stock and conducting a well-founded analysis of all IP rights – these are patents, utility models, trademarks, designs, any licenses granted to them, but also copyrights that cannot be registered, at least in Germany, and any rights to a company’s know-how. As temporary monopoly rights, the aforementioned intellectual property rights convey absolute exploitation rights to the company – absolute because a monopoly right reserves the right for its owner to exploit the protected IP right and the underlying innovation alone and to the exclusion of third parties. This also highlights the importance of such intangible legal assets in the valuation of the company value as part of an asset deal.
What is important in IP due diligence?
IP due diligence is used to determine,
- whether and to what extent the company to be acquired owns property rights,
- whether licenses have been granted to them or whether there is a license dependency,
- whether legal disputes exist, and
- the extent to which know-how is anchored in the company and what measures are in place to protect it.
In the case of a young company or start-up, the focus will obviously be on identifying the know-how, as there may not yet be any patented technology, and perhaps not even a patent-ready technology. In the case of an established company that already has technologies and brands established on the market and an IP portfolio that is at least partially registered, a search in the relevant IP databases can provide a quick and reliable overview. A high-tech or biotech company or a provider of complex technical solutions requires more intensive IP due diligence than is necessary for a company that is mainly of interest to the buyer because of its distribution channels.
The devil is in the detail…
By checking the data in the registers of the competent authorities, you can quickly determine the registered owner, the status of the property right (is the patent or trademark still valid or has the term of protection expired?), the term and the scope of protection of the respective property right. However, register entries do not always reflect the actual legal situation. This is because the IP rights are often not registered in the name of the target company, but – for tax reasons – in the name of an “IP holding company” within a group or in the name of a third party close to the company, e.g. the original company founder or a shareholder. In addition, the register does not reflect whether the IP rights are covered by licenses. However, this is relevant for the availability and intrinsic value of the IP right, which is why a look at the relevant license agreements is absolutely essential. If the acquirer takes over the target company and enters into existing license agreements as licensor, he will usually be interested in a quick termination of the agreement, while on the licensee side he is more likely to be interested in a continuation of the license agreement.
The situation is often even less clear with regard to non-registered property rights, such as copyrighted works, in particular software rights and know-how. These rights are often the actual important asset of the target object and information about them can only be determined after presentation of agreements with third parties – such as research and development contracts, cooperation agreements, IT/software development contracts.
In this respect, complete and accurate documentation is crucial. This also applies with regard to employee inventions, encumbrances of property rights in the form of liens or delimitation agreements as well as any pending or concluded legal disputes in connection with the IP rights.
Conclusion
Potential buyers or investors would do well to focus not only on the tangible assets when examining the “target”, but also to keep an eye on the industrial property rights – this is where the music plays. The more sound the valuation, the more successful the decisions on investments in IP assets, in-licensing / out-licensing or sale / acquisition.
Outlook
This series of articles provides small and medium-sized companies with an initial guide on how a transaction process can be structured and successfully mastered. To this end, the following articles will provide a compact and practice-oriented presentation of the key topics in the context of an M&A transaction. In the next article, we will enter the signing phase of the M&A process: My colleague Christian Schon will provide an overview of the contract negotiation phase and the subsequent signing of the contract.
The author and your usual contacts will be happy to answer any questions you may have!
Micaela Schork, LL.M.
schork@tigges.legal
+49 211 8687 134