An analysis of the Fortune 500 companies found that in 1975, 60% of their market value was
represented by tangible assets. However, in 1995, this percentage dropped to just 25%. Therefore, intangibles such as Intellectual Property (IP) assets have come to accrue a
significant level of importance to individuals and corporate bodies. 

The value of IP is not
dependent on physical components, such as size and structure; instead, IP is valuable
because it represents ownership and in most cases an exclusive right to use, manufacture,
reproduce, or promote a unique creation or idea. In this way, it has the potential to be one of
the most valuable assets a person or a business can own. Therefore, the need to conduct a
thorough IP due diligence when attempting to initiate M&A transactions should be of
paramount consideration. In spite of this, research has shown that in the course of  conducting due-diligence in M&A transactions, lawyers and auditors tend to focus their
efforts mainly on the ownership of the company, equity, company debt as well as the general
physical structure of the company. Furthermore, “most intangible assets are not recognized
in financial statements, and current accounting rules do not require firms to report separate
measures for intangibles.” In doing so, corporate bodies and regulatory authorities
inevitably pay little to no attention to Intellectual Property Rights. 

IMPORTANCE OF CONDUCTING IP DUE DILIGENCE 

The purpose of an IP due diligence is to identify any assumptions regarding valuations and
where possible, to determine and quantify any related risks. The due diligence report may
provide for several types of transactions including company mergers and acquisitions, asset
sales, joint ventures, loans, secured transactions, and valuations, among other possibilities.
For potential buyers, information concerning the strength of a target’s IP assets helps to
assess any risks associated with the seller’s IP portfolio and may determine whether the
transaction is worthwhile. Therefore, unless a due diligence is conducted effectively,
companies may be exposed to unknown risks and liabilities. For sellers, due diligence may
improve the marketability of their company and allow them to identify weaknesses in their IP
portfolio which might compromise a sale. 

CONDUCTING A SUCCESSFUL IP DUE-DILIGENCE 

When conducting IP due diligence, employed professionals may rely on a variety of
approaches including the income and discounted flow methods. In order to ensure that these
approaches are dutifully applied, certain factors must be taken into account. 

This article
provides eight vital factors which must be taken into account when conducting a successful
IP assessment. 

Pre-Due Diligence Formalities 

The first and foremost consideration to be addressed is the legal framework. This often
commences in the form of a letter of intent or memorandum of understanding and commonly
regulates the due diligence process. A confidentiality agreement between the buyer and the
target company is one of necessity and both parties should ensure that it is carefully drafted to include the scheduling, modus operandi and deadlines, with due emphasis on attorney-client privileges. 

Create and Maintain an IP Register 

All business enterprises should endeavour to maintain an up-to-date IP register. This is a
clear demonstration to any investor of a well-managed business that recognises the value
and importance of its Intellectual Property. Often this is limited to patents, trademarks and
designs, but ideally copyrighted material and know-how should also be included The
register should include basic information such as the application number and status of each
IPR, as this is always the first piece of information which is requested when conducting IP
due diligence.8 A more sophisticated approach involves storage of a company’s published
trademark applications and granted patents in a data room. 

Utilize Experienced Personnel 

Having established the need for an updated register as well as a well-drafted contract,
companies must endeavour to employ the services of experienced counsel. The selected
legal counsel must exercise a working knowledge of the primary product lines and future
plans of the target in order to ensure that the team remains focused primarily on the IP
assets which are relevant to the firm. When dealing with M&A transactions, it is highly
important for counsel, which are usually Intellectual Property lawyers, to take all IPRs into
consideration. It is a common misconception that patents are the most important IPR a
company may possess when in actual fact, other assets such as the brand name stand on
an equal and sometimes even more valuable footing. For instance, the Coca-Cola “brand”
alone is valued at US$79.96 billion. Due diligence requires a significant amount of effort
and the average transaction, even if dealing with relatively small businesses, requires hundreds of hours of due diligence with help from appropriate professionals. They must
ensure that every detail, however trivial, is taken into account. 

Determine IP Ownerships 

When conducting IP due-diligence, appointed counsel must clarify issues of undisclosed
ownership. This is a common reason why M&A transactions fall through. Therefore, all
inventors must be correctly identified and the chain of title must also be clearly documented.
Furthermore, the necessary assignments should be well executed and where appropriate,
registered. Without proper investigation into a company’s Intellectual Property assets, an
investor may find, after the conclusion of the transaction that either it does not possess
ownership of the sought after IP assets or that they have been transferred or restricted by
third party interests.
This was an unfortunate consequence of the Volkswagen-Rolls Royce Acquisition. In 1998,
Vickers Plc (owners of Rolls-Royce) decided to sell Rolls-Royce Motors to Volkswagen
Group for £430m. As part of the deal, Volkswagen Group acquired the historic Crewe
factory, plus the rights to the “Spirit of Ecstasy” mascot and the shape of the radiator grille.
However, the Rolls-Royce brand name and logo were controlled by aero-engine maker
Rolls-Royce Plc, and not Rolls-Royce Motors. The aero-engine maker decided to license the
Rolls-Royce name and logo to BMW and not to Volkswagen, largely because the aeroengine maker had recently shared joint business ventures with BMW. BMW paid £40m to
license the Rolls-Royce name and “RR” logo, a deal that many commentators thought was a
bargain for possibly the most valuable property in the deal. Volkswagen Group had the rights
to the mascot and grille but lacked rights to the Rolls-Royce name in order to build the cars,
likewise BMW had the name but lacked rights to the grille and mascot.

Another closely related case that underscores the need to accurately determine value and IP
ownership is the Google-Motorola acquisition. In 2011, Google purchased Motorola’s mobile
phone business for USD 12.5 billion. It based its decision to purchase on the manufacturer’s
patent portfolio of around 17,000 patents. To the surprise of the technology market, Google
sold the business to Lenovo after only two years, although it retained most of the patents in
order to defend its overall Android ecosystem. In an interview with Forbes, Don Harrison, Google’s head of mergers and acquisitions, stated that despite the sale of Motorola to
Lenovo at a lower price, Google still came out on top. He explained that the basic idea was
that the sale of Motorola’s home business, cash on hand, deferred tax assets and the $2.91
billion Google received from Lenovo meant that in the end, Google paid less than $3.5 billion
for Motorola’s patent portfolio, which it retained after the sale. Motorola’s 17,000 patents was
the “cookie” Google was trying to obtain, they were really not interested in the company
hence the sale to Lenovo.
Identify Any Harnessing IPRs
It is important to identify potential sources of income which may not have been harnessed.
For instance, since 2003, IBM has made US$1 billion yearly on licensing non-core
technology, which would have remained unused. 

Identify Litigation Risk 

The due diligence counsel must identify assets which may pose a legal liability to the
company subsequent to an acquisition. For instance, employing top management
employees from a first-tier company might be a litigation risk due to the fact that such
employees might have signed non-disclosure agreements and may possess key information
regarding R&D and company trade secrets. 

Disclose What Is Essential and Refrain from Proceeding without Relevant Information 

The main difficulty in conducting due diligence lies with accurately pre-defining the scope of
information to be reported as well as the level of detail to be disclosed. A good example is
The Daiichi–Ranbaxy deal. In 2008, Daiichi had bought the Singh brothers’ 34.82% stake in
Ranbaxy for $2.4 billion. The total deal value was $4.6 billion.17 Problems emerged soon
after the acquisition, when Ranbaxy’s plants came under scrutiny by the US Food and Drug
Administration (FDA). It was later discovered that a 2004 self-assessment report meant for
the company’s internal use, showed how the company was misrepresenting data and
Malvinder Singh was aware of this information. Ranbaxy did not reveal the internal report, or
its contents, to Daiichi at the time of the 2013 deal, which was a sign of bad faith. In 2013, Daiichi filed an arbitration case against Ranbaxy in Singapore. The firm had accused the
Singh brothers of concealment and misrepresentation of relevant facts. Daiichi claimed that
they would not have paid any price for the Ranbaxy shares, had they been aware of the selfassessment report. The former owners of Ranbaxy Laboratories Ltd., were ordered by a
Singapore arbitration tribunal to pay $385 million to Japanese pharma company Daiichi
Sankyo Co. Ltd., which had bought the firm in 2008. It is important to always disclose relevant and truthful information in M&A transactions as the
“caveat emptor” (buyers beware) principle will not be available as a defence if there is proof
of concealment and misrepresentation. In this circumstance an aggrieved party may be
entitled to damages. 

Conducting IP Valuations 

Arguably the most important step in the IP due diligence process is the IP valuation. This is
the most precarious aspect when it comes to dealing with M&A transactions as there is no
specific formula to IP valuations. Additionally, financial auditors have not helped in this
regard as accounting methods tend to undermine the value of intangible rights and IPRs. 

IP valuations must include all IPRs and intangible rights like goodwill, employee know-how,
instilled employee skill and expertise etc. It is important to consider not only the present
value of the IPRs but also their future value. An IPR for instance might lose its value in 3
years while a presently unharnessed asset may yield immense profits for the company in 3
years. 

RISK FACTORS WHICH MUST BE TAKEN INTO ACCOUNT DURING IP DUE DILIGENCE 

Following a merger or acquisition, certain external factors may emerge and derail the
viability of newly acquired assets to the detriment of the existing company. Therefore, when
evaluating the profitability of a potential IPR, counsel must take some of these factors into
account.