The Problem With Patent Due Diligence in Mergers and Acquisitions and How to Fix It

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As a enterprise or funding skilled concerned in mergers and acquisitions (“M & A”), are you conducting patent due diligence based on the usual practices of your M & A attorneys and funding bankers? When patents type a major side of the worth of the transaction, you’re most likely getting incorrect recommendation about tips on how to conduct due diligence. The due diligence course of should take into accounts the aggressive patent panorama. If aggressive patents aren’t included in your vetting course of, you could be considerably overvaluing the goal firm.

In my a few years of mental property and patent expertise, I’ve been concerned in quite a few M & A transactions the place patents shaped a good portion of the underlying worth of the deal. Because the patent specialist on these transactions, I took course from extremely compensated M & A attorneys and funding bankers who had been acknowledged by C-level administration to be the “actual specialists” as a result of they accomplished dozens of offers a yr. To this finish, we patent specialists had been directed to examine the next 4 containers on the patent due diligence guidelines:

• Are the patents paid up within the Patent Workplace?
• Does the vendor actually personal the patents?
• Do no less than a number of the patent claims cowl the vendor’s merchandise?
• Did the vendor’s patent legal professional make any silly errors that might make the patents tough to implement in courtroom?

When these containers had been marked “full” on the due diligence guidelines, the M & A attorneys and funding bankers had successfully “CYA’d” the patent points and had been free from legal responsibility referring to patents within the transaction.

I’ve little doubt that I performed my patent due diligence duties extremely competently and that I, too, had “CYA’d” myself in these transactions. Nonetheless, it’s now evident that the patent side of M & A due diligence mainly conformed to somebody’s thought of how to not make silly errors on a transaction involving patents. In fact, I by no means felt fairly comfy with the “flyover” really feel of patent due diligence, however I didn’t have resolution rights to contradict the usual working procedures of the M & A specialists. And, I came upon simply how incomplete the usual patent due diligence course of is once I was left to choose up the items of a transaction performed based on customary M & A process.

In that transaction, my shopper, a big producer, sought to broaden its non-commodity product choices by buying “CleanCo”, a small producer of a patented client product. My shopper discovered CleanCo to be an excellent goal for acquisition as a result of CleanCo’s product met a robust client want and, at the moment, commanded a premium worth available in the market. On account of robust client acceptance for its sole product, CleanCo was experiencing large progress in gross sales and that progress was anticipated to proceed. Nonetheless, CleanCo owned solely a small manufacturing plant and it was having issue in assembly the rising wants of the market. CleanCo’s enterprise capital traders had been additionally anxious to money out after a number of years of continued funding of the corporate’s considerably marginal operations. The wedding of my shopper and CleanCo thus appeared an excellent match, and the M & A due diligence course of received underway.

Due diligence revealed that CleanCo had few property: the small manufacturing plant, restricted however rising gross sales and distribution and a number of other patents protecting the only CleanCo product. However these apparently minimal property, CleanCo’s asking worth was upwards of $150 million. This worth might solely imply one factor: CleanCo’s worth might solely be within the potential for gross sales progress of its patented product. On this state of affairs, the unique nature of the CleanCo product was correctly understood to be basic to the acquisition. That’s, if somebody might knock-off CleanCo’s differentiated product, competitors would invariably consequence and ll bets would then be off for the expansion and gross sales projections that shaped the idea of the monetary fashions driving the acquisition.

Taking my directions from the M & A legal professional and funding banker leaders within the transaction, I performed the patent facets of the due diligence course of based on their customary procedures. All the things checked out. CleanCo owned the patents and had saved the charges paid. CleanCo’s patent legal professional had executed an excellent job on the patents: the CleanCo product was lined effectively by the patents and there have been no apparent authorized errors made in acquiring the patents. So, I gave the transaction the thumbs up from the patent perspective. When every part else regarded optimistic, my shopper grew to become the proud proprietor of CleanCo and its product.

Quick ahead a number of months . . . . I started to obtain frequent calls from individuals on my shopper’s advertising workforce targeted on the CleanCo product about aggressive merchandise that had been being seen within the discipline. Given the truth that greater than $150 million was spent on the CleanCo acquisition, these advertising professionals not surprisingly believed that the aggressive merchandise have to be infringing the CleanCo patents. Nonetheless, I discovered that every of those aggressive merchandise was a professional design-around of the patented CleanCo product. As a result of these knock-offs weren’t unlawful, my shopper had no approach of getting these aggressive merchandise faraway from {the marketplace} utilizing authorized motion.

On account of this growing competitors for the CleanCo product, worth erosion started to happen. The monetary projections that shaped the idea of my shopper’s acquisition of CleanCo started to interrupt down. The CleanCo product nonetheless sells strongly, however with this unanticipated competitors, my shopper’s anticipated margins aren’t being made and its funding in CleanCo will take rather more time and costly advertising to repay. Briefly, so far, the $150 Million acquisition of CleanCo appears to be like to be a bust.

In hindsight, the competitors for the CleanCo product might have been anticipated throughout the M & A due diligence course of. As we came upon later, a search of the patent literature would have revealed that many different methods existed to handle the buyer want addressed by the CleanCo product. CleanCo’s success within the market now seems to be resulting from first mover benefit, versus any precise technological or price benefit supplied by the product.

If I knew then what I do know now, I might have endorsed strongly in opposition to the expectation that the CleanCo product would command a premium worth resulting from market exclusivity. Slightly, I might display to the M & A workforce that competitors within the CleanCo product was doable and, certainly, extremely probably as revealed by the myriad of options to the identical drawback proven within the patent literature. The deal should still have undergo, however I consider that the the monetary fashions driving the acquisition could be extra reality-based. In consequence, my shopper might have formulated a advertising plan that was grounded in an understanding that competitors was not solely doable, but additionally probably. The advertising plan would then have been on the offense, fairly than on the protection. And, I do know that my shopper didn’t count on to be on the protection after spending greater than $150 million on the CleanCo acquisition.

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Source by Jackie Hutter