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Expect the expected: Why you should prepare for due diligence before you need to

Jordan Penn

IP is playing an increasingly important role in transactions and influencing company value compared to just 40 years ago. Today’s numbers indicate that intangible assets such as IP contribute over 80 per cent of a company’s value. It’s time to start treating IP like the asset that it is.

Listen, we’ve all heard the adage, “Expect the unexpected,” and while that is certainly a useful perspective, I’m an even bigger advocate for, “Expect the expected.” 

You may hear this and be thinking to yourself, “Well, sure. That’s an obvious piece of advice.” And while you may be right in theory, it’s rarely obvious in practice. We see a lot of patent owners neglecting the basic operational best practices.

When an M&A deal is on the table or you are preparing for investor scrutiny, a poorly organized portfolio can negatively impact the perceived value of your company, leaving potential money on the table instead of in your pocket. 

A missing assignment, an unsigned NDA, a disgruntled former employee, or unclear indemnification are all small things that could derail an otherwise solid IP portfolio and can reflect poorly on the company and management.

Thankfully, a lot of what is required as part of the due diligence process can be reasonably expected and prepared for ahead of time. Meaning, if you expect the expected and prepare for it ahead of time, you can save yourself potential headaches down the road when you find yourself preparing for an M&A or courting investors.  

The areas that see the biggest impact with proactive due diligence are:

1. Ownership

If you are using your IP as an asset, you better have the documentation to prove that you actually have the rights to it and that you are taking the appropriate steps to protect those rights. For patents that means executed documents for inventor declarations and assignment. You’d be amazed at how infrequently IP ownership is clean and complete. For trade secrets that means cataloguing and security measures. 

RED FLAG: Names and inventor details are misspelled or missing from ownership documentation. This could lead to invalidation of the patent.

BEST PRACTICE: IP rights should show a clear chain of ownership from the inventors to the company, with assignments signed before patents are filed.

2. Open-Source Software

OSS is still governed by copyright and licensing agreements, so it is imperative that these are considered during the decision-making/selection process. Proper documentation is necessary in case the acquiring organization has a policy against OSS.

RED FLAG: Designers do not record the modifications that are made to OSS software in use.

BEST PRACTICE: All licenses are kept in a log that details usage requirements and tracks compliance to terms. Both log and compliance audited routinely. 

3. Contracts and Non-Disclosure Agreements

Public disclosure is a key factor in the ability to confer ownership rights for intellectual property. Once a trade secret is revealed or if an idea is disclosed before seeking patent protection, the economic benefit of your invention might be lost. Contract and NDAs are necessary to protect your assets. Be sure that contracts have indemnification clauses and other provisions to protect your interests in partnerships. 

RED FLAG: There is no clear ownership clause for a joint venture with a university or other R&D project which leads to confusion as to who owns the IP at the end of the project. Missing or ambiguous employment contract clauses regarding IP.  

BEST PRACTICE: Confidential information is shared with only necessary employees/contractors. Employee on-boarding policies include provisions for proprietary and confidential company information and are reviewed again prior to the employee departing.

4. Prior Art

This is anything that can be used as evidence that your invention is already known and can affect the patentability of an invention and even invalidate an issued patent. Care should be taken by companies to manage the who/when of searching. It is also a good practice to review past employee literary work such as dissertations to make sure that these do not contain mention of relevant prior art.

RED FLAG: Employees share opinions and search results through unsecured channels and emails that can be uncovered during due diligence. This could be used to implicate the company in accusations of infringement, or to invalidate IP.

BEST PRACTICE: A company policy with explicit searching authority parameters in place that limits internal searching, and a process that engages with professionals to complete the searches. 

5. Management

The day-to-day management of your IP portfolio should include all aspects of your IP strategy in an organized manner so that deadlines and correspondence are not missed. Do you have the answers to any of these questions: How are ideas captured and adjudicated? Is there a budget? How are costs tracked and funds allocated? What is the level of management oversight? How clean and structured are the IP files? Well, you should! Investors may bring in teams of analysts that will ask these questions and hundreds more. Make sure to have proper documentation to support your answers. 

RED FLAG: An inventor hastily files a provisional patent application with the details saved on their personal computer, resulting in a missed deadline and the loss of potential IP rights. Missing files. Confusion over investor questions regarding IP. 

BEST PRACTICE: There is a committee or executive who oversees IP matters, ensuring process and policy is well-documented and adhered to. Proper IP organization and documentation with the ability to provide requested documents on demand.  

This may seem like a large undertaking and daily management is indeed an investment in time and effort, but it will pay dividends when a potential deal is on the table where a missed deadline or a portfolio in disarray could impact the final outcome or even torpedo the deal entirely.

The due diligence process is a necessary step in any M&A or fundraising scenario and chances are, any potential issues or ambiguities will be discovered by the experts employed by the acquiring firm, so not only is it best to be upfront about them, but you can save yourself a lot of stress by preparing yourself ahead of time. Why start two steps behind when you don’t have to?

A good thing to remember is, it’s not always just the IP itself that drives the value of a transaction. It is also the quality of the intellectual property’s management and organization.

Test your aptitude for identifying due diligence red flags by checking out my other post for a fun exploration of how holiday movie characters might approach M&A due diligence and where they would likely go wrong.

ABOUT JORDAN: Jordan is the vice-president at Stratford Intellectual Property, specializing in IP operations and M&A due diligence. He has overseen the IP component of several M&A and fundraising transactions valued between $10M-500M. A native of Ottawa for 34 years, Jordan now lives in San Diego, CA with his wife and infant daughter.