Intellectual Property in M&A Transactions

Given the rapid pace at which technology is evolving, many organizations now find it more economical to purchase IP than to develop it on their own. Acquiring such assets can help a company to quickly expand and improve business performance, as well as create both offensive and defensive positions in the marketplace.

Many companies recognize that a strong IP portfolio can be not only intrinsically valuable, but also can act as a shield against expensive lawsuits. The acquisition of Nortel Networks Corporation's portfolio is a noteworthy example of the potential value of IP assets as part of a comprehensive legal strategy protecting innovation.

A Case in Point

A multinational telecommunications equipment manufacturer, Nortel was once one of the most valuable companies in the world; at its peak, it employed 94,500 workers worldwide. Its fortunes declined in 2004, when the CEO and two other executives were fired in an accounting scandal and the company had to restate financial results for three years. Cisco Systems and other competitors made inroads into Nortel's customer base, while former partner companies, such as IBM and Microsoft, became competitors in the enterprise networking space.

Yet Nortel's research and development continued, as did its patent acquisitions. In 2009, the company filed for bankruptcy protection from creditors, with the goal of selling all of its business assets, including its IP portfolio. This included approximately 6,000 patents and patent applications encompassing technologies such as wireless, wireless 4G, data networking, optical, voice, Internet and semiconductors. Many of these patents are used in popular consumer products, such as the rapidly growing and extremely profitable field of mobile electronics.

While garnering little attention at the time, Google initially placed a “stalking-horse” bid of $900 million. Illustrating the perceived importance of these patents and patent applications, the Silicon Valley search company later upped its bid to $1.9 billion, then to $2.6 billion, and eventually to $3.1 billion. But Nortel's IP portfolio was ultimately sold for $4.5 billion to a different buyer, a consortium that included Apple, EMC, Ericsson, Microsoft, Research In Motion and Sony.

The Importance of Patent Portfolios

Not to be outdone, Google looked elsewhere. In August 2011, the search giant purchased all of smartphone maker Motorola Mobility for $12.5 billion, making clear its desire to own the company's estimated 25,000 patents. Google CEO Larry Page characterized the move as a defensive one that would “strengthen Google's patent portfolio, which will enable us to better protect Android from anti-competitive threats from Microsoft, Apple and other companies.” Clearly, this acquisition was driven at least in part by the purchase of Nortel's 6,000 patents. Battle lines are being drawn around these and other technologies, as companies seek to protect their interests in the competitive mobile industry through IP litigation.

Why are billions of dollars being spent acquiring these patents? Many mistakenly describe patents rights as granting a monopoly, but that description is not entirely accurate. Patent rights don't constitute a true monopoly, as the U.S. government does not grant inventors a right to make something; instead, the right granted allows the patent holder to exclude others from making, using, selling or offering to sell the invention that is protected by the patent. But IP such as patents and trademarks can be used to thwart competitors and third-party manufacturers from making products covered by those patents or trademarks, thereby ensuring market share. Since the law defines patents as the right to exclude others from acting in these ways, patents can be used both offensively and defensively.

In an offensive posture, a patent holder can sue infringers to prevent them from making, using, selling, importing or offering to sell products or services that infringe its patents. Patent holders may be awarded damages, attorneys' fees and even injunctions preventing a competitor from making, using, selling or offering to sell any infringing product in the United States. Further, if it is shown that the infringer had knowledge of the patent, treble damages can be awarded as well, potentially making it very profitable for a patent holder.

On the defensive side, patents can be used as strong deterrent, thwarting competitors from asserting their patent rights. Essentially, this is the equivalent of the Cold War doctrine of mutually assured destruction, with patents as the weapons instead of nuclear weapons. When both sides are heavily armed with patents, each can mitigate patent litigation with a competitor. If one party were to sue the other, both parties would ultimately assert their treasure troves of patents against each other ' beginning a war of attrition. This type of litigation is not always helpful to either side, so both sides may decide not to litigate at all.

As illustrated by the history of the Nortel acquisition and Google's subsequent purchase of the Motorola Mobility patent portfolio, organizations that develop or acquire IP assets can not only enhance their competitive positions in their industry, but also contribute to their organization's bottom line.

Against this backdrop, it is still surprising to find that IP is often overlooked in mergers and acquisitions. Not all patents, trademarks, copyrights and trade secrets are created equal. Some assets may be very valuable, while others might have lost some of their luster in the years following their creation. That is why companies should include IP when identifying and assessing all the property that may be acquired during a merger or acquisition.

Prior to the acquisition of IP through a merger or acquisition, a company should perform due diligence to ascertain the validity of the assets, their value, proper ownership and control over them, and the adequacy of protection that has already been obtained. Confidentiality agreements, license agreements, joint-venture agreements, and agreements confirming payment of maintenance fees and taxes are critical to the analysis. A review of these arrangements helps the acquirer to determine how much the IP adds to the value of the target's, or whether the IP actually detracts from the company's value. It is sometimes difficult to value intellectual assets, especially in fields where technology and products are constantly and rapidly evolving, but numerous valuation techniques are available to reasonably approximate the value of the intangibles.

Due Diligence

As a first step in the due diligence process, an acquirer must establish the IP assets of the target. Generally, this includes reviewing all IP held by the target, and determining the scope of coverage. If the target is large, the transaction team may wish to categorize the assets into different technology areas or business units, so as to better understand areas for which the target has obtained or is in the process of obtaining IP protection, or to reveal areas they may have missed. Specialized software tools may be utilized to help identify and categorize the IP assets. These tools may also be used to analyze how the IP fits into the technological landscape, and identify overlooked opportunities to monetize the assets.

Counsel and their transaction teams should understand that not all patents are valuable. Intellectual asset valuation has pitfalls that are often overlooked in the flurry of activity leading up to a merger or acquisition. For example, IP assets may have already been licensed to others, preventing a new owner from asserting rights to them or licensing them to additional parties. Some rights may have been developed jointly with other entities, creating common ownership and further diminishing their value buyer. Similarly, the extent to which the products or services related to the IP require licenses of other's IP, whether those licenses are transferable, and whether infringement actions have been initiated or initiated, can further detract from the value of the assets.

In addition, the transaction team should review the target's policies and procedures related to innovation, since deficiencies in such policies and procedures can decrease the value of the intangible assets. For example, it is important to review the targeted company's invention process, including the target's processes for identifying promising ideas for patenting, then developing and commercializing the inventions.

These processes also may include how employee inventors assign their IP rights to the targeted organization, and their general employment agreements with the employee inventors. Lack of a proper assignment can impact the value of a patent. Likewise, the acquirer should evaluate the target's procedures for protecting trade secrets and know-how, as their value can be directly affected by lack of secrecy measures and the extent of their exposure to employees and third parties.

Any of the foregoing circumstances or facts can be used in the negotiation process to reduce purchase price. After an assessment of the IP assets is completed, corporate counsel and their teams may undertake further review to determine which ones have significant value, and which have less value. This information may provide the basis for immediate concessions at the closing table, or cost reductions after the close through culling of the portfolio, e.g., by donating, selling or simply abandoning it.
In smaller organizations, such culling may be done rather quickly, but a larger organization may have hundreds, if not thousands, of IP assets to review in order to determine not only the scope of coverage, but also any opportunities to exploit the assets, such as through licensing or enforcement.

After an assessment has been completed and the intellectual assets are purchased, an acquirer can generate revenue through expanding use of the IP across different business units, or through licensing or enforcement against others. Through proper assessment of its IP, a company can identify and exploit assets with strong licensing potential. In some cases, organizations that have vast IP assets may be able to realize unexpected revenues from assets that are not being practiced by the organization, but are being practiced by others. Here, too, software tools for patent analysis can be effectively combined with knowledge of the marketplace to identify targets. Revenue generated from such activity can be significant and can go unrealized without an active IP asset management program in place.

A sale is another option for earning revenue from a newly acquired organization's IP. Some organizations have a wealth of acquired patents that are not currently being practiced, but may be valuable to others who are either practicing the invention or whose competitors are. In this case, a sale of the patent can bring significant revenue to the owner of the patent and provide value to the buyer of the patent.

Conclusion

As in buying a house, a corporate acquirer usually hires an inspector to verify that it is getting what is promised and to look out for any faults. Acquiring IP through a merger or acquisition is no different. Recognizing the importance of IP early in the process during a merger and acquisition, and treating the assets as both legal and business assets, helps ensure that useful, timely and accurate information is provided to key decision-makers in the company so they may direct operations that maximize value and portfolio leveragability. A similar analysis should also be routinely employed by companies to ensure they maximize the value of their IP and enhance profitability.

John A. Lingl is an attorney at Brinks Hofer Gilson & Lione, in Ann Arbor, MI. He can be reached at [email protected] or at 734-302-6021. Michael N. Spink is a shareholder and chair of the Intellectual Asset Management group at the firm, also resident in Ann Arbor. He can be reached at [email protected], or at 734-302-6011.

Recently, intellectual property (IP) has become recognized as the most valuable bargaining chip in today's information-based economy. For companies that rely on innovation, intellectual property assets increasingly drive mergers and acquisitions. Ironically, however, the strategic value of certain IP assets can be overlooked in transactions driven by other considerations. To best protect their companies' interests, corporate counsel should be aware of the IP implications of every M&A transaction, and should adopt a formal approach to identifying those assets and performing IP due diligence.

Online Assets

Corporations and Wall Street now appreciate the value of inventions and discoveries and their implementation. Both revenue and profits are increasingly dependent on not only the familiar intangible assets such as patents, copyright, trademarks, know-how and trade secrets, but also newer forms. These include branded Facebook pages, Internet domain names, even the multidimensional microchip layouts known as “mask works.” These and other forms of IP comprise a substantial part of company assets and market valuation.

Given the rapid pace at which technology is evolving, many organizations now find it more economical to purchase IP than to develop it on their own. Acquiring such assets can help a company to quickly expand and improve business performance, as well as create both offensive and defensive positions in the marketplace.

Many companies recognize that a strong IP portfolio can be not only intrinsically valuable, but also can act as a shield against expensive lawsuits. The acquisition of Nortel Networks Corporation's portfolio is a noteworthy example of the potential value of IP assets as part of a comprehensive legal strategy protecting innovation.

A Case in Point

A multinational telecommunications equipment manufacturer, Nortel was once one of the most valuable companies in the world; at its peak, it employed 94,500 workers worldwide. Its fortunes declined in 2004, when the CEO and two other executives were fired in an accounting scandal and the company had to restate financial results for three years. Cisco Systems and other competitors made inroads into Nortel's customer base, while former partner companies, such as IBM and Microsoft, became competitors in the enterprise networking space.

Yet Nortel's research and development continued, as did its patent acquisitions. In 2009, the company filed for bankruptcy protection from creditors, with the goal of selling all of its business assets, including its IP portfolio. This included approximately 6,000 patents and patent applications encompassing technologies such as wireless, wireless 4G, data networking, optical, voice, Internet and semiconductors. Many of these patents are used in popular consumer products, such as the rapidly growing and extremely profitable field of mobile electronics.

While garnering little attention at the time, Google initially placed a “stalking-horse” bid of $900 million. Illustrating the perceived importance of these patents and patent applications, the Silicon Valley search company later upped its bid to $1.9 billion, then to $2.6 billion, and eventually to $3.1 billion. But Nortel's IP portfolio was ultimately sold for $4.5 billion to a different buyer, a consortium that included Apple, EMC, Ericsson, Microsoft, Research In Motion and Sony.

The Importance of Patent Portfolios

Not to be outdone, Google looked elsewhere. In August 2011, the search giant purchased all of smartphone maker Motorola Mobility for $12.5 billion, making clear its desire to own the company's estimated 25,000 patents. Google CEO Larry Page characterized the move as a defensive one that would “strengthen Google's patent portfolio, which will enable us to better protect Android from anti-competitive threats from Microsoft, Apple and other companies.” Clearly, this acquisition was driven at least in part by the purchase of Nortel's 6,000 patents. Battle lines are being drawn around these and other technologies, as companies seek to protect their interests in the competitive mobile industry through IP litigation.

Why are billions of dollars being spent acquiring these patents? Many mistakenly describe patents rights as granting a monopoly, but that description is not entirely accurate. Patent rights don't constitute a true monopoly, as the U.S. government does not grant inventors a right to make something; instead, the right granted allows the patent holder to exclude others from making, using, selling or offering to sell the invention that is protected by the patent. But IP such as patents and trademarks can be used to thwart competitors and third-party manufacturers from making products covered by those patents or trademarks, thereby ensuring market share. Since the law defines patents as the right to exclude others from acting in these ways, patents can be used both offensively and defensively.

In an offensive posture, a patent holder can sue infringers to prevent them from making, using, selling, importing or offering to sell products or services that infringe its patents. Patent holders may be awarded damages, attorneys' fees and even injunctions preventing a competitor from making, using, selling or offering to sell any infringing product in the United States. Further, if it is shown that the infringer had knowledge of the patent, treble damages can be awarded as well, potentially making it very profitable for a patent holder.

On the defensive side, patents can be used as strong deterrent, thwarting competitors from asserting their patent rights. Essentially, this is the equivalent of the Cold War doctrine of mutually assured destruction, with patents as the weapons instead of nuclear weapons. When both sides are heavily armed with patents, each can mitigate patent litigation with a competitor. If one party were to sue the other, both parties would ultimately assert their treasure troves of patents against each other ' beginning a war of attrition. This type of litigation is not always helpful to either side, so both sides may decide not to litigate at all.

As illustrated by the history of the Nortel acquisition and Google's subsequent purchase of the Motorola Mobility patent portfolio, organizations that develop or acquire IP assets can not only enhance their competitive positions in their industry, but also contribute to their organization's bottom line.

Against this backdrop, it is still surprising to find that IP is often overlooked in mergers and acquisitions. Not all patents, trademarks, copyrights and trade secrets are created equal. Some assets may be very valuable, while others might have lost some of their luster in the years following their creation. That is why companies should include IP when identifying and assessing all the property that may be acquired during a merger or acquisition.

Prior to the acquisition of IP through a merger or acquisition, a company should perform due diligence to ascertain the validity of the assets, their value, proper ownership and control over them, and the adequacy of protection that has already been obtained. Confidentiality agreements, license agreements, joint-venture agreements, and agreements confirming payment of maintenance fees and taxes are critical to the analysis. A review of these arrangements helps the acquirer to determine how much the IP adds to the value of the target's, or whether the IP actually detracts from the company's value. It is sometimes difficult to value intellectual assets, especially in fields where technology and products are constantly and rapidly evolving, but numerous valuation techniques are available to reasonably approximate the value of the intangibles.

Due Diligence

As a first step in the due diligence process, an acquirer must establish the IP assets of the target. Generally, this includes reviewing all IP held by the target, and determining the scope of coverage. If the target is large, the transaction team may wish to categorize the assets into different technology areas or business units, so as to better understand areas for which the target has obtained or is in the process of obtaining IP protection, or to reveal areas they may have missed. Specialized software tools may be utilized to help identify and categorize the IP assets. These tools may also be used to analyze how the IP fits into the technological landscape, and identify overlooked opportunities to monetize the assets.

Counsel and their transaction teams should understand that not all patents are valuable. Intellectual asset valuation has pitfalls that are often overlooked in the flurry of activity leading up to a merger or acquisition. For example, IP assets may have already been licensed to others, preventing a new owner from asserting rights to them or licensing them to additional parties. Some rights may have been developed jointly with other entities, creating common ownership and further diminishing their value buyer. Similarly, the extent to which the products or services related to the IP require licenses of other's IP, whether those licenses are transferable, and whether infringement actions have been initiated or initiated, can further detract from the value of the assets.

In addition, the transaction team should review the target's policies and procedures related to innovation, since deficiencies in such policies and procedures can decrease the value of the intangible assets. For example, it is important to review the targeted company's invention process, including the target's processes for identifying promising ideas for patenting, then developing and commercializing the inventions.

These processes also may include how employee inventors assign their IP rights to the targeted organization, and their general employment agreements with the employee inventors. Lack of a proper assignment can impact the value of a patent. Likewise, the acquirer should evaluate the target's procedures for protecting trade secrets and know-how, as their value can be directly affected by lack of secrecy measures and the extent of their exposure to employees and third parties.

Any of the foregoing circumstances or facts can be used in the negotiation process to reduce purchase price. After an assessment of the IP assets is completed, corporate counsel and their teams may undertake further review to determine which ones have significant value, and which have less value. This information may provide the basis for immediate concessions at the closing table, or cost reductions after the close through culling of the portfolio, e.g., by donating, selling or simply abandoning it.
In smaller organizations, such culling may be done rather quickly, but a larger organization may have hundreds, if not thousands, of IP assets to review in order to determine not only the scope of coverage, but also any opportunities to exploit the assets, such as through licensing or enforcement.

After an assessment has been completed and the intellectual assets are purchased, an acquirer can generate revenue through expanding use of the IP across different business units, or through licensing or enforcement against others. Through proper assessment of its IP, a company can identify and exploit assets with strong licensing potential. In some cases, organizations that have vast IP assets may be able to realize unexpected revenues from assets that are not being practiced by the organization, but are being practiced by others. Here, too, software tools for patent analysis can be effectively combined with knowledge of the marketplace to identify targets. Revenue generated from such activity can be significant and can go unrealized without an active IP asset management program in place.

A sale is another option for earning revenue from a newly acquired organization's IP. Some organizations have a wealth of acquired patents that are not currently being practiced, but may be valuable to others who are either practicing the invention or whose competitors are. In this case, a sale of the patent can bring significant revenue to the owner of the patent and provide value to the buyer of the patent.

Conclusion

As in buying a house, a corporate acquirer usually hires an inspector to verify that it is getting what is promised and to look out for any faults. Acquiring IP through a merger or acquisition is no different. Recognizing the importance of IP early in the process during a merger and acquisition, and treating the assets as both legal and business assets, helps ensure that useful, timely and accurate information is provided to key decision-makers in the company so they may direct operations that maximize value and portfolio leveragability. A similar analysis should also be routinely employed by companies to ensure they maximize the value of their IP and enhance profitability.

John A. Lingl is an attorney at Brinks Hofer Gilson & Lione, in Ann Arbor, MI. He can be reached at [email protected] or at 734-302-6021. Michael N. Spink is a shareholder and chair of the Intellectual Asset Management group at the firm, also resident in Ann Arbor. He can be reached at [email protected], or at 734-302-6011.