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

As a enterprise or investment expert involved in mergers and acquisitions (“M & A”), are you conducting patent due diligence according to the standard practices of your M & A attorneys and investment bankers? When patents type a important aspect of the worth of the transaction, you are probably receiving incorrect suggestions about how to conduct due diligence. The due diligence procedure should take into consideration the competitive patent landscape. If competitive patents are not included in your vetting procedure, you could be significantly overvaluing the target firm.

In my a lot of years of intellectual home and patent practical experience, I have been involved in a number of M & A transactions where patents formed a important portion of the underlying value of the deal. As the patent specialist on these transactions, I took direction from hugely compensated M & A attorneys and investment bankers who have been acknowledged by C-level management to be the “real experts” for the reason that they completed dozens of offers a year. To this end, we patent specialists were directed to verify the following four boxes on the patent due diligence checklist:

Are the patents paid up in the Patent Workplace?
Does the seller seriously own the patents?
Do at least some of the patent claims cover the seller’s items?
Did the seller’s patent lawyer make any stupid errors that would make the patents challenging to enforce in court?
When these boxes had been marked “comprehensive” on the due diligence checklist, the M & A attorneys and investment bankers had properly “CYA’d” the patent issues and were absolutely free from liability relating to patents in the transaction.
I have no doubt that I carried out my patent due diligence duties extremely competently and that I, also, had “CYA’d” myself in these transactions. Having said that, it is now evident that the patent aspect of M & A due diligence generally conformed to someone’s notion of how not to make stupid errors on a transaction involving patents. In truth, I never felt pretty comfy with the “flyover” really feel of patent due diligence, but I did not have choice rights to contradict the standard operating procedures of the M & A specialists. And, I identified out just how incomplete the typical patent due diligence approach is when I was left to choose up the pieces of a transaction conducted according to common M & A procedure.

In that transaction, my client, a large manufacturer, sought to expand its non-commodity solution offerings by acquiring “CleanCo”, a tiny manufacturer of a patented consumer product. My client located CleanCo to be a great target for acquisition due to the fact CleanCo’s product met a robust customer will need and, at that time, commanded a premium value in the marketplace. Due to strong customer acceptance for its sole product, CleanCo was experiencing tremendous development in sales and that growth was anticipated to continue. Even so, CleanCo owned only a tiny manufacturing plant and it was obtaining difficulty in meeting the developing requirements of the market. CleanCo’s venture capital investors had been also anxious to money out soon after a number of years of continued funding of the company’s somewhat marginal operations. The marriage of my client and CleanCo thus seemed a great match, and the M & A due diligence method got underway.

Due diligence revealed that CleanCo had few assets: the smaller manufacturing plant, restricted but developing sales and distribution and various patents covering the sole CleanCo item. Notwithstanding these apparently minimal assets, CleanCo’s asking cost was upwards of $150 million. This price could only imply a single issue: CleanCo’s worth could only be in the prospective for sales development of its patented item. In pre-ipo due diligence , the exclusive nature of the CleanCo solution was correctly understood to be fundamental to the obtain. That is, if somebody could knock-off CleanCo’s differentiated solution, competition would invariably outcome and ll bets would then be off for the growth and sales projections that formed the basis of the economic models driving the acquisition.

Taking my instructions from the M & A attorney and investment banker leaders in the transaction, I carried out the patent aspects of the due diligence process according to their common procedures. Almost everything checked out. CleanCo owned the patents and had kept the costs paid. CleanCo’s patent lawyer had completed a fantastic job on the patents: the CleanCo item was covered effectively by the patents and there have been no obvious legal errors made in acquiring the patents. So, I gave the transaction the thumbs up from the patent point of view. When every little thing else looked optimistic, my client became the proud owner of CleanCo and its product.

Rapidly forward various months . . . . I began to obtain frequent calls from men and women on my client’s marketing and advertising group focused on the CleanCo item about competitive items that were becoming observed in the field. Offered the truth that much more than $150 million was spent on the CleanCo acquisition, these advertising pros not surprisingly believed that the competitive goods should be infringing the CleanCo patents. However, I identified that each of these competitive products was a legitimate design-about of the patented CleanCo solution. Simply because these knock-offs have been not illegal, my client had no way of getting these competitive items removed from the marketplace using legal action.

As a outcome of this escalating competitors for the CleanCo product, price erosion began to take place. The financial projections that formed the basis of my client’s acquisition of CleanCo began to break down. The CleanCo solution still sells strongly, but with this unanticipated competitors, my client’s expected margins are not being produced and its investment in CleanCo will take considerably a lot more time and highly-priced advertising to spend off. In quick, to date, the $150 Million acquisition of CleanCo looks to be a bust.

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