Five Questions for In-House Counsel to Ask Before IP Due Diligence

By Catriona Collins

Intellectual property assets long ago supplanted physical assets as the most valuable components of the typical corporate balance sheet. A recent analysis of the 500 largest public companies in America indicates the dramatic scope of that shift. Intangible assets—largely comprised of IP rights associated with inventions and brands—now account for a stunning 90% of the total value of companies in the S&P 500®, according to the 2020 Ocean Tomo® Intangible Asset Market Value Study.

This means that tangible assets—buildings, equipment, real estate holdings, etc.—now represent just one-tenth of the market value of the S&P 500, a historic change over the past few decades. In 1985, tangible assets accounted for 68% of the value of the 500 largest public companies, and they still represented 32% of total value as recently as 1995.

With businesses in all economic sectors increasingly relying on technology innovation to compete, it is all but certain that IP assets will remain the primary driver determining corporate value for the foreseeable future.

“There are reasons to suggest that the influence of tech and thus intangible assets has more steam in its engine,” according to Visual Capitalist. “The looming 5G revolution, more internet users on the horizon, and the powerful potential of new technologies are all supporting considerations.”

Most in-house counsel are now operating in an economy in which nearly every corporate transaction—on either the buy-side or the sell-side—is going to have a major IP component. Conducting thorough and thoughtful due diligence is critical to the deal-making process, as the value of a corporate transaction often hinges on the strength of a company’s IP portfolio.

It’s essential to be prepared to quickly deploy an IP due diligence plan, whether you execute it with your own internal team or supervise the work being done by outside counsel. Here are five key questions to ask before you get started on IP due diligence.

1. What assets are being acquired?
   After the parties have entered into a non-disclosure agreement to protect the confidentiality of sensitive information exchanged during the deal negotiations, start by getting your arms around the scope of the assets involved in the transaction. Once a list of all known assets has been compiled, your planning team can delineate which ones will be subject to your IP due diligence review.

2. What IP assets are being acquired?
   Now you need to drill down and understand the precise nature of the bundle of IP assets you will be evaluating during the due diligence. This will impact the type of expertise you need on your team, as well as the scope of the due diligence plan. Also, your investigation and documents gathered during this stage may reveal additional potential IP assets that will need to be investigated.

3. What commercial advantage does each IP asset provide in the marketplace?
   This question helps you understand the rights provided by the IP assets in the transaction and determine how those rights affect the marketplace. Specifically, do the IP rights provide a valuable marketplace advantage that the buyer is expecting to receive? If a principal goal of the buyer is to acquire and exploit specific IP assets to gain a market advantage, an extensive and detailed examination of those specific IP rights may be required during your due diligence. If, however, the IP assets are a minor component of the deal, then a less extensive review may be adequate.

4. How will the IP assets be used (e.g., owned vs. licensed, exclusive vs. non-exclusive)?
   The acquirer’s intended use and goals for the IP assets will also play a part in determining the scope of your review of those assets. For example, investigation of the status and validity of IP assets a company intends to own and use on an exclusive basis may be more thorough than investigation when the company intends only to license IP assets for use on a non-exclusive basis. Also, the attention you will give an IP asset in your executive reports may depend on its intended use.
   
   
5. Are there any other factors that may influence the scope of the IP due diligence, such as the industry context or nature of the companies involved in the transaction?
   Examples of industry context that may impact the scope of the due diligence process include the following.
   • If one of the parties—and its IP assets—is part of a heavily regulated industry (e.g., pharmaceuticals) or is concentrated outside the United States, your due diligence review of government-related issues will need to be given greater emphasis than in a less regulated industry.
   • If one of the parties is a startup company, the due diligence review may require more attention to detail and post-transaction follow-up than might be necessary for a large, well-established company with mature IP procedures and safeguards in place.

Since the value of IP assets is the leading driver of the enterprise value and overall business terms of nearly all corporate transactions, both parties need to investigate the nature of the IP assets with a thorough due diligence process. This demands that in-house counsel ask the right questions before the IP due diligence process begins. These questions and related issues are discussed in IP Due Diligence, by Practical Guidance contributors Ethan Horwitz (Carlton Fields, P.A.) and Kandis Koustenis (Bean Kinney & Korman PC), a complimentary copy of which is available for a limited time by clicking here.

For a chart that may be used to track and document IP assets during a due diligence review, see IP Due Diligence Review Charts. For a discussion of key issues in the transfer of intellectual property assets in mergers and acquisitions, see IP Asset Acquisitions.