This is the first in a four-part blog series that examines the IP due diligence process for tech startups and provides insight on due diligence as part of a company’s patent strategy. Read part two, part three and part four.
We’re starting a new blog series that will examine the IP due diligence process for tech startups and provide insight on due diligence as part of a company’s patent strategy. We begin by briefly introducing the IP due diligence process.
If you’re a tech company, your IP portfolio is one of your most important business assets. A tech company’s IP portfolio can also be an important consideration for outside investors, collaborators, and companies who might acquire or license your technology.
So in any major transaction with a tech company, the other party will perform IP due diligence to evaluate the tech company’s IP assets.
Being prepared for the due diligence process can help tech startups in a variety of contexts: when seeking outside funding, entering deals with business partners, or contemplating an exit (e.g., an IPO, merger, or acquisition). Potential investors need to understand the due diligence process to make a more informed purchase or licensing decision before signing a deal with a tech company.
Let’s take a closer look at IP due diligence and why it’s so important for both tech startups and prospective investors.
WHAT IS DUE DILIGENCE?
IP due diligence is a legal audit that assesses a company’s IP assets and investigates their ownership and value. Basically, it’s an in-depth examination of the company’s IP portfolio and/or related products prior to a business transaction.
Think of it like a pre-purchase home inspection: A smart home buyer wants to make a well-informed investment and be aware of any past, present or foreseeable issues with the house that they’re buying.
In the same way, IP due diligence allows an outside investor to make a smart, well-informed investment in a tech company, and to become aware of any past, present and foreseeable issues with the tech company’s IP portfolio.
There are usually two main parties involved in the due diligence process:
- A patent owner (tech company) who owns the patent assets
- An outside party (usually an investor, acquirer, or licensor) who is contemplating a transaction with the patent owner
If you’re a tech startup seeking investment from a venture-capital firm, your patent filings will be an important consideration for the VC firm’s evaluation. So the VC firm will conduct an IP due diligence review to confirm the quality and scope of your patents and patent applications, allowing the investor to discover any undisclosed problems with the patent portfolio.
Due diligence isn’t just about determining the value of a patent portfolio in a business transaction. It also examines the status and quality of the tech startup’s patents and applications, and sometimes goes as far as analyzing their validity and enforceability.
WHO ELSE IS INVOLVED IN DUE DILIGENCE?
Because due diligence is an important part of any business transaction, the tech company’s executives and both parties’ outside IP counsel are usually heavily involved in the process.
The tech company’s executives who are involved with IP due diligence typically include those within the company who are the most familiar with its patent portfolio — think the CTO, CEO, patent liaison, etc. They provide the other parties all the information they need to assess the patent portfolio.
Properly assessing a patent’s value and risk requires experienced IP counsel. Most investors also hire specialized outside patent counsel to provide an unbiased evaluation that can properly assist in the due diligence process.
WHEN DOES DUE DILIGENCE HAPPEN?
Due diligence is conducted toward the end of critical negotiations, just before a deal is completed. The process typically occurs after the parties have agreed to principal deal terms (for example, during an option or “no shop” period before the deal closes).
Transactions that often require some form of IP due diligence include:
- Raising external investment capital
- Mergers and acquisitions
- A company takeover, or sale of a company and assets
- Major licensing deals
- Initial public offering (IPO)
With a strategically timed IP due diligence process, investors and other outside parties can use their findings as leverage to improve deal terms, have problematic issues addressed in a timely manner, and be prepared to proactively manage the IP portfolio going forward.
WHY DUE DILIGENCE IS IMPORTANT
A patent portfolio can be an especially valuable asset and will often be a driving force behind a company’s valuation.
The right kind of due diligence can accomplish strategic business objectives during business negotiations. A properly executed due diligence allows the outside company to:
- Understand the strength and determine the worth of the patent’s owner patent assets
- Identify current or potential issues with their investment
- Make a more educated and informed decision in evaluating business value and investment position
- Gain access to important information about the patents and other IP assets
- Develop a strategic plan for developing and leveraging the IP portfolio going forward
PREPARING FOR DUE DILIGENCE
The IP due diligence process is usually carried out on a constrained timeline before a transaction is completed. Both parties should be prepared ahead of time to ensure the process goes smoothly.
DUE DILIGENCE FOR TECH STARTUPS
If you’re a tech startup, you should be thinking about due diligence long before the process starts (at least several months). This will allow your company to maximize the value of your IP portfolio and avoid issues that could distract investors.
Your main role as the patent owner during the IP due diligence process is to provide information, answer questions, and address issues that arise. You’ll need to identify a point of contact who will handle all requests and ensure that information is provided in a timely, well-organized manner.
Here are some tips to get a head start:
- Work with an experienced IP counsel from day one of your business (yes, you need a patent lawyer)
- Conduct an internal audit ahead of time to avoid any surprises during the actual review
- Discuss issues early in negotiations! Be transparent about problems an investor might find during a due diligence review
- Address any problems you identify before the due diligence process begins
- Be prepared to spend time assisting the investor and their outside counsel in the due diligence process
DUE DILIGENCE FOR INVESTORS
If you’re an investor interested in acquiring or licensing IP assets, due diligence is all about protecting your investment.
Your role during this process is to efficiently uncover any significant issues in the IP portfolio and determine their significance within the context of the transaction. This often means you must also understand the role that IP plays in the relevant industry and its relevance to the transaction.
As an investor, you will want to know as much as possible about the target company and its IP portfolio. Here are a few things that will help you prepare for the IP due-diligence review:
- Retain external IP counsel early
- Request a list of IP assets from the tech company early in the business negotiations
- Ask the tech company to identify a key executive who can provide a verbal summary of the patent portfolio and point out its most valuable elements
- Learn how other tech companies in the same industry have used their IP portfolios to achieve success
Early access to information about the tech company allows you to be ready before the actual due diligence process. Being prepared for the due diligence review will also allow you to choose the most appropriate approach, and can save you time and money.
PREPARING FOR DUE DILIGENCE?
Your patent portfolio is a valuable asset, and you should learn how to avoid unexpected issues during a business deal. To learn how to prepare for the patent due diligence process, you should partner with an experienced patent professional.
Michael K. Henry, Ph.D.
Michael K. Henry, Ph.D., is a principal and the firm’s founding member. He specializes in creating comprehensive, growth-oriented IP strategies for early-stage tech companies.