Intellectual property (IP) is often one of the most valuable assets a company owns. Whether its patents, trade marks, copyrights, trade secrets, designs or proprietary software, IP can significantly influence a company’s market position and valuation. Yet, many investors overlook the critical step of verifying the integrity and ownership of these assets before closing a deal.
Amy Ralston and James Rickard explore the risks of overlooking IP due diligence and the benefits of conducting comprehensive legal due diligence, including an IP health check.
Overlooking IP due diligence
Investing in or acquiring a company without a thorough IP health check can expose investors to significant risks, for example:
- Lack of ownership: the target company may not actually own the IP it claims to. This can arise from poorly drafted employment or service agreements, missing assignments from contractors or joint ownership disputes.
- Infringement issues: the target company’s products or services may infringe on third party IP rights, leading to costly litigation, injunctions or forced product or branding redesigns.
- Insufficient protection: Key IP assets may not be sufficiently protected – trade marks may not be registered in key territories, patents may be expired or invalid – or the assets could be registered in the name of another person or entity.
- Licensing and encumbrances: IP, including software programs, could be subject to restrictive licenses, liens or encumbrances that limit its commercial use of transferability.
IP Health Check
An IP health check can be undertaken by one of our expert IP professionals and is a comprehensive audit of a company’s IP portfolio. It typically includes:
- Verifying ownership and chain of title for all IP assets.
- Assessing the scope and validity of registered rights.
- Identifying potential infringement risks.
- Reviewing IP-related agreements (licenses, assignments, NDAs, software development agreements).
- Evaluating the company’s IP strategy and enforcement history.
Benefits for investors
Commissioning an IP health check before investing offers several key advantages:
- Risk mitigation: identify and quantify IP related risks before they become costly or lead to unforeseen litigation.
- Valuation accuracy: ensure the purchase price reflects the true value and risk of the portfolio.
- Negotiation leverage: use findings to negotiate warranties, indemnities or price adjustments.
- Strategic insight: Gain a clearer understanding of how IP supports the target company’s competitive advantage and growth potential.
Due diligence
It is important not to neglect IP due diligence as part of the legal due diligence exercise prior to the investment. By commissioning an IP health check as part of the process, investors can make informed decisions, avoid costly pitfalls and ensure they are acquiring not just a business – but the rights to the innovations, reputation and branding that make it valuable.
Investment Agreement
Provided the investor is generally satisfied with due diligence, the next step is for the parties to agree and enter into the investment agreement (IA). The IA forms the key document when it comes to any investment. As IP is usually a core value proposition in most companies, IP warranties are commonly included in the IA. In essence, warranties are contractual statements from the company/founder to the investor about the state of affairs of the business/assets (e.g. the company/founder warrants that (i) the company owns all IP, or (ii) that there is no infringement of third party IP) and act as an extra layer of protection for an investor. If it turns out post-completion that a warranty is untrue, an investor may potentially be entitled to bring a breach of warranty claim for any quantifiable loss suffered (subject to any limitations on the founder’s/company’s liability contained in the IA).
In addition to that, indemnities can also be included in the IA which act as a powerful tool to further protect an investor’s investment and usually cover matters specifically flushed out from due diligence or disclosure. Essentially, an indemnity is a contractual promise from the company/founder to reimburse the investor in respect of a specific identified risk (e.g. ongoing IP litigation). If that risk arises post-completion, an investor could be reimbursed on a pound for pound basis in respect of that issue (subject to any limitations on the founder’s/company’s liability contained in the IA). However, an investor does not need to prove breach or quantifiable loss in the same way as a warranty claim – they simply need to show the indemnified event occurred.
This article was co-written by Amy Ralston and James Rickard and if you have any questions about investor due diligence, IP health checks or preparing for investment generally, please contact the team.
Amy Ralston is an Associate in our Intellectual Property, Technology and Data Protection team and James Rickard is a Senior Associate in our Corporate team.