Considerations for preparing the Intellectual Property portfolio for fundraising or exit (and to avoid being blindsided in due diligence)

1. Intellectual Property (IP) is playing an increasingly important role in transactions and influencing company value. 40 years ago, IP & other intangible assets represented approximately 20% of top S&P500 company value. Today that number is over 80% ^{Footnote 1}.
2. There are many reasons why acquiring IP can be an appealing proposition in mergers and acquisitions (M&A). Examples include to litigate, to exclude or limit a competitor, to generate new revenue or protect a product, and to increase company value.
3. IP is often a major factor in helping secure funds for future research and development (R&D). Leveraging IP in fundraising can increase valuation and help assess company viability.
4. Being blindsided in due diligence is often caused by lack of organization and preparation and can reflect poorly on the company and its management. An organized portfolio combined with prepared answers and explanations goes a long way in impressing suitor(s) and securing top dollar for your assets.
5. The five biggest red flags in IP due diligence are:
   • ownership issues
   • poor open-source software (OSS) compliance
   • missing or incomplete contracts & non-disclosure agreements (NDAs)
   • prior art
   • (mis)management
     • a)   Ownership: All IP rights should show a clear chain of assignment from the original inventors to the target company. Ownership is ideally unencumbered (no partial rights or being used as debt security). Inventors should be confirmed before filing any IP with all required assignment signatures procured.

       Example 1: An investor is looking to invest in a Series A round for a high-tech company. They are doing the due diligence and looking at the IP data room. For 2 of the 3 patent applications, assignments from one inventor (a founder who has now left the startup) are not available. The investor further researches the patent and trademark records at the patent office to realize that the founder had not signed the assignment document prior to departing. Further research in the IP data room shows that the founder has not signed any contracts with the startup to assign IP rights. In discussion with the startup, it appears the founder left disgruntled and refuses to sign any further documents. The investor is forced to significantly lower the valuation of the deal given 2/3 of the current IP assets covering the company’s foundational innovations are not legally assigned to the company.

     • b)   OSS: All licenses in use should be kept in a log, with all usages and terms. The log should be regularly audited for completeness and compliance.

       Example 2: A successful startup used open-source software without policy or considering compliance. They are now in detailed due diligence with a tier-1 company for a high value acquisition. The company reviews the IP due diligence and performs a software scan to realize the software is covered with OSS and nothing was provided in the due diligence documents regarding the licenses and related compliance. The company decided to halt the completion of the deal until the startup sorts out its OSS strategy and provides the required proofs of license compliance in the due diligence data room. It will take months for the startup to clean this up... by then the market could have softened considerably and the company significantly lowers its offer in order to close the deal.

     • c)   Contracts/NDA: Employee contracts should include a clause on assigning IP to the company. Proprietary Information and Inventions Assignment (PIIA) is preferable. Exiting employees can also sign a reaffirmation of the PIIA that specifically references all inventions to which the employee contributed. All company contracts need to be reviewed for IP clauses. All employees and contractors should be under NDA. Disclosures should be only to those under NDA unless specifically approved by a director. Joint ventures and R&D agreements should be clear about IP ownership of produced material.
     • d)   Prior Art: There should be a company policy in place regarding internal searching and sharing of results. Usually, it is best to leave this to professionals. Ensure all prior art is submitted to patent offices. Review all employees’ past literary work (e.g., dissertations) for mention of relevant prior art.
     • e)   Management: Day-to-day management should include IP strategy, process, and policy. How are ideas captured and adjudicated? When it comes to budgeting, how are costs tracked and funds allocated? What is the level of management oversight, are they aware of the IP landscape and operations? How clean and structured are the IP files?
6. In due diligence, the acquirer may send a team of experts to analyze the IP and its operations and management. These experts can ask upwards of a hundred questions. Not all answers are clean, but ensure you are always being honest and transparent. Rational explanations go far, and a single misrepresentation can torpedo any transaction (all is eventually discovered anyway!).

Key considerations for Canadian companies regarding preparing their IP portfolio for fundraising or exit:

• Put yourself in due diligence before anyone else! You should be preparing well before M&A discussions are taking place. Audit your IP and clear up any issues or ambiguity before showtime. Assignments and OSS are a great place to start!
• Log all your IP in a database and develop a file/folder structure to organize the myriad of IP documents. Ensure you have a full grasp of upcoming deadlines and activity.
• Create a PPT deck that summarizes your IP (totals by status, country, etc.), your various IP processes and policies, history and trends, and slides addressing any potential issues or concerns, or unique characteristics about the portfolio.
• “It's not always just the IP itself that drives the value of a transaction. It is also the qualityof the intellectual property's management and organization,” says Jordan Pynn, Vice President at Stratford Intellectual Property.

Additional information:

• For information about IP protection in the US, please see the Canadian Intellectual Property Office’s publication on Doing business abroad: Protecting your IP in the United States
• For more material relating to the export of goods to the US, please see the Doing Business in the United States page
• For more information on going global with your IP, visit Canada.ca/export-ip