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IP Allocation and Assignment in Transactions

Posted by Ryan M. Newburn | Aug 02, 2022 | 0 Comments

Intellectual property assets and portfolios can be a driving force in merger and acquisition transactions. These assets hold fundamental value in a company and can add significant value in a transaction. A company that is looking to merge with another company, acquire another company, or is being acquired, often assesses the targeted company's IP to inform their decision on how to move forward in the transaction.

It is important to have these IP assets broken down and assessed so that the target company is maximizing its sale or purchase price. Because all companies possess some IP assets, all merger and acquisition transactions will involve IP analysis in a thorough M&A review.

If you are considering being a party to a merger or acquisition, you must have knowledgeable legal counsel to help you thoroughly evaluate and draft contracts to value that IP effectively. Our merger and acquisition lawyers here at Newburn Law have years of experience ensuring that our clients' IP is protected in any deal.

What is the first step when evaluating IP in an M&A?

The first step when evaluating IP involves confirming ownership of the IP. Whether the target company owns the IP or the acquiring company owns the IP, it is crucial to explicitly lay out in the agreement what IP will be owned by whom.

This first involves conducting thorough due diligence so that the companies have a better understanding of the following:

  • Filings;
  • Deadlines;
  • History; and
  • Development of the IP assets

This article will provide an overview of how IP assets play a vital role in M&A transactions, further break down the practice of managing IP in M&A transactions, and determine what is needed to ensure the successful transfer of IP assets in these deals.

What is IP?

Generally speaking, intellectual property is an intangible product owned by a company or individual protected by law from unauthorized or outside users.

With some IP, such as copyrights, owners must register their intellectual property to be able to enforce their legal rights.

Other forms of IP that a company may own include:

  • Patents, which grant rights to inventors to prevent others from using, making, or selling an invention for a specific period of time;
  • Trademarks, which are words or symbols used to identify an individual or company's goods or services; and
  • Trade secrets, which confidential information, such as formulas, processes, practices, patterns, or complications of data and information that is pertinent to a business' operation.

Best Practices in Managing IP in a Merger and Acquisition

Evaluating and measuring the value of intellectual property in a merger or acquisition transaction can be a burdensome task. Nevertheless, if a company is going to take on the task of evaluating its or another company's IP assets, the review and valuation will need to be thorough. This section will briefly cover some of the best practices when managing IP in merger and acquisition transactions.

Due Diligence

Due diligence is the legal process buyers and sellers undergo to properly identify, investigate, and evaluate a target company's assets, such as intellectual property. The process can be time-consuming. However, effective due diligence can allow buyers and sellers to identify risks and resolve those risks before closing a transaction.

The first step in any due diligence process is getting to know the company. Another important step in the due diligence process is creating a “Company Questionnaire” and “Document List” that will act as a roadmap. These documents will contain:

1) a list of questions to be answered by the companies; and

2) documents needed during the evaluation process.

The final stage will be the evaluation stage. This entails creating a report to identify the IP issues, risks, and other potential problems that may lead to an unsuccessful transaction.

Preparing for Due Diligence

When conducting due diligence, the goal is to thoroughly evaluate the target company's IP, ensuring ownership and no legal issues surrounding the IP. Therefore, the seller (or the target company) should provide the acquiring company:

  • All patent licenses, including patent numbers, jurisdictions, filing dates, registration dates, and issue dates;
  • All patent applications;
  • All confidentiality agreements with employees and/or consultants;
  • All invention assignment agreements with employees and/or consultants;
  • All trademark and service mark registrations, including trademark numbers, filing dates, registration dates, and issue dates;
  • All pending trademark and service mark applications;
  • All trade secrets associated with the company;
  • All proprietary know-how information;
  • All technology licenses received or licensed to third-parties;
  • All proprietary software and databases used by the selling company;
  • Any open source software used in the development or use of the seller's services and products;
  • Any lawsuits against the company pertaining to IP;
  • Any claims for infringement of IP;
  • Any contracts that provide for third-party indemnification relating to IP matters;
  • Any domain names owned;
  • Any liens or encumbrances on the IP; and
  • Any and all social media accounts.

Many of these are typically included in the 'disclosure schedule' of the acquisition agreement. However, any selling company must have these documents prepared when expecting to sell the company.

What if the seller developed IP with another party?

If the target company developed IP with an outside party, the parties must ensure that there are no restrictions on the transfer of the IP. If so, the parties must discuss with the third-party on how to obtain exclusive rights to such IP.

What if developers used open source software when developing IP?

When developers build technology or IP, they often use open source software when developing such products. This can potentially lead to ownership or licensing issues for the acquirer.

This could become a deal breaker. Therefore, the acquirer will likely want representations and warranties from the target company to ensure that the developer did not use open-source or similar software in the IP. The target company will typically try to limit its representations and warranties. However, cross-checking the software against open source databases is critical to avoid potential problems.

How to Value IP?

An IP asset’s value arises from a company's ability to exclusively use the IP, excluding competitors from using it in a specific market. This right to exclude leads to an economic right, allowing the company to control the use of the IP.

To quantify the IP's value, companies must be able to:

  • Evaluate the measurable amount of economic benefit the IP brings to the owner; 
  • Demonstrate that the IP enhances the value of other assets that it is associated with; and
  • Show the ability to directly exploit the IP through sale, licensing, or adding value by:
    • Lowering the negotiation power of the customer-base
    • Offset supplier power
    • Mitigate competition
    • Raise barriers to entry by competitors
    • Reduce the threat of substitutes

Essentially, the value of an IP asset is the potential future economic benefits that the IP owner can have from owning the IP.

What is not Considered IP?

It is important to note that not all creative authorships can be considered IP. For example, designs, such as fashion designs, unless explicitly stated via state statute, are not offered the same protections as other forms of intellectual property.

This is also true for items with a public domain, raw data, or, as mentioned, open source software. These types of works will most likely include an expired patent or copyright. Furthermore, some forms of intellectual property cannot be registered to be protected.

These forms include book titles and domain names that usually cannot be copyrighted, an idea or suggestion that is not new and cannot be patented, and generic words which cannot be trademarked.

Why is IP Important in M&A Deals?

Intellectual property is viewed as a corporation's biggest asset and can be the driving force in merging or acquiring a targeted company's sale or purchase. Furthermore, intellectual property assets are one of the many reasons companies decide to merge or acquire another company. Such M&A transactions with a strong IP presence will allow for the company looking to acquire or merge to strengthen their market shares and consequently elevate their company's overall value.

The advancement of technology has made intellectual property in M&A transactions much more vital and valuable. Because the intellectual property has become a cornerstone to many companies, it has become more task-oriented to identify and efficiently analyze the value of intellectual property assets. Specifically, the value will directly impact the value of the transaction altogether.

Determining Ownership of IP in an M&A

In an M&A transaction, the acquisition agreement must explicitly state who the owner of the IP will be. Sometimes, this will look like a direct sale to the acquiring company, while other times, it can look like a license to the acquiring company.

Sale

Once the acquiring company has completed its due diligence and determined that the IP has a clean chain of title, they often will want to purchase all of the IP as part of the deal. This involves properly valuing the IP and including it in the purchase price.

The contract should specifically state that upon the execution of the acquisition agreement, the acquiring company will be the sole owner of the IP of the target company.

Licenses

Sometimes, licenses can make M&A deals more complicated. If the target company used a key piece of IP they received through a license, they must make sure there is nothing in their license agreement that states that they cannot license the IP to another party. In that instance, the proper structure of the deal is crucial.

This can get extremely complicated, which is why you must consult with experienced M&A lawyers when determining how to license, sell, or transfer the IP within a merger or acquisition.

Protecting IP in an M&A

Most provisions of M&A agreements consist of basic housekeeping details that allow for the finalization of the transaction. To protect IP, the companies will have to negotiate important clauses within the agreement. Some important provisions include:

  • IP Representations and Warranties
  • Assignment/Allocation
  • Interim Operating Covenants
  • Post-Closing Covenants

IP Representations and Warranties

As mentioned earlier, these representations and warranties are crucial for both the target company and the acquiring company. The acquiring company will want guarantees that it will have exclusive rights to the IP and that there are no legal or ownership issues associated with it.

The target company will want to limit the representations and warranties it makes to avoid being held liable for any unknown issues or issues that may arise in the future.

Assignment/Allocation/License

Each M&A will vary with how the IP will be transferred, whether through an assignment, license, or sale. This will depend on agreements or licenses with third parties and other legal ownership issues that may arise when conducting due diligence.

Interim Operating Covenants

This covenant ensures the acquiring company that the target company will operate in the ordinary course of business until the deal is closed. This means that the condition of the target company, and its IP, will be the same at the closing as when the buyer is conducting its due diligence and appraising the value of the IP.

These covenants will also include restrictions on the target company's licensing abilities, assigning abilities, or disposing of the IP during due diligence.

Further, these covenants can require the target company to continue making all filings and payments to maintain the IP status of its assets.

Post-Closing Covenants

Buyers may include a covenant not to sue from the seller relating to the buyer's IP use of the target company's IP.

Further, some buyers may require the seller's key employees with know-how knowledge of the IP use to be available for consultation and/or training for a period after the closing.

Questions?

IP valuations and transfers in mergers or acquisitions can be a long and complicated process. If you have any questions, contact our team today for a free consultation.

About the Author

Ryan M. Newburn

Ryan Newburn is a business and legal expert trusted by Executive Teams and Boards of Directors to apply sound business principals to solve legal and financial problems. Ryan's practice focuses on mergers and acquisitions, financings, corporate formations and corporate governance in a broad range of industries including energy, distribution services, healthcare, medical devices, and technology. Leveraging his formal business training and years of practical experience, including as an executive at public and private companies, Ryan has advised hundreds of companies in dozens of industries of unique legal and financial issues.

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