As a company or investment professional involved in mergers and acquisitions ("M & A"), are you conducting patent due diligence according to the standard practices of your M & A attorneys and investment bankers? When patents form a considerable aspect of the value of the transaction, you are quite possibly finding incorrect suggestions about how to conduct due diligence. The due diligence procedure must take into consideration the competitive patent landscape. If competitive patents are not included in your vetting procedure, you may be substantially overvaluing the target organization.
In my various years of intellectual property and patent encounter, I have been involved in a number of M & A transactions exactly where patents formed a significant portion of the underlying value of the deal. As the patent specialist on these transactions, I took direction from very compensated M & A attorneys and investment bankers who had been acknowledged by C-level management to be the "real specialists" since they completed dozens of deals a year. To this finish, we patent specialists were directed to check the following 4 boxes on the patent due diligence checklist:
- Are the patents paid up in the Patent Office?
- Does the seller honestly own the patents?
- Do at least some of the patent claims cover the seller's items?
- Did the seller's patent lawyer make any stupid errors that would make the patents challenging to enforce in court?
When these boxes were marked "complete" on the due diligence checklist, the M & A attorneys and investment bankers had efficiently "CYA'd" the patent issues and were free of charge from liability relating to patents in the transaction.
I have no doubt that I conducted my patent due diligence duties very competently and that I, too, had "CYA'd" myself in these transactions. On the other hand, it is now evident that the patent aspect of M & A due diligence essentially conformed to someone's concept of how not to make stupid errors on a transaction involving patents. In truth, I never felt rather comfortable with the "flyover" really feel of patent due diligence, but I did not have choice rights to contradict the normal operating procedures of the M & A professionals. And, I identified out just how incomplete the normal patent due diligence approach is when I was left to pick up the pieces of a transaction conducted according to common M & A process.
In that transaction, my client, a large manufacturer, sought to expand its non-commodity product offerings by acquiring "CleanCo", a tiny manufacturer of a patented consumer product. My client discovered CleanCo to be a very good target for acquisition due to the fact CleanCo's product met a strong consumer require and, at that time, commanded a premium price in the industry. Due to robust consumer acceptance for its sole item, CleanCo was experiencing tremendous growth in sales and that growth was expected to continue. Having said that, CleanCo owned only a smaller manufacturing plant and it was getting difficulty in meeting the growing wants of the industry. CleanCo's venture capital investors had been also anxious to money out after quite a few years of continued funding of the company's somewhat marginal operations. The marriage of my client and CleanCo thus seemed a beneficial match, and the M & A due diligence process got underway.
Due diligence revealed that CleanCo had few assets: the small manufacturing plant, limited but growing sales and distribution and several patents covering the sole CleanCo product. Notwithstanding these apparently minimal assets, CleanCo's asking price was upwards of $150 million. This cost could only mean 1 thing: CleanCo's value could only be in the potential for sales growth of its patented item. In this scenario, the exclusive nature of the CleanCo product was appropriately understood to be basic to the purchase. That is, if someone could knock-off CleanCo's differentiated item, competition would invariably result and ll bets would then be off for the growth and sales projections that formed the basis of the monetary models driving the acquisition.
Taking my directions from the M & A attorney and investment banker leaders in the transaction, I conducted the patent elements of the due diligence method according to their common procedures. Every little thing checked out. CleanCo owned the patents and had kept the charges paid. CleanCo's patent attorney had carried out a fine job on the patents: the CleanCo product was covered well by the patents and there were no obvious legal errors created in obtaining the patents. So, I gave the transaction the thumbs up from the patent perspective. When everything else looked positive, my client became the proud owner of CleanCo and its product.
Fast forward several months . . . . I began to get frequent calls from many people on my client's promoting team focused on the CleanCo product about competitive merchandise that were being noticed in the field. Given the reality that alot more than $150 million was spent on the CleanCo acquisition, these advertising and marketing specialists not surprisingly believed that the competitive products must be infringing the CleanCo patents. On the other hand, I identified that every of these competitive merchandise was a legitimate design-about of the patented CleanCo product. Considering these knock-offs had been not illegal, my client had no way of finding these competitive merchandise removed from the marketplace using legal action.
As a result of this escalating competition for the CleanCo item, cost erosion began to happen. The economic projections that formed the basis of my client's acquisition of CleanCo began to break down. The CleanCo item still sells strongly, but with this unanticipated competition, my client's expected margins are not getting created and its investment in CleanCo will take considerably more time and pricey promoting to pay off. In brief, to date, the $150 Million acquisition of CleanCo looks to be a bust.
In hindsight, the competition for the CleanCo item could have been anticipated throughout the M & A due diligence approach. As we identified out later, a search of the patent literature would have revealed that numerous other methods existed to address the consumer will need addressed by the CleanCo product. CleanCo's achievement in the marketplace now appears to be due to first mover benefit, as opposed to any actual technological or cost advantage provided by the item.
If I knew then what I know now, I would have counseled strongly against the expectation that the CleanCo item would command a premium price due to market exclusivity. Rather, I would demonstrate to the M & A team that competition in the CleanCo product was attainable and, indeed, extremely most likely as revealed by the myriad of solutions to the similar situation shown in the patent literature. The deal could possibly nonetheless have go by means of, but I believe that the the monetary models driving the acquisition would be extra reality-based. As a result, my client could have formulated a marketing and advertising plan that was grounded in an understanding that competition was not only probable, but also most likely. The advertising program would then have been on the offense, rather than on the defense. And, I know that my client did not anticipate to be on the defense following spending extra than $150 million on the CleanCo acquisition.
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