Preserving Value: Mitigating IP Transfer Risks In M&A Deals

Mitigating IP transfer risks in M&A deals should be the core focus for dealmakers when conducting due diligence. Especially when the objectives behind the deal is the acquisition of the intangible assets.

Companies must ideate IP or acquire it from smaller startups to stay relevant in today’s competitive business landscape. That’s because economies are increasingly tech and knowledge-driven rather than equipment-based. However, defining IP value, ownership, usage rights, and its full scope and limitations involve several complexities.

Before finalizing the merger, you’ll want to ensure that buyers and sellers have complete access to the IP. You’ll also need assurance that there are no encumbrances and infringements of third-party rights.

Granted, meticulous due diligence can help you identify and address potential issues.

But, Due Diligence Can Fall Short!

Finding Intellectual Property, analyzing its description, and identifying the appropriate listings takes a lot of work. Several factors can limit the availability of the required information in the IP registers or on public forums. Here are some of the factors:

• Intellectual Property (IP) and Intellectual Property Rights (IPR) go through various assignment chains and transform in scope and structure. Registers don’t necessarily reflect all the changes in ownership or the collateral they acquire.
• Buyers should be aware of the possibility of licenses and usage rights granted to third parties or intra-group entities. For instance, employees and consultants who must use the IP to run the company’s operations or develop products and services.
• Integrating and configuring software IP, proprietary and open source, for specific purposes can also transform its design. As a result, its ownership can be conflicting.

These are only some of the reasons why dealmakers should work toward mitigating IP transfer risks in M&A deals. Addressing all the possible issues will clarify ownership and ensure the streamlined transfer of the targeted company’s intangible assets. These IA may include patents, copyrights, trade secrets, trademarks, and PII databases.

You’ll also mitigate the risks of the acquisition failing, a possibility that ranges anywhere from 70% to 90%. While several reasons can contribute to the failure, IP-driven issues need not be a cause.

Risks Associated with IP Transfer Documents

Transferring IP assets involves detailed paperwork that clearly defines the ownership, liens, the right to use, and other clauses. Acquirers must get their legal teams to review the patent and copyright registration carefully to identify any possible discrepancies. Here are some of the areas to cover:

• Examine the Invention Assignment Agreement and Change of Control.
• Check for any broad licensing and assignment of rights to third parties that can interfere with the acquirer’s rights. For instance, the IP transfer agreement may include clauses that impose conditions on the seller’s affiliates for using the assets. The acquirer purchasing the IA may find that the clauses also apply to their subsidiaries after the acquisition is closed. Buyers may want to rethink the M&A deal if these conditions hamper IP use.
• Scrutinize the Definitive Acquisition Agreement between the dealmakers. This agreement may outline certain actions the seller can or cannot take between signing the deal and its closure. Legal teams on both sides of the negotiation table may want to examine the conditions. They’ll ensure the clauses won’t interfere with the seller’s company’s stability and its operations. This situation is particularly relevant in cases with a long delay in the pre-closing deadline.
• Clarify any ownership rights collaborators may have on the IP. Any entities contributing funding and resources for creating the IP may also have rights that you must address.
• Review any loan agreements the seller may have entered into with banks and investors. If they have offered the IP as collateral, you’ll want to resolve any potential complications in the sale.

Risks Related to Any IP Disputes

Before entering into the M&A deal, buyers must look into any ongoing or past litigation the seller may face. You’ll also examine issues like:

• Any disputes with third parties regarding IP ownership that have yet to lead to legal claims and litigation.
• The capabilities of the seller to enforce their rights.
• Any current proceedings before the United States Patents and Trademarks Office.
• The terms and conditions on which the seller settled claims, disputes, and litigation in the past.
• Any releases and covenants the seller may have agreed to prevent further litigation.
• Any unresolved claims for which the acquirer should demand indemnity for protection from the risks of future unfavorable judgments.

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IP Dispute-Related Risks for Sellers

Ongoing claims, liens, or disputes on the seller’s IP also need them to work on mitigating IP transfer risks in M&A deals. Here are some of the risks to consider:

• Acquirers may want to lower their purchase price to compensate for the claims.
• They may request special indemnification provisions to compensate for any pending litigations or the risk of future disputes.
• Buyers may request an additional holdback of some of the purchase price funds held in escrow for indemnity.
• Sellers should prepare for the possibility of any IP-related claims arising in the period between the signing of an acquisition agreement and the final closing.
• Sellers can also reserve the right to defend or fight the claim in court even after the acquisition deal is closed.

Buyers want assurance that they will not be obligated to close the M&A deal if such claims arise. From the seller’s perspective, all the stakeholders will need assurance that the closing will proceed as planned. They may be unwilling to accept the buyer’s conditions.

Issues with unfair and baseless claims can also arise soon after dealmakers publicly announce the acquisition. Third parties may time their litigation threats to coincide with the closing date to use it as leverage for a speedy settlement.

Sellers may have to offer the buyers post-closing indemnification to ensure that the deal progresses as planned. They can, however, add certain conditions or limitations to the risk exposure.

Like, for instance, setting a pre-determined limit on the amount acquirers can claim. That’s one of their strategies for mitigating IP transfer risks in M&A deals. That’s also how dealmakers prevent M&A deals from falling through.

Technology and Open Source Software Risks

A significant percentage of the technology and software used worldwide in devices has copyright and patent protection. Most software engineers and developers base their creations on open-source code and software that is freely available online.

However, using this software to create new products can subject the developers to compliance issues and ownership disputes. They may have to get licenses to use the software.

Or, the original engineers may require users who modify or distribute their codes to make their new creations open to other users. Acquirers interested in purchasing this technology may be interested in getting IP encumbered by such restrictions.

Any representations and warranties the seller draws up should clearly specify that engineers have used open-source code. The documents should also indicate the proprietary software incorporated or used to create the IP.

Acquirers will want to know if they are legally obligated to disclose that they are using the software. They will also need assurance that they are not infringing or violating any existing open-source licensing agreements.

A simple way to get around this issue is to test the Intellectual Property using software applications like Palamida and Black Duck. These tools have the capability to analyze large volumes of code and match them against the databases of open-source code.

Identifying potential issues that can limit the acquirer’s right to exploit the IP is quickly done. These issues may include claims by third parties that the patent is invalid. Or liens on the IP by banks or investors.

Infringement on other patents, inadequate evidence that techs were adequately paid, and collaborator claims are other risks to deal with.

Digital Asset Transfer Risks

The modern-day business ecosystem has a closely integrated digital presence, with companies using their websites and social media accounts as assets. Domain names and social media accounts are a crucial part of the company’s intangible assets and trademarks.

Acquirers purchasing a company must also account for these assets and compensate the seller. But, before negotiating the pricing structure, they’ll ensure that their ownership is clearly defined. Here are some of the aspects to consider for mitigating IP transfer risks in M&A deals:

• Domain name registries must indicate the seller as the registered owner of the domain name. And any other key domain names it claims.
• The Terms of Use Agreement and Privacy Policy should protect the brand against compliance issues.
• The targeted company should comply with the clauses mentioned in the Privacy Policy.
• The company’s different social media accounts and if they are registered in the company’s name. Registrations in employees’ or consultants’ names can present infringement or claims against ownership issues.
• Whether permission is granted to users to upload content and add comments to the company websites and social media pages.
• Ownership status of the content assets available on the company’s websites and social media pages.
• Compliance with the Digital Copyright Millennium Act. This act has several rules and guidelines for the content and computer programs published online. These laws protect online service providers and technological assets.

Protecting Data and PII Risks

Businesses providing online services to clients, vendors, investors, and other stakeholders maintain an extensive database of Personally Identifiable Information (PII). While this database is a valuable IP resource, it can also pose a liability. That is, if the company does not comply with anti-breach laws.

When negotiating the terms of the sale, acquirers need confirmation that the seller has instituted the mandatory data protection protocols. The company must demonstrate the policies, practices, and security measures it has to prevent data breaches. Here are some of the areas to explore for potential risks:

• Cybersecurity teams may study the company’s defenses against cyber attacks and review intrusions that happened in the past.
• Protocols in place for harvesting PII and storing it in compliance with the Privacy Policy terms.
• Exploring claims and complaints brought by third parties for data and privacy breaches
• Examining the targeted company’s business continuity plan in case of hacking or malware incidents
• Internal processes for managing security breaches and the risk of operations coming to a halt.
• Reviewing contracts with third parties to confirm that they are obligated to comply with confidentiality clauses.
• The targeted company’s procedures for conducting background and security checks before hiring employees. These checks may include credit checks, drug testing, and other screening.

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Core Strategy for Mitigating IP Transfer Risks in M&A Deals – Disclosure Schedule

Sellers can mitigate the risks involving IP transfers in M&A transactions by drawing up a disclosure statement. This document accompanies the acquisition agreement and reveals essential information about all IP-related issues. These may include ongoing contracts, pending litigation, employee data, and more.

A detailed disclosure statement is a valuable tool, helping sellers avoid breaching any representations and warranties in the acquisition agreement. Compiling this information is a time-consuming task but having it ready early in the negotiation process is crucial.

Delaying the deal to ensure accuracy and precision is always preferable. Sellers must take their time to include all the appropriate exclusions of the IP representations and warranties. This procedure can help avoid risks by including information such as:

• Patents and pending patent applications, complete with their dates and jurisdictions
• Licensing agreements and technology permits
• Domain names, trademarks, trade secrets, and service marks
• Customer contracts that include IP indemnification
• Bank loans, liens, and investor collaterals on Intellectual Property and Intangible Assets
• Current and potential IP claims on the seller’s company
• Titles of contracts, parties with which the contracts have been created, dates, and revisions involving the IP

The Takeaway!

When Intellectual Property and Intangible Assets form the core drivers of M&A deals, participants should practice due diligence. In addition to examining every key aspect of the targeted company, they should examine the potential risks for IP transfers.

Taking the necessary steps to streamline the transfer will ensure that the transaction progresses as planned. After signing and closure, you’ll integrate the assets seamlessly and prevent litigation and other ownership hassles.

Address the possible issues early on and prepare to address them well before you initiate the final negotiations.

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