You’re the CEO of a software company. You’ve identified a new start-up company that claims to have developed a mobile application that could provide your company, indeed your entire industry, with an exciting new platform to deliver products and services to fast moving customers globally. Your board of directors has authorized you to move forward with the transaction. Your management team has developed a plan to evaluate the target company. It includes an intensive investigation of the target’s management, employees, products and services. It’s a technology transaction so you’ve assigned a team of technologists and outside legal counsel to evaluate the target’s assets and liabilities, and in particular, its intellectual property (IP).
Remember, the key purposes for conducting IP due diligence are to: (1) identify all the IP assets being acquired and their essential characteristics; (2) verify the status of IP assets, in particular, those that subsist in government registries; (3) verify the target owns the IP assets and can pass title or alternatively identify the nature and scope of the target’s rights in the assets; (4) identify adverse third-party claims and interests in the target’s IP assets, and determine whether any third-party activities potentially infringe the target’s IP rights; (5) assess the validity of the target’s various IP; and (6) assess the value of the target’s various IP. Keep in mind that even the most thorough IP due diligence will not provide you with absolute assurance that all potential IP issues will be resolved or found not to exist. Instead, early in the process focus on the material issues most important to your transaction; those that if found to exist will scuttle the deal.
At this point, you’ve developed a thorough due diligence questionnaire. You’ve focused your team on identifying and evaluating the IP rights that are most critical to the target’s products and the reason why your company wants to do the deal. You’ve worked, first, with your own team, and second, with the target’s management team to identify the categories and items of IP that are material to the transaction. You’ve executed a non-disclosure agreement that protects your technologists in their evaluation of the technology and the target’s property rights. Time to dig in.
Where do you start? One place to start is with contracts and other written agreements in the target’s files. They’re easily accessible by the target, easy to provide in electronic format, and don’t take too much of the target staff’s time.
First, collect all of the target’s inbound license agreements to determine if it is operating within the scope of use of the grant clauses. A common problem that arises with software licenses and other IP agreements is that the licensee uses the software outside the scope of the grant clause. It’s frequently inadvertent, but it’s still infringement. For example, a grant clause may allow the target to process its own data. Your investigation shows the target is processing its customers’ data, subsidiaries’ data, and other third parties’ data. That’s a red flag for breach of contract and infringement claims that may come back to haunt you in the future.
Next collect the target’s outbound license agreements to determine the rights and obligations of the target’s licensees. Determine if the target has an audit and compliance program in place. These programs are used to ensure licensees are using the IP within the scope of the grant clause. They also provide information on whether the licensee is allowing infringing activity to occur, and remitting the correct amount of fees to the target for the services provided. These programs are indicia of good management.
Second, review all inbound license agreements the target has entered into to make sure assignment is permitted. Typically it is not. You should also review the licenses for “change of control” provisions to determine whether the licenses could terminate as a result of the acquisition. It’s important to identify the consents needed from third parties under the license agreements, and secure those consents before the transaction closes.
Third, if your investigation discloses that the target company’s technologists have collaborated with another company’s technologists or university professors to develop a product, and proper documentation does not exist, then you will likely have co-ownership issues to address. Always review letters in the file from third parties that offer to license technology or allude to infringement claims. The claims in these letters can lead to substantial legal liabilities and significant business problems down the road. If you discover them, always inquire as to what the target company has done about these claims. Has it taken the claims seriously? Has it investigated the claims? Has it analyzed the merits of the claims? Has it done absolutely nothing? The target’s actions, or lack of action, offer insights into the scope of the problem.
Finally, if you remember one thing from this post remember this: Just because the target company has assured you that it owns and possesses all of the IP rights it needs to lawfully provide its goods and services to customers around world doesn’t mean those assurances are actually true. Trust but verify. If you don’t, your board is going to fire you, and frankly it should.
Finkel Law Group, with offices in San Francisco and Walnut Creek, has assisted many technology company’s and investors conduct due diligence on the intellectual property assets of a target company in an acquisition or strategic investment transaction. When you need intelligent, insightful, conscientious and cost-effective legal counsel to assist you with an intellectual property transaction or investment you may be contemplating, please contact us at (415) 252-9600, or info@finkellawgroup.com to speak with one of our attorneys about your matter.