Mergers and Acquisitions Due Diligence: Seven Critical Steps You Can’t Afford to Overlook
The topic of Mergers and Acquisitions (M&A) has become much more important to many companies today than it has been in the past. The economy appears to be on the mend, and companies are scrambling to find ways to expand quickly. Companies are also being forced to cope with rising litigation risk because the business environment is simply more litigious.
It is not unusual for companies to hold back the acquisition offer until an IP audit is performed and cleared. The litigious nature of business today has even created a relatively new product in the insurance industry. If the company being acquired wants the acquisition offer immediately rather than waiting for clearance, they must purchase an insurance policy that shifts the risk from the acquiring company to the issuing company.
This increased litigiousness has also produced a more rigorous due diligence requirement that involves more focus on the way intelligence is gathered and the processes associated with it. The process is much more regimented than it once was, requiring companies to ask the following questions:
- What IP does the acquisition candidate own?
The acquisition candidate should provide an IP portfolio catalog. The individual patents and trademarks should then be examined to determine any potential liability, which can manifest itself in several ways.
First, you want to make sure you acquire all the Intellectual property patents when the contract is consummated. You can’t rely entirely on the portfolio list provided by the target acquisition. The proper due diligence requires you to verify that the list is complete. The only way to confirm a complete list is to use an analytics tool like Innography. This begs the question, though, “why is a complete list important?”
There are really two reasons to be concerned about the protection of intellectual property in the acquisition: exclusivity and exposure. Exclusivity is important because it has a direct bearing on the value of the acquisition. IP is essentially a technology monopoly, and the degree to which it is exclusive determines, in part, its value. Here are just a few things that you want to examine before the portfolio transfer is executed:
- International patent family members
- Continuations in part
- Patents without current assignee data
- Recently acquired patents that might have been overlooked
- Patent divestitures that are undocumented
- What geographical markets are covered in their portfolio?
It’s no secret that company valuations are complex, but a variable you can’t overlook when evaluating an acquisition target is the geographical composition of their IP portfolio. Geographical concentrations suggest future revenue sources. When technologies and processes are patented in a specific jurisdiction, products associated with that IP can be sold exclusively by you in that jurisdiction. In other words if you decide to sell in that jurisdiction you will have 100% of the market.
Understanding that a certain percentage of your IP is based in a specific region assists with segmented revenue forecasting. Combining this data with an understanding of local economic conditions can greatly increase your forecast confidence.
- How much of the IP portfolio was acquired compared to that developed internally?
One of the many things your IP portfolio represents is know-how. The inventor of the technology protected by a patent is the ultimate subject matter expert for that technology. You would typically rely on that inventor to extend the technology and to develop complementary technologies to enhance your market position in that arena.
If the acquisition target has acquired a significant amount of technology from outside the company, it is possible that there are no subject matter experts to fully exploit the IP the company holds. Even if the technology was developed internally, inventors can also leave the company. The key take-away is that you need to inventory the human resources within the acquisition target to make sure you get the greatest return on your investment.
- In emerging markets, who’s likely to be my competition?
Emerging markets tend to be risky for many reasons, and entering them makes good market intelligence a must. One of your best sources of market intelligence is your competition. You need to understand in which technologies they are investing. The initial challenge is identifying your competition.
One way to solve both problems is to determine who is investing in technologies similar to your potential acquisition for the market you want to enter. Doing so is just a starting point but as you discover potential competitors you have the opportunity to also get a more complete understanding of their technology investment strategy. This should give you clues as to where you should direct your own development resources and it will assist with revenue forecasting.
- If a contract for the current target doesn’t materialize, what is my next best acquisition candidate?
Mergers and acquisitions are typically motivated for specific reasons that go beyond the fact that the two companies seem to be a good fit. Often the candidate was discovered as a result of trying to solve some business problem or meet some business need.
Your first candidate of choice might seem initially attractive. However, as you perform your due diligence you will sometimes find that there is inadequate long term value or too much risk to enable a viable consummation. If that’s the case, you have not solved the problem or filled the business need. It is therefore sensible to have a plan for that contingency.
- What is the litigation risk if I acquire this company?
The most fundamental aspect of your due diligence is determining your exposure to litigation. Sometimes acquiring a company can put a bull’s-eye on your back. Obviously, researching past litigation in which the candidate has been involved is a useful activity, but that’s just the beginning. You need a clear understanding, for example, of whether the acquisition might actually trigger litigation.
Litigious companies sometimes target other small companies for infringement, but to wait until someone with deep pockets acquires them. It might be that a lawsuit against the small company would not be worthwhile because collecting the damages a lawsuit would yield would bankrupt the defendant. The practice of targeting companies is a growing trend, driven by non-practicing entities. Many of these companies acquire IP for the sole purpose of infringement litigation and do not produce or sell anything, instead relying solely on litigation damages for revenue.
- Are there patents on the IP landscape that might block markets I want to enter as a result of this acquisition?
A big concern of any acquisition is freedom to operate. A specific company might seem very attractive if it has product you need because it will enable your entry into a desirable market. If that is an objective of the acquisition it is important to minimize the probability that another company might block your entry with an infringement claim.
As part of your due diligence you should understand before the acquisition is consummated whether that is a possibility. If so, you must determine whether the claim is likely to prevail and have a contingency plan to thwart the claim if you decide that the exposure is minimal enough to proceed.