Australia: Getting your house in order: how IP due diligence pays off

Services: Corporate & Commercial, Intellectual Property & Technology
Industry Focus: Life Sciences & Healthcare

What you need to know

  • Early stage companies spend a lot of time looking for investment, and investors and commercialisation partners are increasingly looking for targets with a competitive IP position.
  • Conducting your own due diligence in advance may not only reduce the time of a transaction, but also improve the commercial terms.
  • It's important to know what questions should form part of an IP due diligence and seek advice to help resolve material issues that are uncovered.

For many early stage and fast growth companies, the most (or only) valuable asset is their intellectual property (IP). IP encompasses various rights such as patents, trade marks, copyright, designs and trade secrets, and is often what gives a company an edge over its competitors.

If your company is seeking to attract investors or other interested third parties, such as commercialisation partners or outright buyers, it's critical to ensure your IP house is in order. Undertaking an IP due diligence review may seem a daunting exercise, but it's one that can yield significant payoffs.

What is IP due diligence?

Conducting an IP audit is a helpful first step to identify a company's key IP assets.

The purpose of an IP due diligence review is to go a step further and seek to identify, using appropriate methodology and at an appropriate cost, material issues relating to the company's IP portfolio. Such issues may include defects in the ownership, validity, scope or maintenance of an IP right.

Why conduct an IP due diligence review?

Ensuring that your company has a solid foundation will make you more attractive to those contributing funds to build the next storey, or looking to move in with you, or buy you outright.

Foster confidence

Potential investors or acquirers will engage in their own qualitative analysis of your company's IP. They will consider how it assists or burdens their business plan. The potential for any IP-related conflicts or disputes to arise will also be a key consideration. Getting your house in order before the first open inspection will help set a positive, amicable and confident tone from the outset of your engagement with an interested third party.

Get a better deal

Tidying up before an investor (or buyer) arrives is of course a sensible idea. However, it's more than a case of whether or not you make a good first impression when you open the door. If a potential investor conducts its own review and finds any material issues with your IP position, this may:

  • limit the amount of the investment
  • delay the provision of funds until issues are resolved
  • provide third party owners of IP used by your company with stronger bargaining power, if you require an assignment or licence of that third party's IP
  • discourage investment altogether.

To mitigate these risks, it's prudent to undertake your own thorough due diligence before seeking investment or acquirers. This allows you an opportunity to fix critical defects before negotiating with an investor.

Facilitate a smooth transaction

Where you have conducted your own due diligence and resolved any material issues that are uncovered, this may significantly reduce the time required for, and increase the success of, funding negotiations. It can also help streamline any due diligence the prospective investor or acquirer undertakes, because there should be no (or minimal) issues to resolve as conditions to the transaction proceeding.

The process may also identify opportunities to secure additional IP rights.

Ensure sound IP management

IP management is fundamental to any business, but particularly to a start-up company's research and development (and ultimately, its success). Conducting a due diligence provides an opportunity to review and assess IP assets themselves, as well as the management of those IP assets.

Evidence of sound IP management will also lower the perception of risk and increase investor confidence, which may encourage a larger investment from an interested third party.

What does IP due diligence entail?

There are four questions that are central to any IP due diligence review:

  1. What technologies and IP rights fall within the portfolio of intellectual assets that will be 'sold' to the interested third party (whether an investor, acquirer or licensee)?
  2. Does the company own those IP rights? If not, are the owners of those rights able to grant to the company sufficient rights to commercialise them?
  3. How likely is it that those IP rights will proceed to registration (in the case of pending applications) and are valid (in the case of granted rights)?
  4. Does the company have reasonable freedom to exercise those IP rights and to commercialise those technologies?

In answering these questions, an effective due diligence review will involve:

  • identifying the IP that the company needs to control or currently controls
  • considering the rights of third parties who have contributed IP to the company, such as licensors, grantors or funders
  • assessing licences from owners under collaboration or licensing agreements
  • considering issues that arise from any joint ownership of IP (a topic that we have previously explored in depth here)
  • reviewing the company's marketing strategy and alignment with trade mark filings (particularly with respect to 'first to file' countries)
  • considering material trade secrets and how well the company protects them.

Freedom to commercialise

Third parties may have patents or other IP rights that limit commercialisation of the company's IP (typically referred to as 'freedom to operate' issues).

Comprehensive freedom to operate searches can seem dauntingly expensive for start-up companies. However, simple searches, limited to major jurisdictions, can be undertaken which should at least identify any major stumbling blocks in those markets. The IP of known competitors and members of research teams in the relevant field can be investigated. A detailed consideration of what products the company intends to commercialise, so that searches are informed, is key. This will then set the scene for an informed risk assessment.

Once a significant round of investment is received, a portion of those funds can then be used to conduct more comprehensive searches and steer product and marketing strategy away from any problematic areas.

Further considerations

IP due diligence investigations will be most effective when IP assets are reviewed in connection with products or services being developed or supplied. A sophisticated investor will want to:

  • analyse in detail what products a company intends to commercialise to ensure IP rights (such as the scope of claims in an owned or licensed patent) permit such commercialisation
  • consider whether the IP is valued correctly (for example, is the IP actually required for a product?)

So stay a step ahead and also consider those aspects when conducting your own due diligence.

A stitch in time

A good spring clean and minor repairs are essential before putting a house on the market. While creating a good impression goes a long way, ensuring the foundations are sound, the termites are evicted and the skeletons in the closet have been removed will have a bigger impact on the eventual sale price. Making the investment in your own IP housework and repairs may bring significant rewards, which could include an investment or acquisition that puts more dollars in your pocket, sooner.

Expert advice and assistance in conducting the most effective investigations for your budget, to identify and fix any major defects prior to sale, will help you get the best deal from your investor, commercialisation partner or acquirer.

This article is intended to provide commentary and general information. It should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this article. Authors listed may not be admitted in all states and territories

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