For a technology company, the value of the business lies in its people and its ability to exploit the intellectual property rights ("IPR") it owns. Google's high-profile acquisition of Motorola Mobility for $12.5 billion last year, mainly for its portfolio of 17,000 granted patents and 6,800 patents pending, illustrates how important IPR is in the modern technology sector.
Ownership of IPR is only one part of what investors look for in a tech business. They want to know that the valuable assets lie with the business, but, more importantly, that the company's IPR is not going to be challenged. An investor will want the funds he invests to help grow the business and give him a decent return, not be swallowed by litigation costs. This is becoming more and more of a risk, as various recent disputes between big tech players like Google, Oracle, Facebook, Yahoo, Samsung and Apple demonstrate. As Joshua Walker (Chairman of Lex Machina, which compiles and analyses data on intellectual property litigation) commented in the Economist at the end of last year, "this really is the first global patent war" (Economist, 19 December 2011).
In addition, technology companies are especially at risk from the increasingly aggressive approaches taken by so-called 'patent trolls', entities which exist solely to hold patents and use the threat of litigation to extract profitable licence fees in respect of these.
In this article, Adam Kuan and Peter Dalton consider what steps a technology company reliant on key IPR should take to maximise the value of its assets and ensure that its IP portfolio is best presented to potential investors. We have assumed a company structure, although these issues would equally apply to sole trader or partnership structures.
1) Identify the IP used by the company
The first step is to identify the IPR used by the company. This may not always be as easy as it sounds, especially in the case of unregistered IPR (i.e. IPR not registered with a national registry such as the UK's Intellectual Property Office) if records have not been kept up to date.
As a guideline, the following is a (non-exhaustive) list of the IPR we might expect to a company to own:
Unregistered trade marks (including logos, commonly used branding etc.)
Know-how, confidential information and trade secrets
Domain Names (not strictly an IPR but nevertheless generally included as IPR in a corporate transactions)
Copyright, for example in:
Any other registered rights available in other jurisdictions (for example copyright registered in the US)
Database rights in databases, such as customer lists or databases licensed by the company as part of software products
In particular you should seek to identify the core asset of the company, and whether this is adequately protected by relevant IPR. For example, the company may have developed a particular piece of software which generates the majority of the company's revenue and value. Whilst investors or buyers will want to know about all of the IP owned by the company, they will be particularly concerned about the IPR protection afforded to core assets. They will want assurance that all core IP which is capable of being registered has been registered (or has pending applications for registration) in all key jurisdictions in which the company operates (or intends to operate in the future). Any challenges to the subsistence of IP in core assets, or to the validity of registered IPR, may be critical to whether the transaction goes ahead.
- You will need to be able to identify the unregistered and registered IPR used by the company;
- Core assets are particularly important and investors will want to see that these are adequately protected.
2) Establish ownership of IPR
Some IPR is likely to be owned by third parties, and licensed by the company (see section 4 below). For IPR owned by the company, investors and buyers will want to see evidence that the company is the proper owner.
a) Registered IPR
In respect of Registered IPR, it should be relatively easy to show that the company is the owner. You will need to make sure that the company is recorded as the owner of the registered IPR in all relevant national registries. In many cases it will be possible to obtain such evidence from the website of the registry in question, although in some jurisdictions the company may have to rely on a paper certificate. If IPR has previously been transferred to the company, ensure that there is a formal written agreement assigning the relevant rights and that this change of ownership is recorded in the relevant national registries.
b) Unregistered IPR
With unregistered IPR, there may be no single document which proves ownership. You will need to show a chain of ownership from the original creator of the IPR which shows that the company is now the proper owner.
You will therefore need to identify the original creator; as a general rule, work created by an employee is in the course of employment belongs to the employer, not the employee. However, a buyer or investor will often want to see contracts of employment with that employee to ensure that there is nothing contradictory in those employment contracts which could displace this presumption. Generally it is best to have a specific clause in those contracts which sets out that IPR produced during the course of the employment belongs to the employer.
This presumption does not apply to work produced by third party contractors. Here the default position is that IPR belongs to the contractor, not the party which commissioned the work. The commissioning party will often simply have a licence to use the work in question (although the terms of such a licence will not be clear). It will therefore be necessary to show that the contract of work contained a clause by which the contractor assigned all IPR in the work to the company. If you cannot show this, any buyer or investor may require the company to obtain such an assignment from the contractor.
If you have purchased or otherwise obtained unregistered IPR under an assignment from a third party, you may need to show that the assignor was the proper owner of the unregistered IPR when it was assigned to the company. Investors / buyers may be satisfied if the document assigning the IPR contained a warranty to that effect given by the assignor.
- Showing ownership of registered IPR will generally be relatively easy, as the registration documents should show ownership.
- For unregistered IPR you will need to show the IPR passed from the original creator to the company. This may involve producing contracts governing the creation of the IPR.
- IPR produced by an employee in the course of employment is owned by the employer, however in the absence of written agreement to the contrary, IPR produced by a contractor is owned by that contractor, not the party commissioning the work. These presumptions can be displaced, most often by terms in the employment or contractor contract.
3) Third party challenges
Buyers or investors will want to know the extent of any allegations that the company's IPR infringes third party rights (this includes applications to invalidate, cancel, revoke or modify registered IPR) or that the IPR is otherwise not capable of protection. They will also want to know about any infringement allegations made by the company against third parties. If the company is involved in litigation which could threaten the company's ability to use a core piece of IPR in the future, this is likely to be a serious stumbling block for any investor or buyer.
It is also likely that you will be asked to disclose what checks have been made to ensure that such risks do not exist in the immediate future. For example, were searches undertaken when trade marks were registered to ensure that there were not similar marks registered which could be used to challenge the registration. Or when entering a new market, were freedom to market searches undertaken to look for patents which might exist in that area. Registered IPR can still be challenged by pre-existing IPR holders, even if no complaint was raised when the registration was originally made; such searches and checks will help satisfy buyers / investors that the registration is secure.
Investors or buyers will want to know:
- whether there have been any allegations of IP infringement by or against the company;
- whether there have been any challenges to the validity or subsistence of the company's IPR; and
- what checks as to the existence of third party rights have been made.
You will need to consider what IPR your company licenses in from third parties. Buyers or investors will want to know that your company has valid licences to use any third party IPR which it needs. This will be especially important if your core products or services incorporate such third party IPR. If your company uses third party IPR on an informal basis, you should consider putting in place formal written licences with proper commercial terms.
Whilst some licences will be clearly marked in individual licence documents, other documents may also contain licences which are not immediately clear; for example, research and development, collaboration, trade mark co-existence agreements and IT Services Agreements could all incorporate some form of IPR licence.
You should also be aware of the terms of licences and whether they contain onerous provisions or represent areas of risk for the business of the company. For example, overly high royalty rates, uncapped indemnities given by the company, or abilities of the licensor to terminate at will and thus remove the company's right to use the subject of the licence. Buyers and investors are likely to request copies of licences, certainly in respect of core products or services, and you will need to be able to justify any questionable terms.
You will also need to be able to identify any licences of IPR which your company has given and provide copies of these. Buyers and investors will want to be sure that such licences are in the company's interests and give it adequate protection in respect of the licensee's use of the licensed IPR. As well as any formal licences, you should consider whether the company has given any informal permissions to third parties to use IPR. These may need to be formalised in written licences.
It will also be important to consider whether any licences (in or out) contain change control provisions which could be triggered by the proposed transaction; if so, these licences may need to be varied to ensure they continue after the transaction has taken place.
You will also be required to identify any material breaches of licences which have occurred or have been alleged, again either by or against the company.
- You will need to be able to identify that the company has a formal licence of any IPR needed by the business, and that such licences do not contain overly onerous terms and will not be jeopardised by the proposed transaction or by any other situation in the immediate future.
- Buyers and investors will also want to see the terms of any licences of the company's IPR to third parties, to ensure that these are on appropriate commercial terms.
5) Open Source Software
The presence of open source software (OSS) in a target company's products was once considered a potential deal breaker. This is no longer the case as OSS has become more mainstream; however, especially where the company in question is a software provider, buyers or investors will want to satisfy themselves that the use of OSS in the company or its products does not compromise the business of the company.
Questions which are likely to be asked include:
- Where the OSS originates from;
- What the OSS does;
- Where or how the OSS is being used and re-used internally or distributed externally;
- The terms of OSS licences and whether there are conditions on use; for example a requirement that any distribution includes copyright notices or attributions or (more importantly) that the source code must be made available if a derivative work is created and distributed.
In general the use of OSS is unlikely to be a major issue, especially if such OSS is licensed under permissive licences such as MIT or BSD. Where OSS is governed by restrictive licences (especially those containing 'copyleft' provisions which require source code of derivative works to be made available to the public) this is likely to be ok as long as the software in question is only used internally and is not distributed outside the company (either in isolation or as part of a wider product). However, care must be exercised where products / services containing OSS licensed under restrictive licences (such as the GPL) are distributed to third parties, where this could give rise to a risk that source code in proprietary software must be disclosed.
- Buyers and investors generally understand that it is sometimes appropriate to use OSS.
- However, you must be able to adequately document your company's use of OSS to ensure that the use does not present any risks to the company.
- In particular, investors or buyers will want to know that the company is in compliance with any OSS licences, and that no licence poses a risk to the business model (for example by imposing 'copyleft' provisions on proprietary software owned by the company which might require the source code to be disclosed).
6) Encumbrances, confidential information and competition
A buyer or investor will want to know whether any of your company's IPR is secured against lending, as this would reduce the value of that IPR to the company in the event of a sale. In the case of registered IPR, such encumbrances may be registered on the register.
You may need to show that the company has put in place adequate protections to protect its confidential information. You may also be required to provide a schedule of such information. You will also need to identify any breaches of confidentiality which have taken place or have been alleged, either by or against the company.
You may also be required to provide a schedule of obligations of confidence owed to third parties in respect of third party confidential information in the hands of the company.
Technology or software companies are often at risk of falling foul of competition law where their market share is such that they can be said to be in a dominant position. Smaller companies are not immune if the market they operate in is defined narrowly by the relevant competition regulator.
In such a situation, business practices which are deemed 'anti-competitive', such as excessive pricing, price fixing, or bundling of products, can be prohibited. Regulators can even force dominant companies to licence industry standard technology to their competitors in order to encourage competition.
You may therefore be asked to provide evidence of the company's market share in its particular market, and also evidence as to whether any competition issues have been raised in the past. Buyers or investors may also wish to scrutinise licences or agreements with third parties relating to the company's IPR, to see if these contain anti-competitive terms which could be challenged.
- You will need to identify IPR which is secured against debts; this will reduce the value of the IPR in the eyes of the investor / buyer.
- The company's confidential information is also an important IPR of the company which you will need to show is properly recorded and protected.
- If your company is in a dominant position in the market, regulators could restrict certain 'anti-competitive' business practices and even require industry standard IPR to be licensed to competitors. You will need to be able to demonstrate to a buyer or seller how likely it is that the company is in such a position, and if so whether its activities could be deemed 'anti-competitive'.
Investors or buyers will require evidence that the target company has a strategy in place for properly protecting its intellectual property assets. Whilst this likely to be especially important where the company operates in the technology or digital sectors, it is increasingly something which will be expected of all companies regardless of the sector in which they operate.
It is important therefore to be able to demonstrate at the outset of a potential transaction that IPR is being pro-actively managed, protected and enforced, with a clear view of the importance of IPR to the overall business strategy of the company. This will help to ensure that no issues with IPR are encountered down the line, and also help demonstrate that the company is well managed and potentially a good prospect for investment or purchase.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.