Foreword by Andrew Chilvers
For ambitious companies eager to expand into overseas markets, often the
conventional route of organic business development is simply not fast enough. The other option to invest in or buy a business outright is far quicker but often fraught with unforeseen dangers. And even the biggest, most experienced players can get it badly wrong if they go into an M&A with their eyes wide shut.
If you search for good and bad M&As online the Daimler-Benz merger/acquisition with Chrysler back in 1998 is generally at the top of most search engines on how NOT to undertake a big international merger. Despite carrying out all the necessary financial and legal measures to ensure a relatively smooth deal, the merger quickly unravelled because of cultural and organisational differences. Something that neither side had foreseen when both parties had first sat down at the negotiating table.
These days the failed merger of the two car manufacturers is held up as a classic example of the failure of two distinctly different corporate cultures. Daimler-Benz was typically German; reliably conservative, efficient, and safe, while Chrysler was typically American; known to be daring, diverse and creative. Daimler-Benz was hierarchical and authoritarian with a distinct chain of command, while Chrysler was egalitarian and advocated a dynamic team approach. One company put its value in tradition and quality, while the other with innovative designs and competitive pricing.
Questions answered by Karin Klempp Franco of Barcellos Tucunduva Advogados
What is your best practice approach to IP due diligence as part of the deal making process? E.g. Schedule of IP and establishment of transferable ownership rights?
Intellectual property can dramatically increase the value of a company and turn a medium-sized company into a leader. In certain circumstances, the IP itself is the reason for a
deal, for example when the target has built a reputation or developed a cutting-edge technology. Hence, there is no doubt about the importance of identifying the main intangible assets of the target company and if they are sufficiently protected.
The scope of an IP-oriented due diligence must include information related to the target’s IP according to a checklist prepared by the support office. This includes a schedule of registered and pending trademarks and patents, copyrights, software and algorithms, if there are any existing IP license agreements and supporting assignment documentation, and lists of registered domain names and relevant unprotected know-how and trade secrets, among others depending on the company’s core business.
Understanding the core business and technology employed for its activities is paramount for the IP due diligence. The due diligence team must analyse the information and documentation provided and conduct additional checks and searches as applicable to ensure the information is complete. It is important to establish sufficient evidence of ownership of IP, which may be tricky for long-acquired rights and for technology initially developed by one of the shareholders that was incorporated in the company´s business, for example. The search in a due diligence is for risks and threats to IP ownership, use and enforceability. The report compiles the risks that may be found, as well as mitigation and asset management suggestions, like the execution of IP assignment instruments, non-compete agreements and royalty-free license agreements recognising a factual situation. Losing the registration of a trademark or patent, or the right to use certain technology can make a business unfeasible and end a buyer or investor’s interest in a target company.
Which methods of valuing patents, trademarks or trade secrets are most common in an M&A deal in your jurisdiction (e.g. cost, value or market approaches)? Any examples?
Despite the practical difficulty in valuing intangible assets due to the range of variables affecting their worth, there are some common strategies in Brazil for their valuation to lessen future uncertainty and the discrepancy of results. The main methodologies used for Brazilian deals are based on expected income, market value and/or costs for development. In income-based methodologies, the asset value is a function of how much the rightsholder could reasonably expect to receive upon licensing the IP to a third party, on the profit necessary to attract an investor, on the capitalisation of future profit flow premiums attributable to IP or on the profits earned by the use of the IP itself. When based on market value, the methodologies use the profits derived from exploitation of the IP or its expected turnover in certain market conditions. Finally, the cost-based valuation methodologies start from an estimate of the amounts and resources invested in the development of the asset. There is, however, no one correct or preferred methodology. The choice relies on the parameters used by the company to calculate the values of its assets, context and specificities of the case at hand, which may deem one or more bases for valuation more adequate than others. Other than that, in Brazil it is very likely for market researchers, analysts and rankings to base their conclusions on information of profitability of the company and the contribution of certain intangible asset to these numbers (i.e. income-based methodologies). For example, according to the Brazilian version of the BrandZ ranking, the most valuable Brazilian brand is “Itaú” (finance), currently valued at US$8.2 billion, according to Kantar based on Bloomberg data.
What warranties and indemnities do you recommend putting in place to ensure IP value is fully preserved?
Other than due diligence accompanied by specialised lawyers to validate the IP information sent by the target company, it is important to accommodate the risks of the deal through appropriate documentation. Representations and statements of responsibility of the target company on the lawfulness of the IP, its validity and absence of disputes regarding ownership is a must-have. The company should also be queried to signoff registered IP rights, such as trademarks and patents, in a separate document to expedite annotation of the assignment at the Brazilian Patent and Trademark Office to the acquiring company. The company and their shareholders, if feasible, or owners should also be bound to specific duties to compensate the new rightsholders in case of a dispute arising for ownership of rights or a suit to invalidate their registration, as well as any other risks found out during the due diligence. Non-compete, non-solicitation and specific confidentiality duties may also be helpful to ensure the protection of the value of intangible assets, especially when dealing with know-how and trade secrets.
Top Tips – To accurately establish IP ownership proces
– Know which IP is subject to protection through a registration process (patents and trademarks), through secrecy (trade secrets), or upon simple creation and use (copyrights and trade dress).
– Clearly establish the chain of assignment of rights from the developer(s) all the way through the present rightsholder since most kinds of IP require written agreements and annotations for full effect of the assignment.
– Keep in mind that written agreements are needed for a company to fully own the copyrightable works of their employees, even if the creation of copyrightable works is included in their job description.
– Be active in the protection of the trademark and patent portfolios, registering all appropriate variations of the trademarks for all applicable goods and services, and all relevant additions to patented inventions.
– Keep trade secrets confidential and use nondisclosure agreements, clear labeling of confidentiality and adopt information security best practices.