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.
Mark Millward and Eliza Low discussed The Art of Deal Making: Using External Expertise Effectively as part of the IP chapter.
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?
It is essential to ensure the deal team engages specialist IP counsel at the earliest opportunity. In many instances IP rights underpin the target’s business operations. For example, in the production of consumable goods, brand/trademarks are the lynchpin for successful sales, technology companies rely on copyright to protect their source code and manufacturing companies often rely on the monopoly afforded by patents.
Once the nature of the business and the jurisdictions it operates in have been identified it is advisable to create a schedule of all IP owned or licensed to or from the business that allows it to operate effectively. The structure of the schedule generally focuses on the most significant IP first.
The schedule should contain at least:
• Description of IP owned
• Details of IP licensed to or from a third party
• For registrable IP, such as a trademark, details of the registration or application number, relevant dates and jurisdiction
• For non-registrable IP, such as copyright, a detailed description of the asset (such details cannot be obtained from public registers)
Where “licensed” IP has been identified, further due diligence is required. Often the licence agreement terms can obstruct the sale. The licence agreement may prohibit transfer of the licence or termination rights may exist in the event of the sale. The purchaser should also be mindful of the duration of the licence and that the description of the IP is accurate.
For technology companies, in particular, copyright is the key protection for valuable source and object code. Where the target asserts ownership of copyright, due diligence should confirm that code has been developed by employees rather than third party providers. In the latter case, verification will be required to ensure that express written assignments of copyright are in place.
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?
In the context of an arm’s length M&A transaction, the purchaser will most likely focus on two financial components.
The purchaser’s advisors will scrutinise the balance sheet from a finance and accounting perspective. IP needs to be capitalised appropriately and in the case of intangible assets, businesses in Australia may attribute separate values for “identifiable” assets such as patents, copyright and trademarks and “non-identifiable” assets such as goodwill. The financial, accounting and tax specialists to the M&A transaction will consider the notes to the accounts to understand the valuation methodology that has been applied (such as acquisition cost or market value). In this context they will normally consider whether the valuation methodology applied is in accordance with the Australian Accounting Standards Board recommendations and other relevant authorities including the Australian Tax Authority and the Australian Securities and Investments Commission. This analysis will not involve the lawyers assisting in the transaction.
From a commercial perspective, the IP’s value is driven by the market, i.e. what does the market think the relevant asset is worth. The arm’s length purchaser attributes a value that it is willing to pay for the relevant IP. Whilst the balance sheet is relevant in the context of the transaction, the purchaser is unlikely to be guided or bound by it. Instead, the purchaser will make a calculated commercial decision on how significant the IP is in the context of the relevant business being acquired. For example, in respect of registrable rights such as patents and trademarks, the purchaser will consider how long the monopoly protection will last for and thus what its value is from a commercial perspective.
What warranties and indemnities do you recommend putting in place to ensure IP value is fully preserved?
The preservation of IP value post-completion is supported by the warranties and indemnities contained in the transaction agreement. The purchaser should be mindful that the seller will initially present minimal assurances to the purchaser. From the purchaser’s perspective, extensive warranties and indemnities should be sought.
The following warranties are recommended but will need to be tailored to the transaction and the nature of the business. Often greater protection is required for a business sale:
• The schedule of IP sets out accurate details of all IP owned or used in conducting the business
• The purchaser will acquire all legally effective IP rights necessary to conduct the business
• The IP does not infringe any third party rights and to the seller’s knowledge, no third party is infringing the IP used in conducting the business
• All IP is either owned or appropriately licensed
• The IP owned is not the subject of any security interests
• For registrable IP applications (e.g trademarks), no ‘objections’ have been raised by the examiner/third party
• For unregistered rights, such as copyright, which has been developed by the target, that the IP has either been created by employees of the company or developed by a third party but effectively assigned
• There is no dispute “on foot” in respect of any IP
• Where IP is not owned by the seller there are appropriate licences in place which will survive completion
• No IP has been licensed to third parties other than in the ordinary course of business.
It is open for the parties to agree whether a seller provides a general indemnity to a purchaser for any breach of warranty, otherwise, indemnities are typically only included to deal with specific issues identified as part of the due diligence process.
Top Tips – To Accurately Establish IP Ownership Process
• In respect of registrable rights such as patents and trademarks, implement independent verification of ownership of those rights by undertaking relevant “searches” of ownership/title and registration details (registration number, jurisdiction and duration of the registration/monopoly) with the relevant intellectual property governance authority such as IP Australia.
• In respect of non-registrable rights, such as copyright, which have previously been acquired by the target company, ensure that such rights have been successfully transferred and documented. Verify contracts to ensure there is an effective assignment which is compliant with law and accurately and comprehensively describes the IP.
• Verify that IP developed by the target company has either been created by employees of the company or, where developed by consultants or other third parties, that an adequate assignment/ transfer agreement is in place.
• Seek warranties/assurances of ownership from the seller as part of the sales transaction agreements.