Intellectual Property (‘IP’) and Mergers and Acquisitions (‘M&A’) have conventionally been two distinct areas of law, seemingly in water-tight compartments. However, with the advent of today’s ‘idea economy’, the importance of IP in commerce and its contribution towards the economic viability of businesses has seen a sharp rise.
In the present times, businesses value IP as much as, if not more than, tangible assets. Investing in IP rights has become not only lucrative investment opportunity, but has also proven to change the commercial fate of the companies.
M&A is a tool for reconstruction of companies, aimed at maximisation of their wealth and market reach. Mergers refers to when two or more companies come together to form a single company. Acquisition refers to takeover of one company by another through purchasing its majority ownership.
M&A aids companies to pool their resources, consolidate their businesses and expand their playing fields in the market. On the other hand, IP is an umbrella term for a gamut of exclusive rights over intangible properties, including patents, trademarks, copyrights, geographical indications and appellation of origin, design rights, protection of plant varieties, traditional knowledge, and trade secrets. These are types of protection that the law grants over different subject-matters.
Each type of IP comes with its own set of rights which can be exploited only by the owner of such IP. Essentially, every IP creates a monopoly over commercial use of the subject matter over which the IP right has been granted, and restricts any other person or entity to make such commercial use without the IP owner’s authorisation. This ‘monopoly over commercial use’ has immense economic significance attached to it.
The intersection between IP and M&A comes from the fact that today, every business holds some form of IP, whether registered or not. Therefore, every M&A transaction necessarily involves a transaction of some form of IP.
IMPORTANCE OF IP IN M&A
The significance of IP in M&A transactions can be ascertained by the benefits of acquiring IP.
IP assets in M&A add value to the asset portfolio of the acquiring company. In today’s rapidly transforming and volatile markets, it is not possible to keep coming up with new innovations and generate a consumer base for such new innovations.
Thus, acquiring IP assets not only help companies to own existing innovations and invest into new opportunities, but also enhances the valuation of the acquiring company by increasing the value of its assets.
As previously discussed, IP rights create monopoly. This monopoly has economic significance because of the competitive edge it gives to the IP owner over other players in the market for similar goods and services. This competitive edge and monopoly help the companies to establish a dominant position in the market.
M&A can be an excellent tool to facilitate technology transfer between companies. The cost of innovation and research and development (R&D) is soaring, and investing in a particular technology or its development may not be economically viable to a company.
Through transfer of technology in M&A, the companies can utilise each other’s IP rights in order to exploit them in the most efficient and effective manner, without having to invest in the development of such IP.
Sectoral, Geographical, and Demographical Diversification
M&A opens doors to different market sectors, geographical areas and demographics to the companies involved. The IP of one company which operates in one market sector is made accessible to the other company in another market as well. It is easier to gain foothold through pre-established resources as the cost of operation and initial barriers to enter the market or sector are reduced to a great extent.
Acquiring an IP asset in an M&A transaction helps in the company’s growth by infusion of new and competent technology, ensuring that the company’s asset portfolio is in line with current market demands. Further, IP assets also create cash flow through royalty, licensing and assignment arrangements with third parties.
PROCESS OF ACQUIRING IP ASSETS
The process of acquiring IP assets in an M&A transaction comprises of three major stages: identification and taking stock of relevant IPs, valuation and due diligence of the identified IPs, and recording of the change in ownership with the concerned IP authority. These stages are described in detail in the subsequent paragraphs.
Stage I: Identification and taking stock of relevant IPs
This is the preparatory stage of any M&A transaction which includes transfer of any form of IP. In this stage, the acquirer identifies and lists all the relevant IPs held by the acquiree, and decides which of the IPs will form a part of the M&A transaction. This is important because not all the IPs owned by the acquiree are significant for and in line with the objectives of the acquirer.
At this stage, it is also crucial to take note of the legal owner of the IP in the register of the concerned IP authority, and whether the IP has been licensed to any third party. In cases where an IP is held by a group of companies, it is also necessary to identify the actual owner of the IP in intra-group inventories.
There may also be an arrangement where one company is the legal owner of the IP, but it shares profits derived from that IP with another company in lieu of the latter’s contribution at the development stage.
For a successful M&A transaction and proper valuation at a later stage, the identification, description, categorisation, and listing of relevant IPs at the beginning is of utmost importance.
Stage II: Valuation and due diligence
This stage essentially comprises of listing the identified IP’s known and documented encumbrances and potential legal risks in order to arrive at a monetary valuation. This provides critical information regarding the economic viability of the M&A and serves as an indicator of the level of current and future use of the IP.
The monetary value of any IP can only be estimated based on a number of factors as it is volatile and dependent on “the present value of the future economic benefits or losses that can be reasonably anticipated to accrue to the owner.”
Valuation of any IP has to be done from a multi-disciplinary perspective as it involves economics, commerce, law, accounting, investment, finance, consumer and market studies. The three most commonly used methods of valuation of IP are:
1. Market-based Valuation: In this method, the valuation of an IP is ascertained by looking at the market price of a comparable IP. However, this method comes with its own set of difficulties as it is not always necessary that an IP has a comparable IP in the market, especially in case of patents.
Additionally, even if there is a comparable IP, its value in the market is likely to be distorted by the presence of the IP sought to be acquired.
2. Cost-based Valuation: In this method, the valuation of an IP is determined by the cost of its creation or the cost which would be incurred to replace it. But this method, although comparatively easier, disregards time value of money, maintenance costs, and opportunity cost.
Further, the purpose of valuation and due diligence is to quantify the remaining useful life of the IP, and this method uses only historic costs to come to a valuation.
3. Discounted Cash Flow: This method assigns value based on estimates of future economic benefits that can be derived from the IP. It analyses capitalisation of historic profits, gross profit differential methods, excess profits methods, and the relief from royalty.
This is regarded as the most accurate method of valuation and is hence, the most widely used one.
Regardless of which of the aforementioned methods is used for valuation, it is important to take into account factors such as:
- The type of IP asset: whether it is a trademark, patent, design, copyright etc.
- Status of the IP asset: whether it is registered, licensed, applied for registration etc.
- Ownership of the IP asset: whether the acquiree company holds sole ownership over the IP, or is it jointly owned.
- Third party interests in the IP asset: whether there are any infringement issues, tax considerations, unpaid maintenance fees etc.
- Geographical and demographical use of the IP asset: whether the IP asset targets only a specific demographic, has limited market access in terms of territory, registration only in certain territories etc.
- Past and potential violations of antitrust laws, both domestic and international.
- Impact of foreign laws on the use and transfer of IP asset: whether there are any jurisdictional issues, registration is conditional upon usage only in specified territory etc.
After the IP has been valued, and a purchase price has been agreed between the companies, the actual transfer begins. Here, it is important to specifically mention IP Assets in the M&A Agreement, as the ‘Assets Sale’ clause does not generally include the sale of intangible assets. If not, the IP can also be transferred via a separate agreement.
Stage III: Recording of change in ownership with authorities
Once the IP asset is transferred to the acquiring company, it is mandatory to record the change in ownership with the relevant IP authorities. For instance, if a trademark registered in India has been transferred, the details of the new owner have to be registered with the Trade Marks Registry. The recording of change in ownership should be done with the authorities of all the acquired IPs and across all jurisdictions.
IP ISSUES INVOLVED IN M&A TRANSACTIONS
M&A transactions are complicated, regardless of whether any IP transfer is involved or not. However, transfer of IP in an M&A transaction adds to its complexity and brings a host of issues of its own. Few major and common issues have been identified below.
Identification and taking stock of unregistered IP
While identifying and taking stock of IPs in Stage I of the process for acquiring IP asset, difficulty may arise with respect to unregistered IPs. For example, trademarks, although a statutory right, is not always registered, and therefore, as remedy for their unauthorised use and infringement, the action of passing off is available under common law.
Trade secrets are another form of IP which do not, and in a lot of jurisdictions cannot, be registered under any IP statute. In an M&A transaction, it becomes very difficult to ascertain the valuation of these IPs due to the difficulty in their identification.
Jointly owned IP
In many cases, the IP asset is jointly owned by two or more persons or entities. For instance, an IP asset may be jointly owned by two or more companies which pooled their resources for research and development, or between the Government and a private entity.
In these scenarios, it is important to understand whether the joint owner has the right to unilaterally transfer the entire ownership over the IP, or is he/she entitled to transfer only his/her part ownership without the consent of the other joint owner. In any case, joint ownership necessarily involves another party into the transaction, making it more complex to negotiate the purchase price and demarcate rights and liabilities.
Third-party claims and interests
Any pending or potential litigation, and subsisting licenses and assignments related to the IP add a layer of complication in the M&A transaction. Legal disputes are uncertain in terms of outcome and pendency, hence, an M&A transaction involving transfer of a disputed IP asset must be undertaken with a greater degree of caution.
It is imperative to take any such third party claims or potential disputes into account while valuation and ascertainment of the purchase price. On similar lines, if the IP asset has been licensed or assigned to a third party, and the same is subsisting when the M&A transaction is underway, the future of such assignment or license after the M&A should be determined before transferring the IP.
Risk of public disclosure
In certain forms of IPs, such as trade secrets, non-patented inventions, patent-pending inventions etc., secrecy of the information is crucial. If details of such forms of IP are disclosed publicly, the commercial value of the IP asset may tank to zero. Hence, in an M&A transaction involving confidential information pertaining to IPs, greater degree of caution is required to ensure continued confidentiality.
IP laws, although modeled around the TRIPS Agreement, vary from jurisdiction to jurisdiction. After any M&A, the acquiring company normally uses or plans to make use of the IP asset in a different jurisdictions. Here, the asset may be subject to conflicting IP laws. For instance, the disparity in the standards of originality for copyright may lead to issues such as invalidation or refusal of copyright registration.
Hence, the acquiring company must look into such aspects in an M&A transaction, particularly while dealing with unregistered IP. Another way of avoiding jurisdictional issues is to record change in ownership with the concerned IP authorities of the relevant jurisdictions as soon as the transfer of IP takes place.
Possible conflict with anti-trust laws
In many jurisdictions, IP laws and anti-trust laws are seen as contradictory to each other. Additionally, IP law of one jurisdiction may be in contravention of the anti-trust law of another jurisdiction. If the acquiring company plans to make use of the IP asset across several jurisdictions, it must ensure the compatibility of IP laws and anti-trust laws in all those jurisdictions.
Additionally, many national anti-trust laws prohibit horizonal agreements, or look at horizontal agreements with greater stringency. This is likely to lead to legal issues where the M&A transaction is a horizontal agreement which enhances the market domination of the companies involved through transfer of IP.
Unsound valuation and due diligence
As previously discussed, valuation and due diligence of an IP asset is a complicated exercise, but forms the core of an M&A transaction involving transfer of IP. It is important to not only rely on historical information, but due importance should be given to the future potential of cash flows which can be generated by use of the IP asset.
If valuation and due diligence is not carried out properly, the acquiring firm may end up paying an inflated purchase price for the IP asset, or get itself involved in tedious and expensive IP disputes.
With the increasing awareness of IP protection globally, the involvement of IP in M&A transactions is also likely to increase. The world economy today runs on ideas and innovations, and hence, corporate laws and IP laws are bound to interact and overlap in the commercial and economic space.
The involvement of an IP asset in an M&A transaction increases its complexity, but it also comes with immense economic opportunity for the acquiring firm. In order to fulfil the objective of the transaction and for it to be economically viable, it is important to take into account the issues raised due to involvement of IP assets.
The soul of such an M&A transaction is in accurate valuation and due diligence of the IP asset. That alone is the solution for most of the potential problems that may arise with respect to transfer of ownership of the IP asset.
–Team AMLEGALS assisted by Ms. Gazal Sancheti
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