Not being prepared for intellectual property due diligence puts any financing event at risk. But, by acting proactively, you can mitigate this risk and use diligence as an opportunity to present a positive narrative about the company that makes it more attractive to investors. You can prepare by understanding and addressing these three paramount questions investors will ask in IP due diligence:
1. Does The Company Own Or Control All Of Its Proprietary Technology?
Much of the value of a technology company lies in its proprietary technology. But, if a company doesn’t have control over that technology, its value evaporates.
The CEO of an early-stage biotech company had invented the company’s core technology. The company filed patent applications on the inventions and then completed a series A venture round. A few months later, the investors were contacted by CEO’s previous employer. It turned out that the CEO had invented the technology while still an employee of the previous employer, and was obligated to assign the inventions. The biotech company had to give back all the patents, return what was left of the investment to the investors stores and shut its doors. If the biotech's counsel had done diligence on the biotech, they would have discovered this fact and, possibly, struck a deal with the previous employer for an exclusive license to the technology.
What you should do:
Determine whether inventors have an obligation to assign their inventions to a third-party.Make sure that all employees have signed employment agreements assigning their inventions to the company.Make sure all inventors have actually executed assignments of their inventions to the company.Confirm that all exclusive patent licenses the company has are valid and in force.Identify any encumbrances, such as liens on the company’s patents.
2. Does The Company’s IP Give It A Competitive Advantage In The Market?
The primary value of the patent portfolio lies in its ability to exclude competitors from its market. If a patent portfolio does not meaningfully exclude competitors, it has very little value.
A small pharma company filed a patent on a method of formulating a drug that significantly improved drug delivery. However, in production, they modified the method slightly so that it was no longer covered by the patent. During diligence, the investors’ attorneys pointed this out. The company responded, “We can change the method back so that it’s covered by the patent.” "Yes," the attorneys responded, "but any competitor can use the modified method not covered by the patent."
What you should do:
Identify all technology aspects of your product from start to finish. This includes, features of the product itself, components used with the product, such as kits, methods of making the product and methods of using the product and complements to be used with a product.Map your existing patent claims to each of these technological aspects.Wherever you find holes in coverage, get claims on file to fill these holes, either by filing claims in existing patents, filing new patents or acquiring rights to third-party patents.Develop a narrative explaining how your patent portfolio excludes competitors from the technology that gives your products the greatest value.
3. Does The Company Have Freedom To Operate?
Confirming freedom to operate is the most important aspect of diligence: If you don’t have a patent you will have competitors in your market; if you don’t have freedom to operate, you are not in the market.
A small biotech company was the acquisition target of a much larger company. During IP diligence the prospective acquirer identified an issued patent they believed posed a freedom-to-operate concern. The small biotech hadn’t known about this patent. Its explanation of non-infringement, made under the time pressure of the deal, did not satisfy the acquirer. The acquirer made the acquisition contingent upon the small biotech’s obtaining a license under the patent.
What you should do:
Perform a thorough freedom to operate analysis long before diligence is likely to commence.For patents posing potential problems, determine whether the best course of action is to: (a) obtain a non-infringement/invalidity opinion of counsel, (b) obtain a license under the patent or (c) prepare for litigation. The choice will depend on your appetite for risk and the litigiousness of the patent owner.In any case, do not subscribe to the theory that you’re better off not learning about problematic patents. If you identify such a patent early, you can take action to neutralize it or, at least, avoid enhanced damages for willful infringement. But, if you don’t know about such a patent, you’re walking blind.
By preparing for IP diligence in advance you arm yourself with the ability to overcome concerns that may inhibit an investor or an acquirer from doing the deal. Be proactive. Do diligence on yourself before due diligence is done on you.