How Intellectual Property (IP) Affects Your Exit Valuations

When a company deals with innovative products, services or business models, its intrinsic knowledge is highly valued. Intellectual property rights (IPR or IP) is the intangible assets of a company for how they do things differently to others, and why that works better from a financial standpoint. The term IP was coined to summarise this complex abstract concept.

Intellectual Property came to be a highly regulated legal area which uses patents, trademarks and copyright laws to turn this intangible knowledge into something which can be defined. Yet there are many other intangible assets which are much harder to define, e.g. “know-how” (kind of like the “secret sauce” recipe), software code, and of course “goodwill”.

When a company is IP savvy, it brings them a competitive advantage. Naturally, understanding and diligencing the IP becomes a focus for an acquirer.

IP can make or break a company exit. As reported by Wired, just ahead of Twitter being listed on the NYSE, IBM contested “at least three” of its own patents being used by the social network. This resulted in Twitter purchasing 900 IBM patents for an estimated $36m just months later, showing just how much the looming prospect of a patent lawsuit can discourage investors.

How does IP impact business valuation in an exit?

Regardless of which type of exit you are undergoing, having an adequate IP strategy in place is essential to:

• reassure the buyer that there are robust protections in place to minimise threats and challenges;
• boost your company valuation by materialising the abstract value of your knowledge, innovations and systems; and
• create new revenue streams relying on IP – for example through licensing.

An ongoing patent or trademark infringement allegation from a third party could mean, in the best of cases, that the acquirer will want to lower your valuation as a means of insurance, but it’s not uncommon for buyers to require settlement as a closing condition or to back out of the deal altogether.

Some of the most common scenarios that involve neglected IPRs unexpectedly backfiring during an exit include:

• Software companies having dependencies on open source code, which based on the specific licences may leave it open for exploitation by competitors or even hackers;
• Key domain names, trademarks or other IPRs registered in the name of the Founder, or in the case of code or marketing assets with freelancers or agencies who authored the copyright or code;
• A critical piece of tech IP being licensed from an academic institution under an agreement that requires its express permission in order to be assigned to a new owner.

Another important aspect to keep in mind is how much of your company’s IPRs are held by your key employees, for example know-how or client relationships.. This is extremely relevant for companies operating in creative industries like fashion or media, but also for tech businesses relying on brilliant scientific minds for their R&D.

Because of this, your IP strategy during an exit is often intertwined with your retention and incentivisation plans for key people.

How to successfully prepare a strategy ahead of an exit?

While it is considered best practice to start thinking about your IP strategy as soon as your company starts developing valuable intellectual property, it becomes mandatory to be in control of the relevant patents, trademarks and other IP assets ahead of due diligence, to avoid any unpleasant surprises.

Below are some of the key steps to take to sort out your IP ahead of an exit:

1. Systematically index all of your Intellectual Property in a single file, ideally with a handy dashboard that allows each asset to be easily reviewed and valued, speeding up due diligence and gives the buying-side confidence;
2. Make sure the relevant documents proving ownership and licences are also indexed and easy to browse;
3. Ensure that all licensed and registered IP is up to date with no fees outstanding;
4. Carry out an active review of third-party dependencies, with a critical eye on licence agreements, being ready to address any possible concern upfront;
5. Consider taking advice on future IP strategy and options. Even if you don’t or can’t take action immediately, showing it in your future plans shows a potential buyer that you are diligent and place high value on IPR planning;
6. Have deep knowledge of your IP portfolio, and possibly appoint a dedicated figure within the M&A negotiation team to handle and discuss the position and valuation of each asset.

Because each of these points takes time – this is especially true for so-called knowledge intensive companies – it is never too soon to start thinking about your IP strategy and how that is going to affect your exit. Getting advice from an IP lawyer with exit experience will help you highlight possible weak points of your strategy and help you strengthen your portfolio, boosting your exit valuation.