IP's Impact on M&A and Corporate Values

According to a survey by the Mergermarket Group in late 2008, “more than half of corporate and private equity executives believe intellectual property will become a more important factor in M&A deals during the next five years.” With the economic downturn, competition in the marketplace has only stiffened as companies struggle to ease the minds of shareholders and consumers. Following high-cost settlements and royalty payouts over the past few years, intellectual property portfolios have proven to be an invaluable asset to companies across industries.

Here, Susan Perng Pan, Washington, DC-based patent attorney and partner of the intellectual property firm SUGHRUE MION, PLLC, discusses best practices and strategies for in-house counsel to assess, protect, and evaluate the worth of their portfolios, both domestically and globally. Ms. Pan focuses her practice on preparing and prosecuting patent applications before the U.S. Patent and Trademark Office, and represents U.S. and international clients, with a special focus on Asia.

Q.: According to the Mergermarket Group, intellectual property (IP) portfolios are becoming a major contributing factor to the success of a merger & acquisition. Why do you think companies are now starting to pay attention to IP portfolios as part of their larger business decisions?

A.: For a long time, the vast majority of a company's value stemmed from its intangible assets, rather than its tangible holdings. However, it was only recently that the valuation of intangibles, patents in particular, started becoming demystified. Further, of a company's intangible assets, intellectual property is likely to be the most concrete, since it usually includes a government-backed document such as a patent or a trademark registration.

With the continued increase in technology-driven businesses, patents have clearly assumed characteristics of assets, which can be flexibly sold or licensed as a form of capital to further business ventures, to create a revenue stream or to serve as “collateral” for smaller companies seeking financial backing. This would account for the higher recent visibility of patent portfolios in M&A deals.

A number of valuation tools have cropped up in the past few years to attempt to put a dollar figure on a patent portfolio. However, even with traditional accounting methods and new valuation methodologies specific to patents, patent portfolio valuation remains difficult. For example, 85% of corporations view IP assets as having equal or greater importance than other corporate assets in M&A deals. Despite the acknowledged importance of IP assets, only 32% of corporations investigated IP value in depth before completing such transactions.

Q.: How can a company's IP portfolio ' or lack thereof ' impact a company's overall value? How are they evaluated?

A.: Without at least a rudimentary patent portfolio to protect its inventions and innovations, a company is at the whim of competitors and copycats as soon it enters the marketplace. The value of a patent portfolio accrues to the patent holder in multiple forms. Traditionally, patents confer the right to exclude others from operating in the market area that is covered by one or more patent claims, thus providing a legal monopoly. In this regard, the patent further entitles its owner to recover monetary damages from anyone who uses the technical subject matter covered by the patent claim without authorization. As a strategic tool, a patent operates as a counter measure to barter for market entry and co-existence with other patent holders who would otherwise seek to exclude the patentee from the market.

Because a patent can serve as the source of a licensing revenue stream or accord a company limited monopoly status, a rudimentary value can be placed on patent assets. As with all assets, the values rise and fall with the economic tide. Traditional valuation tools include: 1) the 25% method, which assigns approximately 25% of a company's operating profits to its patent holdings; 2) the income method, which evaluates a patent as a present value of a future income stream; 3) the market method, which evaluates patents relative to similar patents; and 4) the cost method, which assigns values as the cost of designing alternatives for patented technology. However, the unique character of patents and other IP renders standard application of these valuation tools extremely difficult.

New valuation tools geared specifically to set a value on large portfolios take into account basic information of the patent. This may include the number of times that a particular patent (or patents) is externally referenced in the general body of patent literature. Some valuations models analyze the word count in claims of the patent, because the claims actually set the legal boundary of protection. Such word-count valuations are premised on the concept that a claim with fewer words is less restrictive and thus more valuable. Even assuming that any statistical correlations can be derived from these newer evaluation tools, such analyses simply cannot be a sole or even primary indicator of patent value. For example, if a claim includes even a single word that excludes a significant portion of what is being practiced in the marketplace, then that claim is not commercially viable even if it is otherwise expressed with great economy in language. On the other hand, special forms of patent claiming actually would accord higher value to claim scope if the claim has more words. Nevertheless, these new valuation tools do have their place, especially those that have demonstrated strong statistical showing between the quantitative characteristics that they monitor and historic financial performance of the patent holder.

Traditional valuation tools in conjunction with a statistical tool together help form a comprehensive picture of the value to place on a portfolio.

Q.: What are the top challenges in evaluating a portfolio's value? What key factors do in-house counsel need to look for?

A.: Even as patents, along with other intangible assets, become reported as financial entries, it is important to remain cognizant of the patent as a form of technical estate, its value being determined by legal boundaries.

Individual value assessment for patent claim in any sizeable portfolio, including a liability determination and revenue stream, is impossible. The value of a patent thus lies largely in its potential. If due care is not taken to preserve that potential while prosecuting the patent in the U.S. patent office, the patent's value easily becomes deflated. When a patent application is originally filed, the applicant may have attempted to claim a large piece of a technical estate. The U.S. patent examiner will attempt to force to the patent applicant to accept a narrower set of rights. An unwitting patent applicant may make representations or modify the application to exclude a particular technical sector, leaving only a portion of the original claim intact. Though it sounds counter-intuitive, the best strategy before the U.S. Patent Office is to avoid touting the benefits of the invention and to focus on the procedural errors of the U.S. Patent Office in refusing to grant a patent. If at all possible, it is also important to resist narrowing of the original patent claims due to legal precedents that tend to penalize such activity.

Q.: Are there additional challenges in evaluating the value of a portfolio during M&A negotiations with a foreign company?

A.: Each country has its own requirements for patenting technology and enforcement of those patents. Therefore, where clear liability attaches in one country, this may not be so clear in another jurisdiction. As a result, the accounting methods and metrics that apply to patent valuation in the U.S. may have less relevance for the patent holdings in a foreign country. The pertinent experts should be consulted in each country where a company holds any sizeable patent portfolio. In addition, repatriation of money from foreign countries may also affect the value of a portfolio, even if liability or valuation in that foreign jurisdiction is clear.

Q.: What can in-house counsel do now to bolster and protect their portfolios in preparation for future M&A deals?

A.: A sound strategy would be to identify a small number of patents in a group that are deemed to be of the greatest commercial value, at least in the short term. In this group, evaluate the strength of the patent against market products. This will help set a baseline of the value of the portfolio as linked to current market conditions.

Next, evaluate patents of the group that appear to fall around the edges of the above “core” group, and which are “improvement” technologies over the core group. A dense patchwork of protection over improvement technologies will help provide a basis for future revenues. Such improvement patents should be spaced appropriately over time to afford the maximum benefit.

The overall portfolio can become weakened when the basic technology is held by the corporation, but all the improvement patents are held by third parties or by competitors. The lack of holdings in the improvements area may signal a corporation's lack of commitment to that particular technology. Moreover, significant third-party holdings of improvement patents will decrease the company's leverage at the negotiating table.

Q.: What key strategies can in-house counsel implement to avoid a lapse in IP coverage for those companies with large portfolios?

A.: Never overlook the administrative components. These include verification of proper ownership of the patents by necessary assignment documents, timely payment of patent office maintenance fees, verification that all possible validating information has been considered by the U.S. Patent Office, and verification that the filing dates for the patents have been properly preserved.

Q.: We've seen in recent years how court rulings in IP cases ' whether favorable or not ' can directly impact a company's stock values. What strategies can a company implement to minimize concern among its shareholders and other interested parties?

A.: In an economic downturn, a company can find itself on the receiving end of legal complaints from disgruntled shareholders who claim a company has been too passive in management of its IP. These can stem from allegations that a corporation has not been active enough in pursuing potential patent infringers. They can also stem from not being active enough in pruning a large portfolio such that unnecessary fees are accrued in pursuing or maintaining certain patent assets that hold no commercial value.

To guard against such claims, a sound strategy is to devise a systematic monitoring of the company's patent portfolio in two respects. The first aspect includes routine analysis of the maintenance of the appropriate patents and abandonment of those patents whose value become diminished as the commercial landscape matures. The second aspect includes an external analysis of the market to enjoin potential infringers from treading on patented technology or to negotiate a royalty for use of the patent where infringement is apparent. The system should include regular documentation, audit and update, preferably on a yearly basis.

Q.: What strategies can a company follow to successfully monitor and enforce its IP rights against infringers to further protect its portfolio's value?

A.: As patents continue the transition from legal documents to financial assets, it is increasingly important that a company's finance and accounting unit, technology center and marketing departments exchange information and coordinate on a regular basis. If the marketing department observes commercial success for a particular product (whether its own or the competitors), this information should be passed to the business unit handling the patents for that product (or similar product) so that the relevant patents can be identified and evaluated against potential infringers.

On the other hand, if commercial viability of one product wanes, this will also be most apparent to the
marketing departments. This information should be relayed to the technology, or R&D unit, so that the patent portfolio for that particular product can be pruned in a productive manner. This could mean licensing out, sale, donation or simple abandonment of the patent(s) in question.

Recognition of the above commercial shifts will also aid R&D decisions as to where future technological investments should be made and funded.

Q.: What are the top challenges in doing so in the U.S. as well as internationally?

A.: The information exchange discussed above is rendered more difficult and even more decentralized when such information must cross national boundaries and span multiple time zones. In such dispersed markets, it is even more important to maintain the concerted effort to manage the relevant product, technical and financial information in a comprehensive way.

Q.: Do you have any additional advice to in-house counsel regarding their IP portfolios?

A.: Because of the dual characteristics of a patent document as both a legal instrument and financial instrument, legally trained counsel can use patents to find even footing with a company's business-trained managers. In-house counsel would bring many benefits to their departments by trying to identify ways to move IP from a company's expense column to the asset column. Some of the responses above generally outline how this can be accomplished.

In the context of an M&A transaction, the flexibility and uncertainty in patent portfolio valuations cuts both ways. Because valuation is not a concrete exercise, there can be many factors to focus on if one wishes to undercut a portfolio's value if one is seeking to purchase a company with significant patent holdings. By the same token, there are also factors to focus on if one is seeking to buoy the value of a portfolio. This fluidity should assist in the closing of M&A deals on terms that are amenable to all parties.

Adam J. Schlagman is Editor-in-Chief of this newsletter.

According to a survey by the Mergermarket Group in late 2008, “more than half of corporate and private equity executives believe intellectual property will become a more important factor in M&A deals during the next five years.” With the economic downturn, competition in the marketplace has only stiffened as companies struggle to ease the minds of shareholders and consumers. Following high-cost settlements and royalty payouts over the past few years, intellectual property portfolios have proven to be an invaluable asset to companies across industries.

Here, Susan Perng Pan, Washington, DC-based patent attorney and partner of the intellectual property firm SUGHRUE MION, PLLC, discusses best practices and strategies for in-house counsel to assess, protect, and evaluate the worth of their portfolios, both domestically and globally. Ms. Pan focuses her practice on preparing and prosecuting patent applications before the U.S. Patent and Trademark Office, and represents U.S. and international clients, with a special focus on Asia.

Q.: According to the Mergermarket Group, intellectual property (IP) portfolios are becoming a major contributing factor to the success of a merger & acquisition. Why do you think companies are now starting to pay attention to IP portfolios as part of their larger business decisions?

A.: For a long time, the vast majority of a company's value stemmed from its intangible assets, rather than its tangible holdings. However, it was only recently that the valuation of intangibles, patents in particular, started becoming demystified. Further, of a company's intangible assets, intellectual property is likely to be the most concrete, since it usually includes a government-backed document such as a patent or a trademark registration.

With the continued increase in technology-driven businesses, patents have clearly assumed characteristics of assets, which can be flexibly sold or licensed as a form of capital to further business ventures, to create a revenue stream or to serve as “collateral” for smaller companies seeking financial backing. This would account for the higher recent visibility of patent portfolios in M&A deals.

A number of valuation tools have cropped up in the past few years to attempt to put a dollar figure on a patent portfolio. However, even with traditional accounting methods and new valuation methodologies specific to patents, patent portfolio valuation remains difficult. For example, 85% of corporations view IP assets as having equal or greater importance than other corporate assets in M&A deals. Despite the acknowledged importance of IP assets, only 32% of corporations investigated IP value in depth before completing such transactions.

Q.: How can a company's IP portfolio ' or lack thereof ' impact a company's overall value? How are they evaluated?

A.: Without at least a rudimentary patent portfolio to protect its inventions and innovations, a company is at the whim of competitors and copycats as soon it enters the marketplace. The value of a patent portfolio accrues to the patent holder in multiple forms. Traditionally, patents confer the right to exclude others from operating in the market area that is covered by one or more patent claims, thus providing a legal monopoly. In this regard, the patent further entitles its owner to recover monetary damages from anyone who uses the technical subject matter covered by the patent claim without authorization. As a strategic tool, a patent operates as a counter measure to barter for market entry and co-existence with other patent holders who would otherwise seek to exclude the patentee from the market.

Because a patent can serve as the source of a licensing revenue stream or accord a company limited monopoly status, a rudimentary value can be placed on patent assets. As with all assets, the values rise and fall with the economic tide. Traditional valuation tools include: 1) the 25% method, which assigns approximately 25% of a company's operating profits to its patent holdings; 2) the income method, which evaluates a patent as a present value of a future income stream; 3) the market method, which evaluates patents relative to similar patents; and 4) the cost method, which assigns values as the cost of designing alternatives for patented technology. However, the unique character of patents and other IP renders standard application of these valuation tools extremely difficult.

New valuation tools geared specifically to set a value on large portfolios take into account basic information of the patent. This may include the number of times that a particular patent (or patents) is externally referenced in the general body of patent literature. Some valuations models analyze the word count in claims of the patent, because the claims actually set the legal boundary of protection. Such word-count valuations are premised on the concept that a claim with fewer words is less restrictive and thus more valuable. Even assuming that any statistical correlations can be derived from these newer evaluation tools, such analyses simply cannot be a sole or even primary indicator of patent value. For example, if a claim includes even a single word that excludes a significant portion of what is being practiced in the marketplace, then that claim is not commercially viable even if it is otherwise expressed with great economy in language. On the other hand, special forms of patent claiming actually would accord higher value to claim scope if the claim has more words. Nevertheless, these new valuation tools do have their place, especially those that have demonstrated strong statistical showing between the quantitative characteristics that they monitor and historic financial performance of the patent holder.

Traditional valuation tools in conjunction with a statistical tool together help form a comprehensive picture of the value to place on a portfolio.

Q.: What are the top challenges in evaluating a portfolio's value? What key factors do in-house counsel need to look for?

A.: Even as patents, along with other intangible assets, become reported as financial entries, it is important to remain cognizant of the patent as a form of technical estate, its value being determined by legal boundaries.

Individual value assessment for patent claim in any sizeable portfolio, including a liability determination and revenue stream, is impossible. The value of a patent thus lies largely in its potential. If due care is not taken to preserve that potential while prosecuting the patent in the U.S. patent office, the patent's value easily becomes deflated. When a patent application is originally filed, the applicant may have attempted to claim a large piece of a technical estate. The U.S. patent examiner will attempt to force to the patent applicant to accept a narrower set of rights. An unwitting patent applicant may make representations or modify the application to exclude a particular technical sector, leaving only a portion of the original claim intact. Though it sounds counter-intuitive, the best strategy before the U.S. Patent Office is to avoid touting the benefits of the invention and to focus on the procedural errors of the U.S. Patent Office in refusing to grant a patent. If at all possible, it is also important to resist narrowing of the original patent claims due to legal precedents that tend to penalize such activity.

Q.: Are there additional challenges in evaluating the value of a portfolio during M&A negotiations with a foreign company?

A.: Each country has its own requirements for patenting technology and enforcement of those patents. Therefore, where clear liability attaches in one country, this may not be so clear in another jurisdiction. As a result, the accounting methods and metrics that apply to patent valuation in the U.S. may have less relevance for the patent holdings in a foreign country. The pertinent experts should be consulted in each country where a company holds any sizeable patent portfolio. In addition, repatriation of money from foreign countries may also affect the value of a portfolio, even if liability or valuation in that foreign jurisdiction is clear.

Q.: What can in-house counsel do now to bolster and protect their portfolios in preparation for future M&A deals?

A.: A sound strategy would be to identify a small number of patents in a group that are deemed to be of the greatest commercial value, at least in the short term. In this group, evaluate the strength of the patent against market products. This will help set a baseline of the value of the portfolio as linked to current market conditions.

Next, evaluate patents of the group that appear to fall around the edges of the above “core” group, and which are “improvement” technologies over the core group. A dense patchwork of protection over improvement technologies will help provide a basis for future revenues. Such improvement patents should be spaced appropriately over time to afford the maximum benefit.

The overall portfolio can become weakened when the basic technology is held by the corporation, but all the improvement patents are held by third parties or by competitors. The lack of holdings in the improvements area may signal a corporation's lack of commitment to that particular technology. Moreover, significant third-party holdings of improvement patents will decrease the company's leverage at the negotiating table.

Q.: What key strategies can in-house counsel implement to avoid a lapse in IP coverage for those companies with large portfolios?

A.: Never overlook the administrative components. These include verification of proper ownership of the patents by necessary assignment documents, timely payment of patent office maintenance fees, verification that all possible validating information has been considered by the U.S. Patent Office, and verification that the filing dates for the patents have been properly preserved.

Q.: We've seen in recent years how court rulings in IP cases ' whether favorable or not ' can directly impact a company's stock values. What strategies can a company implement to minimize concern among its shareholders and other interested parties?

A.: In an economic downturn, a company can find itself on the receiving end of legal complaints from disgruntled shareholders who claim a company has been too passive in management of its IP. These can stem from allegations that a corporation has not been active enough in pursuing potential patent infringers. They can also stem from not being active enough in pruning a large portfolio such that unnecessary fees are accrued in pursuing or maintaining certain patent assets that hold no commercial value.

To guard against such claims, a sound strategy is to devise a systematic monitoring of the company's patent portfolio in two respects. The first aspect includes routine analysis of the maintenance of the appropriate patents and abandonment of those patents whose value become diminished as the commercial landscape matures. The second aspect includes an external analysis of the market to enjoin potential infringers from treading on patented technology or to negotiate a royalty for use of the patent where infringement is apparent. The system should include regular documentation, audit and update, preferably on a yearly basis.

Q.: What strategies can a company follow to successfully monitor and enforce its IP rights against infringers to further protect its portfolio's value?

A.: As patents continue the transition from legal documents to financial assets, it is increasingly important that a company's finance and accounting unit, technology center and marketing departments exchange information and coordinate on a regular basis. If the marketing department observes commercial success for a particular product (whether its own or the competitors), this information should be passed to the business unit handling the patents for that product (or similar product) so that the relevant patents can be identified and evaluated against potential infringers.

On the other hand, if commercial viability of one product wanes, this will also be most apparent to the
marketing departments. This information should be relayed to the technology, or R&D unit, so that the patent portfolio for that particular product can be pruned in a productive manner. This could mean licensing out, sale, donation or simple abandonment of the patent(s) in question.

Recognition of the above commercial shifts will also aid R&D decisions as to where future technological investments should be made and funded.

Q.: What are the top challenges in doing so in the U.S. as well as internationally?

A.: The information exchange discussed above is rendered more difficult and even more decentralized when such information must cross national boundaries and span multiple time zones. In such dispersed markets, it is even more important to maintain the concerted effort to manage the relevant product, technical and financial information in a comprehensive way.

Q.: Do you have any additional advice to in-house counsel regarding their IP portfolios?

A.: Because of the dual characteristics of a patent document as both a legal instrument and financial instrument, legally trained counsel can use patents to find even footing with a company's business-trained managers. In-house counsel would bring many benefits to their departments by trying to identify ways to move IP from a company's expense column to the asset column. Some of the responses above generally outline how this can be accomplished.

In the context of an M&A transaction, the flexibility and uncertainty in patent portfolio valuations cuts both ways. Because valuation is not a concrete exercise, there can be many factors to focus on if one wishes to undercut a portfolio's value if one is seeking to purchase a company with significant patent holdings. By the same token, there are also factors to focus on if one is seeking to buoy the value of a portfolio. This fluidity should assist in the closing of M&A deals on terms that are amenable to all parties.

Adam J. Schlagman is Editor-in-Chief of this newsletter.