Turning intellectual property assets into M&A opportunities

Andrew Sherman is a capital partner in the Washington, DC, office of McDermott, Will & Emery, an international law firm with nearly 1,000 attorneys worldwide. He can be reached at (202) 756-8610, or email ajsherman@mwe.com.

Steven Gerbsman is a turnaround professional who set up the
Technology Recovery Group in 1999 to maximize the stakeholder and shareholder value of underperforming, undervalued and undercapitalized technology or Internet companies and their intellectual property. He can be reached at (415) 456-0628, or email steve@gerbsmanpartners.com.

Business publications frequently remind us that 'intellectual capital' represents the most important asset of Internet-driven companies, as it does in their more traditional counterparts. At the same time, most companies face the challenge of how to enhance the performance and productivity of their businesses and organizations.

In the knowledge era, the speed of access to data and the quality of the information often determine the competitiveness of a business and ultimately its success or failure. Small and growing technology companies that are able to extract their intangible value, transform it into knowledge and bundle it into protectable intellectual property will be in a much better position to be considered for purchase or be candidates for alliances or spinoff transactions.

How can management gather and package intangible assets to position the company for sale or related transaction? Intellectual capital is a difficult concept to grasp because it encompasses intangible items used to measure a company's success and wealth. Intellectual capital typically falls into the following three categories:

  1. Human capital. Everything in this category exists within the skills, experience and abilities of your employees. Creativity, innovation and forward thinking drive a company forward and enables it to compete in an environment that is becoming more complex and idea-dependant. Human capital is hard to measure, but is usually viewed in terms such as turnover and employee satisfaction.

  2. Organizational capital. This category only includes things owned by the company, such as patents, trademarks, copyrights, formulas and databases. Converting human capital into organizational capital is difficult and involves collecting, cataloguing and storing employee knowledge so it belongs to the company.

  3. Relationship capital. Putting an emphasis on the customer can be extended to any external relationship that creates value for a company. Some organizations have been keeping tabs on this information as it relates to the revenue base, and many are now recognizing the relationship between customer loyalty and increased profits.

It is critical to take inventory and understand the potential value of intellectual capital before positioning a company for sale or related transaction. If you do not know your inventory levels of intellectual capital, you cannot accurately allocate the proper amount of resources to develop your business in the most profitable direction. In addition, taking the time to study all of your company's assets may uncover attributes or applications that may be of strategic value to a buyer or partner and will help you maximize the value to your shareholders from these transactions.

In order to capture and protect the inventory of intellectual capital, it is crucial for a technology or Internet company to build an intellectual asset management (IAM) system. This involves planning a system to create, organize, prioritize and extract value from a set of intellectual property assets.

The intellectual capital and technical know-how of a company are among its most valuable assets, provide its greatest competitive advantages; they are the principal drivers of shareholder value. But it is rare for companies to have adequate personnel, resources and systems in place to properly manage and leverage these assets.

Establishing an IAM system also involves monitoring specific developments in the company's marketplace, such as:

  • Gathering intelligence on direct, indirect and potential competitors.
  • Monitoring developments abroad.
  • Tracking innovation – for example the more than 20,000 new patents issued each month in the US alone.
  • Maintaining license agreements and streams of royalty payments on both an inbound and an outbound basis. For example, royalty audits help ensure against underreporting (inbound) and overpayments (outbound). Are you getting paid? Is there anyone you are paying but shouldn't be? Are performance standards being met? Are you in relationships with the right parties? What could be done to strengthen existing relationships or distribution channels?

The key intellectual assets of the technology-driven company may include: brands, goodwill, URLs; patented designs, inventions or business processes; strategic relationships with customers, vendors, alliance partners; proprietary content, data, customer lists; key employees such as knowledge workers and technical staff; software codes and business models or systems; and regulatory approvals (FDA, FCC, etc.).

To make the intellectual capital a critical component of the exit or liquidation strategy, a detailed action plan should be developed and should include the following key steps:

  1. 1. Conduct a legal and strategic audit of the company's commercially marketable IP.
    1. Analyze IP for direct and indirect applications.
    2. Prepare written summaries for prospective purchasers, licensees and partners.
  2. Phase out the current use of the IP (if selling IP only and not as a going concern).
    1. Analyze current operations and services running using the IP.
    2. Prepare a phase-out/shutdown plan.
    3. Manage the shutdown process.

  3. Provide clean title for the prospective buyer of the intellectual property.
    1. Analyze current financial situation by reviewing the balance sheet – accounts payable, executory contracts and other contingent liabilities.
    2. Develop and execute strategy to insure no 'fraudulent conveyance' issues.
    3. Determine best method to give 'clean title' – assignment for the benefit of the creditors, foreclosure, chapter proceeding and/or a reserve clause in sale.
  4. Prepare prospect/distribution list.
    1. Identify top prospects together with company, equity investor(s) and other sources.
    2. Analyze current customers and competitors – 'who is out there that could benefit from access or ownership of our IP?'
    3. Draw up an additional list of qualified equity investors, investment bankers, lawyers, accounting firms and technology/Internet-related organizations in order to offer the IP to their portfolio companies and/or investments.
  5. Manage the process.
    1. Respond to interested parties.
    2. Set 'due diligence date(s)' – at 'war room' of company.
    3. Set formal 'bidding date,' minimum bids supported by cashier checks, or go through normal M&A process.

-- Andrew Sherman and Steven Gerbsman