The Importance of Periodic Intellectual Property Audits
Andrew J. Sherman, Partner, Dickstein Shapiro Morin and Oshinsky LLP
Despite the critical importance of the role of intellectual property and intangible assets as key components of the net worth and overall shareholder value of many fast-track growth and established businesses, many entrepreneurs fail to appreciate and take inventory of the assets they have developed and as a result under leverage these assets. At a time when entrepreneurs and companies of all sizes are under pressure to make more out of what they already have developed and to create incremental revenue streams and new opportunities, it is critical that you consider a periodic intellectual property audit and strategic analysis.
Over the past few years, I have been working with companies of all sizes and in many different industries on a proprietary legal and strategic review process known as the Intellectual Property Protection and Leveraging Analysis (IPPLA). The IPPLA provides a growing company with a realistic and creative assessment as to what intellectual property assets the company has, the strength of these assets and the opportunities for leveraging these assets into new markets or revenue streams or to improve existing channels. Among the questions that are addressed during an IPPLA:
- What technologies have non-competing applications that could be licensed to others?
- What brands offer value in a brand-extension licensing or co-branding relationship?
- What distribution channels or partnering opportunities can be strengthened if the company had greater control over these channels or relationships?
- What growth and expansion strategies are being used by the company's competitors? Why? How are their circumstances different, if at all?
- Where are the strategic/financial holes in the company's current licensing and alliance relationships?
- What is the company's on-line and e-commerce strategy? How could it be strengthened or improved?
- Going through a strategic process such as the IPPLA is a particularly important growth step given today's economy and capital market conditions because:
- Entrepreneurs and growing companies must protect what they have and use these intangible assets to penetrate new domestic markets or be the fuel for international expansion. The key challenge is how to keep growing in a slowing economy.
- Capital-efficient growth is the mandate of many CEO's and CFO's during these turbulent financial markets. Entrepreneurs are under pressure to create new opportunities and new revenue streams from existing assets (technologies, systems, brand, relationships, know-how, etc.). The results of the IPPLA may also identify a need or an opportunity to restructure the company around the IP portfolio or create subsidiaries or spin-out companies based on IP leveraging opportunities.
- Entrepreneurs and growing businesses need to periodically re-evaluate whether current distribution channels and market-partners are really working effectively to generate the highest and best shareholder value and income streams/profits (e.g. is this the highest and best strategy available to meet our objectives? What is origin of these relationships? What politics or red tape will we face if these agreements and relationships are re-evaluated? Should there be restructuring around a real or perceived imbalance in the economics of any existing relationships? Wall Street does not reward companies who make their licensees and market partners wealthy at the company's expense.)
- Companies need to repair channels and relationships which are broken, ineffective or where greater controls over the channels would yield better results.
- With high levels of employee turnover and competition for a qualified work force, it is more important than ever that employees are educated on their obligations to protect the company's IP on an in-term and post-term basis.
- From a licensing out perspective, many companies may be sitting on a portfolio of patents, technologies and brands that can be licensed in non-competing ways to augment existing initiatives and core businesses such as the diagram sets forth below.
- 1 - Direct Use and Application in Company's Core Business
- 2 - Licensed For A Parallel, Non-Competitive Use to Third Party (Limited Use)
- 3 - Licensed To A Competitor Abroad (Limited Geographic Area)
- 4 - Consortium (nonexclusive)
- 5 - Research and Development (To User Who Hopes To Find Other Applications Within Non-Competing Industries/Option to License)
- 6 - Licensed to Aftermarket Service Provider (Service, Maintenance, Parts, etc.) (Multiple Applications/Multiple Revenue Streams)
- Even from a licensing in perspective, growing companies may not have the resources to conduct research and development at the same levels and may need or want to explore access to technologies and brands which are already established or readily-available on an off-the-shelf basis and coupled with training support and valued-added services or where Goliaths will partner with David to get access to resources and technology. There may also licensing in opportunities, which when paired with the company's current technology portfolio, can create new products, services and market opportunities.
- Technology licensing, brand-extension licensing, joint ventures and strategic alliances, business format franchising, outsourcing are all intellectual property leveraging strategies which are being regularly discussed and adopted inside today's corporate boardrooms, and need to be coupled with an effective IP portfolio analysis to be effective. Various intellectual property leveraging strategies are often precursors to capital formation transactions, such as venture investments and acquisitions, especially in David/Goliath transactions as well as peer-to-peer transactions.
- In today's merger and acquisition frenzy, an IPPLA may be an excellent way for a growing company to prepare for a buyer or a merger partner's due diligence process in order to ensure that gaps in the chain of title are filled or any potential disputes over ownership are resolved. The results of the IPPLA may also be necessary to support the company's proposed valuation if and when it is a target in an M & A transaction. The IPPLA can also be a good opportunity to examine the company's current IP docketing and database management systems.
- In an environment of market relationships constantly changing and evolving, an IPPLA will help the company determine whether any assets in the IP portfolio are subject to the rights of third parties, which may exist by virtue of coauthorship, coinvestorship, joint venture, teaming, co-branding, license or statutory or contractual rights of termination or reversion.
- Many emerging growth companies simply do not have the time, resources or expertise to identify development and implement new strategies for leveraging their IP portfolio without the help of a catalyst. Others simply may need a fresh look, a new perspective as to how their IP can be leveraged (classic "too close to the trees to see the forest" syndrome).
- The driving force behind the need for an IPPLA may be the senior management of the company, the chief patent counsel or even board members/outside shareholders (or venture capitalists in earlier-stage venture-backed companies) who are pressuring the company to produce new revenue streams before another infusion of capital can or will be committed. The strategic objectives of the IPPLA include:
- To determine the origin of intangible assets and the extent of the company's interest in technology and related intellectual property rights;
- To determine the scope of rights that third parties may have, by license, ownership, or otherwise, in the company's assets;
- To institute systematic procedures for protecting and perfecting the company's intellectual property rights;
- To detect defects in the company's existing intellectual property assets and establish the mechanisms and procedures for protecting and perfecting the same;
- To take steps to prevent the assertion of some of the more common defenses available to misappropriators and infringers (such as estoppel, laches and waiver); and
- To avoid liability for third party claims of infringement resulting from the development of new products.
In preparing for the IPPLA, the legal and strategic review and analysis team will prepare an Audit Plan outlining (a) the specific areas of inquiry (e.g., divisions, lines of business, affiliated or non-affiliated agency operations), (b) the scope of inquiry (e.g., only registered assets or a broader scope), (c) the timetable for the IPPLA, (d) the responsible parties for each part of the IPPLA, and (e) the form of the final report to be produced. In terms of initial information gathering, the legal and strategic audit team will identify those intellectual property rights such as patents, copyrights and trademarks which have already been registered or are in the process of being registered. The legal and strategic audit team next will obtain copies of all affiliate agreements (e.g., administrative services, cost allocation), employment, consulting agreements (including web site design agreements), license and maintenance agreements, joint venture agreements, distribution agreements, security documents and UCC filings, confidentiality agreements, litigation files (including outside counsel responses to auditor's letters), source code escrow agreements (in connection with software), any documentation relating to "clean room" development of software, database licenses and relevant corporate policy statements, including document retention policies.
After the relevant documentation has been identified and organized, the legal and strategic intellectual property audit team should then prepare an electronic index of the materials, noting with respect to each intellectual property asset: (a) the nature of the company's ownership interests (e.g., sole or joint ownership, exclusive or non-exclusive license, the royalty or other costs associated with the license and the estimated legal duration and period of technological usefulness of the asset) and whether the nature of the interest is in doubt, (b) any restrictions on the use of the asset (e.g., product or agency-related restrictions, territorial restrictions, assignment or transfer restrictions, time restrictions, non-compete clauses), (c) relevance of the asset to the core business of the company (e.g., whether the asset is a critical asset or an ancillary asset) and connection with other key non-IP assets of the company, (d) whether the asset has been pledged, or in any other way encumbered, and (e) potential for a third party claim of infringement or damages due to the company's use of the asset. In the course of analyzing the assets, the legal and strategic audit team may decide it is necessary to directly interview the company's personnel responsible for the development, acquisition or use of the intellectual property assets.