| As a business or investment professional involved in | | | | company's somewhat marginal operations. The |
| mergers and acquisitions ("M & A"), are you | | | | marriage of my client and CleanCo thus seemed a |
| conducting patent due diligence according to the | | | | good match, and the M & A due diligence |
| standard practices of your M & A attorneys and | | | | process got underway. |
| investment bankers? When patents form a significant | | | | Due diligence revealed that CleanCo had few assets: |
| aspect of the value of the transaction, you are | | | | the small manufacturing plant, limited but growing |
| probably getting incorrect advice about how to | | | | sales and distribution and several patents covering |
| conduct due diligence. The due diligence process must | | | | the sole CleanCo product. Notwithstanding these |
| take into consideration the competitive patent | | | | apparently minimal assets, CleanCo's asking price was |
| landscape. If competitive patents are not included in | | | | upwards of $150 million. This price could only mean |
| your vetting process, you may be significantly | | | | one thing: CleanCo's value could only be in the |
| overvaluing the target company. | | | | potential for sales growth of its patented product. In |
| In my many years of intellectual property and patent | | | | this scenario, the exclusive nature of the CleanCo |
| experience, I have been involved in a number of M | | | | product was properly understood to be fundamental |
| & A transactions where patents formed a | | | | to the purchase. That is, if someone could knock-off |
| significant portion of the underlying value of the deal. | | | | CleanCo's differentiated product, competition would |
| As the patent specialist on these transactions, I took | | | | invariably result and ll bets would then be off for the |
| direction from highly compensated M & A | | | | growth and sales projections that formed the basis |
| attorneys and investment bankers who were | | | | of the financial models driving the acquisition. |
| acknowledged by C-level management to be the "real | | | | Taking my instructions from the M & A attorney |
| experts" because they completed dozens of deals a | | | | and investment banker leaders in the transaction, I |
| year. To this end, we patent specialists were | | | | conducted the patent aspects of the due diligence |
| directed to check the following 4 boxes on the | | | | process according to their standard procedures. |
| patent due diligence checklist: | | | | Everything checked out. CleanCo owned the patents |
| - Are the patents paid up in the Patent Office? | | | | and had kept the fees paid. CleanCo's patent |
| - Does the seller really own the patents? | | | | attorney had done a good job on the patents: the |
| - Do at least some of the patent claims cover the | | | | CleanCo product was covered well by the patents |
| seller's products? | | | | and there were no obvious legal errors made in |
| - Did the seller's patent attorney make any stupid | | | | obtaining the patents. So, I gave the transaction the |
| mistakes that would make the patents difficult to | | | | thumbs up from the patent perspective. When |
| enforce in court? | | | | everything else looked positive, my client became the |
| When these boxes were marked "complete" on the | | | | proud owner of CleanCo and its product. |
| due diligence checklist, the M & A attorneys and | | | | Fast forward several months . . . . I began to receive |
| investment bankers had effectively "CYA'd" the | | | | frequent calls from people on my client's marketing |
| patent issues and were free from liability relating to | | | | team focused on the CleanCo product about |
| patents in the transaction. | | | | competitive products that were being seen in the |
| I have no doubt that I conducted my patent due | | | | field. Given the fact that more than $150 million was |
| diligence duties highly competently and that I, too, | | | | spent on the CleanCo acquisition, these marketing |
| had "CYA'd" myself in these transactions. However, it | | | | professionals not surprisingly believed that the |
| is now evident that the patent aspect of M & A | | | | competitive products must be infringing the CleanCo |
| due diligence basically conformed to someone's idea | | | | patents. However, I found that each of these |
| of how not to make stupid mistakes on a transaction | | | | competitive products was a legitimate design-around |
| involving patents. In truth, I never felt quite | | | | of the patented CleanCo product. Because these |
| comfortable with the "flyover" feel of patent due | | | | knock-offs were not illegal, my client had no way of |
| diligence, but I did not have decision rights to | | | | getting these competitive products removed from |
| contradict the standard operating procedures of the | | | | the marketplace using legal action. |
| M & A experts. And, I found out just how | | | | As a result of this increasing competition for the |
| incomplete the standard patent due diligence process | | | | CleanCo product, price erosion began to occur. The |
| is when I was left to pick up the pieces of a | | | | financial projections that formed the basis of my |
| transaction conducted according to standard M | | | | client's acquisition of CleanCo began to break down. |
| & A procedure. | | | | The CleanCo product still sells strongly, but with this |
| In that transaction, my client, a large manufacturer, | | | | unanticipated competition, my client's expected |
| sought to expand its non-commodity product | | | | margins are not being made and its investment in |
| offerings by acquiring "CleanCo", a small manufacturer | | | | CleanCo will take much more time and expensive |
| of a patented consumer product. My client found | | | | marketing to pay off. In short, to date, the $150 |
| CleanCo to be a good target for acquisition because | | | | Million acquisition of CleanCo looks to be a bust. |
| CleanCo's product met a strong consumer need and, | | | | In hindsight, the competition for the CleanCo product |
| at that time, commanded a premium price in the | | | | could have been anticipated during the M & A |
| market. Due to strong consumer acceptance for its | | | | due diligence process. As we found out later, a |
| sole product, CleanCo was experiencing tremendous | | | | search of the patent literature would have revealed |
| growth in sales and that growth was expected to | | | | that many other ways existed to address the |
| continue. However, CleanCo owned only a small | | | | consumer need addressed by the CleanCo product. |
| manufacturing plant and it was having difficulty in | | | | CleanCo's success in the marketplace now appears to |
| meeting the growing needs of the market. CleanCo's | | | | be due to first mover advantage, as opposed to any |
| venture capital investors were also anxious to cash | | | | actual technological or cost advantage provided by |
| out after several years of continued funding of the | | | | the product. |