Intellectual Property: Pitfalls in M&A deals

published on 21 December 2023 | reading time approx. 3 minutes

Intellectual Property (IP) is often a valuable asset in companies, sometimes even their core value. With the shift towards Industry 4.0, and thus, the networking of machines and people, machine learning, and Artificial Intelligence, the assets of many companies include no longer only assets of material nature but also intangible assets which in particular are becoming increasingly important. This is now happening in almost every industry and applies to all types of production.

In M&A deals, this means for both the seller and the buyer that particular attention should be paid to the IP of the target company in order to avoid any nasty surprises for both parties in the end.

In this article, we explain what particular attention should be paid to in M&A deals.

Intellectual Property as an asset

IP or Intellectual Property such as patents, trademarks, designs, or other property rights are becoming increasingly important as intangible assets in the M&A process. However, they are often not given the necessary attention in corporate transactions, both in legal terms and with regard to a comprehensive and appropriate valuation.

Lack of IP protection as a source of risk?

As a matter of principle, companies should adequately protect their IP, whether or not they are involved in an M&A deal. This includes choosing the right IP strategy depending on the company's activities and registering the necessary property rights such as patents or trademarks. But a company’s IP should be protected also beyond the registration of property rights – internal and external confidentiality measures are a must in this respect.

IP protection is particularly important in M&A deals, as it often shows whether the target company has carefully protected and maintained its intellectual property. The buyer must know exactly what scope of protection the existing rights have in order to avoid nasty surprises and financial losses. An often underestimated aspect: It is often overlooked that property rights are, as a rule, subject to the principle of territoriality. This means that the protection of an IP right is generally limited to the territory of the country where it has been granted. If the company operates internationally, it is therefore not enough to secure the property rights only in the home country. The buyer is well advised to carefully check as part of the legal due diligence whether the target company has obtained the necessary protection in all geographical markets he wants to pursue and whether this protection is sufficient for his future plans with the target company. And the seller should act as quickly as possible if he discovers a gap in protection. This is because this gap in protection can result in indemnification obligations or obligations under warranties included in the purchase agreement to the detriment of the seller and in a lowered valuation of the purchase price.

What is the value of a company's IP?

Once it has been established what kind of IP a company has, the buyer's next question is usually what value it has. It is particularly important to determine which property rights are actually important for the company, as target companies often have a number of property rights – often for historical reasons – but not always all of them are important for the current or future operations of the target company. Here, it is important to check which of them are really attractive for the acquisition and fit in with the buyer's growth strategy.

Determining the value of the IP to be acquired is a major challenge, especially in M&A transactions involving technology companies. The risk of wrong assessment is obvious for both parties: If the value of IP is assessed too high, the buyer will pay too much; if it is too low, the target company will sell itself short. Both parties should therefore have a realistic valuation carried out by specialists.

Legal disputes relating to IP rights

In addition to the question of the existence of the property rights portfolio and its economic valuation, it is very important whether the target company is involved in legal disputes relating to intellectual property.

This may result from the fact that the target company has taken legal action against third parties that infringe its property rights. But especially in the opposite case, where it is the target company’s products that infringe upon third-party rights, the buyer must be able to assess the risk arising therefrom, in particular the threat of claims for damages. This is because, after the deal, the buyer may be held liable and, in the worst case, the existence of his company may be jeopardised.

Ultimately, the buyer can take these risks into account in the purchase agreement by incorporating appropriate warranties or indemnities. However, it is better to clarify in advance whether the existing risks can be eliminated.

The devil is in the details of the check carried out!

Often, critical issues relating to the IP of the target company can be resolved before the actual closing of the deal. For this to happen, however, the risks must be recognised at all, and this, again, requires a detailed check.

Once the IP due diligence has been carried out, it is often possible to solve any identified problems at an early stage of the transaction, for example by subsequently registering property rights or obtaining the necessary licences. Another way to eliminate IP risks is to incorporate closing conditions in the purchase agreement.