How to avoid investment train wrecks: Do your IP homework

Failing to conduct effective IP due diligence has led to many technology investors losing millions they didn’t need to

Failing to conduct effective IP due diligence has led to many technology investors losing millions they didn’t need to.

A very experienced (and wealthy) technology investor once told me: “If you want to make a small fortune in technology, start with a large one.” Sage advice, as every week we see professional and part-time investors who have put millions into tech ventures that have gone wrong. It often falls to us to deliver the reality check: not only will this venture not deliver Scrooge McDuck like wealth, but more critically, it was never going to.

What is surprising is often it is possible to tell in advance that a venture will not succeed. The secret? Undertake proper intellectual property (IP) due diligence before investing. 

Why is IP due diligence important? If you’re investing in a technology-based deal (which could include acquiring a tech business or concluding a strategic alliance, development agreement or joint venture with one) then most of the value is likely to be in intangible rather than tangible assets. You are, after all, investing in technology, not a landscaping business, residential property or the corner dairy! 

Consequently if most of the value is in the intangibles then the IP that underpins those intangibles will be central to the venture’s ultimate success or failure. 

Here are just a few of the investment train wrecks we’ve seen:

• A ground-breaking tech with ‘bulletproof IP’ which basic due diligence revealed had been publicly disclosed decades earlier, rendering the IP essentially valueless.

• A technology with ‘broad patents’, which, on closer inspection, were actually very narrow given a competitor owned earlier IP, which the investee venture was now infringing.

• Genuinely valuable IP that, regrettably, was not owned by the venture at all, but by a disgruntled former contractor.

The reality is that in any of these situations the venture is highly likely to fail, or at the very least generate returns that are significantly lower than it would have otherwise, had the IP been strong and clean. In short, if the IP is shaky, then the venture is shaky.

IP due diligence not only reveals threats, it also provides valuable international market intelligence in the process: who is developing or using similar technologies, the state of development in the segment, potential opportunities and so on. This becomes a target list of future customers, development partners, collaborators and further investors.

A few rules of engagement for effective IP due diligence:

• IP due diligence is not “does it have a patent?” Yes / no, tick … move onto ‘IT due  diligence’. If that’s your idea of IP due diligence, well then a fool and his money …

• Don’t ask the venture’s patent attorneys for their take on the IP. They are unlikely to suddenly ‘mea culpa’ and admit the IP they’ve been paid to protect is flawed.

• Don’t only look at patents – IP frequently includes trade secrets, copyright, design rights, brands and other assets – focusing solely on patents blinds you to other opportunities and threats.

• Don’t assume the chain of title is clean – who actually owns this IP? Is it already encumbered, and if so, how?

• Do investigate whether the IP is actually aligned with the technology itself and the venture’s longer term development strategy.

Effective IP due diligence should at minimum include a comprehensive, international, multilingual prior art search, an in-depth analysis of those search results to establish IP position, technology alignment and any infringement issues plus a detailed chain of title examination.

Like any due diligence exercise, using a professional, knowledgeable and most of all, independent, firm is critical. This is particularly important in New Zealand, where the IP industry is very small.

The good thing about IP due diligence is that it can be carried out early in the investment process and is relatively inexpensive – and that is a positive bargain compared to losing half a million dollars.

Paul Adams is CEO of EverEdge IP, New Zealand’s largest and most successful intangible asset management and commercialisation firm, winner of the Outstanding IP Leader Award, China 2012 and ranked as one of the world’s Top300 IP Strategists, www.everedgeip.com.