Proper due diligence in a valuation engagement takes considerable time and attention to detail. Much information must go into the analysis to provide a credible valuation. In fact, specifics of the due diligence process can fill a book. However, the five critical components that cannot be missed when performing IP valuation due diligence are as follows:
Ownership – Verifying ownership is one of the most important due diligence steps in IP valuation. For instance, copyright ownership is not always straightforward. Typically,the person who creates a copyrighted work is the author of the work. However, in work made for hire situations, the person who created the work isn’t necessarily the owner of the work. For other types of IP, acquisitions can also create ownership confusion if the IP is not transferred to the new owner. If the correct owner is not listed with the USPTO, then the IP only holds value to the owner listed with the USPTO. Therefore, it is imperative to determine that the apparent IP owner even has title to the IP.
Lawsuits – When conducting due diligence, a valuation analyst must take into consideration any lawsuits regarding the IP. For instance, lawsuits present challenges to trade secret value. Trade secrets hold value when they are not revealed and only a limited number of people have access to them. However, in the event of a lawsuit, trade secrets may be revealed, which would increase the risk of trade secret impairment. Enforcement of trade secrets in a lawsuit requires the trade secret owner to disclose in great detail the trade secret, which opens the opportunity to disclosure.
Reexamination - Is the IP in any form of reexam? Patent owners are often at risk that a third party may request a reexamination with the USPTO in effort to invalidate a patent claim. During a reexamination, the USPTO reviews any claim of a patent based on prior art from patents or printed publications that the third party believes may have a bearing on the patentability of the claims that the USPTO already awarded. The USPTO determines whether the original claim remains patented or whether to remove claim protection, which would impair or erase value for a given patent.
Claims – A valuation must determine whether any claims exist against the IP. This component is especially critical if royalty obligations exist. When an IP owner has to pay a royalty fee to another owner to avoid infringement of some prior art in the use of the owner’s own IP, the value may be lower. The royalty obligation lays an effective claim against any revenues that the IP generates.
Value proposition – One of the biggest misconception about IP is that it always has value. In reality, IP may have little or no value in many cases. If IP owners do not protect their IP (such as paying patent maintenance fees, protecting trade secrets adequately, etc.), they destroy value for their IP. Also, the utility of the IP asset may offer no value proposition. For instance, consider VHS videotapes versus DVDs today. In addition, the nature of the IP may make any traditional benefit more difficult to calculate. This is particularly common with new technologies that are potentially disruptive in the market. In such a situation, the valuation analyst must reasonably speculate as to what the incremental benefits may be, and how the market may value those incremental benefits when the product does eventually reach the market.
While there are many aspects to review in the due diligence process, the five components listed above are the most critical and cannot be overlooked. If these are overlooked, a valuation analyst is more likely to misstate value. That said, a valuation analyst must take into consideration all aspects that will affect an IP’s value. The more the valuation analyst reviews about the particular IP, the more credible the valuation.