Advances in automated approaches to due diligence increase efficiency and reduce transaction costs – making the easy things, easy.
8th April 2021
Due Diligence: don’t make the easy things hard
Advances in automated approaches to strategic patent intelligence pave the way for increased efficiency and reduced transaction costs.
Due diligence is the essential requirement in a transaction to establish ‘what’s going on’. It is about identifying risks that might otherwise trip-up a purchaser on the foundational principle of let the buyer beware. Patents have always been an important aspect of this and more so today than ever before.
What’s involved in patent due diligence?
In an M&A context, patent due diligence is the need to establish that the business being bought or sold has all the rights necessary to carry on. This requires at a minimum:
- Reliable scheduling of patents in a form that can be rapidly reviewed,
- Estimating costs for managing the portfolio and how it fits with your existing portfolio,
- A picture of how the target asset compare with other owners of similar patented technologies,
- An understanding of how existing patent licences bolster or weaken the commercial position,
- Whether there is significant litigation risk, either now or in the foreseeable future.
What’s the problem?
The problem has always been that due diligence is slow and expensive. Too much time reviewing documents and not enough time to identify and resolve issue that arise. Let’s consider this challenge in the context of a typical transaction:
- Patents owned – a typical portfolio for a business with more than $1B of revenue is 250 patent families – each with say 3 grants or applications across a range of international patent offices (countries). The minimum information required for each patent is description, age and status.
- Licensed patents – the patent licences need to be categorised as “in” (granted to the business) or “out” (granted by the business). These are complex agreements and due diligence means conducting a detailed review. Material terms include not only the patents, the scope of the licence (eg: exclusive/non-exclusive), term and financials (in particular royalty payments). You can reasonably expect there to be 20 or more agreements of this sort.
- Used, but not owned or licensed – this is commonly referred to as third party infringement risk. Some of this will be known (actual or threatened litigation) but most of this risk falls into Rumsfeld’s “unknown unknowns”.
It’s easy to see why conventional manual review might be slow and expensive. Let’s assume that you outsource this task to external advisers charging $250ph. If we further assume that it takes an hour to review a patent and 3 hours to review a licence, that’s $80,000 before you are in any position to actually do anything. In terms of time, that’s over 300 hours, equivalent to 4 FTE weeks. This back of envelope calculation ignores infringement risk, which is often sidestepped as being too hard.
What’s the alternative?
Many companies report that they are no longer willing to pay the bill for due diligence leaving it to warranties and indemnities to allocate risk. While this approach is not crazy, it does reverse the preference for prevention being better than cure. In turn, this has led to the growth in IPR insurance where sellers find the residual risk under the sale agreement unpalatable.
The dynamic changes completely if there is a fast, low-cost solution to due diligence. Enter Cipher and strategic patent intelligence. Cipher can automatically generate a report including:
- Patents owned – clustered into technology areas, with comprehensive analysis of ownership, age, geography.
- Patent cost and quality – cost projections for the portfolio to date (and forward-looking).
- Litigation history – global patent litigation by or against the company.
This is a game changer with a number of immediate benefits:
- Swap perspiration for inspiration – highly qualified professionals get no joy out of counting, sorting and reviewing patents. It is soul destroying and inefficient. The alternative is presenting the information to the deal team enabling them to spot anomalies and ask better questions.
- Save and shift time – due diligence is often quite late in the day, after the “data room” has been assembled and made available. Cipher takes a shortcut by accessing the vast quantities of publicly available data with no need to wait.
- Process – related to the previous point are the advantages of automation and digitisation. For anyone who has been presented with a 100-page PDF with badly formatted (or just wrong) patent numbers, it is pure joy to have the data available and shareable in an on-line interactive SaaS (software as a service) platform.
Forbes focused on many of these benefits at the time of the Softbank acquisition of ARM.
And there’s more…
Conventional patent due diligence is one dimensional, in that it typically focusses on what’s presented to the team tasked with preparing the report. Imagine a world where due diligence puts the target company in perspective. The Cipher platform includes proprietary cluster and compare algorithms that both analyses the target portfolio and can also compare the portfolio to other owners of similar rights.
This opens up a wealth of other opportunities:
- Context – while owning patents is often better than the alternative, owning the wrong patents can be worse.
- Optionality – connected to the timing point above, the earlier information can be made available the more likely it is that you can do something with it. Cipher has real world experience of a purchaser going down a different avenue in the face of compelling evidence of a better alternative.
- Sector risk – understanding litigation by and against competitors and other owners of relevant patented technology is often a predictor of patent risk for the target. This is of direct benefit in the Rumsfeld arena, when knowing sector trends is often a sign of trouble ahead.
Is this just an efficiency play, or additional insight?
Cipher’s core competence is automated patent to technology mapping (referred to as classifiers). This enables due diligence to focus on what matters, rather than reviewing everything and boiling it down. Imagine a Cipher Report that identifies that the portfolio relates to Technologies A, B and C (in 20 seconds).
Sharing this with the deal team confirms that the value is seen in area A. At that point Cipher generates a landscape of all owners of patents in that area. The deal team considers a range of issues including patents owned by organisations who are not competitors, as well as sector risk discussed above and non-practising entities (NPEs) active in the area.
Does this approach have application outside M&A transactions?
While due diligence was made infamous in the context of M&A and corporate finance, with many lawyers having the scars to reflect the inefficiency of manual review, due diligence is a feature of all commercial transactions. This includes patent licensing and cross licensing, patent acquisitions and divestment and in-bound patent assertion.
- Licensing – strategic patent intelligence has a significant role to play in both due diligence and commercial assessment of the commercials. Refer to How Many Patents are Enough? With the increased prevalence of portfolio cross-licensing, classification provides a compelling solution to calculating the balance of trade between organisations.
- Acquisition and divestment – more organisations are turning to the secondary market for both selling patent assets (where they are overstocked) and buying (where they are understocked). Due diligence can now help with pricing considerations – providing objective evidence of whether the transaction represents good value.
- Inbound patent assertion – the current recession caused by the pandemic will lead to an increase in litigation both from operating companies and NPEs. Due diligence when faced with a large portfolio (and little evidence of relevance) requires rapid identification of those assets that pose a real-world threat. Cipher’s patent to technology mapping delivers this capability.
The current economic climate puts even greater pressure on efficiency. Cipher provides the capability to achieve more with less.