IP strategist: Start-ups should always be preparing for due diligence

A due diligence review is often requested of start-ups before important events such as investment rounds, acquisitions and stock market launches. As intellectual property is increasingly important in determining the value of start-ups, the investigation of IP risks and opportunities related to the start-up’s assets and operations can form a significant part of this process. Such an investigation may include a review of IP assets owned and used by the start-up, operational IP processes and the start-up’s IP position in relation to competitors and other relevant rights holders.

Problems identified during due diligence may affect both the likelihood and value of the intended transaction. Significant problems can cause investors and buyers to withdraw from a deal entirely and even small issues can have a significant impact. High-level terms will have been agreed before any due diligence process starts, so problems identified at this later stage may trigger a renegotiation of terms, where the target is in a relatively weaker position and less able to control information flow. Renegotiation may result in a reduced share price or affect other contractual terms – for instance, relinquishing greater control to investors or an increase in cash held in escrow forfeitable to a buyer. Even if issues are resolvable during due diligence, the time taken to identify and implement solutions may result in the buyer forming a poorer impression of the target or simply finding an alternative business opportunity.

Be prepared

Given the importance of due diligence, preparation is a worthy investment of time. In addition, thorough preparation can significantly increase a start-up’s likelihood of success in the following ways:

• Reducing the risk of failure by identifying and resolving issues early – some issues that would be otherwise unresolvable during due diligence can be mitigated if identified earlier (eg, a disagreement on ownership could be resolved contractually when less is at stake, a validity issue could be resolved by narrowing the prosecution scope, a licensing agreement which conflicts with acquirer requirements could be more limited in scope or a substantive infringement liability could be resolved through in-licensing). Early identification can also help to position unresolvable issues in a more positive light.
• Impressing the requestor by meeting deadlines and responding quickly – due diligence can be time consuming for a resource-constrained start-up, and meeting deadlines and responding to additional requests promptly may be difficult enough without having to resolve unexpected problems. Early collection of data and issue resolution will help to maintain a good impression with an investor or buyer and ensure that preferred terms of the agreement are retained.
• Adding value to the start-up by becoming a sophisticated IP operation – due diligence preparation will identify value-related risks associated with IP assets and processes. The earlier an assessment is carried out, the more effectively a start-up can prioritise its normal IP activities and the more sophisticated its operations can become.

Including due diligence in normal IP processes

Before preparing for due diligence, a start-up needs to determine what information is likely to be required, including questions which may be asked, documents which may be requested and warranties which may have to be provided. While buyers and investors will each have unique goals and information-gathering requirements, it is relatively easy for a start-up to determine what information to prepare without a specific third party in mind. Minimal research is needed to discover articles containing due diligence strategies, checklists and common issues; each of these can be considered against a start-up business to identify what likely requesters will consider important. Alternatively, experts who have previously gone through the process can be engaged to advise on preparation, including patent attorneys, IP consultants and business advisers.

The information needed for due diligence can then be used for data collection and to identify high-impact risks and opportunities.

Data collection

The collection of all relevant information should be incorporated into normal IP processes and should be stored in a way that makes it simple to extract for due diligence. For example, if buyers want to know what obligations a start-up has made in relation to open source projects, details of all open source usage and contributions should be constantly recorded, including a determination of key obligations from the relevant open source licence(s). Leaving this to due diligence may take a considerable amount of time and identify issues too late to resolve them.

Identify high-impact risks and opportunities

Knowledge of information which will be provided during due diligence can be used to spot issues early. For example, if a buyer is likely to want patent rights to assert against its competitors, patent filing or prosecution opportunities should be identified and their priority increased more than they might otherwise have been; leaving this to due diligence may result in missed opportunities due to priority dates or missed continuation or divisional deadlines.

Smooth IP due diligence is crucial for start-ups hoping to raise capital or achieve a successful exit. Being constantly prepared for due diligence is one way to significantly increase the chances of start-up success.