During operational due diligence, how can you identify a company's most valuable intellectual property?

Intellectual Property ("IP") is the asset class that distinguishes one business from another. Whether its a brand, customer list or other data, unique manufacturing process, novel technology, etc., patents, copyrights, trade secrets and trademarks are the IP that provide the basis for the future earnings of the company. IP is a key reason why companies trade at multipliers of their PE ratio.

The concept of intellectual property (IP) encompasses intangible assets derived from human creativity, including patents, trademarks, copyrights, and more. IP can provide companies with a competitive advantage, bolster brand reputation, generate revenue, attract talent, and drive innovation. However, it also presents risks like infringement, theft, litigation, and regulatory challenges. Investors must comprehend a company's IP portfolio's nature, value, and impact on operations, strategy, and performance to make informed decisions. Understanding and managing IP effectively is crucial for long-term success and sustainability in today's dynamic business landscape.

It is important that the focus is not just on the registered forms of IP like patents and trademarks. The unregistered forms like trade secrets and know-how may be the crown jewels of the company. Being unregistered means that these foms present some interesting challenges. Hence a trade secret and know-how asset harvesting exercise may be required.

Identifying a company's IP during operational due diligence requires a detailed understanding of the business and its operations. Low hanging fruit is to see what's been filed for protection and confirm assignments to the company have completed. But, the devil is in the details. Patents: review the prosecution history; ensure a prior art search was completed; are the patent claims current with products made by the business/competitors... Trademarks: has the brand been used as a noun or verb; has the company policed the way the brand is used in the market; is it identified as a trademark... Trade secrets: has the information been protected internally; are employees aware it's confidential; is access limited; are there unique processes...

When conducting ODD to assess a company's IP, a structured approach is crucial. The initial step involves reviewing the company's IP strategies, outlining objectives, priorities, and processes for managing IP assets. Subsequently, a thorough IP audit is conducted, encompassing inventory, valuation, protection, exploitation, and enhancement of IP assets. Valuation considers market potential, competitive position, revenue impact, development costs, and risk exposure. Assessment of protection evaluates the adequacy of legal and technical safeguards against unauthorized use. Lastly, identifying opportunities for improvement through research, innovation, collaboration, or acquisition aims to enhance the value and performance of IP assets.

The IP strategy varies in each business scenario. When a large company launched a product line with the same pre-fix as my client's industry specified brand, I've advised my client to pursue litigation. I wasn't concerned about the immediate business loss, but a loss of 5-10% year over year would have been catastrophic years later. It was worth the legal fees to protect the brand. Cost to enforce IP rights are key considerations for any business. If you don't enforce your IP rights, you can lose your IP. Offensively, there are also ways to challenge a patent and force a competitor to spend ~$500K or they risk losing their patent. An attorney will help you get the IP, but you need to know the business considerations to make it an asset.

Industry dynamics, market conditions, technological advancements, legal frameworks, and business strategies all contribute to determining the significance and value of different types of IP. Technological factors like life cycles, trends, and disruptions can affect the novelty and longevity of IP. Legal systems with diverse rules, standards, and enforcement mechanisms for IP protection and infringement introduce complexities that influence the risk and cost considerations related to IP. Moreover, differing business models bring unique approaches, capabilities, and resources to IP creation and exploitation, influencing the efficiency and effectiveness of IP management strategies.

When valuing IP, find someone who can handle business models, financial projections, and also understands IP (not just a patent/trademark prosecutor/litigator). You need someone who understands business, otherwise you could leave tens of millions on the table. For example: When Bed Bath & Beyond ("BB&B") sold their IP assets to Overstock.com for $21.5M, Overstock's market cap went up by $600M. Why was there a $578.5M differential? Overstock bought BB&B's brand, that customers know and trust, and BB&B's customer list with at least 9.6M active customers for only $2.24 per active customer. The people selling BB&B's IP did not understand the asset and did not know how to position it to get maximum value. A reasonable $10 per customer = $96M.